Deus Ex Macchiato

The slogan ‘defaulter pays’ is often used of collateral and other credit support arrangements. It’s seductive: after all, shouldn’t the defaulter pay for the damage their default might do to another party? Yes they should – but they don’t. Instead, as Mark Roe points out in a new article (although the point is hardly new), it is the unsecured creditors of the defaulter’s estate who pay. Taking collateral from someone removes it from their estate upon bankruptcy (if you have done it right, anyway): you get paid, which means that someone else doesn’t. In this sense, CVA has its attractions, in that by paying for credit cost up front, as part of the trade price, the defaulter really is paying as part of their ongoing business: that cost is charged to shareholders as it is incurred. By posting collateral, the company doesn’t pay now, and hence its revenues are higher. Instead, if it defaults, a smaller pool of funds is available to pay creditors. ‘Defaulter’s unsecured creditors pay’ is a less catchy slogan, but it is closer to the truth of financial collateral.

Posted in: Clearing and Collateral by David /
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Herbert Smith has a nice summary here (HT the OTC space). What I for one had not realized is that from September 2013, EU parties with more than 500 trades, of whatever status, must establish procedures for Portfolio Reconciliation and they must at least semi-annually consider Portfolio Compression and provide valid explanations if they choose not to engage in it.

Posted in: Clearing and Collateral by David /
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While we can clearly agree that Bloomberg has a dog in the futures vs. swaps fight, that does not necessarily mean that all of their comments are wrong. Here for instance is an interesting observation by Bloomberg CEO Daniel Doctoroff in the Huffington Post:

Congress mandated that swap transactions be reported to a “Swap Data Repository” that regulators can monitor to conduct real-time market surveillance and that the public can access immediately and for free. Nothing comparable exists in the futures market. There is no “Futures Data Repository,” and no real-time public reporting of futures data, which means that the public will no longer have the access to market data that it was supposed to have under Title VII. This also creates a firewall between the markets and regulators, denying them access to the real-time trading data they need to determine whether speculators are manipulating the energy markets.

Posted in: Clearing and Collateral by David /
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In a move that will at very least make life more interesting, Bloomberg has done as it threatened and sued the CFTC. Their bone of contention is the so-called margin period of risk on OTC derivatives vs. futures. As the FT reports:

Bloomberg objects to how the CFTC has set different margin rules, that favour swap futures at the expense of OTC swaps, arguing that they are similar financial products with the same risk profile for investors.

The CFTC has set minimum margin collateral that can cover five days of possible losses for cleared financial swaps, while margin for futures contracts traded on exchanges presently covers the risks of one to two days of losses.

In other words, swap futures are economically (very nearly) identical to swaps, but have roughly half the margin – and that, Bloomberg suggests, is wrong. The FT quotes their lawyer, Eugene Scalia, as saying “It’s a basic legal principle that similar matters should be treated in similar ways.” Watching the CFTC try to defend this one is going to be fascinating.

Posted in: Clearing and Collateral, Legal Risk and Trade Documentation by David /
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So say the CFTC, according to Bloomberg:

Commissioners approved a rule excluding inter-affiliate trades from requirements that swaps be guaranteed at clearinghouses that protect buyers and sellers against defaults, the CFTC said yesterday.. “The rule requires documentation of such exempted swaps, centralized risk management and reporting requirements for such swaps,” CFTC Chairman Gary Gensler said in a statement.

Posted in: Clearing and Collateral by David /
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Reuters, in between telling a interesting story of the impact of Kweku Adoboli’s losses on UBS, gives us some insightful information on the close out of his position:

The call that would eventually spell the end for [UBS boss Oswald] Gruebel came at 4 p.m. on Wednesday, September 14… [Gruebel] ordered a small taskforce — dubbed “Project Bronze” by those involved — to immediately close Adoboli’s open positions…

The Swiss stock exchange had to be informed by 7.30 a.m. With two-thirds of Adoboli’s open positions closed out overnight, the scale of the losses was clear and executives agreed they would have to say something…

Bankers said Adoboli’s positions were completely closed out by Friday lunchtime.

That would be a little less than two days, then, to get out of exchange traded positions (including ETFs).

Posted in: Clearing and Collateral, Markets by David /
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Continuing the OTC derivatives futurisation trend, ICE announced this week that it will introduce credit index futures in May on the CDX IG, CDX HY, iTraxx main and iTraxx cross-over. Anyone care to take a bet on how much volume will be in futurised swaps vs. cleared OTCs this time next year?

Posted in: Clearing and Collateral by David /
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First, IntercontinentalExchange said it will launch credit-default swap futures in May.

Second (and as an update from an earlier version of this post), Bloomberg threatened to sue the CFTC unless it halts regulations setting higher collateral standards for swaps than comparable futures:

Bloomberg LP, the parent company of Bloomberg News, said the collateral rules are arbitrary and harm its plans to operate a swap-execution facility, according to a news release and letter yesterday from Eugene Scalia, partner at Gibson Dunn & Crutcher LLP.

Swaps that are converted to futures will “automatically be subject to a lower minimum liquidation time, which in turn will result in more favorable margin treatment,” Scalia said in the letter to the Commodity Futures Trading Commission. The different standards will drive business away from Bloomberg’s swap-execution facility, Scalia said.

The CFTC should stay the regulations, which set a five-day liquidation requirement for financial swaps compared with a one- day period for futures, Scalia said. He requested a response from the CFTC by March 19.

Posted in: Clearing and Collateral by David /
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The CFTC has announced that mandatory clearing begins today
(well actually yesterday as I am out of town and got to this a day late).

The requirement applies to new and notated swaps which fall within the CFTC’s clearing mandate.

Posted in: Clearing and Collateral by David /
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I’m a little busy, so this will be short form:

• Jon Danielsson has a piece on VoxEU about the desirability of diversity in capital models. I don’t agree – I think we need fewer models used for capital purposes – but the argument is interesting.
• There’s a (sadly firewalled) opinion piece by De Larosière on centralbanking.com about the tradeoff between bank regulation and economic growth. Unsurprising, he comes down on the side of too much regulation (in places) and too little growth.
• LSE/LCH looks to be nearly done.
• Scott O’Malia is not happy about the CFTC approving CME’s trade repository.
• There is an effort to repeal the swaps pushout provision (section 716) of Dodd Frank. It is early days, but this may come to something.
• And finally… the corporate CVA exemption is apparently still in the near-final text of CRD IV. if you know what that somewhat opaque sentence means, then you will likely cheer: if you don’t, err, sorry, try here.

I will try to get to the RBS breakup news tomorrow.

Posted in: Clearing and Collateral, Regulation by David /
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I’m a little late with this, but it is interesting. Bart Chilton, CFTC Commissioner, on the futurisation of the swaps market:

while I’m interested in hearing the concerns about futurization, I am more concerned about, a silent creeper. That is, the “swapification” of the futures markets. Specifically, I’m concerned that the conversion of certain standardized cleared swaps will be under-regulated–under-regulated–in the futures markets. It may be block rules or something else, but we need to be cautious about converting certain swaps to futures in an attempt to export the deregulated, opaque swaps trading model to these new futures markets. Let’s be cautious about allowing lax oversight of these futures contracts, regardless of how they were treated before they were futurized.

Posted in: Clearing and Collateral by David /
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From the Bundesbank:

Frankfurt-based Lehman Brothers Bankhaus AG settled its monetary policy transactions with the Eurosystem via the Bundesbank… In September 2008 … liabilities vis-à-vis the Bundesbank stood at €8.5 billion. These liabilities originated exclusively from monetary policy refinancing operations, for which LBB had pledged a total of 33 securities, chiefly highly complex instruments… Since autumn 2008 the Bundesbank has gradually resolved the pledged securities, in some cases having to restructure them. In 2012, Diversity and Excalibur*, the two largest positions in the LBB collateral portfolio, were sold, amongst other assets. The process of winding down the pledged securities is now complete.

The situation after more than four years of resolving collateral is as follows. With proceeds from sales as well as interest and redemption payments totalling €7.4 billion.

In other words, LBB’s collateral turned out to be worth 84 cents on the dollar, after accounting for haircuts; and it took four years to get that much.

*Diversity and Excalibur where European CMBS deals. See here and here for further details.

Posted in: Clearing and Collateral, Mortgages by David /
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The recent speech by Jeremy Stein received a lot of attention for its suggestion that monetary tools might be used in addressing credit market-overheating. That is an interesting argument, but I don’t want to deal with that today. Rather, I want to look at Stein’s comments on collateral transformation:

Collateral transformation is best explained with an example. Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral must be “pristine”–that is, it has to be in the form of Treasury securities. However, the insurance company doesn’t have any unencumbered Treasury securities available–all it has in unencumbered form are some junk bonds. Here is where the collateral swap comes in. The insurance company might approach a broker-dealer and engage in what is effectively a two-way repo transaction, whereby it gives the dealer its junk bonds as collateral, borrows the Treasury securities, and agrees to unwind the transaction at some point in the future. Now the insurance company can go ahead and pledge the borrowed Treasury securities as collateral for its derivatives trade.

Of course, the dealer may not have the spare Treasury securities on hand, and so, to obtain them, it may have to engage in the mirror-image transaction with a third party that does–say, a pension fund. Thus, the dealer would, in a second leg, use the junk bonds as collateral to borrow Treasury securities from the pension fund. And why would the pension fund see this transaction as beneficial? Tying back to the theme of reaching for yield, perhaps it is looking to goose its reported returns with the securities-lending income without changing the holdings it reports on its balance sheet.

There are two points worth noting about these transactions. First, they reproduce some of the same unwind risks that would exist had the clearinghouse lowered its own collateral standards in the first place. To see this point, observe that if the junk bonds fall in value, the insurance company will face a margin call on its collateral swap with the dealer. It will therefore have to scale back this swap, which in turn will force it to partially unwind its derivatives trade–just as would happen if it had posted the junk bonds directly to the clearinghouse. Second, the transaction creates additional counterparty exposures–the exposures between the insurance company and the dealer, and between the dealer and the pension fund.

What this makes clear is that high collateral quality thresholds can be deeply unproductive, in that they encourage collateral transformation activities without enhancing safety. Equity markets professionals have long been used to the idea that low quality highly volatile assets often make good collateral providing that the haircut is big enough (and there isn’t substantial jump risk). That is surely right. Low quality assets can be a lot safer than high quality ones in that their haircuts are less procyclical: they are always big. I’d much rather post 200% of the value of my exposure as BBB bonds and know the haircut was highly unlikely to ever be more than 50% than post 105% of AAAs with the risk that my haircut quadruples at the first sign of trouble. (Assuming good segregation and bankruptcy remoteness of the overcollateralisation anyway.)

Posted in: Clearing and Collateral by David /
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Futurisation is the current buzz word in the swaps market. I’ll let Bloomberg explain:

On Friday, Oct. 15, a rule designed to improve [US] government oversight of the multitrillion-dollar market for derivatives took effect. The following Monday, many energy traders moved their swaps business to a futures exchange. After the U.S. Commodity Futures Trading Commission put two years into building its regulatory framework for swaps, a slice of the market simply sidestepped it.

Really, you have to applaud. The market noted that the margin period of risk for futures was one day, compared to five days for a swap, and that futures did not have onerous block trading or regulatory capital requirements. So, with the flick of a pen, they started trading futures on swaps rather than swaps. A future on something, you see, is a future for regulatory purposes, not a something. Futures on CDS on ABS anyone? No, really, c’mon never mind the quality feel the margin…

Posted in: Clearing and Collateral by David /
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US GC repo is going lower, because, well, the Treasury has most of the assets, thanks to QE. Given that these assets are needed for collateralised funding and collateralised risk taking, that is having an impact. Izzy at Alphaville relays the following, very much along the line we have taken on this:

overly strict collateral policy, implemented post crisis, is now constraining the market’s ability to take on risk, because the ability to fund or run “risk-on” trades is determined by how many safe assets an institution has available for margin posting.

Risk positioning is increasingly being held back by a static pool of risk-free collateral.

Furthermore, if and when the risk positions sour, that divide only gets wider as further safe collateral calls are made, sucking more safe assets out of the system.

You can’t both demand that funding and risk taking are often collateralised then buy up most of the collateral without it having an impact.

Posted in: Clearing and Collateral, Economic Theory, Liquidity and liquidity risk, Markets by David /
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My new book, OTC Derivatives: Bilateral Trading & Central Clearing will be delivered to the publisher this week. These roughly 300 pages of goodness should be out in the summer. Just to whet your appetites, here’s the table of contents.

Introduction

Chapter 1 – Over-The-Counter Derivatives
1.1 OTC Derivatives: Trading And Its Consequences
1.2 The Risks of OTC Derivatives
1.3 The Pre-Crisis OTC Derivatives Market

Chapter 2 – The Counterparty Relationship
2.1 Portfolios and Payment Netting
2.2 Default and Close Out Netting
2.3 Credit Support: Margin and Collateral
2.4 Rehypothecation and Funding
2.5 Novation, Standardisation and Simplification

Chapter 3 – The Valuation and Risk of OTC Derivatives
3.1 Derivatives Valuation Under a CSA
3.2 Estimates of Default Risk and CVA Management
3.3 Counterparty Credit Risk
3.4 The Risks in Credit Support and Procyclicality
3.5 Wrong Way Risks
3.6 Regulatory Capital Requirements for Default Risk

Chapter 4 – The Role of OTC Derivatives in the Crisis
4.1 The Dogs That Barked and The Dogs That Didn’t
4.2 A Very Short History of the Financial Crisis
4.3 Credit Derivatives In The Crisis
4.4 OTC Derivatives and Interconnectedness
4.5 Broader Vulnerabilities

Chapter 5 – Regulatory Responses To The Crisis
5.1 Capital
5.2 Liquidity Risk
5.3 Pre– and Post-Trade Reporting
5.4 Disclosure
5.5 Interconnectedness
5.6 Resolution
5.7 Risk Coverage

Chapter 6 – OTC Derivatives Central Clearing
6.1 OTC Derivatives Central Counterparties
6.2 Clearing and Clearing Houses
6.3 Organisational and Legal Issues
6.4 Client Clearing
6.5 Margin and Default Management
6.6 Segregation for Cleared OTC Portfolios

Chapter 7 – The Emerging OTC Market Infrastructure
by Bill Hodgson
7.1 The Current Bilateral OTC Environment
7.2 Trading In The Future Cleared OTC Environment
7.3 CCP Processes For Clearing Members
7.4 Clearing For Clients
7.5 Other Issues

Chapter 8 – Risks in OTC Derivatives Central Clearing
8.1 Risks To CCPs
8.2 CCP Risk I: Mitigation
8.3 CCP Risk II: Externalities
8.4 Risks from CCPs
8.5 Risks from Mandatory Clearing

Chapter 9 – Design Choices in Central Clearing and their Consequences
9.1 Financial resources
9.2 CCP Organisation
9.3 Clearing Mandates
9.4 Opposing paradigms
9.5 Deconstructing an OTC derivatives CCP

Chapter 10 – The Aftermath of Mandatory Central Clearing
10.1 Winner and Losers
10.2 The Future of OTC Derivatives Markets
10.3 The Impact of Mandatory Clearing on End Users
10.4 Post-crisis Ruling Making and its Consequences

Index

Posted in: Clearing and Collateral, Publications by David /
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Brace yourself, gentle reader: democratic accountability for financial regulation may be coming our way. From Reuters:

The European Parliament may demand a rethink [of EMIR]… Members of the Parliament are discussing a resolution which, if approved next month, would trigger a formal review of the rules, two sources from the European Parliament said… The issue is with exemptions from the rules for “non-financial” companies, such as airlines, which use derivatives to hedge fuel costs.

If the Parliament approves a resolution rejecting some of the rules, the European Commission and the European Securities and Markets Authority (ESMA) will have to come up with alternatives… the Parliament considers that exemptions for users of derivatives from the “real economy,” such as airlines, are not flexible enough.

Quite right too. I hope that Sharon and friends follow through on this.

Posted in: Clearing and Collateral by David /
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You may have heard the term `quad party’ or `fourth party’ custodian bandied around recently if you have been following the clearing discussions closely. The idea is as follows:

In client clearing, you have 3 parties already: the client, the clearing member, and the CCP. The Custodian is the fourth party. Rather than the client moving collateral to the CM who moves it to the CCP, in quad party the custodian delivers the client’s collateral, under the clearing member’s instruction, directly to the CCP. Similarly to tri-party repo, the collateral always remains at all times within the custodian (or securities depository), so there is no settlement risk.

It’s clearly a good idea, it just reminds me a little of epicycles.

Posted in: Clearing and Collateral by David /
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Like the pent-up demand released in yesterday’s equity rally, there has clearly been a lot of good writing going on over the holidays that is coming out. There is too much to comment on in detail today, so here are some highlights:

• Lisa Pollack in FT Alphaville on reconciling between US GAAP and IFRS presentations of derivatives. The bottom line is that accounting standards are a mess, but at least footnotes will now provide some reconciliation between the differing approaches. If you level the differences, the top of the list of banks by size of derivatives balance sheet is JPM, BAC, BNP, Barclays, DB, RBS, SG, UBS, CS, GS, MS. Is anyone else as surprised by how high the French are in this list as I am?
• Lisa again on the slightly troubling lack of clarity on who collateral posted by ERISA pension funds at FCMs should be returned to in the event of bankruptcy. Ooops.
• A good, long read from Frank Partnoy and Jesse Eisinger in Atlantic magazine on bank disclosures. Favourite quote: “There is no major financial institution today whose financial statements provide a meaningful clue about its risks”.
• Coppola comment on a BIS paper on safe assets (which I have yet to read, but will get to). I agree (and have been pushing) the idea that we consider the perspective whereby “the purpose of government debt is not to fund government spending. It is to provide safe assets.” (HT to Izzy for picking this one up.)
• Ross Gittins in the Sydney Morning Herald on the gangs which run America.

Posted in: Accounting, Clearing and Collateral, Economic Theory by David /
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“Self regulatory organisation.”

From Bloomberg:

The botched initial offering of Facebook Inc. (FB) is the catalyst that should lead to U.S. exchanges being stripped of self-regulatory powers and their related benefits, a Credit Suisse Group AG (CS) executive said.

Nasdaq Stock Market’s claim of immunity from liability for $500 million in brokerage losses stemming from technology problems on May 18 exposes a conflict between the historical, quasi-governmental role of exchanges and their status as profit- seeking public companies, Dan Mathisson, head of U.S. equity trading at Credit Suisse, told U.S. senators in Washington last week. Those tensions can’t be managed fairly and should spur a regulatory overhaul of the securities market, he said.

Legislation that created the Securities and Exchange Commission in 1934 also deemed the main venues self-regulatory organizations, or SROs, overseeing their member firms and trading. Critics say the Facebook mishap shows how changes in the structure of markets have made old regulations obsolete and created an uneven playing field where exchanges are governed by one set of rules and their competitors another.

That, surely, is difficult to argue with. 1934 supervisory architecture is not fit for 2013.

Posted in: Clearing and Collateral by David /
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Bloomberg has a story on what it terms the looming swaps armageddon. I would not perhaps go that far, but the article is interesting.

I was spluttering at the first part of this sentence from Bloomberg about OTC derivatives clearing “This arrangement can withstand almost any shock, including defaults by four of the biggest lenders,” but the authors redeemed themselves with the kicker “according to the clearinghouses”. That’s pretty much like `Christmas is bah humbug stay home alone and eat pasta… according to turkeys.’

Craig Pirrong kicks in with a useful corrective in the next paragraph: “I just don’t think that realistically you can exclude the possibility that taxpayers could be at risk.” Indeed. Still, we can’t say that the supervisors have not been generous for Christmas. As Bloomberg points out, the Dodd-Frank rules could mean as much as $1 billion in new annual revenue for clearinghouses. This is of course the reason ICE can afford to buy NYSE Euronext: their stock price reflects the expectation of these future profits.

What we have really done with OTC clearing, it is increasingly clear, is to turn the low probability high severity event of a big OTC derivatives dealer failure into the perhaps lower probability probably higher severity event of CCP failure. This is exactly the wrong direction. Bloomberg quotes Blankfein on this: “We have to make sure that something that we do to reduce the risk in a once-in-a-20-year storm doesn’t increase the risk in a once-in-a-50-year storm.” Yes, we do: but we haven’t.

Meanwhile CCP resolution remains jejune and their disclosures are not sufficient to permit outsiders to assess their risk properly. “None of the major clearinghouses are providing sufficient detail on their default-management plans,” said Darrell Duffie, quoted in Bloomberg. “They don’t want to talk about that.” Meanwhile according to Bloomberg, “in non-public meetings this year at the New York Fed, Citigroup and JPMorgan pushed CME Group, Intercontinental and LCH to reveal more about their finances and risk-management policies, people with knowledge of the matter said.” There is a certainly going to be a lot to do on this in 2013. For the next few days, I am ignoring the advice of the Turkeys.

Posted in: Clearing and Collateral, Photography by David /
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Felix Salmon on the ICE purchase of NYSE Euronext:

Exchange mergers… aren’t actually boring at all: they’re an indication that the financial-services industry is desperately trying to protect the rents it can collect by means of consolidation. There are lots of stock exchanges, and none of them make much money. By contrast, there are relatively few derivatives exchanges, they tend not to compete directly with each other, they tend not to compete on price, and they’re wildly profitable.

Posted in: Clearing and Collateral by David /
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A mixture today:

From a Bloomberg story as part of their America’s Great Payroll Giveaway series:

“There’s a mythology promulgated by people in administration that you have to pay competitive salaries to attract the best people,” said Benjamin Ginsberg, political science professor at Baltimore-based Johns Hopkins University and author of a book detailing how universities are adding administrators even as state funding drops. “In point of fact, no one can show there is any relationship between what these people are paid and the quality of the work they do.”

From a story in the Securities Lending Times on CCP ownership:

Research firm Finadium interviewed major CCPs worldwide to find out how they view the role of collateral for both risk management and as a potential competitive lever in the marketplace.

Its subsequent report—CCPs and the Business of Collateral Management—was released on 15 November.

Stock, options and futures exchanges own 60 percent of recognised CCPs, said the report. “This ownership structure makes CCP activity part of the strategic direction of the exchange itself; decisions made at the exchange level trickle down as opposed to CCP decisions trickling up.”

Boards of industry representatives or outside parties run the remaining 40 percent.

“These ownership structures complicate the process of categorising the intentions of the CCP community; some CCPs operate truly as utilities for the benefit of their users while others are inclined towards market growth through acquisitions and new product development. Further, many exchanges including the CME, ICE and London Stock Exchange are competitive, publicly traded entities, putting their fully owned CCP functions in a competitive position as well.”

From Jesse Eisinger’s new article on US mortgage finance:

…with little planning and paltry public discussion, the government has almost completely taken over the American home mortgage market. Banks and other for-profit financial services companies lend money to homeowners, but without the guarantees and other support the government provides, the housing market would barely be functioning now.

Fannie Mae and Freddie Mac, the taxpayer-controlled housing giants, guaranteed 69 percent of new mortgages in the first nine months of the year, up from about 27 percent share in 2006, according to Inside Mortgage Finance. Meanwhile, the Federal Housing Authority and the Department of Veteran’s Affairs currently back another 21 percent of mortgages, up from just 2.8 percent in 2006. Altogether, 9 of every 10 new mortgages are backed by the U.S. taxpayer, up from three in 10 in 2006, when the government share hit a decade-low, according to the publication.

From a BIS working paper Global safe assets by Pierre-Olivier Gourinchas and Olivier Jeanne:

…a convincing link can be established between macroeconomic shortages of safe assets and some of the most disturbing features of our recent global financial history… a natural way to eliminate the financial instability arising from the asset scarcity consists in supplying public safe assets. In turn, the safety of public asset may require a monetary backstop. We show that this backstop can increase significantly the safety of public securities, with minimal or no consequences in terms of price stability.

Posted in: Clearing and Collateral, Compensation, Mortgages by David /
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From the FT:

US banks are making a last-minute push to ease new global liquidity requirements, arguing that they would need to come up with an additional $800bn in easy-to-sell assets under the proposed standards.

While ISDA says that the impact of requiring initial margin for bilateral transactions with a $50M threshold and assuming everyone uses an internal model is $800B.

Them’s big numbers, yep.

Posted in: Clearing and Collateral, Regulation by David /
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The FT reports that the London Stock Exchange and LCH.Clearnet are in talks about changing the terms of their €463m deal:

The two parties have been thrown by tough new European rules forcing clearing houses to hold more capital. LCH needs to raise up to €375m to meet the new rules.

Oops.

Posted in: Clearing and Collateral by David /
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The SWP has a post here on the on-going swap data repository mess (SDR) in the US. I admit to not having fully thought through the pros and cons of vertical integration in this space, although I do have concerns about the monopoly issues that come with vertical integration, so I won’t comment on the first part of his post. This, though, is clearly right:

there are substantial scale and scope economies in creating and operating an SDR, and that an SDR is a natural, multi-product monopoly. It is highly likely that the efficient form of organization would be an industry utility/cooperative, likely a non-profit.

Unfortunately that is not what we are going to get. Therefore, as SWP says, “although mandatory reporting to a [single] data hub/SDR is a good idea, as a result of political economy considerations it will be implemented in a highly inefficient way.”

Posted in: Clearing and Collateral by David /
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CFTC Commissioner Scott D. O’Malia recently gave a speech which has a fair assessment of the CFTC’s efforts in implementing Dodd Frank, and a warning for the future:

Given the regulatory frenzy, it’s not surprising that there are many unintended, overreaching and technologically infeasible provisions in our rules… Unfortunately, the Commission’s rulemakings have already disincentivized trading on swaps venues by implementing burdensome swap dealer registration rules and disadvantageous margin requirements for swaps. As a result, energy traders fled from the swaps market to the standardized futures markets in October, a transition dubbed “futurization,” just ahead of the effective date for swaps regulations. Although futures contracts cannot be tailored to meet a company’s specific risk needs, they do offer far greater regulatory certainty, deeply liquid markets within which to hedge commercial risk, and capital efficiency to market participants. As the Commission reviews these transactional rules, it is important to make necessary regulatory adjustments in order to avoid a complete shutdown of the swaps market

These are indeed best wishes to – and prudent concerns for – the swaps market. I wonder what kind of new year the CFTC and ESMA will let it have.

Posted in: Clearing and Collateral by David /
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Reporting OTC derivatives to trade repositories is one of the unequivocally good parts of post-crisis legislation. Such reporting is vital for regulators to have a complete view of the market. It is therefore perhaps no surprise that, as Bloomberg reports

CME Group Inc. (CME), the world’s largest futures market, sued the U.S. Commodity Futures Trading Commission, challenging cleared-swaps reporting requirements imposed under the Dodd-Frank financial reform legislation.

CME, in a lawsuit filed yesterday in federal court in Washington, seeks a permanent injunction against rules requiring registered derivatives clearing organizations, or DCOs, such as itself, to provide nonpublic reports of cleared swap transactions to a new swap data repository established under the act. CME has until Nov. 13 to comply.

Posted in: Clearing and Collateral by David /
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As it turns out, a few miles from Belfast:

Posted in: Clearing and Collateral, Fun by David /
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Like many, I am reading the FSB report on shadow banking. The most important issue here is the fifth workstream, securities lending and repo — yet the proposals seem, well, a little bland. Here are the suggestions in brief:

1. Improving regulatory reporting
2. Improving market transparency
3. Improving corporate disclosures
4. Improving reporting by fund managers to end-investors
5. Introducing minimum standards for haircut practices
6. Limiting risks associated with cash collateral reinvestment
7. Addressing risks associated with re-hypothecation of client assets
8. Strengthening collateral valuation and management practices
9. Evaluating the establishment or wider-use of central clearing where appropriate
10. Changing bankruptcy law treatment of repo and securities lending transactions

All good stuff, but if a money market fund requires something like capital because it is bank-like, shouldn’t there be capital requirements for all repo rather than Basel II’s safe harbour (zero capital for certain qualifying transactions)? And, if not, on what basis is liquidity risk being `traded off’ against systemic and credit risks? Just askin’.

Posted in: Clearing and Collateral, Liquidity and liquidity risk by David /
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