The thing about useful stuff is

Japan's CCP connundrum Monday, March 14, 2011

Derivatives Week 14th March 2011 edition is reporting that Japan's Regulators are seeking to provide clearing members with limited liability at the same time as preserving the local law which precludes a CCP from going bust.

The reported solution for who should pick up losses in the event of a default exhausting the resources of the CCP, which includes capped contributions of surviving members, is to declear trades back to their original counterparties.

This is an awful solution, widely rejected in almost all major CCPs, for several reasons.

Firstly, it removes certainty from clearing. As a consequence, counterparties will retain a contingent exposure to their original counterparty, with a consequential capital requirement.

Secondly, in most CCPs, trades are offset with each other to create net positions with the CCP. Under this model, one clearly cannot net trades since preserving the identity of the original counterparty is essential if trades are to ever be re-allocated back. As a result, whilst one may have exited a position some months/years ago, a potential exposure remains if those trades are ever unwound by the CCP to revert back to a bilateral exposure. To close such an exposure in the ordinary course of business, one may have to do offsetting trades with the original counterparty, but even that may not suffice depending upon how the CCP determination of unallocated trades works.

Whilst members cannot be exposed to an unlimited liability in order to keep a CCP afloat, and the possibility of a CCP failure sends terror into the heart of regulators, operating contingent clearing simply creates other unpalatable problems.

I sincerely hope that the groups working on this will come up with a more palatable solution, hamstrung as they are by the notion that a CCP may not go bust.

Labels: auction, CCP, CDS, Credit default swap, Japan, member default

posted by John Wilson @ 10:05 AM Permanent Link ,

newsvine reddit

Steve Eisman of Front Point Partners called "spoof" on CDOs Tuesday, December 02, 2008

RAMONA, CA - OCTOBER 30: A real estate for sa...

Image by Getty Images via DaylifeMotleyFool has an interesting piece with Michael Lewis (Liars Poker fame), who talks about the huge sums Steve Eisman made for his funds by spotting the lunacy surrounding certain Collateralised Debt Obligations [CDOs] as well as Mortgage Backed Securities [MBS] and shorting them via credit default swaps. In essence, he paid a small annual premium to an investment bank as insurance against these instruments defaulting, in the expectation that they would collapse. Once these assets began to implode, the price of the CDS protection rocketed and he was able to profit, without evening having to wait for default to occur.

In the piece, Lewis recounts that

"Eisman called S&P, the ratings agency, and said, Look, I know you are rating these things AAA, and your model says they are AAA, but what happens if real estate prices go down? And the guys says, Actually there is no place in their model to put a negative number. I can't tell you what happens when real estate prices go down."

So much for stress testing.

Labels: CDS, Collateralised debt obligation, MBS, Standard and Poor

posted by John Wilson @ 2:42 PM Permanent Link ,

newsvine reddit

CDS losses are going to sink some funds Monday, October 06, 2008

With a number of financial institutions going under, receiving state aid or being nationalised, large payouts under credit default swaps ("CDS") are looming since these constitute credit events under any normal contract.

Payouts under CDS contracts are typically determined via an auction for the debt - the deficit between the auction price and par being the payout. This week defaulted credit derivatives linked to Fannie Mae and Freddie Mac were settled at 92 to 93 cents in the dollar. With up to $500bn of credit derivatives linked to them, this could mean pay-outs of $35-40bn by sellers of default protection.

Due to the OTC nature of CDS deals, the identity of the end holders of these losses i.e. the "insurers", are not a matter of public record. Hence, worries abound regarding who will have to absorb these losses and their ability to settle the claims. These concerns are further fuelling the panic in the markets since it could result in further collapses. Hedge funds, insurers and banks are all potential "victims".

Labels: CDS, Credit default swap, Credit derivative

posted by John Wilson @ 9:07 PM Permanent Link ,

newsvine reddit

Freddie Mac CDS payout Monday, September 08, 2008

WASHINGTON - JULY 11: U.S. Secretary of En...

Image by Getty Images via Daylife Wow - Bloomberg is reporting that Investors may be forced to unwind contracts protecting $1.47 trillion of Fannie Mae and Freddie Mac bonds against default after the U.S. government seized control of the companies in a bid to bolster the housing market.

13 major CDS dealers agreed unanimously that the rescue constitutes a credit event triggering payment or delivery of the companies' bonds, the Market makers for the privately traded contracts will discuss how to settle them in a conference call at 11 a.m. in New York.

This will be an enormous settlement undertaking without the aid of a centralised infrastructure to orchestrate it. In simple terms, buyers of CDS will either be required to deliver the bonds to the CDS sellers in exchange for the par value of the bonds in cash or the seller will pay the buyer the difference between the par value and the market price of the bonds.

Fannie Mae 5yr CDS premiums fell from a record high of 364 basis points on Aug. 20 to close on Sept. 5 at 233 i.e. $233,000 annually to protect $10 million in bonds from default.

Labels: CDS, Fannie Mae, Freddie Mac

posted by John Wilson @ 1:41 PM Permanent Link ,

newsvine reddit

A deal too good to miss? Wednesday, March 19, 2008

The panic in financial market is causing violent swings in prices. At the top and bottom of these, apparently even cautious investors are starting to re-enter the market to take advantage of the overshoot and comparative value implied.

For instance, the price of a 5 year Credit Default Swap on iTraxx Europe hit than 160 basis points this week. This means anybody selling protection on £10m would earn £160,000 a year. Of course, you face the potential of paying out £10m were the index constituents to default. However, if you believe that prices are very frothy and will return to levels consistent with the past, then you could close you CDS position out as prices fall i.e. you receive £160k today but if you can cover this risk in a month's time for say £140,000, then you have a clear £20k profit.

Similarly, the credit spreads on some banks such as HBOS and Lehmans, were at levels typically associated with Nigeria. In comparative value terms, does that make sense?

Labels: CDS, credit crunch, markets

posted by John Wilson @ 10:32 AM Permanent Link ,

newsvine reddit