Derivatives

  • 16 Sep 2011 at 2:59 PM
  • Banks

Let’s Just Go Ahead And Assume That Greek Letters = Evil

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The fact that one lovable rogue in London misplaced UBS’s bonus pool for the year has people talking again about the Volcker rule, which would ban proprietary trading at banks. I still don’t really understand that, and I’m not alone. Here is a thing about the Volcker rule and “Delta desks” (what?):

Yet the definition of what constitutes proprietary trading can be fuzzy. Many on Wall Street consider proprietary trading, or prop trading, to involve only trades made by dedicated traders who are using the bank’s capital and do not have access to client information. The trading done on Delta desks, they contend, is done on behalf of clients.

Those boundaries, however, can blur. A bank may buy a derivative or security from a client in order to make a market, then decide it is worth hanging onto, turning it into a proprietary bet.

The Volcker rule of the Dodd-Frank act is named after Paul A. Volcker, the former Federal Reserve chairman who proposed it. It is intended to prevent American banks from taking on too much risk. The fine print, however, has yet to be worked out, and regulators are debating just how comprehensive to make the definition of proprietary.

This is sort of correct but nicely embodies the conceptual confusion that I suspect lies behind the Volcker rule. Let’s spend four hours talking about it, shall we?
Continue reading »

  • 08 Sep 2011 at 3:39 PM

Goldman Would Be Happy To Take Some Correlation Off Your Hands

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Goldman Sachs Portfolio Strategy Research has a fascinating research piece out today on equity correlation markets. It does good work as a piece of research because (1) if you like equity derivatives, it’s got all sorts of fun charts and technical stuff and (2) if you don’t, it’s got a hard sell: trade equity corr with Goldman!

There are many market participants that are affected by the level of equity correlations but are not yet trading correlation actively. So far, the market has been primarily one-way; banks selling correlation and hedge funds and proprietary trading desks buying it for the positive carry. We believe that the correlation market can become a new area in which institutional investors could add alpha.

The equity correlation market, which is pretty niche-y, lets investors bet on how dispersed the returns of stocks will be in the future. And the trade to make now, Goldman thinks, is to sell correlation, which “appears attractive,” meaning that current implied correlation is much higher than they think realized correlation will be in the future: Continue reading »

  • 05 Aug 2011 at 1:48 PM

Things That May Not Blow Up The World: Derivatives?

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As Marc Faber prepares for war and Europe tries to figure out Italy, derivatives trade group ISDA wants you to know that one thing is safe: OTC derivatives.

This might surprise you, since they’ve been famously called “weapons of mass destruction” and since counterparty risk in the over-the-counter derivatives market has been a big motivating force behind regulatory changes. But ISDA concludes that that risk is no big deal:

The [report] shows very limited counterparty credit losses at the bank level. Since 2007, losses on OTC derivatives positions in the US banking system due to counterparty defaults have totaled less than $2.7 billion, a period that includes the failures of over 350 banks with assets of more than $600 billion, as well as the failures of firms such as Lehman Brothers, Fannie Mae and Freddie Mac.

The ISDA report includes this chart, from the Office of the Comptroller of the Currency, showing credit losses (how much U.S. banks actually lost on their derivatives counterparties not paying what they owed) and net credit exposures (credit risk as a percentage of outstanding notionals):

Losses peaked in 1Q09 and have never been more than $1bn in a quarter, even when Lehman filed. Which suggests that maybe derivatives counterparty risk really is no big deal? That’s ISDA’s claim – that, and that additional Dodd-Frank regulation of derivatives won’t help much.

Of course this report has some caveats: Continue reading »

  • 27 Jun 2011 at 9:33 AM

Larry Fink Is Writing A Dictionary

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Efforts to create the first electronic “dictionary” defining derivatives and other financial instruments universally have moved ahead with the creation by US regulators of a committee to help develop it made up of BlackRock, the investment manager, CME Group, the derivatives exchange, and Google.
Global Derivatives Lexicon Edges On [FT via HNM]

  • 26 May 2010 at 4:50 PM

Blanche Lincoln’s Derivatives Provision All But Dead Now

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Blanche Lincoln’s famed derivatives legislation, which would basically prevent any big bank from ever trading CDS again, has already been chastised by Barney Frank. Now, a senior Treasury official has essentially delivered another blow to the Lincoln legislation.

In a briefing for reporters today, Assistant Treasury Secretary Michael Barr said the derivatives rules were not part of the administration’s four “core objectives” for financial reform. Translation: The Lincoln legislation can die a slow death for all we care. Continue reading »

  • 25 May 2010 at 1:24 PM

Barney Frank Deals a Death Blow to Derivatives Reform

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Barney Frank just delivered a speech at Compliance Week’s annual conference in Washington D.C. and he seems to have confirmed what Goldman Sachs analysts told us yesterday – new legislation that forces banks to spin-off their derivatives business probably won’t make it into the final financial reform bill. Continue reading »

  • 21 May 2010 at 4:06 PM

Blanche Lincoln Ain’t Backing Down from Derivatives Overhaul

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Sen. Blanche Lincoln, Arkansas Democrat, was able to push her controversial derivatives amendment into the financial regulatory reform bill yesterday, despite threats from Wall Street. And any banker that thinks Blanche is going to back off derivatives reform after she wins the Arkansas primary runoff on June 8 has no clue how hard-nosed she really is.

“Suggestions that my provisions are the result of the current political climate are completely baseless,” Ms. Lincoln told DealBook. “I am not concerned about politics when Americans are depending on us to ensure that our financial system is secure.”

We’ll see about that. In the meantime, we wonder if Sen. Lincoln is tough enough to do a Dunkaroo – an old Arkansas drinking tradition perfected in Little Rock. Continue reading »