Europe to Crack Down on Derivatives Risk

The European Commission said on Friday it intends to make proposals to control risks in the $60 trillion credit derivatives market, seen as one of the causes of the worst financial crisis in 80 years.

"Regulators need to have a much better view of where the real risks in these instruments lie," EU Internal Market Commissioner Charlie McCreevy said in a statement.

"I would like to have by the end of this year concrete proposals as to how the risks from credit derivatives can be mitigated," McCreevy said.

The contracts are traded over-the-counter or off an exchange, and are therefore more lightly regulated with risks less controlled.

Contracts could be standardised more, McCreevy said.

"But there is a far more pressing need and that is to have a central clearing counterparty for these derivatives," he said.

Standardised derivatives are already traded and cleared on exchanges such as Eurex, Liffe and the CME. But the off-exchange market, with its bespoke contracts, is far bigger.
One sector, credit default swaps (CDS) are "insurance" against a company defaulting and have been widely traded, with poor records of where these contracts have ended up or whether the owners have the capital to honour them if needed.

Central clearing for credit derivatives such as CDS contracts was particularly urgent, McCreevy said.

"No one is able to say how these swaps will unwind. Regulators have little sight of potential liabilities that could be building up for individual participants," he added.

McCreevy's moves mirror those in the United States where the Securities and Exchange Commission and Federal Reserve Chairman Ben Bernanke have said there should be more oversight of credit derivatives.

The Commodity and Futures Trading Commission, which oversees derivatives in the United States, has said centralised clearing of contracts is an "immediate" step that could be taken to cut risk.

Liffe said on Thursday it has struck a deal with Markit Group, a financial information provider, to launch exchange-traded credit default swaps that are cleared centrally.

Publish Date: October 17, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=211201590

Wall Street Systems launches post-trade processing utility

Wall Street Systems has launched a "pay as you go" post-trade processing utility for FX cash, FX derivatives, money markets, vanilla interest rate derivatives, and listed futures and options.

Launched in conjunction with industry partners Currenex, Bloomberg, Icap and Logicscope, the Electronic Settlement Network (ESN) provides an outsourced, on-demand processing hub for financial institutions, eliminating the need for large investments in IT infrastructure, upfront software license fees and ongoing operating costs.

Its services span the entire post trade lifecycle including position management, P&L, deal confirmation, settlement, credit exposure, cash management, scenario and risk analysis, accounting, reconciliation, overall workflow and reporting.

Wall Street Systems' last foray into providing outsourced post-trade processing services was the Settlement & Operations Clearing eXchange (SOCX) - a joint venture with Deutsche Bank, that launched in 2001 but failed to win any clients. The venture closed when Deutsche Bank took its processing back in-house in 2003.

Tony White, managing director of product and research and development at Wall Street Systems, says the vendor learned a few important lessons from that experience.

"The costs and risks of many outsourcing arrangements are seen as being too high, so we've gone with a pay-as-you-go model for ESN, where we assume all the risk," says White.

"Having a bank involved as an owner of the utility is also not the best thing, as other banks don't want to benefit their competitor by helping reduce their cost of processing," he says. "And SOCX was also too technical, which turned off a lot of the tier two banks that could have been clients. So we've tried to make connectivity and client on-boarding as easy as possible by partnering with Logicscope."

Wall Street Systems also partnered with Logicscope last year to add post-trade notification and STP capabilities to its Wallstreet FX ASP hosted foreign exchange dealing system.

Wall Street Systems claims the on-demand ESN service sets the benchmark for the lowest trade processing costs in the industry. "It's coincidentally good timing to be launching such a service," says White. "With the current restructuring in the financial services industry there is an increased cost focus and a shift back to vanilla products. Tier two banks are also aware that there's no competitive advantage in trade processing."

Rajeena Brar, consultant at Pierre Audoin Consultants (PAC) says: "As FX further establishes itself as a fast-growing asset class, a utility model such as this is a natural evolution for the industry. This has been evidenced by the adoption of shared service models in other sectors, which have drastically improved operational efficiencies and costs."

On the issue of cost, White believes that lots of banks are deluding themselves about the true cost of processing, particularly small banks that don't have the volume required to run a cost-efficient processing operation.

While individual bank circumstances will vary, Wall Street Systems claims that ESN can reduce average cost per trade from $25 to under $1.

The company currently has three pilot customers that have been trialling the service - describes as "tier two banks", although one of them is among the top 10 banks in the US. In terms of geographic focus, the service is initially targeted at North American and European firms. The vendor hopes to have five clients on board by the end of this year and 10 by the end of 2009.

Source URL: http://www.finextra.com/fullstory.asp?id=19133

Bank of New York Mellon Chosen to Help Manage $700 Billion Bailout

The Bank of New York Mellon today confirmed that it has been selected by the U.S. Department of the Treasury to provide a range of services to support the government's Troubled Asset Relief Program authorized under the Emergency Economic Stabilization Act (aka the $700 billion bailout bill).

Treasury has hired the company to provide the accounting of record for the portfolio, hold all cash and assets in the portfolio, provide for pricing and asset valuation services and assist with other related services. The Bank of New York Mellon will serve as auction manager and conduct reverse auctions for the troubled assets.

The company's support will be administered through its securities servicing businesses.

"Our market leadership and experience have given us a keen understanding of the challenges facing the U.S. Treasury in these extraordinary times," said Robert P. Kelly, chairman and chief executive officer of The Bank of New York Mellon. "We will immediately deploy our resources and expertise, joining the team of public and private organizations that are working hard to earn the trust of the American taxpayers and to address the ongoing economic challenges."

The Bank of New York Mellon has a long history of partnering with the U.S. government to drive the development of the markets. Its founder, Alexander Hamilton, was the first Secretary of the Treasury. The company made the first-ever loan to the U.S. government and provided financing for the construction of the Erie Canal. Another key company leader, Andrew Mellon, served as Secretary of the Treasury during three presidential administrations.

Today, The Bank of New York Mellon has $23 trillion in assets under custody and administration, more than $1.1 trillion in assets under management and services $12 trillion in outstanding debt

Publish Date: Oct 14, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=211200501

NY Fed Calls Friday Meeting for CDS Players to Determine Clearing House

The Federal Reserve Bank of New York said Wednesday it has summoned participants in the $55 trillion credit derivatives market to a meeting on Friday, which sources say will focus on determining which clearing house the market will support.

Calls for regulation and centralized clearing of credit default swap trades have gathered steam in the wake of Lehman Brothers' failure last month.

Critics charge that credit default swaps are central to the spreading fears in the markets and pose systemic risks, as the market's private nature makes it impossible to know the size of a counterparty's exposures and where they are distributed.

A central clearinghouse will remove the risk of a large counterparty failure.

There are several competing plans to launch a clearinghouse under way. But the Fed wants one clearing house to win widespread support, sources familiar with the meeting said.

The Fed hosted a meeting Tuesday to discuss the matter, but found no clear winner, sources said. The meeting on Friday will continue the discussions.

The Chicago Mercantile Exchange, or CME Group Inc , and Citadel Investment Group unveiled plans on Tuesday for an electronic exchange for credit default swaps, which they said would be integrated with a central clearinghouse.

The initiative is competing against dealer-owned Clearing Corp, which will act as a central counterparty to the market and is expected to launch by year-end.

Dealers have been hesitant to support exchange trading in the past as the private market is more profitable, and the liquidity they provide may be key to the success of exchange trading.
CME and Citadel are offering equity stakes in their joint venture to major market participants to encourage their support for the exchange.

Meanwhile, NYSE Euronext's Liffe unit has also said it will launch its BClear OTC clearing house facility in the fourth quarter.

U.S. business television channel CNBC also reported on Monday the Fed was planning talks with the CME and the Intercontinental Exchange, or ICE, on the creation of a credit default swaps exchange.

Publish Date:October 09, 2008
Source URL:http://www.financetech.com/showArticle.jhtml?articleID=210800639

Auction Settles $400 Billion Worth of Lehman-Related CDSs

In an auction held today for the bankrupt Lehman Brothers by the International Swaps and Derivatives Association, Markit and Creditex, $400 billion worth of Lehman-referencing credit default swaps were settled. The final price for the contracts was 8.625%, in other words, sellers of credit-default protection will have to pay holders 91.375 cents on the dollar. (The total amount of cash exchanged will net out to about 2% of that $400 billion notional amount because the participating firms have multiple contracts with each other.) The auction took place electronically on a Creditex trading platform.

At a press conference this afternoon, ISDA executive director and chief executive officer Robert Pickel spoke proudly of the event, saying the auction went smoothly and efficiently, following successful implementation of ISDA's CDS protocol. He noted that auctions for Fannie Mae and Freddie Mac related derivatives took place earlier this week and that upcoming auctions will settle derivatives referencing Washginton Mutual and three Iceland banks.

Pickel spoke glowingly of the CDS market in general. "Despite defaults in recent months, CDS markets remain strong," he said. "CDSs have come under scrutiny and criticism lately, but CDS contracts did not cause any firm to fail. The underlying problem affecting firms is the risks they chose to take on."

Publish Date: October 10, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=211100202

OTC Markets Handle Increased Demand in September

The over the counter (OTC) wholesale financial markets successfully handled increased demand during the month of September, according to ICAP, an interdealer broker. In the OTC spot FX market, average daily electronic broking volumes on ICAP's EBS platform in September reached a new high of US $274.2bn. This is an increase of 43 percent on September 2007. In the 12 months ending September 30, 2008, average daily electronic FX broking volumes on the EBS platform increased by 31 percent over the corresponding period in 2007 to $219.2bn.

Average daily volume in US Treasury products on the BrokerTec platform increased 18 percent year on year in September to $172.8bn. Total average daily electronic broking volumes at ICAP, including spot FX, US repo, EU repo and US Treasury products increased nine percent year on year in September to $903.2bn.

"The OTC financial markets are functioning very well and OTC market participants including banks, brokers, prime brokerage clients and post trade providers, have worked together to respond to the increased volatility. The EBS and BrokerTec platforms continue to deliver orderly, reliable and fair access to highly liquid and transparent markets. The high performance of our e-platforms during recent extreme conditions demonstrates ICAP's key role in the OTC markets and underscores our ability to provide value to our customers at all times," said David Rutter, deputy CEO for ICAP electronic broking, in a press release. Each month ICAP publishes average daily volume data in spot FX, U.S. Treasury and European and U.S. repo products.

Publish Date: October 03, 2008
Source URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=210605541

The Rush to Regulate Credit Default Swaps

It seems like politicians, regulators and even the average Joe on the street now knows something about credit derivatives. These complex instruments are being blamed for the near meltdown in the financial system. No one outside of the credit markets paid much attention to credit default swaps or CDS until they threatened Bear Stearns and Lehman Brothers.

On Monday, New York State Governor David Patterson said his state had the authority to regulate part of the credit default swap market and would require issuers to register as insurance dealers. Patterson told the media that his state’s insurance department would regulate CDS as insurance products in cases where the buyer of the derivative owns the underlying bond.
But the chorus of voices recommending increased regulation of credit default swaps has been growing in recent days, following the bankruptcy of Lehman Brothers, the fall of Fannie Mae and Freddie Mac and the bailout of AIG.

On Tuesday, SEC Chairman Christopher Cox called for giving the agency the authority to regulate credit default swaps. Testifying before the Senate Banking Committee on the turmoil in U.S. credit markets, Cox told Congress “the $58 trillion notional market in credit default swaps— double the amount outstanding in 2006 – is regulated by no one.”

Right now these over-the counterderivatives are not traded on an exchange, and are not regulated by any of the traditional regulators- such as the SEC or CFTC. “Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market,” Cox told the Senate.

It’s believed that the credit derivatives market contributed to the fall of Lehman Brothers and AIG, as the cost to buy protection against a bond default surged and pushed down their stock prices.

But the real danger is that brokers and hedge funds were apparently using credit default swaps to speculate on which financial trading counterparty would default next. They could sell the CDS without owning the underlying bond on which it was based. “Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS,” said Cox in his speech. “This means CDS buyers can ‘naked short’ the debt of companies without restriction.”

Some traders used the credit default swaps to bet on the likelihood of default in the bonds of their trading counterparties, namely Lehman Brothers, AIG and Morgan Stanley. As the cost of buying protection against holding the bonds of banks and brokers surged, traders used that as a signal to short the stocks, which caused the credit agencies to lower their ratings, thereby raising the cost of capital for these companies and sending them into a cash crunch and death spiral. The SEC is concerned that credit derivatives were used to manipulate the pries of securities companies and drive them out of business.

As part of its stepped up enforcement efforts, Cox told Congress, the SEC is conducting a sweeping investigation of market manipulation of financial institutions, focused on broker-dealers and institutional investors with significant trading activity in financial issuers and with positions in credit defaults swaps. It would be easier to conduct the investigation if these instruments were traded electronically on a centralized exchange. But CDSs are for the most part traded over-the-counter, between dealers, banks and asset managers. On the dealer side, Creditex, a business that was owned by the dealers and recently sold to the InterContinental Exchange (ICE) offers an execution platform for use by the dealers.

It’s clear that regulators are now focusing on the need for oversight and transparency in credit derivatives. Usage of CDS has grown dramatically among traditional asset managers and hedge funds, which means they are exposed to the counterparty risk of the investment banks that sold them protection. No doubt, there will be renewed calls for trading credit derivatives on exchanges, which can work for standardized, highly liquid contracts, and for a central clearing counterparty. But what will happen to the more customized instruments, known as bespoke instruments? In a research note published this week, TowerGroup’s Senior Research Director for Investment Management, Dushyant Shahrawat, predicts, “Brokerage firms burned by OTC derivatives like credit default swaps and other esoteric structured products will greatly reduce their involvement in these instruments.” Despite resistance from the dealers, Bloomberg reported yesterday that credit swaps could move to an exchange in order to exist.

In the meantime, politicians are learning more about these instruments and forming quick opinions. Patterson told The New York Times he had not heard of credit default swaps until he read an article in The Economist six months ago. He said he thought they should be regulated by the gaming industry and he equated the derivatives with gambling.

Publish Date: September 25, 2008
Source URL: http://www.advancedtrading.com/blog/archives/2008/09/the_rush_to_reg.html?cid=nl_wallstreettech_daily