The following is a snapshot of the distribution of the Derivatives Market. It comes from the website of the “Bank for International Settlements” (BIS). BIS is the true “world clearing house for international exchange”. BIS should not to be mistaken for the so named “World Bank” that focuses on ending poverty in developing countries through principal loans and guarantees.
The above table and charts show the bulk of the exposure resides in OTC “interest rate
derivatives”...policies aimed at protecting the parties from swings in interest rates over term. How does hyper inflation and faster rate adjustment effect this position? Negative for sure.
INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC. (
ISDA) and its
member banks clear about 87% of the market for derivatives. The below is snapped from a
survey
ISDA took of leading derivative holders and issuers....banks, lending institutions,
securities institutions. While not a complete view of the total derivatives market, it is
however, representative of the large exposure in this segment.
http://www.isda.org/c_and_a/pdf/ISDA-Margin-Survey-2009.pdfA shift from 29% to 66% exposure is risk that is not mitigated.
And now the Fed Treasury makes an announcement to regulate the unregulated.
May 13, 2009
tg-129
Regulatory Reform Over-The-Counter (OTC) Derivatives
The crisis of the past 20 months has exposed critical gaps and weaknesses in
our financial regulatory system. As risks built up, internal risk management
systems, rating agencies and regulators simply did not understand or address
critical behaviors until they had already resulted in catastrophic losses. Those
failures have caused a dramatic loss of confidence in our financial
institutions and have contributed to a severe recession.
Last March, Secretary
Geithner laid out new regulatory rules of the road to
ensure we never face a crisis of this magnitude again. An essential element of
reform is the establishment of a comprehensive regulatory framework for
over-the-counter derivatives, which under current law are largely excluded or
exempted from regulation.
As the
AIG situation has made clear, massive risks in derivatives markets
have gone undetected by both regulators and market participants. But even if
those risks had been better known, regulators lacked the proper authorities to
mount an effective policy response.
Today, to address these concerns, the Obama Administration proposes a
comprehensive regulatory framework for all Over-The-Counter derivatives.
Moving forward, the Administration will work with Congress to implement
this framework and bring greater transparency and needed regulation to these
markets. The Administration will also continue working with foreign
authorities to promote the implementation of similar measures around the
world to ensure our objectives are not undermined by weaker standards
abroad.
Objectives of Regulatory Reform of OTC Derivatives Markets
• Preventing Activities Within The OTC Markets From Posing Risk To The Financial System – Regulators must have the following authority to ensure that participants do not engage in practices that put the financial system at risk:
• The Commodity Exchange Act (
CEA) and the securities laws should be amended to require clearing of all standardized OTC derivatives through regulated central
counterparties (
CCP):
•
CCPs must impose robust margin requirements and other necessary risk controls and ensure that customized OTC derivatives are not used solely as a means to avoid using a
CCP.
• For example, if an OTC derivative is accepted for clearing by one or more fully regulated
CCPs, it should create a presumption that it is a standardized contract and thus required
to be cleared.
• All OTC derivatives dealers and all other firms who create large exposures to
counterparties should be subject to a robust regime of prudential supervision and regulation, which will include:
• Conservative capital requirements
• Business conduct standards
• Reporting requirements
• Initial margin requirements with respect to bilateral credit exposures on both standardized and customized contracts
• Promoting Efficiency And Transparency Within The OTC Markets -- To ensure regulators would have comprehensive and timely information about the positions of each and every participant in all OTC derivatives markets, this new framework includes:
• Amending the
CEA and securities laws to authorize the
CFTC and the
SEC to impose:
•
Recordkeeping and reporting requirements (including audit trails).
• Requirements for all trades not cleared by
CCPs to be reported to a regulated trade repository.
•
CCPs and trade repositories must make aggregate data on open positions and trading volumes available to the public.
•
CCPs and trade repositories must make data on individual
counterparty's trades and positions
available to federal regulators.
• The movement of standardized trades onto regulated exchanges and regulated transparent electronic trade execution systems.
• The development of a system for the timely reporting of trades and prompt dissemination of prices and other trade information.
• The encouragement of regulated institutions to make greater use of regulated exchange-traded derivatives.
• Preventing Market Manipulation, Fraud, And Other Market Abuses The Commodity Exchange Act (
CEA) and securities laws should be amended to ensure that the
CFTC and the SEC have:
• Clear and unimpeded authority for market regulators to police
fraud, market manipulation, and other market abuses.
• Authority to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets.
• A complete picture of market information from
CCPs, trade repositories, and market participants to provide to market regulators.
• Ensuring That OTC Derivatives Are Not Marketed Inappropriately To Unsophisticated Parties Current law seeks to protect unsophisticated parties from entering into inappropriate derivatives transactions by limiting the types of
counterparties that could participate in those markets. But the limits are not sufficiently stringent.
• The
CFTC and SEC are reviewing the participation limits in current law to recommend how the
CEA and the securities laws should be amended to tighten the limits or to impose additional disclosure requirements or standards of care with respect to the marketing of
derivatives to less sophisticated
counterparties such as small municipalities.
All this is fine, needed and better late than never. My question is what happens between now and time all this is implemented? Nothing would suggest that Regulations would be retroactive....and that is a serious problem considering 525 trillion+ is involved.
http://www.bis.org/review/r090710e.pdfSnap of chart in Haldane speech showing the capital levels (equity as a percentage of assets) of US commercial banks.
The chart above shows how commercial banks have: 1) improved their ROE over time by increased leveraging of assets and 2), decreased their equity position. Higher risk???? Not so, unless the risk is systemic, or is based on a poor mix of assets and market assumptions, or unless major processing payment and settlement systems breakdown at clearing banks through either a lack of trust in the true value of the dollar, or in the the ability of parties to honor their transactions. One should remember Argentina and the collapse of their system due to the printing of money. It is clear to me that we are in for a long ride.
NEW Threat: Question: When was the last time in history that one major country stopped buying treasury notes (debt) of another major country. Answer: Britain to Germany...it resulted in a war called WW1. “
Chimerica” (China-America) is a weak relationship based on the buying of debt for trade. China has already signaled the FED to change it's monetary policy (stop devaluing the dollar) or they will stop buying debt.
Reckless Cap and Trade or National Health Care plans will push us into the abyss. We cannot afford either. What ever happened to the 500 Billion in US Bearer Bonds seized in Italy from 2 Japanese. Who is dumping 500 million dollar face value bonds???
