Value-at-risk for merger arbs

New York-based consultancy Capital Markets Risk Advisors (CMRA) is developing a database it says will allow investors to apply value-at-risk to portfolios with investments in merger arbitrage hedge funds.

Merger arbitrage plays take the form of bets on the likelihood of the convergence of one or both stocks of companies involved in a merger. Speculators win in a merger stock deal, for example, by shorting the acquiring company’s shares and by going long the acquired company’s shares.

As with “market-neutral” strategies, investors like merger arbitrage investing because the risks are largely deal-specific – arising from the legal and regulatory challenges to a merger going through – and, hence, have low correlation to capital markets. Richard Horwitz, a principal at CMRA involved in the project, says that, especially with the recent decline in US equity markets, institutional investors want to expand their capacity to assess and manage the risks of hedge fund investing. CMRA has been working since July on the database in conjunction with a large client that manages a fund of hedge funds. Horwitz wouldn’t say when it would be finished.

Some major risks to merger arbitrage are that a deal will take longer to close than anticipated, which reduces overall returns, or that the announced acquisition price will be changed. But the chief risk is that the deal will collapse and the two companies’ stocks will diverge, returning to their historic ranges.
Horwitz says the CMRA database will allow more accurate analysis of the stock price behaviour of two merging companies after a merger announcement and, separately, if a deal falls through. The database will also help portfolio managers diversify away any market risk in the deals through better knowledge of the correlations that merger events have across debt and equity markets and their sub-sectors.

But applying VAR to merger arbitrage poses a special technical challenge, as the weaker of the two speculative assets concerned effectively detaches from its price history once a merger has been announced. This price “step” precludes the use of standard techniques to estimate the risks involved with the new stock price going forward to merger completion, because VAR typically requires data histories of a continuous nature.

And sceptics think VAR has little application to merger arbitrage given the deal-specific nature of the risk and the scarcity of merger bets possible. Ben Golub, co-head of risk management at BlackRock, the New York-based money manager and risk advisory firm, says that, conceivably, a risk manager could come up with statistics about the number of merger deals that fail, assume that the failures are uncorrelated, and then claim to have a VAR by applying the data to a particular portfolio of risk arbitrage bets. “But I don’t think I would believe it with my own money,” says Golub.

Even if it is technically feasible, others say presently available risk management techniques for funds of funds are adequate. Norman Chait, head of the hedge funds group at AIG Global Investment Corporation and portfolio manager of AIG Diversified Strategies Group in New York, says most good hedge fund managers would not give out the position-level data in the manner required for third-party VAR evaluators. Besides, a good fund-of-funds manager doesn’t need VAR, Chait argues. He just needs to be able to phone his managers. The basic information needed – gross, net, long and sector exposures, assets under management, and so on – are all obtainable from individual managers in time for effective risk management.

Many agree that recent attempts to “institutionalise” hedge funds are wrong-headed. Hedge funds, they say, are a talent pool not an asset class. With merger arbitrage funds, in particular, Chait makes an assumption that limits the appeal of the usefulness of fund of funds VAR. He says that, in his experience, all hedge fund managers doing merger arbitrage are in on the same deals. That means the marginal diversification gained by investing beyond a few “core” merger arbitrage managers is small, and a focus on manager talent and managers’ risk tolerances should be the major investment criteria.

Whatever the debate on the merits of VAR for merger arbitrage, Horwitz says several third parties are interested in the firm’s work, including a risk management technology vendor and a prime broker, which he declines to name.

Meanwhile, Measurisk, the New York-based risk management application service provider, plans to release FundScape, a new service that will perform VAR analysis for funds of funds, next month. To build FundScape, Measurisk worked with its long-standing client, the World Bank, and the 25 hedge funds it invests with, and with a newly announced client, Blackstone Alternative Asset Management, a fund of funds with $2 billion under management. Neil Paragiri, director of Measurisk, says access to a sufficient level of hedge fund position data is essential to VAR for fund of funds. Because Measurisk is an independent risk management provider, says Paragiri, Fundscape can guarantee the protection of the proprietary value of position data for merger arbitrage managers.

State of independence

What a difference a few years can make. In late 1998, Richard Fuld, chairman and chief executive officer of Lehman Brothers Holdings, was forced to personally call on his firm’s lenders and counterparties to assure them that Lehman was not about to file for bankruptcy. The Wall Street rumour mill had circulated exaggerated estimates of Lehman’s exposure to Long-Term Capital Management and the emerging markets, causing its stock to plummet.


Two and a half years later, the firm not only remains independent but it is, by most measures, thriving. Its return on equity – which once languished in the high single-digits – is now the industry’s second-highest. Its revenue growth rate averaged 26% between 1997 and 2000, second only to Goldman Sachs. And, while many firms are faced with the prospect of cutting staff due to the markets’ downturn and the ballooning compensation costs in recent years, Lehman has just announced plans to expand its head count by 10% this year.

Lehman officials say the firm does not covet the market volumes that many of its competitors have achieved through mergers. But the question of whether bigger is better is central to the firm’s fortunes. Lehman officials argue that the firm uses capital more efficiently than many of its larger competitors, and that the confusion that inevitably follows a merger gives it an advantage in recruiting and business development. For example, Lehman hired three interest rate marketers and an options trader in February, and a synthetic collateralised debt obligation (CDO) trader last month, all from JP Morgan Chase.

Ken Umezaki, co-head of global high-grade credit trading at Lehman in New York, says he welcomes mergers among his competitors, since these usually set the merged entity back months or more in forming and executing an effective business plan. “It doesn’t scare me that these guys are merging, in fact it’s a good thing – their eyes are off the ball,” he says.

Lehman is certainly no minnow. Although, in the cash bond markets, it remains outside the “super-bulge” bracket, it placed ninth in Thomson Financial Securities Data’s 2000 international bond book-runner league table, with 5.15% market share. (Merrill Lynch, holding the top slot in that table, had a 10.59% share.)
Lehman’s over-the-counter derivatives businesses have all grown in the past several years, but the firm is not yet showing up regularly in Risk’s global derivatives rankings. These, admittedly, only rank the top three banks in each category, and have recently been dominated by firms with both large structured and high-turnover vanilla businesses. Lehman did appear in two categories of the last rankings, published in September. It was the number-one dealer in US dollar repurchase agreements and tied for second place in sterling repos with UBS Warburg.

Kaushik Amin, global co-head of interest rate products in New York, says Lehman has more than doubled the head count in its interest rate derivatives department in the past two years. While he admits that reliable estimates of market share in the OTC market are hard to find, Amin estimates Lehman’s share of the interest rate product market at 6% globally and 8% in the US. “We’ve always had good market share in fixed-income, and now our derivatives market share is catching up,” he says.

Lehman has also moved in the past year to integrate its cash and derivatives businesses. In recent months, it formalised this move in the interest rate business by putting governments, agencies and derivatives under one group, run by Amin in New York and his co-head, Andy Morton in London.

The structured credit trading group, which handles credit derivatives and CDOs, is also aligned with Lehman’s cash credit business. Like its interest rate counterpart, Lehman’s credit derivative business has grown substantially in the past two years, according to the firm’s counterparties. One US protection seller that specialises in investment-grade single-name default swaps said he has seen Lehman’s market-making activities double in that sector of the market in the past 12 months. Umezaki says that, in the firm’s fixed-income business, credit derivatives contribute about a third of the revenues of the non-mortgage credit business.
Umezaki says that while the firm has seen significant growth, it is not chasing volume. “We’re not going forward with the sole objective of being a top-three market maker. We view the credit derivative product line as a part of the overall portfolio of credit products,” he says. “We want to marry what our clients want with the market and products.” The firm has 40 bankers in structured credit trading globally, and another 50 in CDO origination.

Umezaki says that roughly 70% of the firm’s business is client-driven and 30% is done on the back of that flow. “It just happens to be that the market has grown dramatically over the last two years, so it should be expected that our volumes have also grown,” he says.

Lehman’s equity derivatives business, like those of its competitors, has also done well recently, benefiting from the high levels of market volatility in the past 12 months. “Like several other firms, last year equity derivatives was a big winner for Lehman,” says Peter Nerby, vice-president and senior credit officer for financial institutions at Moody’s Investors Service in New York.

The growth of Lehman’s derivatives businesses comes at a time when there is growing shareholder, regulator and counterparty scrutiny of investment banks’ off-balance-sheet activities. But Lehman’s risk management department, run by Maureen Miskovic, gets high marks for both keeping the firm out of trouble and providing tools for efficient capital allocation.

The quiet revolutionary

Bank of America is in transition. Most visibly, its chairman and chief executive, Hugh McColl – largely responsible for merging NationsBank and Bank of America into the US’s largest bank in 1998 – is retiring this month. But more profound changes are occurring behind the scenes.

The Charlotte, North Carolina-based bank has adopted an integrated, cross-product marketing approach it hopes will better serve its clients’ needs. It is also establishing a risk-based capital allocation system. These initiatives are central to the success of the bank’s recently established global risk management products group, run by William Fall.

Fall came to NationsBank during its attempts to build an over-the-counter derivatives capability in Chicago, after its 1993 acquisition of the exchange-traded options firm Chicago Research and Trading.

He began his career in finance with Kleinwort Benson back in the early 1980s, and has worked in derivatives and risk management since about 1984 – with one hiatus to earn his masters degree in architecture. But that was not his only foray beyond the world of finance. Fall started out as a veterinary surgeon in the UK. “My father was a farmer, my mother was a doctor. It was the eternal English compromise,” Fall says.
Seeking different challenges, he turned to finance. The transition went surprisingly smoothly. “The English merchant banks at that time were not interested in MBAs, they wanted bright people who they could train,” he says.

Today, he runs a group with nearly 900 people worldwide, incorporating Bank of America’s foreign exchange, fixed-income derivatives, commodity derivatives, exchange-traded and credit derivatives businesses, including both generic and structured products. In February, the bank combined the derivative products businesses that had been under Fall with its 380-person foreign exchange business. The move was spurred by the retirement of Robert McKnew, the former head of global foreign exchange, and the desire to capture infrastructure efficiencies and better integrate the product lines.

Fall emphasises that this is not an attempt to staff the sales team with generalists. Rather, the bank is taking a team-oriented approach based on strong quantitative research support. Fall notes that part of the inspiration for this came from the firm’s foreign exchange research team, which had a strong macro research capability but also the ability to generate actionable deal ideas.

One manifestation of this focus was the bank’s formation of a quantitative interest rate modelling group in London in February. Among those hired for the group was Jesper Andreasen, this year’s winner of Risk’s quant of the year award.

Fall says the greater sophistication of corporate clients is driving the trend toward solution-oriented, cross-product approaches. “There are now about 12 banks fighting it out tooth and nail in the global market business,” Fall says. “We think, to succeed, you need to tie all the products together in a structure that is integrated around the client’s needs. Thinking from a client point of view, rather than from a product perspective, is becoming the criterion for success going forward,” he says.

Meanwhile, the bank is reviewing its approach to allocating capital. It was one of the first banks to embrace risk-adjusted return on capital. But it did not apply it to capital allocation decision-making. “We should be allocating capital on that basis now,” Fall says. “But we got somewhat distracted in the merger. Part of [our] goal is to have much more of our allocation of capital done on the basis of returns. But we must be very comfortable with the metrics we choose.”

The bank is seeking to develop a core unit of risk to use as a capital allocation metric. But this is a challenge. “We are boiling down all types of risk into a common metric that we can use to allocate capital across businesses,” he says. “You need to be able to compare the risks of different products. For example, how much risk is in a one-year funded credit versus a forex option?”

The bank’s next challenge will be to devise standards for allocating capital against these risks. “For example,” Fall says, “how much capital do you allocate to a five-year swap with Ford? How does it change if you collateralise it with single-A or triple-B collateral? What if you buy protection on the first loss position?”

A third concurrent and related initiative is the bank’s review of its credit portfolio. “Traditionally we’ve had large amounts of floating-rate loans in our portfolio. Now we are getting nearer to a more dynamic portfolio-based approach,” Fall says. “We are looking at mechanisms for distribution of risk, not only through loan sales but also through synthetics and other mechanisms.”

Investors’ worries about the bank’s credit portfolio – in particular, its loan exposure to the troubled California utilities – combined with unfounded rumours of derivatives trading losses, triggered a short-term drop in stock in January. While investors focused on the news, Fall says he was surprised by how few clients called up to enquire about it, which he attributes to their being comfortable with the bank’s prospects.

While Fall strikes a bearish note about the prospects for the economy, he says Bank of America is well positioned to expand its global markets businesses, despite the downturn. “I think the pending recession is going to be pretty grim, but I still think we should be able to get 20% year-on-year increases in gross revenues,” he says. In particular, he sees growth potential in non-US markets. “We make 25% of our global revenues in non-US markets. That percentage should be higher,” he says.

One area he is adamant about protecting from downturn-related budget cuts is e-commerce. “The worst thing you can do right now is cut back on investment in e-commerce,” he says. “I still do not feel the industry understands all of the ramifications of e-commerce. It will cause a fundamental change in the ways of thinking about our businesses.”

While Bank of America has suffered in the past from misperceptions about the strength of its businesses, it has also been partly to blame for its shortfalls. The groundwork it is laying now could finally allow it to achieve its global ambitions.

Electoral hedging gains votes

Academic experiments have shown that “electoral markets” – where players make cash bets on the outcome of a ballot – are better predictors of the result than traditional opinion polls. Money talks.

In a provocative technical paper in this month’s Risk (see “Hedging Electoral Risk”, pages 95–98), assistant professor Steve Kou and professor Michael Sobel of New York’s Columbia University suggest a way in which these electoral forecasting markets (EFM) can be developed into an effective market for hedging political risk – an electoral hedging market (EHM).

Such a market could provide companies with a better alternative to the established ways that they use to hedge their political risks, by spending money on lobbying and party political donations for example.

Scroll back to November 7 last year – the day the US went to the polls to elect a new president. Nobody anticipated the tortuous weeks of confusion that would follow and the almost impossibly narrow result by which George W Bush finally won. During those weeks, financial markets were no better informed than any individual US citizen about the likelihood of the eventual outcome.

That experience might provide the motivation for establishing an EHM. Bush versus Gore was not the most market-sensitive of contests, but consider the following scenario.
Candidate Smith states that if he becomes president, he will severely restrict the right to bear arms. The ammunition makers believe the implementation of the policy will force them out of business. Short of diversifying their product range, how could they hedge the financial risk inherent in the election? They could make a donation to Smith’s strongest rival, candidate Brown.

If the donation helps Brown win, then this is money well spent. But, if Smith wins, it has been wasted and – worse still – could encourage Smith to pursue his hard-line policy further. There is a large downside risk.

In 1988, the University of Iowa created an alternative to the polls: an EFM called the Iowa Electronic Market (IEM). In total, 192 traders played the market on that year’s Bush-Dukakis presidential contest.

The IEM is a real-money market, where participants trade shares in the presidential candidate they believe will win. In the 1988 IEM, traders received a payout proportional to the candidates’ final share of the popular vote in the real election.

Over the years, the final prices in the IEM have proven to be accurate indicators of the presidential results, although the precise reasons for this remain a matter of debate.
Kou and Sobel have analysed the results of the IEM and other electoral markets using options theory. In terms of probability theory, candidates’ market prices are expectations taken with respect to a real-world probability measure.

To create an EHM, Kou and Sobel propose developing this precisely defined forecasting tool into something akin to a futures market. For this to happen, investment caps need to be removed and short-selling and buying on margin should be allowed. “We hope that individuals and corporate actors will appreciate the potential of our work and that such markets will be established in the near future,” says Sobel.

High energy

Deregulation in financial markets is often a case of regulators playing catch-up with the real world – an acknowledgement of the new status quo. But the December 15 enactment by Congress of the US Commodity Futures Modernization Act of 2000 could turn out to be a seismic shift.

It means that derivatives exchanges in the US can now offer clearing services and an open market-place for over-the-counter derivative products. The exchanges believe they can offer their customers the key advantage of being able to offer net margining. That means dealers will be able, for example, to trade swaps and futures in the same place and their margin exposure will be the net. 

Marty Chavez believes that, for commodities dealers, this could mean the end of any real distinction between exchange-traded and OTC derivatives. Chavez is co-founder and chief executive of Kiodex, a New York-based trading and risk management solutions provider for the commodities markets. Kiodex has struck a deal to provide the order-matching system for the New York Mercantile Exchange’s (Nymex) new electronic trading and clearing platform – enymex – beating off stiff competition from rivals as large as exchange technology specialist OM Group and Microsoft. In addition to offering the order-matching system, Kiodex is an application service provider (ASP) supplying trading technology and risk management via the internet. Its portfolio management tool, Risk Workbench, will be co-marketed with Nymex.

Enymex launches in the second quarter of this year, and Nymex has plans for a plethora of new derivative contracts that were previously limited to the OTC markets, initially for energy and metals markets, and later for a range of new markets, such as steel, chemicals and even telecommunications bandwidth. Nymex is already the largest physical commodities exchange in the world, trading futures and options on oil, gas and metals. With electronic trading, Nymex says it wants to reach deep into the B2B market for commodities.

The Kiodex office, opposite the Staten Island ferry terminal in Manhattan, buzzes with the sense of potential. It’s like the dotcom bubble never burst. Many of the staff are former colleagues of Chavez from Credit Suisse First Boston (CSFB), where he was head of energy derivatives. They are IT specialists who have traded good jobs for a start-up they believe will fly.

Kiodex began life last February in true dotcom style when Chavez e-mailed a four-page business plan to all his investment contacts, and quickly raised $8.16 million of seed capital. His plan is that Kiodex’s revenues will exceed costs in 2002.

A computer sciences graduate, Chavez started his career in commodities at Goldman Sachs in 1993. At that time, Goldman was still in the early phase of building its J Aron subsidiary, a coffee trading specialist, into a major player in forex and metals markets. Chavez’s main task over the next couple of years was to implement Goldman Sachs’s firm-wide trading risk system, SecDB, at J Aron.

The system allowed J Aron to run a global commodities trading book of tens of thousands of positions, and that meant it could sell a range of new exotic hedging products to clients. “This was a business fraught with peril in the early days. Increasingly our competitors were mispricing options, but Goldman Sachs dedicated the resources and had the strategies to make it work,” recalls Chavez.

In 1997, Chavez joined what was then Credit Suisse Financial Products. CSFP had a different approach to modelling risk. “At Goldman Sachs everyone had their own product line. The CSFP structure was that the derivatives marketers each had a regional focus. They could cross-market credit derivatives or asset swaps, for example,” says Chavez. “The task of the modelling group was to create one options calculator to cover all the different asset classes, whereas Goldman might have used a thousand variations on Black-Scholes across the firm... I saw the value of a uniform approach to modelling.”

Pooling
It also became clear to Chavez while he was at CSFB, he says, that all kinds of trading were heading for the Web. By pooling customers, the Web will offer the chance to tap into order flows of a scale previously available only to major banks, with their thousands of credit lines.

Chavez cites the example of Enron Online, the electronic trading platform launched in November 1999 by Enron, the Houston-based energy giant, which now trades around 850 different products, as evidence of opportunity.

What this huge new market will lack though, is the ability to calculate risk. “When I started Kiodex, I knew that no-one in the business had the risk technology apart from Enron, J Aron and CSFB,” says Chavez. “Furthermore, it’s not just a case of buying risk management software. You can spend a million dollars and that’s just the start of your problems – you need the people who can cajole and nurture it. The customers don’t want software, they want answers. They want mark-to-market and P&L reports in Adobe and Excel.”

There are three big winners in the new regulatory and technological environment, according to Chavez’s vision of the future: the exchanges that can provide the unglamorous but lucrative clearing services; electronic market-makers such as Enron Online; and the ASPs that can offer the growing army of end-buyers independent risk calculation on a “pay-as-you-go” basis.

Nymex is only Kiodex’s first partner in the distribution of its risk technology. Chavez also plans to sell and market his products through other exchanges and through dealers. That’s the real beauty of the ASP model: “We can go everywhere,” he says.

VAR modelling for non-financials

An economic consulting firm owned by Marsh & McLennan Companies, the insurance, asset management and consulting giant, has developed a model to measure the risk of corporate cashflow shocks. The firm, White Plains, New York-based National Economic Research Associates (Nera), was prompted to develop its model, called Cash Flow at Risk (C-FaR), by inquiries from Marsh’s consulting clients, who wanted to know if there was a parallel to value-at-risk for non-financial corporations.

“These people want to know the probability of their running out of cash and being unable to fund investment expenditures,” says Jeremy Stein, a professor of economics and corporate finance at Harvard University and a consultant to Nera. The firm plans to market the model primarily to Marsh’s existing client base.

C-FaR, launched in January, provides a probability distribution of company cashflows one quarter or one year in the future. Stephen Usher, a consulting economist who helped devise the product, says the model will be valuable for companies seeking to stress-test their capital structures. “They can ask whether, in a one-in-20 worst-case scenario, they can continue to fund their value-creating investments,” he says. It can also be used to enhance disclosure and as a tool for doing cost-benefit analyses of risk management policies.

Rather than analysing and aggregating individual risks upward to come to an estimate of a company’s total cashflow risk, Nera has built its model using a top-down approach based on the behaviour of comparable companies. “Operational risk and strategic errors tend to dominate the problems for companies’ cashflows.

Can you build up from the bottom a list of all the risks facing a company and then model them? We decided that this was an intractable problem, and you could miss an important risk,” Usher says. Stein adds: “Some of a company’s exposures are to measurable things like exchange rates or currencies, but how do you capture the risk for Dell that demand for computers will go down?”

Nera has built the C-FaR model’s distribution using 11 years of data on corporate cashflow behaviour, obtained from Compustat, Standard & Poor’s database of public company financials. Nera uses four criteria to find a proper set of comparables for the company being analysed: market capitalisation, profitability, industry riskiness and stock price volatility. Stein says the result provides a level of predictive information similar to an insurance company’s actuarial table.

Currently, the main product in the market for measuring risk to corporate earnings and cashflow is the RiskMetrics Group’s CorporateMetrics system.

CorporateMetrics uses the bottom-up approach that Nera is eschewing. It uses a VAR-style methodology to analyse the effects of changes in market variables such as foreign exchange rates, interest rates, commodity prices and equity prices on a company’s earnings and cashflow.

Stein notes that there is a trade-off between the two approaches. Nera’s top-down approach may incorporate more potential risks at the expense of predictive accuracy for a specific company. Meanwhile, the bottom-up approach used by CorporateMetrics has a high degree of predictive accuracy for specific risks as they relate to a specific company, but it may miss non-market risks like declining demand for a company’s products. “Perhaps there is no one right way to do it,” he says, adding that the two approaches may be useful reality checks on one another.

Op risk fears for European asset managers

The US Securities & Exchange Commission (SEC) is changing its rules to encourage domestic securities firms to base their derivatives business on its home turf. And the SEC makes no bones about its willingness to reduce capital requirements in order to see trades currently being booked in London, or other more lenient offshore regulatory regimes, booked in the US instead. 

The SEC’s new rules – which it introduced in December 2000 – are based on the value-at-risk modelling of a securities firm’s derivatives positions. They are designed to take account of the reduced risk of hedged positions. The SEC’s current broker-dealer lite rules do not take account of risk exposure, instead using a “binary” system that treats derivatives as long or short underlying positions. 

Michael Macchiarola, SEC assistant director of market regulation, says: “Here’s an attempt to accommodate US firms that want to do business in the US. Business that is ‘properly’ US business – with a US customer, involving a US security – should be done here. There’s no reason to put it in London other than to get lower capital charges. That’s a distortion of business.”

The SEC has tested the new rules – a revision of its broker-dealer lite regime – with Goldman Sachs’ equity derivatives division. According to Macchiarola: “The VAR approach allows you to net a great deal more than was allowed under the old net capital rules. A lot more correlations are tolerated.”

A second component of the new rules focuses on credit risk. Macchiarola says the SEC adapted to derivatives counterparty risk its earlier rules for bond trading portfolios, which applied a credit risk charge based on credit rating. “The charge is actually less, but we built in concentration provisions that were different from regular securities regulations,” Macchiarola says.

Finally, margins for derivatives – which were treated like outright stock positions under the SEC’s old rules – will be abolished. The net effect of these three changes is substantial. Across its equity derivatives portfolio, Goldman Sachs estimates that its capital charge has been reduced by half. 

While the SEC’s new capital rules have been influenced by the US Federal Reserve’s risk-based approach to financial holding company capital reserves, the SEC has recognised that the nature of securities company regulation has to be different, says Macchiarola. “Until 10 or 12 years ago, everything on a broker-dealer’s balance sheet was collateralised. Then they got into derivatives.”

Some observers say the SEC’s biggest challenge will be to persuade US securities firms to book their interest rate derivatives transactions at home. Equity derivatives are closely related to the underlying securities, and it suits firms to book deals under the same jurisdiction as the cash securities market. However, interest rate swaps and options have no status under US securities law, observers point out. Although the Commodity Futures Modernization Act passed by Congress in December may change this, US broker-dealers currently book trades via unregulated affiliate entities, and see no reason to change this status quo.