Abuse of official secrecy. It’s been one of the more corrosive but — by definition — shadier aspects of the eurozone crisis.
It can take the form of a report on money-laundering in Cyprus. Or the opaque process by which Troika debt sustainability analyses are drawn up. Emergency liquidity assistance to banks, even. Read more
“What happens when one bank defaults across six CCPs? The remaining members will have to pick up the bill. Given that they are almost certainly members of the other CCPs, this will result in a default contribution bill so large it could potentially lead to their failure also.”
That’s Gary Dunn, senior manager for regulatory and risk analytics at HSBC, being quoted by Risk at Isda’s AGM last week. Given the increasing concentration of risk in central counterparties, he thinks that they would ultimately have to be bailed out by taxpayers, after the CCP’s buffers were exhausted. Read more
Barclays views it as imperative that the market has access to Benchmarks that are well constructed, transparent and that inspire the confidence of other market participants and regulators…
You can say that again.
Some (more) Libor reading landed this week — the responses from banks, and other cogs and gears of the market, to a recent report by Iosco about reforming financial benchmarks. Everyone from Thomson Reuters to the European Central Bank, Blackrock to Calpers, has weighed in here. Read more
Netting of the mark-to-market of derivatives positions is attractive. It’s more efficient when it comes to posting and receiving margin, decreasing the amount of operational and counterparty risk. The ultimate in netting efficiency is, of course, the newest too-big-to-fail institutions — central counterparties (CCPs) and clearinghouses.
There’s another place where offsetting positions is attractive: financial statements. It can make a big difference. Citi demonstrates this with estimates of what derivatives exposures (including repos, brokerage receivables, and associated collateral) would look like if you applied full netting instead of that dictated by respective accounting standards… Read more
David at Deus Ex Macchiato = disturbed:
I went to a conference yesterday which started very well, but ended up about as scary as Romney’s economic policy. Why? Because a regulator from a minor European country (but who nevertheless is apparently influential at ESMA) suggested that it was official policy to substantially reduce the size of the OTC markets in general, and the inter-dealer market in particular.
A survey of financial market participants most likely to be negatively affected by new regulations on uncleared swap trades revealed that they don’t like this new-fangled way of doing things at all. No, no, they really don’t.
The completely predictable result was published in an article in Risk on Wednesday: Read more
On the surface, the story around Libor is relatively easy to understand, hence easy to write something about. All one needs to reel readers in is a big, flashy headline number. Or so goes the theory…
Unfortunately, there aren’t any easy numbers to hand. This has not, however, stopped people from finding some figures to abuse. Read more
Isn’t it annoying when particular clients insist on being treated differently to everyone else? Like, just because your client is well, England, or Italy, or some other sovereign nation, doesn’t make them ‘special’. It’s also kind of annoying when they make regulations that make business tougher for banks and then still expect to be treated differently.
Interestingly though, the Bank of England just stopped asking for one such special exception when it comes to certain derivatives that it enters into on behalf of the nation in order to best manage its balance sheet and the Treasury’s foreign exchange reserves. Read more
Central counterparty clearing and settlement was always intended to make the financial system safer.
If you use a CCP, the idea goes, you’re far more robustly protected against counterparty default. The counterparty default risk has been absorbed by the much larger central entity. (The CCP can weather the default risk because its exposure is spread across numerous members.) Read more
April 2012 was a pretty big month in Dodd-Frank Act rulemaking; the SEC and CFTC agreed how to define “swap dealer”, “major swap participant”, et al. under Title VII of the Act, dealing with over-the-counter derivatives.
Still a way to go though. Read more
‘Greece Pays Finland Collateral Money,’ goes the Bloomberg headline.
Well, that’s broadly true we suppose. Technically, Greek banks which cannot be named have transferred €311m of Greek government bonds which then moved into the custody of an international investment bank which cannot be named which (at some point) will sell them, put the revenues in safe assets, and release the collateral to the Finnish government if Greece does things which cannot be named to its EFSF bailout loans of which Finland provides a portion. (Finland pays a fee as part of its end of an exchange of cash-flows.) 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
For those new to the story, Bloomberg and WSJ reported on Friday that a handful of hedge funds and dealers claimed that a trader in JP Morgan’s Chief Investment Office has been selling so much protection on the Markit CDX.NA.IG.9 credit index that it was “distorting” the market — making the index too cheap.
While FT Alphaville thinks that a lot of this is getting way overblown, the story is performing a few useful useful functions. Namely, it’s: 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
Andrew Sentance, senior economic adviser at PwC and former member of the Bank of England Monetary Policy Committee, has just penned this strongly worded think-piece in the FT about the current lack of action stemming from central banks with respect to rising commodity prices.
Safe to say he feels it’s about time central banks stopped turning a ‘blind eye’ to the inflation problem this poses. Read more
Companies will be able to sell up to twenty times more derivatives than originally planned before they are counted as swap dealers by regulators, the FT says. In the original regulations, firms had only been allowed $100m before hitting the rules’ threshold, but this amount is now likely to be $2bn. While the amount could change further ahead of a key CFTC vote on the rules, energy and commodities firms have fought against being swept into the definition, which carries tough requirements on dealers’ capital and disclosures. Read more
Take a moment to imagine what it must be like to be an American regulator. There are plenty to imagine being: the OCC, the Fed, the CFTC, SEC, FDIC, and that thrift one, until it subsumed into the OCC. Got one?
Law firm Clifford Chance must be tired of fielding questions about what would happen to derivatives contracts should one’s eurozone counterparty exit the single-currency. So much so that they’ve put a document together covering 20 of what we imagine have been the most frequently asked questions.
FT Alphaville has waded through the legal mists, guided by Clifford Chance, to give you a bit more pedantic detail than “it depends”. Read more
The EFSF has opened the kimono a little on how it would work as a sovereign bond insurer. Answers from an updated investor Q&A — especially interesting ones have been bolded by us:
E11 – What will be the scope of the protection under option 1 [credit enhancement]? Read more
Britain has withdrawn its objections to a key piece of European Union financial regulation after winning a series of last-minute concessions over the rules for derivatives markets, the FT reports. While failing to achieve his most ambitious goals, George Osborne, the UK chancellor of the exchequer, hailed a clutch of “significant steps forward” in talks where he was at one point “outnumbered 26 to one”. However, he dropped Britain’s most controversial demand – to extend the scope of the regulation package to exchange-traded derivatives. The concession enables EU member states to agree to begin talks with the European parliament on new rules for over-the-counter derivatives. Read more
Britain is bracing for defeat in Brussels on a critical piece of financial regulation, which would force it to cede control over the shape of key markets in the City of London, home to more than three-quarters of Europe’s derivatives trading, the FT reports. George Osborne, UK chancellor, is insisting that European Union finance ministers next week continue to debate new requirements for clearing derivatives, in spite of his counterparts making clear that London is alone in opposing the package. Mr Osborne is expected to break from next week’s Conservative party conference in Manchester and travel to Luxembourg to seek a reprieve over the derivatives regulation, as well as press his European colleagues for action on the eurozone crisis and fight a proposed financial transaction tax that would hit trades that are overwhelmingly routed through the City of London.
The head of the largest US futures exchange has labelled derivatives that track the price of traditional commodity futures “parasitic”, stoking tension over proposed US curbs on speculators, the FT reports. Craig Donohue, chief executive of Chicago-based CME Group, said that pending US rules limiting commodity speculation would prompt banks and hedge funds to abandon futures that require physical delivery and pour money into contracts that settle in cash. The reason for this, he said, was that the US commodity regulator had proposed allowing traders to hold five times more cash-settled contracts than traditional futures contracts. “What you’re doing is you’re encouraging people to leave the physical delivery, price discovery contract and move to what I would call a parasitic, second-order derivative,” Mr Donohue told the Financial Times. CME’s exchanges list leading physical commodity futures, including West Texas Intermediate crude oil, natural gas, corn and soyabeans. Read more
Goldman Sachs has lost more than a dozen traders in North American bonds and derivatives as it switches from proprietary trading to client sales, Reuters says. The departures include Brian Mooney, a veteran interest rates derivative trader who has left for Merrill Lynch. Junior traders have also left for other investment banks and to hedge funds, seeing Goldman as becoming less prestigious. While the ‘Volcker rule’ under the Dodd-Frank Act allows prop trading in Treasuries and the interest rate swaps market in order to hedge positions, traders said they felt limited by risk managers. Read more
Just to be totally clear we’re talking plain vanilla derivatives like, say, interest rate swaps a bank might arrange on behalf of a company. But it seems they’ve taken on a more exotic flavour, of late.
From the clever Chris Whittall over at IFR: Read more
What price sovereign risk within a bank bond? BIS answer here:
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