cds

  • 22 Feb 2012 at 6:29 PM

One Last Greek CDS Post Before It All Goes Poof

By Matt Levine

One of the side benefits of Greece taking whatever somewhat irreversible steps it is now taking is that something will happen to CDS written on existing Greek debt and that will mean that we can stop talking about what will happen to CDS written on existing Greek debt and start talking about more interesting things like quasi-CDS written by the EFSF on shaky Eurozone government debt.

For now, though, we’ve got at least a few more weeks of surprisingly and unsurprisingly ill-informed fretting that triggering the $4bn of Greek CDS will Bring Down The Entire Global Financial System. That seems sort of silly because notionals aren’t that big, mark-to-market collateral is mostly being posted, and at this point the marks are pretty close to what you’ll get from Greece so it doesn’t look like there’s tons of unknown unrecognized losses lurking out there.

On the other hand, we’re mostly through with the speculation that not triggering Greek CDS will Prove That CDS Is Worthless and thereby Bring Down The Entire Global Financial System, so that’s nice. The reason that’s mostly over is that it sure looks like Greek CDS will in fact trigger, as Athens has moved to adopt a collective action clause that will flip the Greek restructuring from “voluntary, heh heh heh” to “involuntary” and thus trigger the ISDA restructuring event definition. You can argue that the mechanics of the cash settlement auction will mildly screw CDS holders but I’m not so sure, and in any case this is pretty solidly in the category of derivatives nerdery rather than Bring Down The etc. Continue reading »

  • 10 Jan 2012 at 7:16 PM

Jerks To Get Paid More Than Nice People

By Matt Levine

No, not your comp, though probably that too. The Times and the Journal check in today on the state of play in Greece and it’s kind of how you might expect. From the Times:

For months now, Greece has desperately been trying to persuade its private-sector creditors that it is in their interest to exchange their existing Greek bonds for longer-term securities and accept about a 50 percent loss as part of the bargain. The negotiations are known as the private sector involvement, or P.S.I.

A few months ago the deal looked doable, as the large European banks that held must of this debt, estimated to be around €200 billion, recognized that it was probably a better alternative than default, which could cost them everything. Moreover, the banks were sensitive to political pressure from their home countries, where they have a big stake in remaining on good terms with the government and key officials.

But as the talks have dragged on, many of these banks, especially big holders in France and Germany, have sold their holdings. Among the buyers have been hedge funds and other independent investors who are now questioning why they should accept a loss, known as a haircut, if, as it turns out, the deal remains voluntary in nature and Greece keeps paying interest on its debt.

And as the number of such hedge funds holding Greek debt has grown, so has their ability to forestall a restructuring agreement, thus bringing them closer to being able cash in on their high-stakes gambit.

From the Journal:

There are many potential pitfalls, each, in a way, leading to another pitfall-strewn path.

Ha! Also ha! on the Times’s sort of strange description of what the hedge funds are up to, though what they’re up to doesn’t itself sound strange. If I were a hedge fund here is what I would do:

1. Not buy bonds and then later “question why I should accept a loss”;
2. rather, buy bonds because I plan to get a gain;
3. specifically because I’m planning to be all “oh, man, I must have lost that consent solicitation in the mail, could you send it again” and otherwise generally stall on this voluntary offer until my bonds come due and are paid off with bailout money (maybe?);
4. or, alternatively, because I’ve got CDS against those bonds and have no intention whatsoever of voluntarily exchanging them and voiding my protection.

That or “stay the hell away from this situation.” But, like, the above is at least a strategy. Now, if I were a French or German bank here is what I would do: Continue reading »

  • 10 Jan 2012 at 1:18 PM

The SEC Wants Banks To Tell You Where They’re Hiding Their Terrible European Exposure

By Matt Levine

You can’t argue too much with the SEC’s gentle suggestion that maybe banks should tell people, in a consistent format, what’s up with their European debt exposure. It seems to be a thing that is on investors’ minds, so why not have the SEC try to put their minds at ease:

“Our staff has been working with banks to improve their disclosure about sovereign-debt exposure for several months,” SEC Chairman Mary Schapiro said in a written statement released Monday. “Even so, I understand this is an area of focus and uncertainty that could really benefit from further transparency and consistency, particularly as we head into annual reporting season. I think the staff’s guidance should help achieve that goal.”

Yep. The release is here and contains a good list of things you might want to know, including things like “The effects of credit default protection purchased separately by counterparty and country,” “The fair value and notional value of the purchased credit protection,” and “The types of counterparties that the credit protection was purchased from and an indication of the counterparty’s credit quality.” It’s not exactly a standardized form for disclosure that will allow everyone to do detailed comparison among the banks and/or sleep well at night, but it should at least shame people into giving reasonably detailed substantive information so that when your bank blows up you at least won’t be surprised at which European country did it. That seems good. It even seems like what the SEC is supposed to do.

The Journal, ever fair, finds a token objector, sort of: Continue reading »

  • 12 Dec 2011 at 3:12 PM

New Report Features CDS And Shadow Banking, Is Not In The Sunday Times

By Matt Levine

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. Continue reading »

  • 23 Nov 2011 at 2:31 PM
  • CDS

The New York Fed Is Not Buying Any Crazy CDS Conspiracy Theories

By Matt Levine

I have a hazy memory of those exciting days in 2008 and 2009 when the world was going to be remade, shiny and new, with all of the risk gone from the financial system. The way we were going to get rid of all the risk, as I recall, was with the Volcker Rule and transparency around derivatives trading. That way, no shady prop trading of derivatives could blow up our financial system again, as long as you don’t think too hard about the word “again.”

Anyway, how’d it work out? Well, the New York Fed, who you’d think would have something to say about all of that, put up a note today about transparency in CDS trading. Their feelings about transparency in CDS trading can be summed up as “meh, we could take or leave transparency in CDS trading.” Specifically:

Data on trading activity in the CDS market paint a mixed picture of the likely impact of trade reporting rules. The high levels of standardization of trading and contractual terms are apt to enhance the ability of market participants and policymakers to interpret the reported transactions. However, the low frequency of trading diminishes the potential price discovery benefits of real-time trade reporting.

So real-time trade reporting won’t cause undue problems for dealers because most CDS is in fact a pretty standardized product that can be reported on a comparable basis. There’s “an impressively high level of standardization of contract terms and market conventions” in single-name CDS, including things like standardized coupons, payment dates, and the fact that “47 percent of single-name transactions and 84 percent of index trades … are in the five-year tenor.”

But no one will care about that reporting, because there just isn’t that much trading. This is based on a longer New York Fed paper from earlier this year, which we’ve mentioned before, but this graph is worthy of another look:

You could quibble with the data design (next graph I do will have three color-coded categories, “big numbers,” “medium numbers,” and “small numbers,” and they will be interspersed randomly across the graph!) but let. it. go. Instead let’s talk about the fact that for something like 1,200 of the 1,500-ish corporate CDS reference entities, the average trading frequency is less than once per day. Continue reading »

What Are You Paying Ratings Agencies Zero Dollars For, Anyway?

By Matt Levine

Fitch released a report today saying “ohmygod banks Europe” and the market went down and maybe there’s a causal link, whatever.

The report mostly takes notice of US banks’ European exposures in general, and the mystery of net versus gross derivatives exposure in particular, in which one asks “if Bank A sells CDS on $100bn of Italian debt to Bank B, and buys CDS on $100bn of Italian debt from Bank C, then when things go pear-shaped is it on the hook for zero (because it has no ‘net exposure’) or $100bn (because Bank C goes belly-up) or somewhere in between (because of collateral, sub-1 correlations, etc.)?”

It’s an important question: net exposures are manageable, gross exposures are terrifying, and there are legitimate questions about whether in a stress case the netting could break down. Various people who are smarter than me have tried to triangulate around parts of the answer using public data.

I don’t know the answer and doubt I’ll find out, though my gut is that netting should kind of sort of mostly work (I find Graph 5B of this, and the definition of “bilateral netting,” oddly comforting). What troubles me today, though, is that Fitch has no clearer answer than I do. Continue reading »

  • 08 Nov 2011 at 11:04 AM

In Which Gretchen Morgenson Gets Credit For Understanding Derivatives

By Matt Levine

Here’s a trade. I’ve got these bonds, see? I will sell them to you. You will pay me $100 and get $100 face amount of bonds (if you like, you can get $80 or $120 face value of bonds, depending on where the bonds are trading – but let’s make them par bonds, to keep things simple).

But we’re not done. I will also write a contract under which, if these bonds default prior to maturity, you can hand them back to me, and I will give you back your $100. My loss will be the $100, minus whatever I can get from the defaulted bonds. In exchange for this commitment from me, you will pay me a running payment. That payment will be equal to (1) the coupon payment on the bonds (remember, they’re par bonds, for simplicity), minus (2) a risk-free rate of equal maturity, plus or minus (3) a basis driven by the cost of funding and differences in relative demand for different sorts of payments. Let’s say the bonds pay 6%, the relevant risk-free rate is 2%, and our funding costs are 50bps. Then you pay me 350bps running. The payments, and the contract, expire at maturity of the underlying bond.

Ah, but you have an objection. You’re paying me this running payment in exchange for my promise to cash you out if the bonds default – but how do you know I’m good for it? Fair. Why don’t we do this. I will collateralize that promise. At first my collateral will be quite small, since default is unlikely so the expected value of my promise is small, but it will go up if the bonds decline in value and/or my credit deteriorates.

Okay, fine, now we’ve got a deal. So … what is our deal? I’ve sold you bonds in a spot sale – that much seems clear – and we’ve got … this other thing, this contract. What do we call that contract?
Continue reading »