Thursday, November 13, 2008

Derivatives, the starting of Blackbird

November 13 2008
By R Raymond May (c) 2008
1526 Reverdy Oaks drive, Matthews NC 28105 (tel) 704.847.0008

In 1986 I joined JP Morgan London as a freshly qualified accountant to be a junior staff member on a policy and procedures working team. Just six weeks into my career at JP Morgan I was sidetracked by the controller to help with the operations of the small business that was suffering growing pains - derivatives or in our jargon – Swaps. At that time only 5 business personnel and a single clerk, each trade tracked on a separte spreadsheet. I spent the next six years developing technologies covering operations, accountancy, risk management, valuation and more for what become a huge business. I can confidently claim to have first designed and developed systems that used mark-to-market accounting, value at risk and complex yield curve construction.

In 1992 I moved with my family to New York to take up a junior role on the trading desk. My first responsibility was to implement the risk management technologies I had developed in London. Secondly I took these models and arbitraged the long-term foreign exchange forward markets. In 1994 I took over responsibility for all U.S. dollar derivatives at JP Morgan.

At the end of 1996 I considered the methodology for trading in the swaps market to be inefficient and opaque. There must be a better way! Just that year a new trading platform had been introduced to trade foreign exchange. With my technology background and deep understanding of the swaps market I felt uniquely qualified to develop an electronic exchange for this huge growing derivatives market. In early 1997 I resigned from JP Morgan and set up camp in Charlotte North Carolina to commence the development of a new and complex marketplace, which we subsequently called Blackbird.

Over the next three years we raised $40,000,000 and developed the complex technology to allowed traders to trade between each other all forms of OTC derivatives. It was a major accomplishment.

The first serious challenge we faced came from the established Chicago exchanges in the form of regulation. Were we an exchange? And the challenge was launched by the CFTC. This was a complex question and one in which we could not afford to lose if we planned to have any clients. If we were to be regulated so to would all the Wall Street banks. With the help of the same banks and the top lawyers in the land we defended ourselves before six Congress committees. The final outcome was legal certainty on the regulation of derivatives. OTC derivatives would not be regulated providing that they were bilateral financial contracts and not fungible.

Our next challenge was to attract the banks to use our platform to trade OTC derivatives. This was a brick wall. This was a very profitable business, the larger banks generating more than a billion dollars a year, and the respective large bonuses. Under no circumstance would they countenance the risk that we've would spoil the party. The 10 largest created a consortium "Swapswire" each contributing $10,000,000 to develop their own version of a trading system and blocking our launch.

Since its launch in 2000 Blackbird has been unable to break down this brick wall.

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