Tuesday, June 2, 2009

major participants in the derivatives market have agreed to what amounts to a significant overhaul of the OTC universe.

TO BE NOTED: From Alphaville:

Wall Street makes significant concessions on OTC derivatives

Apoplectic regulators like CFTC chairman Gary Gensler - on the job for all of a week and already condemning the evils of credit default swaps - ought to welcome the news that major participants in the derivatives market have agreed to what amounts to a significant overhaul of the OTC universe.

Wall Street banks have committed to the following, according to a statement from the New York Fed issued on Tuesday (emphasis FT Alphaville’s):
* Recording all OTC derivatives transactions in trade repositories: Registering the complete universe of OTC derivatives trades in either central counterparties or trade repositories will improve the ability of regulators to monitor the OTC derivatives market and will increase transparency to the public. The signatories have committed to record all of their credit derivatives trades by mid-July and to establish centralized reporting infrastructures for interest rate and equity derivatives.

* Expanding CDS central clearing to customers by mid-December 2009: A key regulatory priority is to extend the risk reduction benefits of CDS Central Counterparties (CCPs) to all market participants. Dealer clearinghouse participants have committed to provide their clients* with access to any viable CDS CCP solution no later than December 15, 2009.

(*By “clients” read “hedge funds”)
* Expanding central clearing to a wider range of OTC derivative products: Market participants have set near-term targets to expand central clearing support for credit and interest rate derivative products. Expanding central clearing support for standardized OTC derivatives instruments will maximize the credit risk reduction and operational efficiency benefits provided through use of prudently managed, financially strong and regulated CCPs.

* Strengthening counterparty risk management: Major dealers have committed to implement daily reconciliation of portfolios, a requisite practice for robust counterparty credit risk management, by June 30, 2009. In addition, by September 30, 2009, market participants will publish a standard mechanism for timely and fair resolution of valuation disputes.

* Establishing broad-based and transparent industry governance: The industry commits to enhance its newly-established governance structure to ensure that a broad range of market participants will be included in open, transparent decision-making processes that fairly balance the interests of dealers and their customers.

* Continuing to drive operational performance improvements: Market participants have committed to improve operations in four key areas: matching trades on trade date, increased automation, increased standardization and continued reduction of trade confirmation backlogs.

Of course, not all of these are new - dealers have been promised to reduce trade confirmation backlogs for the better part of a decade - but they are notably more specific. Crucially, this is the first time industry participants have set dates and timelines for achieving their various “operational efficiencies.”

Wall Street’s letter to the Fed laying out its commitments is here; a summary (in handy table format) is here.

Related links:
BlueMountain set to earn $817m on CDS - Bloomberg
Central counterparties and CDS risk, a contrarian argument - FT Alphaville
US calls for OTC derivatives regulation - FT


Don the libertarian Democrat Jun 2 23:02
I'd like to know how this would help in a panic. The reason that CDSs and CDOs froze was because they were sitting right on the bottom of the Flight to Safety totem pole. In other words, in a Flight to Safety, they lost a good part of their worth, especially as compared to other assets. That left the owners of them in a quandary. Whether to sell or hold onto them. The crisis was a huge disparity between bid and ask. That will happen next time as well, if we have a Flight to Safety. The reason is simple: Safe is relative to other assets and the financial context. You cannot stop this reordering and revaluation of assets in a panic. You can only hope to smooth it out. This might help marginally, but, unless the assets are immediately callable, I don't see how.

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