The thing about antitrust law is that it’s so understandable. Not in the sense that a human can easily understand antitrust law, particularly, just that it’s easy to understand where the people who violate it are coming from.1 This EU antitrust case against 13 banks for “colluding to prevent the lucrative global business of trading credit derivatives from moving onto regulated exchanges and away from markets controlled by the banks themselves,” for instance. Like, here you are in 2006 or whatever, and you’re a big bank, and you’ve built yourself a nice little business buying and selling credit default swaps. This generates information and that information is useful; it’s even more useful if you share it with your other CDS-trading friends. So you and your big-bank friends and your ISDA and your Markit get together to share trade data, just like those guys did under that buttonwood tree that one time. Once you’ve got trade data, for instance, you can make an index, and so you can trade index CDS, which means you can move from having a weird niche product to a macro credit product, and it is good. Also you can gouge customers because, y’know, it’s OTC and stuff.

Anyway one day an exchange comes to you and says “we’d like to take all your data and use it to massively undercut you on price and drive you out of this lucrative little business you got here, whaddaya say?” And so obviously you say no. Read more »

  • 26 Mar 2013 at 5:42 PM

ISDAt Wrong?

The European Union will be very cross if it finds out that the International Swaps and Derivatives Association conspired with its members to keep out would-be members. Read more »

  • 11 Mar 2013 at 4:15 PM

CDS Market Almost Ready For Another Greek Default

Last week ISDA, who are in charge of credit default swaps, circulated some proposed changes to CDS to account for all the Greek, Argentine, SNS, everything unpleasantness. This prompted me to try out my one journalistic technique – calling1 ISDA and asking them to send me a copy – but they declined, so we’ll just rely on this research note from JPMorgan’s Saul Doctor and Danny White. Here’s the gist:2

ISDA will publish a list of “Package Observable Bonds” (POBs) based on size, liquidity, maturity and governing law. The proposals suggest that there could be one domestic and one international law bond in each of the following silos – a) 1-3 years, b) 3-12 years, c) 12-30 years – based on a set of rules that determine the largest and most frequently traded bond in each silo. An initial POB will remain as such unless, prior to the Credit Event, it no longer meets the deliverability criteria, is called/matures, or is reduced below a threshold. New bonds would be added when a particular bucket is empty.

If a Credit Event occurs (Restructuring or other Credit Event) and a POB has been restructured into a package, then that package, in its entirety, will be deliverable into the auction. For example if a POB with a notional of $100m is written down by 50% and the remaining portion converted into 50 shares, then the 50 shares could be delivered against $100m of CDS. If there is more than one package on offer, then the one that has the highest subscribers will be chosen. All obligations meeting the deliverability criteria remain deliverable as long as they were issued prior to the Credit Event.

So lots of people have been calling for this for a long time – me least of all, but also real people like the Managed Funds Association and Darrell Duffie. But you get a sense from that summary of how it’s more complicated than dopes like me think. Read more »

  • 08 Mar 2012 at 4:54 PM

So Maybe Greek CDS Will Be More Than Fine?

Gaaaaaaaaaaaaaaaah Greece.

Okay so all systems appear to be go on the Greek debt exchange, which means its time to decide What This Means, and, I just. Really. Greece. Come on. All I want is to talk about 13D reporting requirements, and now I have to pay attention to Portugal? No. Just no.*

Still here is arguably a fun factoid:

On Wednesday, Swiss bank UBS AG started quoting a “gray market” in new Greek sovereign bonds … using as a guide details of the debt swap Greece has put on the table for private investors to accept until Thursday evening. The “bid” price for a batch of future Greek bonds due in 2042, or the highest price the dealer was willing to pay, was around 15 cents on the dollar; the “offer” price, or the most the dealer was willing to sell at, was 17 cents on the dollar, the first person said. … The prices quoted by UBS imply that losses private creditors to Greece will take are more like 79% of face value, not the original haircut of 70-75% many had expected.

Yeah but. If you believe this horrible CDS mechanics stuff that various people including me have been yammering about for weeks – here is the best explanation – that means that if for some reason you had the foresight to be long Greek bonds and hold CDS against them you’d end up with a package worth (1) 21 on the bonds and (2) 83 on the CDS (assuming that the 17 offer for the 2042 bonds represents a real price for the cheapest-to-deliver new bond in the Greek auction) for (3) 104 total which is (4) more than par, so you win this particular game, yay. Which you were at risk of losing – a week ago one of our fearless commenters spotted the longest new bonds at 25ish vs. 24ish for the old-bond-y package, for a total of 99 for the hedged holder – losing 1 point versus par.** Read more »

ISDA decided today that there has been no credit event for purposes of Greek CDS. Obvs! And by “obvs!” I mean what I said the other day, which is that with 100% certainty there’s been no credit event yet, but with 100% certainty there will be, so everyone should just chill out.

Except that it seems like that last part may be wrong. So go ahead and panic.

I used to make convertible bonds and some of my time was spent answering questions about what happened to things upon Events. The most popular was: what happens after a merger? If you have a convertible that converts into 10 shares of XYZ stock, but now XYZ is being acquired and each share of XYZ is being acquired for $30 in cash and 4.5 shares of PQR stock and a pony – what happens to the convertible? And the answer I would give usually started with “don’t trouble your pretty little head about it.” Like, it’s fine: you have a convertible that converts into 10 Things, and before the merger each Thing was an XYZ share, and after each Thing is exactly what an XYZ share transformed into, so you convert into $300 and 45 PQR shares and 10 ponies. It just works because it has to work. Economic interests follow without interruption from changes in form; derivative securities poof into derivatives of things that the underlying poofs into. There is no arbitrage!

That assumption is central to doing any sort of derivative work, and it spoiled me a bit. Sometimes people would come up with more complicated scenarios involving dividends, multiple-step transactions, weird splits and spinoffs and sales, etc. etc. And I would generally start from the bias “it has to work, so I am sure the document written in the way that works.” Where “works” means “the economics and intent of the trade are preserved after the change in form.” But of course the document was written by humans, often specifically me, and those humans, often including me, are fallible. So there may well be documents from my former line of work that don’t “work” in the sense that an issuer could do some structural tricks that would screw holders out of their economics – where the derivative doesn’t follow the underlying everywhere it might go. These tricks are unlikely enough that I don’t lose sleep over them. You can’t predict everything.

I sort of assumed that Greek CDS also had to just work but here is Felix Salmon at Reuters saying no. Lisa Pollack at FT Alphaville said something similar a week ago but I could not fathom that she meant it so I read it to mean something else. But she means it, and Felix does too. Go read it but the basic gist of this theory is: Read more »

The Consumer Financial Protection Bureau, the socialist conspiracy politburo set up to allow Elizabeth Warren to terrorize the banks until her Senate seat is ready for her, or something, today released a new model credit card agreement. It’s two pages long and looks sort of comforting and friendly, like a new Facebook competitor or something. Matt Yglesias likes it:

Basically what they did was sit down and try to apply some basic design principles to the question “how can we convey to consumers information about their credit card.” Currently the way credit card agreements are written is more like the reverse, they apply basic design principles to the question “how can we maximize the chances that consumers will neglect something or get confused while meeting our technical legal obligations toward disclosure.” In an increasingly attention-constrained world, these kind of design questions around disclosure rules matter more and more.

I had my doubts that a two-page agreement in a normal font size could convey the level of detail and obfuscation you can get in a good credit card agreement, but I agree with him, this is a nice effort. The way they manage to keep it to two pages is by putting all the definitions on the CFPB web page. So you have a very skeletal document that just fills in basic numeric and economic terms – your APR, how long you have to dispute charges – while all the legalese, and lots of things that have economic effect like how interest is calculated, are squirreled away in definitions that you can find elsewhere.

Now because I was once a derivatives marketer, rather than a human, this made me think of the ISDA documentation system, which basically allows dealers and customers to send each other two-page confirmations documenting their derivatives transactions while all the nasty guts of the agreement are buried elsewhere, in a Master Agreement or in ISDA definitions. And so you get two pages that say things like “Fixed Rate: 1.25%,” which is pretty clear and very efficient, but also things like “Loss and Second Method apply,” which is totally inscrutable. Read more »

  • 05 Aug 2011 at 1:48 PM

Things That May Not Blow Up The World: Derivatives?

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: Read more »