And the war over credit default swaps rages on.
On Thursday, Europe wheeled out out the big guns, with four of the region’s leaders demanding an inquiry into the CDS market.
The leaders of Germany, Luxembourg, France and Greece sent a joint letter to European Commission President Jose Manuel Barroso and Spanish PM Jose Zapatero (whose country currently holds the EU presidency).
Here is that letter, courtesy of the Economist’s Buttonwood. It looks pretty grim on first reading:
Should the inquiry ascertain market abuses or that there is a well-founded suspicion that speculative practices are having a considerable impact on the development of yields, we should quickly examine measures to determine whether they are suitable and, if necessary, pass the appropriate legislation.
They’d like the nefarious instruments to be banned, in other words. And that’s a call based on “well-founded suspicion” – not evidence. Yikes.
But — and there is a but! — the decision to move to a ban isn’t quite in their hands (to say nothing of the practical difficulties of such a move).
It’s also worth pointing out other European countries, notably the UK, don’t necessarily take the same view.
Plus, there’s more stuff in the letter, which may suggest the furious four might be persuaded that there are other ways to lessen the risks of the instruments, bans aside. Emphasis ours:
…we should now advance and intensify the current European initiatives aimed at increasing transparency on the derivative markets on the basis of the G20 decisions: (i) Regulatory authorities should have access to current portfolio and trading information relating to derivative transactions, including CDS trading, through mandatory reporting of all derivative transactions to a trade repository located in Europe. This will allow the regulators to identify the main dealers and tightly monitor their activity. Regulators should have unlimited access to those market data. We also have to work towards ensuring that European regulators receive the relevant detailed information from non-European trade repositories.
(ii) As recommended by the Commission and the Ecofin, we should improve the safety of OTC derivatives markets through mandating that all eligible derivatives products be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCP). These entities should be adequately supervised to ensure improved safety and soundness. We strongly support the location of European CCPs within the euro area to enhance integrity and stability of the European financial system.
On the wider issue of OTC derivatives reform, the letter is very keen on the creation of central clearing houses as a way to mitigate counterparty risk.
(We’ve seen proposals for CDS clearing come and go on FT Alphaville with reservations aired along the way. Deutsche Bank also studied centralised CDS clearing in a report in December that’s well worth reading again now. )
And the issue of central clearing continues to crop up in the debate.
Consider, for example, this from the Economist’s otherwise caustic leader on the anti-CDS bandwagon:
Some reform of the market for sovereign CDSs is needed. Like other credit-default swaps, there is a strong case for moving these over-the-counter instruments on to central clearing-houses, which stand between buyers and sellers and reduce counterparty risk. Sensible changes of this kind are already in train in Europe and America…
And from Gary Gensler, an ex-vampire squid who is starting to forge a lead on US derivatives reform, with some new proposals recently billed by the NY Times:
The proposals include forcing the big banks that sell derivatives to conduct their trades in the open on public exchanges and clear them through central clearing houses, so that any investor can see the prices that dealers charge their customers. Today, those transactions are bilateral and private.
Are we seeing things? Is this even that important in the grand scheme of things, especially when a European ban remains very much in the offing?
Perhaps so. You could also argue that the entire clearing house debate is merely being reheated. France, for one, has played this tango before, with eurozone CDS clearing having played to its self-interest long before Greece hit the headlines.
Still, no amount of CDS market reform will help Greece now. To end with a quote from a regulator:
Calls to ban sovereign CDS [in the Greek context] are like asking for a ban on smoke detectors right before you die of smoke inhalation.
Someone should have put that in a letter to the European Commission.
Repeat after me: CDS are not insurance – FT Alphaville
NYSE Liffe quits the CDS clearing game – FT Alphaville
The benefits of naked CDS – FT Alphaville
Gary Gensler vs. Craig Pirrong: who’s right on OTC derivatives? – FT Alphaville