swaps - Blog - Global Risk Community2024-03-28T21:05:09Zhttps://globalriskcommunity.com/profiles/blogs/feed/tag/swapsWeapons of Mass Financial Destruction (WMFD)https://globalriskcommunity.com/profiles/blogs/weapons-of-mass-financial-destruction-wmfd2016-01-30T00:11:00.000Z2016-01-30T00:11:00.000ZEnrique Raul Suarezhttps://globalriskcommunity.com/members/EnriqueRaulSuarez<div><p></p><p><a href="{{#staticFileLink}}8028241683,original{{/staticFileLink}}"><img width="400" class="align-center" src="{{#staticFileLink}}8028241683,original{{/staticFileLink}}" alt="8028241683?profile=original" /></a></p><p></p><p class="center" style="text-align:center;"> </p><p class="center" style="text-align:center;"><span class="font-size-4">Weapons of Mass Financial Destruction (WMFD)</span></p><p class="center" style="text-align:center;"></p><p class="center" style="text-align:center;"></p><p class="center" style="text-align:center;">By:</p><p class="center" style="text-align:center;"></p><p class="center" style="text-align:center;"><strong>Bill Holter</strong></p><p class="center"></p><p class="center" style="text-align:center;">Global Research, January 29, 2016</p><p class="center" style="text-align:center;"></p><p>Every once in a while it is a good thing to review something we already know and have known for quite a while. What we’re talking about are derivatives and the very basics of how they work… or not.</p><p>We have seen massive volatility since the Fed raised rates last month.</p><p>The humor (tragedy), admitted to yesterday by the Fed, the 4th quarter saw slowing economies all over the world and “Nobody Really Knows Anything Right Now” !</p><p>I say “humor” because the Fed tightened rates just as the economy was weakening again. Many have said the Fed raised rates at “exactly the wrong time”. History may agree with this, I do not. In fact, there has not been one single day since the end of 2008 the Fed “should have” raised rates simply because of the massive debt embedded in the system and those pesky weapons of mass financial destruction called DERIVATIVES! Higher rates will only serve as a “margin call” in a system with no margin left!</p><p>First, derivatives are generally a zero sum game contract between two parties “betting” on something. They can be looked at as a speculation, a hedge, or even “insurance”. For this missive, let’s look at the “insurance aspect” of derivatives as literally $10′s of trillions in gains and losses have occurred just this month alone worldwide.</p><p>For example and as you know, the price of oil has collapsed. Ignoring the gains and losses directly on oil, let’s look at companies who’s business is oil. Whether it be production, exploration, transport or even “trading”, huge sums of money have been gained or lost depending on which way your bet was. Many oil related companies have CDS (credit default swaps) written against their debt. These contracts have been rising and rising in value as oil has dropped and the possibility of bankruptcies have risen. Huge gains by owners and losses by the “writers” of CDS have accrued.</p><p>This is just ONE AREA as derivatives are everywhere and written just as bookies would regarding almost anything. In fact, CDS is even written on the debt of sovereign governments …including the U.S. Treasury.</p><p>Please think this through for a moment, who, or what “company” could possibly perform and payout the “insurance” to someone who bet (and won) the U.S. Treasury would default? Would anything even be open? If the U.S. Treasury defaulted, would stock or bond markets be open? How about your bank? How about ANYTHING (including your local Walmart)! Do you see where we are going here?</p><p>Now lets talk for a moment about “collateral” as presumably this is what needs to be used or “put up” by the issuers of CDS if their exposure begins to broaden if the contract goes against them. I have spoken many times in the last few years about collateral and specifically the LACK of collateral.</p><p>Whether it be QE in the U.S. or Europe soaking up too many sovereign bonds or systemically nothing left to borrow against, the lack of collateral is a direct problem for derivatives. You see, as a contract moves one way or the other, theoretically the party who is losing needs to post more collateral. It was this inability to post collateral in 2008 by Lehman Bros. that kicked off the problem.</p><p>From a broad perspective, everyone is running down the street naked while assuring everyone else they are “insured”. Greece was even aided into the ECU because they claimed their derivative positions “erased” much of their debt, fat chance!</p><p>In the end, “losers” must pay winners. If losers lose so big as to bankrupt them, the winners will not get paid. Both sides are losers. When this happens on a grand scale, it will be the entire financial system and thus “us” who are the ultimate loser.</p><p>I have a topic to finish with but want to make a statement, then ask a couple of questions first. Someone recently said to me regarding the trek from 2008 to present, “the only thing that has changed since 2008 is that nothing has changed”. I would pretty much agree with this, the policies in place that put us on our knees are still in place, only being implemented with more force. I would also say the biggest change is we now have more debt, more derivatives and much more money supply.</p><p>Please remember, the Fed took all sorts of substandard paper (mortgage backed securities) on to their balance sheet. What has happened to all of this paper? Much of it is non performing but sitting in a dark corner and being ignored …because it HAS TO BE! What would happen if the Fed ever sold any of this paper for a true market value? Banks would have to mark their portfolios down, that’s what! One last question, if this “bad paper” amounts to more than $100 billion in losses (it does, probably by many multiples), what would it mean if the loss was greater than the Fed’s “equity” reportedly now less than $50 billion? Just because the Fed does not ‘fess up to the losses on their books …does not mean the losses do not exist. Going one step further in this thought process, if the Fed admitted to these losses, they would be admitting to a negative net worth! Would you accept an IOU from someone you knew for fact had a negative net worth? I hate to state the obvious but, you do this every single day when you accept dollars for payment!</p><p>One last topic and I’m not 100% positive what it means. Silver flash crashed last night and the morning fix came in .84 cents below where spot was quietly trading on the LBMA <a href="http://www.bulliondesk.com/silver-news/update-silver-market-disarray-after-benchmark-priced-far-below-spot-rate-108129/">http://www.bulliondesk.com/silver-news/update-silver-market-disarray-after-benchmark-priced-far-below-spot-rate-108129/</a> ! My initial reaction was someone needed to “settle” a trade and the price had to be below $14 in order to not trigger something. In fact, it is being said that this anomalous “fix” will not be reversed but will instead stand. Why would this be? Why, if it was a “mistake” would it not be fixed?</p><p>After a five mile afternoon ride to ponder this, I can only come up with two viable scenarios. Scenario A. as I just mentioned above, it is possible some bank, broker or other entity needed to “settle” some sort of contract UNDER $14. It is possible this fishy fix enabled someone to close a short without any pain. It may have been an “accommodative” trade so to speak. Scenario B. this may have been “margin liquidation” meaning someone was long silver but received a margin call from another market that needed to be met and very sloppily liquidated all at once. This is not normally how trades are done but if it was a forced sale, the action is possible. We have had huge volatility in so many other markets, it is certainly possible this was a forced sale. The one thing I am quite sure of since backwardation now rules the day in London, this was not a “cash” fix. I am quite sure it was a paper contract “fix”. Why else is China so hell bent on creating a “cash only” exchange? Because China knows!</p><p>It is important to understand we will see things going forward we never expected or ever dreamed of. What started to happen in 2008 where counterparties lost trust in each other is exactly where we are headed again. Central banks stepped in to restore trust, I am not so sure they have enough credibility or goodwill left to turn a far larger credit tsunami than 2008. The credit bubble is again unwinding like 2008 with no White Knights large enough or credible enough to restore confidence once broken. All I can say is “gee, what rocket scientist could have figured out the greatest credit boom in the history of history would begin to unwind after an interest rate increase”?</p><p></p></div>Analyzing Effective Asset Valuation and Hedging Strategies to Optimize Investmentshttps://globalriskcommunity.com/profiles/blogs/analyzing-effective-asset-valuation-and-hedging-strategies-to2013-08-16T21:15:00.000Z2013-08-16T21:15:00.000ZTyler Kelchhttps://globalriskcommunity.com/members/TylerKelch<div><p>The energy market is becoming increasingly competitive and volatile. The key to maintaining a competitive advantage is to develop effective hedging strategies and minimize risk exposure. With the new regulations introduced by the Dodd Frank Act, energy companies have seen a big change in their approach to hedging and they are on the look-out for establishing effective hedging strategies to value their assets and optimize their revenue.</p><p>Stephen Wemple, Vice President, Regulatory Affairs, Con Edison Competitive Shared Services recently spoke with Global Financial Markets Intelligence (GFMI) about key topics to be discussed at the upcoming GFMI <a href="http://www.global-fmi.com/IHPOE2013_SWempleIntvw">Intelligent Hedging and Portfolio Optimization for the Energy Markets</a>, October 24-25, 2013, in Houston. <i>All responses represent the view of Mr. Wemple and not necessarily those of Con Edison and its subsidiaries.</i></p><p><b>A major topic of focus right now is the impact of swaps to futures on hedging strategies brought on by Dodd Frank. Can you explain your thoughts on what kind of impact this move to futures will have on hedging? Do you think energy companies will switch to the so called “futurisation” in order to avoid being a swap dealer?</b></p><p><b>SW:</b> The trend from swaps to futures was highlighted by the conversion of all of the Intercontinental Exchange (“ICE”) products last year into futures. That decision takes significant pressure off larger energy producers and/or trading shops that may have otherwise been getting close to the $8 Billion de minimis threshold for potentially being classified as a Swap Dealer or the equivalent tests for Major Swap Participants.</p><p><b>With the increasing cost for hedging with OTC derivatives, do you think energy companies will reduce their hedging or will just hedge with futures instead? Is there still room for bilateral contracts?</b></p><p><b>SW:</b> The increased cost may reduce some speculative trading but should not impact hedging activity which is determined by each company’s risk tolerance. As for bilateral contracts, they have been under pressure even before implementation of Dodd Frank as credit concerns have increased the use of exchange brokers to clear transactions. However, there is a real cost to clearing transactions that can be avoided if parties are willing (and able) to transact bilaterally. As a result, we believe there will be a continuing level of bilateral contracts, albeit diminished from historical levels.</p><p><b><u>Living in the New Regulated Market</u></b><b>: What needs to happen for energy companies to better understand how to implement Dodd Frank into their procedures?</b></p><p><b>SW:</b> By now, I expect most companies have integrated reporting and record retention requirements into their internal procedures to ensure that the reporting party is clearly identified and each party understands their obligation as well as begun the process of obtaining board approval to use the end-user exemption.</p><p>One remaining challenge is the determination of what constitutes a hedge. Unfortunately, CFTC has not provided much, if any, guidance; leaving companies to develop their own criteria for determining if a transaction is hedging commercial risk and can be considered a hedge. </p><p><b><u>Impact on End Users</u></b><b>: How will Dodd Frank affect their counterparties and their credit risk? Do you think that the new rules imposed by Dodd Frank will effectively reduce speculations and increase transparency in the market?</b></p><p><b>SW:</b> From our perspective, the energy industry had already taken significant steps to address credit risk before the implementation of Dodd Frank such as clearing more transactions and providing credit support for bilateral contracts. </p><p>One potential impact of Dodd Frank is it may constrain the types of energy products offered to municipal and governmental entities due to the lower de minimis threshold for Special Entities and smaller counterparties that may not have the capability to clear swaps or are not Eligible Contract Participants and are therefore not eligible to enter into swaps.</p><p><b>As counterparties shut down their swap-trading desks and shift their focus on exchange-traded products, end users fear that liquidity in bilateral markets will dry up. Is this worry warranted?</b></p><p><b>SW:</b> The lack of bilateral liquidity and the increased use of exchange traded and cleared products does have an economic cost to market participants in the form of working capital to post initial margin and meet daily margin calls, but the trade-off is a reduction in the risk of the counterparty defaulting.</p><p><b>“The best option for energy traders is hedging physical assets.” Would you agree or disagree with this statement? Why?</b></p><p><b>SW:</b> Clearing products on an exchange is clearly the most risk-averse way to execute hedges but may not be the most cost-effective, especially for those market participants that are entitled to elect the end-user exemption and transact bilaterally.</p><p><i>Stephen Wemple is the Vice President of Regulatory Affairs at Con Edison’s Competitive Shared Services company. He represents Con Edison’s non-utility affiliates, Con Edison Development, Con Edison Energy and Con Edison Solutions in State and Federal regulatory proceedings and has been an active participant in the New York, New England and PJM wholesale markets. Mr. Wemple has worked for the Con Edison family of companies for 26 years with responsibilities ranging from resource planning for steam-electric generation, the design and implementation of energy efficiency programs, the development of retail access programs as well as marketing and business development for the wholesale and retail commodity businesses. Mr. Wemple received his Bachelor of Science and Master of Engineering degrees from Cornell University and has been a volunteer firefighter in New York since 1987.</i></p><p>The <b>GFMI Intelligent Hedging and Portfolio Optimization for the Energy Markets Conference</b> will take place in Houston, October 24-25, 2013. For more information, visit the <a href="http://www.global-fmi.com/IHPOE2013_SWempleIntvw">event website</a>.</p><p>For more information, please contact Tyler Kelch, Marketing Coordinator, Media & PR, GFMI at 312-894-6377 or <a href="mailto:Tylerke@global-fmi.com">Tylerke@global-fmi.com</a>.</p><p><b>About Global Financial Markets Intelligence</b></p><p><i>GFMI is a specialized provider of content-led conferences for the financial markets. Carefully researched with leading financial market experts, our focused quality events deliver key bottom-line value through targeted presentations, interactive discussions and high-level networking opportunities. </i></p></div>MiFID II – Trade Automation, Part 2https://globalriskcommunity.com/profiles/blogs/mifid-ii-trade-automation-part-22013-04-02T08:30:37.000Z2013-04-02T08:30:37.000ZKiki Pentheroudakihttps://globalriskcommunity.com/members/KikiPentheroudaki<div><p><i>by Kiki Pentheroudaki </i></p><p>We have discussed the historic development of automated trading and how regulators are pushing high-frequency traders to become market makers. We now want to look at further ways to regulate automated trading under MiFID II.</p><p><a href="http://www.thetradenews.com/news/Trading___Execution/Dark_pools,_HFT_braced_for_a_tough_2013.aspx">The impact of high frequency trading (HFT) flow on markets will also see continued attention from market participants and regulators alike</a>. In 2012, significant regulatory attention focused on HFT, such as provisions in the European Parliament's version of MiFID II. The document called for venues to instate order-to-trade ratios, a 500 millisecond minimum resting time for orders, and a ban of the maker-taker pricing model, which rewards posting passive liquidity but can lead to potential conflicts of interest among market participants.</p><p>For HFT there are concerns that not all high frequency traders are currently required to be authorised under MiFID as the exemption in Article 2.1(d) of the framework directive for persons who are only dealing on their own account can be used by such traders. While HFT represents an increasing and substantial share of market transactions and the liquidity they provide to the market may replace the more traditional market making activities, high frequency traders have no incentive or obligation to continue to provide ongoing liquidity in a distressed market situation unlike registered market makers.</p><p>High-frequency traders usually remain in the market for a mere blink of an eye but this restriction – an introduction of the 500 millisecond latency in a bid to make a stand - against the rise of high-frequency trading could significantly alter the way they operate and could also have unintended consequences for the wider market.</p><p>The HFT community says that Brussels’ plans will result in less liquidity and wider spreads for other market participants, while some in the market believe HFT will likely benefit from the move anyway as they will just pinpoint 499 and 501 milliseconds in the future to generate their profits (the original MiFID regulation made no such provision).</p><p>From a wider regulatory perspective, the CFTC and SEC are currently reviewing rules on Automated Trading and HFT. They are working together with the markets to consider recalibrating the existing market-wide circuit breakers. The CFTC has published proposals targeted at specialist automatic trading rules as part of the rules for the newly introduced Swap Dealers and Major Swap Participants. Persons involved in "automated and high frequency trading" who are direct members of a regulated market or MTF will be required to be authorised and supervised as investment firms. There will be specialist rules for firms involved in algorithmic trading including compliance, risk controls, and notification to regulators of algorithms. In addition firms will be required to flag the use of algorithms in transactions and orders.</p><p>Several concerns have been raised regarding the very broad scope of the proposed provisions, in particular on the obligation for algorithmic traders to provide liquidity at all times, and the legal uncertainty that would be created by the fact to leave the specification of the scope of this provision to delegated acts. Independent investors said they hoped MiFID II would shield them from HFT practices, which are often accused of distorting stock markets and profiting at the expense of traditional market players.</p><p>Regulators need to find a balanced approach of checks and balances to weed out the ‘bad’ HFT from the ‘beneficial’.</p></div>Trading swaps in a cleared worldhttps://globalriskcommunity.com/profiles/blogs/trading-swaps-in-a-cleared-world2012-10-31T05:43:34.000Z2012-10-31T05:43:34.000ZTom Riesackhttps://globalriskcommunity.com/members/TomRiesack<div><p>Meet Joe. Joe is a swaps trader within a small institution that has a straightforward hedging strategy at both the micro and macro level. Being a price-taker, Joe has built and maintained broker relationships that enable him to easily get a swap priced at an acceptable level provided counterparty limits allow. Joe’s back office is practicing weekly collateral exchange with various counterparties in cash. As such, Joe lives in a very comfortable world.</p><p>But Joe is in for a nasty surprise. The practice of looking for a good price from a trusted broker dealer is about to be turned upside down. Regulations spanning from Basel III and CRD IV to Dodd-Frank and EMIR will make the decision of where to trade what and with whom a lot more complicated. Deciding on a trade has become extremely varied across cleared trades, electronic trading and bilateral trades. A number of additional influencing factors play a significant role with the added complication that these factors are not always correlated. Some factors are the:</p><ul><li>cost of clearing</li><li>size and cost of posting initial margin, at the CCP as well as bilaterally</li><li>cost of collateral transformation</li><li>cost of capital</li></ul><p>These are some examples of what Joe needs to consider in the future:</p><ul><li>If the intended swap is eligible for clearing, what will the clearing cost be?</li><li>Collateral now needs to be posted daily, and not only variation margin but also initial margin. And margin posted to the clearing broker needs to be paid on the same day. Where does Joe fund that money from?</li><li>Which clearing broker do I use?<ul><li>This involves thinking about the impact on initial margin requirements that the change of the swap portfolio held at that clearing broker would result in</li><li>Interest on initial margins at clearing houses typically does not yield market rates as clearing houses take a cut, e.g. EONIA -30 basis points, which would mean an interest loss as Joe needs to fund the amount posted as initial margin at market rates</li><li>Would it now make sense to backload some existing bilateral trades into clearing to reduce the initial margin? How does that offset correlate with the cost of backloading?</li></ul></li></ul><p>This train of thought is endless and it puts Joe in a very dire situation. There is no immediate remedy such as an algorithm that could be employed to help with his trading decision. This calls for a set of strategic trading policies that Joe should adhere to which should be combined with regular reviews of such policies and their resultant cost of trading.</p><p>The incoming regulations will no doubt be costly but being smart and strategic in dealing with the consequences ensures that the cost will not break Joe’s or your business.</p><p><i>Next week marks the last instalment of the OTC blog series, this time covering the impact of the new regulatory regimes on corporates.</i></p></div>The hare and the tortoise: the fastest is not always the strongesthttps://globalriskcommunity.com/profiles/blogs/the-hare-and-the-tortoise-the-fastest-is-not-always-the-strongest2012-09-19T09:32:03.000Z2012-09-19T09:32:03.000ZSebastien Jaouenhttps://globalriskcommunity.com/members/SebastienJaouen<div><p>Despite the current economic turmoil, we have recently witnessed a frenetic race for ultra low latency, privileging speed over costs. But now the reality of these decisions is catching up and trading institutions are finding that the fastest is not always the strongest – much like the hare and the tortoise.</p><p>Being lean and controlling costs is a new priority for banks, focusing on their core business. We are seeing major changes in strategy, with organisations moving away from the extremely risky high frequency trading (HFT) which has become more popular and going back to basics where the focus is on servicing customers and offering brokerage services. These HFT teams are not simply disappearing but they are opening their own businesses, stepping outside global tier one banking institutions. The race for speed for these break away teams is still on. </p><p>As brokerage margins continue to decrease on mainstream asset classes, brokers are swiftly investing in electronic platforms for Swaps and FX. They do so in line with regulations such as MiFID II which is designed to bring greater transparency and promote best execution.</p><p>All this triggers new requirements to connect to multiple platforms worldwide and managing client connectivity on a global scale. Although major tier one banks have enough staff to manage these connections, the challenge is in leveraging new markets and connecting to new pools to survive in the near future.</p><p>Survival is not only a question of costs and economies of scale for small and large institutions. Externalising connectivity for market data, trading applications, electronic platforms and clients is key when focusing on core business and getting the most out of existing resources. Expansion into new markets is also essential to drive future success. Banks should look to partners offering quality SLAs and reliability to expand their reach and win the connectivity race. </p></div>