The Depository Trust and Clearing Corporation, and representatives of trade association Isda, have stated on several occasions that 98 per cent of all credit derivatives outstanding are recorded in the Trade Information Warehouse that the former organisation runs. For an initiative that is all about transparency, it struck us as odd that it’s so difficult to find out how they determine that number.
FT Alphaville’s theory, outlined on Friday, was that it came from some of the surveys which measure the overall size of the credit derivatives market. This turned out not to be true. Our readers helpfully provided some of their own theories too.
However, after speaking to both DTCC and Isda, we’d like to outline where it really comes from.
The backlog
G-14* dealers, plus a number of buyside institutions, made a commitment to global supervisors to backload their credit derivative trade records by July 17, 2009. By March 2010, letters by the group listed the commitment as “completed”. Therefore it is assumed that all old trades are in DTCC.
Some proportion of the old trades will be so-called “copper” records rather than “gold”. Aggregated tables of the latter type of trades are available publicly, whereas those of the former are only available to regulators. DTCC stated in a press release that halfway through 2011, they had $28tr notional of gold trades and £3.3tr of copper.
Back in 2009, Derivatives Week covered the story of DTCC’s new colour-coding scheme and illustrated it thus:
They also gave this handy explanation:
Standardised trades that can be confirmed electronically have been classed as ‘gold’ records, meaning there is a legally binding copy of the trade on file. Vanilla trades that are matched but not legally binding because they are incomplete are known as ‘bronze’ records, since they are only eligible for some processing through the warehouse. (There are currently none of these on file.) And customized OTCs that cannot be confirmed electronically or cleared are known as ‘copper’ trades, since they are unilaterally submitted and not legally binding. There is no silver category.
Today’s trades
The running assumption is, therefore, that all historic trades are covered by DTCC. But what about trades done today? For information on that, you would have to look at the 2010 ISDA Operations Benchmarking Survey. A total of 69 Isda members participated in the survey, which despite its name, actually covers 2009. Here’s the relevant table:
If a trade is electronically confirmed, it will count as a gold record in DTCC, as per the above. There are a few trades that are customised enough to not be electronically eligible, and it can be seen how far behind some other over-the-counter derivatives markets are when it comes to confirming trades electronically.
The table above, along with the commitment to backloading, is the reason for the 98 per cent.
On May 27 this year, the 2010 survey was released. It used the responses of 66 members. Here was the updated table:
It would seem that Isda didn’t get the memo on the 99 per cent as they were still quoting the 98 figure nearly half a year later. A bit nonsensical given that it’s their own survey — but we guess no one can read everything all of the time and/or they are just being conservative.
All trades face big dealers, we think
One of the biggest assumptions in the above methodology is that a dealer participating in the commitments and surveys will be on at least one side of every trade.
If a trade was between two entities that didn’t make any such commitments to regulators to backload their trades, and they also weren’t among the 60-odd in the Isda survey, then those trades would fall through the net completely.
DTCC’s trade repository actually shows a handful of non-dealer to non-dealer trades:
Generally speaking though, it does seem very likely that a dealer is on at least one side of nearly ever trade, so we’re not disputing the 98 or 99 per cent. Not on that point at least. And the backloading seems plausible too.
Define it
There still is a point that makes FT Alphaville a little uneasy though…
What is a “credit derivative”? Does it, for example, have to be governed by an Isda Master Agreement to be defined as such? Where is the line being drawn, just so that we are completely clear?
Will we one day find that there are instruments out there that look and smell like credit derivatives but are labelled as “guarantees” and hence not counted?
Consider the following footnote (#7) that appears in a note by Deutsche Bank:
A large fraction of protection sold comprised guarantees to structured investment vehicles, such as CLOs, CDOs or other ABS, which do not show up in the common CDS statistics provided by the BIS, ISDA or DTCC.
In fairness, the BIS statistics do actually have a line for “SPVs, SPCs, or SPEs” and the net value against them is less than one per cent of the overall market value of credit derivatives reported.
It could well be that we are worrying about peanuts here. It genuinely could be. Thing is, we’ve been conditioned to be a bit suspicious…
Our commitment to clearing (…and some other stuff)
Sometimes the commitments that dealers make sound like one thing and mean another. For example, when it came to the commitment to clearing trades. Quoting from the same March 10, 2010 letter as above:
On September 8, 2009, each G14 Member (individually) committed to submitting 95% of new Eligible Trades (calculated on the basis of previously agreed methodology) for clearing.
An eligible trade is one that’s been clear-able for a few months, which is fair enough. The capital letters are a road sign that you should look up the definition — all well and good. But frankly “submitting” should have been highlighted too, because here’s the definition of a submitted trade (emphasis ours):
Eligible Trades that are either: 1) submitted by the reporting G15 counterparty for clearing at one or more Eligible CCPs, or 2) terminated as part of a process to compress offsetting trades without having been submitted to clearing.
Which basically means that a dealer can participate in a process that gets rid of redundant trades, that doesn’t involve uploading into a clearinghouse, and still get credit for it towards a commitment to clearing. And what are “cleared trades”?
Eligible Trades that are either: 1) matched by submissions from another G15 counterparties to an Eligible CCP, which trades are then accepted and cleared by the Eligible CCP; or 2) terminated as part of a process to compress offsetting trades.
So it’s still not in a clearinghouse, but it’s “cleared”?
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In any case, FT Alphaville was very pleased to get to the bottom of the 98 per cent issue, and learn that it is in fact 99 per cent.
The credit derivatives market has come a very long way: from completely opaque with faxes of novations sitting in basements waiting to be sorted, to having a good deal of information publicly available, and a lot more besides that’s available to regulators.
We hope the regulators are using it… as whether they actually are is yet another thing that makes us queasy.
* Bank of America-Merrill Lynch, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank AG, Goldman Sachs & Co, HSBC Group, J.P. Morgan, Morgan Stanley, The Royal Bank of Scotland Group, Societe Generale, UBS AG, Wells Fargo Bank, N.A.
Related links:
98 per cent of credit derivatives are recorded by DTCC… right? - FT Alphaville
The Fed commitment letter process is alive and well, say Isda panellists – Risk
The future of the Fed letter commitments – Risk