Here is a wonderful sentence:

A key insight from the enhanced BIS credit derivatives data is that non-rated multi-name credit risk sourced from multiple sectors has been transferred from derivatives dealers to IFGCs, SPVs and OFCs.

Yeah! Wh … what?

It’s from the quarterly review of the Bank for International Settlements, which is a delightful hodgepodge of hard-to-read charts, hard-to-read sentences, and general oblique glances at the guts of the global financial system. It is both glancing and gutsy. There are reams of tables. Give it a read.

The quote above is about this:

Everything clear now?

I love charts and all but I mostly think in stories, and I’m trying to parse together the story for these facts because they seem somehow important. It seems to go like this.

These charts show the movement of credit exposure via credit derivatives. Various big banks and dealers report their derivatives exposure to their central banks, which report it to the BIS. There’s some $32 trillion of gross CDS notional outstanding, but obviously dealers take mostly-offsetting positions; these bars represent the gross long exposure in various categories minus the gross short exposure in those categories. A positive number means that the dealers are long protection / short credit; a negative number means they’ve sold protection / are long credit. The three charts are three ways of slicing it; the left-hand one, “by sector,” seems the most interesting to me.

So what are those bars?
BSDs – banks and securities dealers. Despite the acronym, these are probably mostly smaller and less important banks, that is, the non-reporting dealers, meaning in the U.S. banks and broker-dealers that are not Fed primary dealers. The reporting dealers are not listed here because their net exposure to each other should be zero.
IFGCs – insurance and financial guarantee companies, and (for some reason) pension funds
SPVs – special purpose vehicles – presumably, securitizations
OFCs – other financial companies; per the report, “Other managed funds, such as money market mutual funds, are well represented in the OFC category”
NFIs – non financial institutions, meaning I guess corporates
HFs – hedge funds

The most interesting slices of the bars are the forest-greeny-bluey ones for “multiple sectors.” In a footnote, the BIS explains that these are probably mostly synthetic CDOs and CDS index and basket products:

Information is not available on positions in CDS that are both non-rated and reference multiple sectors, but supplementary BIS data do show that the majority of non-rated risk transfers to IFGCs, SPVs and OFCs occurred through multi-name CDS. Multi-name CDS that are likely to reference multiple sectors and be classified as non-rated include basket CDS, synthetic collateralised debt obligations (CDOs) and CDS index tranches. Where multi-name CDS did not have a rating, reporting dealers were asked to allocate these instruments to a rating bucket on the basis of the credit quality of the underlying debt, unless this was “not possible or very burdensome”. The products listed above would probably fit this description.

In short, the reporting dealers seem to own (eyeballing it here) $1 trillion of credit protection from a fairly even mix of smaller banks, insurers, SPVs, and other financial companies, plus a small slug of non-financials. And they’ve sold about one-third of that amount to hedge funds.*

This seems to abstract this into two big flows of money:

1. The bigger flow is: Bank lends money to a person or business to buy a home or build a machine. Bank then offloads credit risk to a series of acronyms – IFGCs, SPVs, OFCs, etc. – that are loosely speaking in the shadow banking system. Bank does the underwriting in the individual names but sells the risk mostly in vast undifferentiated pools of stuff so that the shadow banks don’t have to do too much credit work.

On the one hand, great. Banks get more balance sheet to lend, and systemically important banks are less likely to go bankrupt due to bad credits – they reduce their credit risk except in a turtle-y, what-if-the-shadow-banks-go-bankrupt way, which the BIS notes. (“The new data also show that BSDs and SPVs had sold on a net basis credit protection on financial debt. The risk of simultaneous default of protection sellers and reference entities is often higher when these institutions come from a common sector, rather than different sectors.”) Banks do credit work by lending to single names; shadow banks are essentially credit indexers, willing to take on broad classes of credit risk rather than individual names – in other words, banks provide the lending expertise, shadow banks, with apparently longer time horizons, supply the risk appetite. This seems like a decent division of labor.

On the other hand, hmm, transferring risk from people supposed to underwrite individual credit risks to index players who buy big pools of stuff without examining the underlying credits – haven’t we heard about that before? The BIS quote above starts some general nervousness on the part of the otherwise fairly unruffled BIS:

A key insight from the enhanced BIS credit derivatives data is that non-rated multi-name credit risk sourced from multiple sectors has been transferred from derivatives dealers to IFGCs, SPVs and OFCs. Such risk transfers are likely to have been generated by basket CDS, synthetic CDOs or CDS index tranches. These types of CDS can be difficult to value and have experienced significant price jumps in the past. To the extent that such risks remain, they appear to have been passed on from the banking sector to parts of the non-bank financial sector often known as shadow banks.

2. Same as above, except instead of sourcing credit risk by lending money to people to do risky things, the bank sources credit risk by writing CDS to hedge funds to give them short credit exposure to the things they want short credit exposure to:

Accordingly, in the past year or so hedge funds have been using CDSs to express increasingly bearish views on debt markets, which the report indicates primarily relate to sovereign and (non-financial) corporate debt. And because these graphs show that dealers are net long in their CDS positions, hedge funds’ CDS shorts are probably ultimately being absorbed by the other categories of counterparties.

This one is more opaque and the BIS statistics don’t tell a complete story. Maybe all those hedge funds are buying CDS to hedge their own real-economy contributions: maybe they’re supporting Greece by buying Greek bonds but hedging using CDS; maybe they’re lending to companies and proxy hedging with correlated CDS. Or maybe they’re just making zero-sum directional bets against credits that they don’t like. Maybe they’re doing the credit work to find the worst sovereigns and companies, and using dealers to facilitate their short bets against those entities – with the other side taken, again, by indexing schlubs who aren’t interested in doing credit work. We’ve heard that one before, too.

Enhanced BIS statistics on credit risk transfer [BIS]

BIS Quarterly Review, December 2011 [BIS]

Hedge Funds Transfer Credit Risk to Derivatives Dealers [Lawbitrage]

BIStimates of the over-the-counter derivatives market [FTAV]

* That’s about one-third of notional (again, from eyeballing). It’s probably less than that in terms of actual risk exposure, measured by DV01 or market value or whatever, because for instance the hedge fund short exposures tend to have shorter tenors than the non-HF long exposures. This seems to be true based on the BIS’s chart of market values:

26 comments (hidden to protect delicate sensibilities)
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Comments (26)

  1. Posted by Anon | December 12, 2011 at 3:23 PM


  2. Posted by Potcallingkettle | December 12, 2011 at 3:24 PM

    This made me chuckle…

    "It’s from the quarterly review of the Bank for International Settlements, which is a delightful hodgepodge of hard-to-read charts, hard-to-read sentences, and general oblique glances at the guts of the global financial system."

  3. Posted by Bandersnatch | December 12, 2011 at 3:24 PM

    There is only a step from the sublime to the ridiculous and you had to take a flying leap.

  4. Posted by Texashedge | December 12, 2011 at 3:31 PM

    Interesting that the least hedged out debt is the unrated stuff. Penis.

  5. Posted by Guest | December 12, 2011 at 3:33 PM

    Matt, go run around a tree, naked, at 186,000 miles/sec.

    –Guy who heard in Physics 102 this is the theoretical equivalent of fucking yourself

  6. Posted by Black | December 12, 2011 at 3:34 PM

    No it didn't

  7. Posted by Sophomoron | December 12, 2011 at 3:38 PM

    I don't know why, but this made me laugh more than anything today so far.

  8. Posted by Guest | December 12, 2011 at 3:39 PM

    Oh no you didn't!

  9. Posted by one | December 12, 2011 at 3:46 PM

    Depends on the size of it.

  10. Posted by JDizzle | December 12, 2011 at 3:48 PM

    What is it with Goldman and paragraph long footnotes?!

  11. Posted by derp | December 12, 2011 at 3:52 PM

    Look At This Effing Chart

  12. Posted by Guest | December 12, 2011 at 4:05 PM

    I find the earth tones soothing. Take note, Levine.

  13. Posted by Bing | December 12, 2011 at 4:12 PM

    If my index finger has to scroll more than 3 times after clicking an article to get to the comments, I know it's a Matt article.

    -Guy who hasn't read who the author of DealBreaker articles is the past couple months due to the genius discovery outlined above

  14. Posted by WCrasher | December 12, 2011 at 4:23 PM

    In the words of the Virgin Mary… Come again?

  15. Posted by Guest | December 12, 2011 at 4:27 PM

    damnit matt

  16. Posted by guest | December 12, 2011 at 4:30 PM

    And we would have gotten away with it too, if it weren't for that meddling Matt Levine!

    – not a single shadow banker

  17. Posted by Yakiddinme | December 12, 2011 at 4:44 PM

    Sad to say, I enjoyed it. Whatever Matt has, it's contagious.

    I have to lie down for a bit.

  18. Posted by VonSloneker | December 12, 2011 at 5:42 PM

    "Despite the acronym"??? Fuck you Matt…we are a critical cog in the global banking machine.

    I am somebody dammit!

    – Cash McMogulson, VP & BSD (the big swinging kind), Flatbush Bancorp

  19. Posted by guest | December 12, 2011 at 6:16 PM

    It's interesting because there's always been an element of moral hazard in the banking business–if someone is asking you to lend them money with an asset they own as security, there's always a risk that they're trying to put one over on you by getting you to lend them more than the asset is really worth. But, in traditional banking, there are a lot of other reasons why that person would want to sell you their credit risk–most notably, that they're getting actual cash up front. Banks sourcing credit risk by taking the other side of CDS trades with hedge funds pretty much just isolates the moral hazard side.

  20. Posted by Nerd from the 90s | December 12, 2011 at 7:07 PM


    I keep hitting the arrow keys, but I am unable to make the blocks turn for a Tetris. Also the cool music isn't working. Please fix this.

  21. Posted by Guest | December 12, 2011 at 8:38 PM

    Thanks for the clever tags.

  22. Posted by Cosmo | December 12, 2011 at 9:27 PM

    Matt, do you have a going problem?

    It could be that you have a GROWING problem.

    -The Assman

  23. Posted by FinneganKristiansen | December 13, 2011 at 12:15 AM

    BIS reading material>Playboy reading material


  24. Posted by Billy Batts | December 13, 2011 at 4:06 AM

    get your shine box.

  25. Posted by Guest | December 13, 2011 at 7:57 AM

    How could it be hazardous if one has no morals?

  26. Posted by HFguy | December 13, 2011 at 11:17 AM

    which is a delightful hodgepodge of hard-to-read charts, hard-to-read sentences, and general oblique glances at the guts of the global financial system. It is both glancing and gutsy. There are reams of tables.

    Looks like BIS is talking about you Matt