“One thing that I think would stand you in very good stead is to avoid lobbying – influencing policy is probably a better way to put it. We hear so much about fragmentation, but then the banks and trade associations discuss at great length trying to lower the standards.”
That’s William Coen, deputy secretary-general of the Basel Committee on Banking Supervision, as quoted by Risk on Wednesday. Read more
Heavily processed foods are generally unhealthy. Those looking after their waistline may wish to read ingredients lists and follow food journalist Michael Pollan’s advice: “Don’t eat anything that your great-great grandmother would not recognize as food.”
Could the same be said of financial accounts? That is: “Don’t trust anything your grandparents wouldn’t recognise as a justifiable line item.” Read more
What’s a bank to do when it has to sit on exposures that it doesn’t like?
Sell them of course! Especially if those exposures are expensive to hedge and costly in terms of regulatory capital charges. Read more
If you read some of the regulations written recently, you may be forgiven for thinking that central clearing is the solution to all the risks in the over-the-counter (OTC) derivatives market. Some rules mandate clearing for certain market participants and trades, while others impose higher capital requirements for staying outside of the system. There is, of course, an implicit assumption in all of this that central clearing is an unequivocally good thing.
If only it were that easy. In fact, there are lots of issues with OTC derivatives clearing. Today, we’ll just look at one aspect: that of margin. Read more
Before the crisis, it wasn’t too hard for a corporate client to trade over-the-counter derivatives. They just had to find a bank willing to sign them up, agree some documentation, and they were good to go. For most corporates, banks were eager to help, so the client could probably find someone willing to meet their needs both in terms of what they want to trade and how they wanted to trade it.
If they didn’t want to post collateral, then that was fine. Certain trading arrangements had a cost, sure, but derivatives sales people are known for being accommodating (especially given that they get paid based on the deals that they close). No collateral? No problem, sir! Read more
The Basel III capital rules for credit valuation adjustments (CVA) create new, large capital requirements for over-the-counter derivatives trading with counterparties who don’t post daily cash collateral. Yesterday we saw how these rules were inspired by CVA losses on credit protection written by monolines like MBIA and Ambac. Today we’ll examine the unintended consequences of the new rules.
First we have to get a bit technical about how the CVA capital charges work. Sophisticated banks will be required to put their CVAs and eligible hedges into a value-at-risk (VaR) model. That model will use historical credit spread movements to estimate possible losses for the current CVA and its hedges. The capital charge is based on the one-in-a-hundred loss. Read more
Yesterday we saw how bank credit risk management imposed credit valuation adjustments (CVA) on over-the-counter derivatives trading to charge for the credit risk being taken. CVA is biggest where the counterparty does not post collateral, is not a good credit, and owes a lot of money under the derivative contract in question.
Act 1 Read more
In the first post of his series for FT Alphaville, Deux Ex Macchiato writer David Murphy introduces us to credit valuation adjustments (CVA) by providing some historical perspective. More on David and his background beneath the post.
Whenever you are promised cash in the future by someone who might not pay you back, you have credit risk. In derivatives trading, situations often arise where someone might owe you money in the future, perhaps because you have purchased an option from them, or because a coupon on a swap goes your way rather than theirs. This means that derivatives trading often includes taking some credit risk, along with the more obvious market risks. Read more
The story so far:
In Part 1, we reminded you of Morgan Stanley’s footnote in their fourth quarter earnings, whereby the bank stated that it had reduced its exposure to Italy by $3.4bn while benefiting from a positive hit to net revenue of $600m. All of this was as a result of restructuring certain derivatives transactions with the sovereign. Read more
Or, “This House believes all interesting things are in footnotes and FT Alphaville reader comments.”
Allow us to make the case in favour of the motion. Beginning with: Read more
In Part 1, FT Alphaville described what ‘synthetic securitisation’ deals done by Standard Chartered in the second half of 2011, looked like:
In Part 1, we looked in and around Morgan Stanley’s mysterious little footnote about how the bank had reduced net exposure to Italy from $4.9bn to $1.5bn with a restructuring that settled in the early days of 2012.
As the bank doesn’t want to give any additional detail on what the restructuring, the below outlines some of the possibilities and the implications thereof. We emphasise that we don’t know which is the case and, again, we did ask Morgan Stanley for comment. Read more
(7) On December 22, 2011, the Company executed certain derivative restructuring amendments which settled on January 3, 2012. …
This mysterious little footnote announced to the world that in the fourth quarter, Morgan Stanley managed to arrange a deal that reduced the bank’s net exposure to Italy from $4.9bn to $1.5bn. Read more
Deutsche Bank’s credit strategists presented a useful analysis piece on Friday whereby they asked what the impact would be if one of the peripheral countries experienced a “credit event” on credit default swaps that reference them, thereby triggering payouts on the derivatives. Their conclusion from the exercise being that it’s far more important to mind the cash exposures to the European periphery than the derivatives ones.
To allay fears on the CDS front, the strategists discuss the potential fallout from credit event being declared by Isda’s determinations committee. The size of said fallout depends on: Read more
Valuation adjustments were the hot new item during New York bank earnings week.
Everywhere we looked, bank CDS spreads were widening, leading — paradoxically — to a positive adjustment to earnings. Read more
It’s the data you’ve all been waiting for. It’s from DTCC and it covers sovereign CDS. Has the market shrunk, given that whatever is going on in Greece hasn’t yet met the definition of a credit event?
Erm, turns out it hasn’t. Here’s the data on what the total outstanding contracts are as of Friday: Read more
UBS beat profit forecasts with their Q3 results on Tuesday, coming in with a SFr 1.02bn ($1.13bn) of net profit.
In the absence of unauthorised gains to offset them, unauthorised (er) losses from the trading scandal cost the group SFr 1.85bn. All more or less as expected, and in a tough market environment (click to expand):
Morgan Stanley beat analyst expectations with third quarter earnings Wednesday morning. FT Alphaville looks under the bonnet, but first, here’s the announcement (with our emphasis and including some choice footnotes ’cause that’s how we roll):
NEW YORK, October 19, 2011 – Morgan Stanley (NYSE: MS) today reported income of $2.2 billion, or $1.14 per diluted share, 1 from continuing operations applicable to Morgan Stanley for the third quarter ended September 30, 2011 compared with income of $314 million, or $0.05 per diluted share, for the same period a year ago. Net revenues were $9.9 billion for the current quarter compared with $6.8 billion a year ago. Results for the current quarter included positive revenue of $3.4 billion, or $1.12 per diluted share, compared with negative revenue of $731 million a year ago related to changes in Morgan Stanley’s debt-related credit spreads and other credit factors (Debt Valuation Adjustment, DVA). 2,3 Read more
Alright, Bank of America, you win. FT Alphaville thought Citi was the worst when it came to being obtrusive about taking gains on the deterioration of their own creditworthiness. Citi’s DVA of $1.9bn was “Liabilities at Fair Value Option”. Fine.
BofA would like to introduce you to its “FVO on structured liabilities” in its Q3 earnings, moving from a mere $214m in the second quarter to $4.5bn in the third. And it looks like the third quarter of last year was a good one in terms of creditworthiness, hence a bad one in terms of completely fictitious revenue from the firm’s own debt. Read more
Clearly, gaining $1.9bn in revenue from your own credit spreads blowing out must be the trophy asset for the A/W ’11 US bank earnings season…
Citigroup’s Q3 results, out on Monday (total revenue $20.8bn): Read more
JP Morgan came out on Thursday with a juicy $1.9bn gain from debit valuation adjustments (DVA) as a result of their widening credit spreads. This acted to offset some of the loss on credit valuation adjustments (CVA). To summarise in tabular format, here is the effect that widening credit spreads have:
The Markit iTraxx SovX CEEMEA contains a basket of 15 sovereigns from Central and Eastern Europe as well as the Middle East. Italy’s CDS spread is now wider than all but one of them – Ukraine.
Looking at the Markit CDX.EM, only Argentina, and once again the Ukraine, can offer chunkier spreads. Outer limits, indeed. Read more
Morgan Stanley may have suffered a $91m loss on Wednesday, on slowing momentum in its trading business, but a significant chunk of its underperformance was also down to the firm’s so-called debt valuation adjustments (DVAs) — rather than trading itself.
In this case DVAs reflected tightening spreads in the company’s own debt (and others), and via that, a mark-to-market loss in the credit default swaps purchased to protect against defaults in that debt. Read more
Basel is busy bolting stable doors.
Indeed, one of the big drivers behind new Basel III counterparty risk capital requirements is the infamous negative basis trade. Read more
With Ireland spreads widening on Friday, it’s an apt time to turn to Fitch’s latest edition of its annual survey of credit derivative traders.
Not least because it offers some revealing insights on how sovereign CDS contracts are actually used in the market. Or at least, on bank desks: Read more
Hot on the heels of Portugal’s two-way CSA, comes a partial step from Spain.
From the excellent Chris Whitall, over at Risk Magazine: Read more
Continued from Part II.
A valuation-based approach may be the FSA’s preferred option for fixing banks’ trading books and fortifying them against future risk, but it’s difficult, to say the least. The very thing the FSA is trying to remedy — inconsistent valuations — seem endemic in the financial system: Read more
Warning: This is not your standard PIIGS Club Med European peripheral CDS post.
Risk’s excellent Duncan Wood reports on Tuesday that Portugal’s debt office is now agreeing to post collateral to derivatives dealers. That’s the industry standard one-way CSA turned on its head. Read more
Here at FT Alphaville, we do like to cover the effects of gains and losses stemming from changes in banks’ own debt quality.
These, as we’ve written before, are known as CVAs: credit value adjustments. Read more