Let the Sun Shine In

Sunday’s New York Times contained yet another column on the OTC derivatives markets. This time, the commentary focused on transparency, as well as on the amendments regarding electronic trading platforms proposed by Representative Scott Garrett and others.

The article notes there are two aspects to the transparency debate. The first – regulatory transparency – “has pretty much been accomplished.” Trade and position details are being reported to a centralized trade information warehouse to which regulators have access.

To which we say: Thank you.

The article goes on to contend that another issue remains: “a lack of transparency in the market as it relates to swaps customers hasn’t been addressed.”

The column relies on some estimates provided by a small trade group to support its contentions. These estimates are supposedly part of a study of transaction costs and potential cost savings that the group conducted. Has anyone seen this study? We have not, though we have asked to see it. So too has Rep. Garrett, who was told it would be provided during a recent congressional hearing. (We also note that letters from BlackRock and the Investment Company Institute supporting the proposed amendments were read into the record in that hearing, but were not mentioned in the Times piece.)

It’s ironic that while one trade group’s elusive report is treated as credible, the research that ISDA has conducted and publicly released finds no place in the column. Our research – and we understand that third parties can and should consider the source of the research – finds that swaps prices are incredibly competitive in the most liquid parts of the market. It also finds that the potential price improvements that infrequent swaps users may receive from the CFTC’s electronic execution rules are dwarfed by the higher costs that these rules will impose on all market participants (see Costs and Benefits of Mandatory Electronic Execution Requirements). We’d be happy to shed some light by arranging a simple demonstration of live pricing that is available to derivatives end-users.

Finally, the column considers neither how swaps trade now nor the pricing information that exists. End-users can call firms (as many as they like) for quotes. They can review the price screens that these firms provide to them. They can look up prices on their Bloomberg terminals. They can access existing electronic platforms for price information.

In other words, as it relates to swaps customers, there really isn’t “a lack of transparency in the market.”

Three Cheers for the New York Times

Forget, for a second, the lovely mid-November golf weather in New York this past Sunday. The real treat last weekend was an article in Saturday’s New York Times. It was called “A Big Market, But Not Necessarily Dangerous” and it was written by Times veteran Floyd Norris.

The article is about the credit default swaps market, and it explores recent activity in sovereign CDS. As it does so, the article references information about trading volumes, risk exposures and CDS premiums – information that is available from a variety of sources.

Accompanying the articles is a series of charts that compare 10-year bond yields, CDS prices, CDS notional outstanding and weekly CDS notional trading volumes for Italy, Spain and France. The charts graphically display the thrust of the column, as encapsulated in the caption: “As worries over the safety of some European sovereign bonds grew this year, volume in credit default swaps rose sharply, particularly in September. But the changes in net contracts outstanding rose at a much slower pace.”

We like the column for three reasons. First, there’s the headline. Given today’s press coverage of derivatives, “Not Necessarily Dangerous” is a ringing endorsement. We had, in fact, considered it as part of our new logo but ultimately decided on “Safe, Efficient Markets.”

Second, and more seriously, the article is factual. The Times (and Mr. Norris) might disagree with our conclusion here, but the column shows that an awful lot of information – prices, volumes, exposures – is in fact available on this market. It’s true that not all of this information might be available to the average person, but the swaps market is, after all, an institutional market. Market participants have price transparency and access to data.

Third, the article does more than string together a series of quotes from a select few “independent experts” who can always be counted on for a critical quote. It weaves together facts and data to tell an interesting story.

We can’t wait for next weekend.

Sad Proof

This Sunday’s New York Times Business Section carried an interesting column (“Sad Proof of Europe’s Fallout.”) It essentially claims that MF Global “was felled by over-the-top leverage and bad derivative bets on debt-weakened European countries.”  It goes on to say that one of the lessons of MF Global’s failure was that when Euro-shocks “reach our shores, they usually ride in on a wave of derivatives.”

Pretty compelling stuff.

Except that it’s not true.

MF Global did not use derivatives to make its bets on European sovereign debt.  As the company stated in its third-quarter earnings release on October 25th:

“As of September 30, 2011, MF Global maintained a net long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity (repo-to-maturity), including Belgium, Italy, Spain, Portugal and Ireland.”

So it seems clear that MF’s European sovereign debt holdings were just that, bond positions financed via repo transactions.  Repos, of course, are NOT OTC derivatives.  (They’re also not listed derivatives.)  They are basic tools of corporate finance commonly used to finance cash bond positions.

We would have thought that, with a little checking, this point would be pretty obvious to one and all.  We would have also thought that reporters (and consultants who are used as expert sources on financial matters) would know that because MF Global was an SEC registered Broker-Dealer and CFTC registered Futures Commission Merchant, regulators at all times had full transparency into the nature and extent of MF Global’s trading and risk positions.

In short, there were no derivatives, no opaque financial instruments and no hidden risks in the story of MF Global’s downfall.  There were, though, a lot of inaccuracies in the way that story was told.

Sad proof indeed.

It’s Time to Stop the Nonsense

It’s hard to overstate the amount of nonsensical chatter on credit default swaps (CDS) in the past few days.  At the top of our list is a column by physicist Mark Buchanan in Bloomberg BusinessWeek.  It says that CDS make today’s sovereign debt crisis “different – and possibly more dangerous” because they create a “largely invisible network of ties among institutions around the world, which could ultimately cause global financial chaos.”   That’s because CDS are “mostly arranged ‘over-the-counter,’ not traded on any exchange or recorded by any central information repository.”


Does the author not know about DTCC’s CDS Trade Information Warehouse?  (For that matter, doesn’t anyone at Bloomberg BusinessWeek know about it either?)  It’s only been up and running since 2008, capturing more than 98% of all CDS transactions.  Its launch may not have rivaled the neutrino time trials recently carried out by CERN in Europe.  But surely its existence should be known to someone purporting to be an expert on the CDS market.

The CDS warehouse offers a significant level of regulatory transparency and helps to ensure that AIG can’t happen again.  Some of the information it captures is public and is available here.

Note in Table 6 of the DTCC data that the net notional on Greek debt currently measures US$3.7 billion.  This figure is calculated by summing the net exposures of the protection sellers, so it is impossible for any one firm selling protection to have more than $3.7bn in exposure.  Of course, given that there are many net sellers, any one seller’s exposure is likely to be far less.

Also, firms’ net exposures are partially offset by the recovery value of the underlying obligations. For example, if the post-default recovery value of Greek debt was (hypothetically) 50%, the maximum aggregate amount payable would be 50% of $3.7 billion, or $1.85 billion. Furthermore, statistics indicate that, on average, 70 per cent of derivatives exposure is collateralised and the level of CDS collateralization is likely to be even higher as over 90% of CDS transactions (by numbers of trades) are collateralised. Thus, in this example, of the $1.85bn that would be payable, about $1.5bn is secured.

So please, let’s stop the nonsense. There are serious issues to be discussed regarding global regulatory reform and the financial markets.  Greater transparency and the threat of CDS contagion in the event of a Greek default aren’t among them.