Financial Times - A Small Step in the Right Direction

1. 16 FINANCIAL TIMES MONDAY AUGUST 2 2010
FTfm report – Clearing OTC derivatives
A small step in the right direction
clearing inherently provides
Crisis evasion the necessary backstop to
protect the system. While
Moves to regulate its spokesman admits the
derivatives have not full network is not yet in
place, extensive dealer
addressed all the membership in these
inherent risks. Eric houses and the extensive
margin that will be
Uhlfelder looks at involved in clearing deriva-
some of the issues. tive trades will mutualise
risk, he says.
The CFTC is also optimis-
T
he move to regulate tic that requiring daily
derivatives trading mark to market pricing –
has been well currently not necessary for
received but the devil, and bilateral agreements – will
eventual effectiveness of enhance visibility of condi-
reform, will be in the tions, as will consistent
details that will be years in reporting to regulators.
the making. Contrary to Mr Acharya’s
Insurer AIG had more point, he says under
than $500bn (£321bn, extreme circumstances
€384bn) in credit default clearing houses can get
swaps on its books in 2007. access to Federal Reserve
In December, as market capital.
conditions worsened, To Jonathan Kanterman,
Joseph Cassano, who had managing director of Still-
run the company’s deriva- water Capital, a $750m fund
tives unit, told investors of hedge funds, regulators
these positions would need must use this moment to
to be marked down only cosmically alter their treat-
modestly. ment of CDSs.
The following year, the “Once and for all they
US bailed out AIG to the must recognise these con-
tune of $182bn. tracts as insurance policies
There was not anything and require sufficient capi-
fundamentally wrong with tal reserves,” says Mr Kan-
derivatives that hedged terman.
against a bond default. But He points out that the
the creation of credit majority of the $787bn US
default swaps without suffi- bail-out programme actu-
cient capital behind them ally went to stabilise CDS
revealed just one of many trades. The issue is espe-
examples of how exposed Calpers, the $205bn California pension fund, has been using collateral support deals for some time Getty cially critical, he says,
the US economy was to ill- when we see underwriting
conceived derivatives. Mak- of swaps that are many
ing matters worse was the organisations that are too mation. “Not only does this market is pricing in higher times the size of the under-
huge information gulf ‘Even with big to fail. lead to compromised deci- margin costs, Mr Abrams lying debt.
between what underwriters sufficient capital, “It will take years to sion-making on the buy- says. Nevertheless, he “Even with sufficient cap-
knew and what buyers did effect the new regulations side,” he says, “but directly believes reform will lead to ital, this could lead to dys-
not know, which prevented this could lead and the interests of these contributes to excess a reduction in leverage and functional, destructive mar-
the market from self-
correcting.
to dysfunctional, institutions will be well rep-
resented in the process,”
returns when buyers can’t
compare risks and prices.”
help ensure a more stable
financial system.
ket behaviour,” Mr Kanter-
man says.
The passage of the Dodd- destructive warns Mr Kaufman. He He is unsure how regula- Even before the financial Second, he wants bond
Frank Wall Street Reform fears one such place of com- tors will devise new rules crisis hit, Calpers, the ownership rights to be
and Consumer Protection
market behaviour’ promise will involve propri- that will address these $205bn California pension affected by the degree of
Act responds to this and the etary trading, where there issues, and does not believe fund, had increasingly CDS exposure. “There’s the
many other market failures But it is far from certain can be serious conflicts of that clearing – in this relied on collateral support potential for a conflict of
that brought the US econ- whether the necessary interests. instance – will make much agreements, which is com- interest by debt holders
omy to its knees. Political standards needed to imple- Mr Kaufman is also con- of a difference. parable to the use of mar- who could stand to profit
rhetoric aside, virtually all ment these changes will be cerned that there may be There will also be addi- gins. Eric Busay, head of more from bankruptcy than
observers believe the act is enacted. These are the insufficient transparency to tional costs related to mar- the fund’s foreign exchange restructuring,” explains Mr
a step in the right direction. details that must be worked discern full underwriter gin requirements. Titan and international fixed Kanterman. And he would
The move to shift the out. derivative exposure by Capital Group, a hedge fund income exposure, explains like to see limits placed on
majority of derivative trad- Henry Kaufman, an eco- scale, sector concentration, manager with $400m in Calpers is already moving the purchase of naked
ing to exchanges and clear- nomic and financial con- and event exposure. assets, relies largely on in the direction in which shorts – default protection
ing houses will help lower sultant, believes reliance on A chief economist at one derivatives to execute its the reforms are heading, so without ownership of the
risk, according to the direc- clearing houses will help of US’s largest banks volatility trading strategy. he thinks the evolving rules underlying security. Mr
tor of public affairs at the enforce key trading require- shares this concern in see- Russell Abrams, president, will not materially affect Kaufman agrees.
US Commodity Futures ments and mitigate the ing the likely continuation says the market still does the way Calpers functions. Like many regulatory
Trading Commission, potential impact of counter- of asymmetric infor- not know how much mar- Viral Acharya, a profes- changes necessary to effect
which, in concert with the party risk. gin regulators will sor at New York Univer- reform, Mr Kaufman wor-
Securities and Exchange “This will help us avoid Henry require. But however sity’s Stern Business ries the new rules will not
Commission, will translate one source of difficulties Kaufman: ‘It much it is, it will School, agrees that be able to limit the use of
Congressional intent into that fuelled the financial will take cut into returns. improved transparency pro- derivatives for speculative
practice. meltdown in 2008,” he says. years to The current vided through clearing will purposes.
The Dodd-Frank Act But he remains sceptical effect the spike in implied enhance the efficiency of “Use of derivatives in this
requires prudential regula- that a key fundamental new volatility – espe- derivatives markets. way exacerbated the impact
tors to set minimum capital issue will be addressed. regulations’ cially involving But he is concerned how they had in the financial
requirements, while clear- “The vast majority of the equity index the government would crisis,” observes Mr
inghouses require pricing derivative market is under- options that go out intervene if clearing houses Kaufman, “and going for-
regularly marked to mar- written by five to six major 10 years and longer were hit by the same blow ward, without meaningful
ket. Just as important, reg- financial institutions,” says – suggests the that hit traders several restrictions over the origi-
ulators will establish stand- Mr Kaufman. years ago. nation and trading of these
ards of business conduct, He does not believe that “These structures aren’t securities, they could again
including record keeping new rules will alter this banks and how government send serious shock waves
and reporting so regulators fact, leaving in place the could provide liquidity is throughout the financial
will be able to monitor systemic problems of con- not clear,” says Mr Ach- system when we are hit by
transactions. centration and financial arya. The CFTC thinks the next seismic event.”