OTC to CCP - the regulatory derivatives revolution is about to arrive with a bang.
In the next few months the CFTC and SEC will release new rules that will shape the world's derivative markets for years to come. The worlds derivatives markets are holding their collective breath to see how the markets will react and evolve in response to what is the greatest revolution in derivatives trading since the introduction of the 'interest rate swap'.
Clearing houses are working hard behind the scenes to prepare themselves to offer products in anticipation of which derivatives will have a 'mandatorily cleared' tag on them. Derivative end users themselves are slowly realising that the relationships with their dealers will be unrecognisable after the new regulation is introduced.
So what should a casual blogger with a unique window into the world of derivatives and risk management say in a blog?
Prepare. And prepare with a chaotic theme in mind.
No one can confidently predict where these rules will be pitched and what their ultimate effect will be on the market. Over the coming year, the derivatives market will descend into a state of orderly anarchy. SEF's will fight it out, as will CCPs. Open interest will ebb and flow. The winners will slowly rise to the surface and will probably be evident come this time next year. They will also be those with experience and those with a sound operational record. As Graeme McDowell will tell you, the cream always rises to the top, even when the hopes of an entire continent are resting on a single man's shoulders. If you want a prediction, follow the talent,
Happy hunting,
Andy
Wednesday, October 6, 2010
Thursday, June 17, 2010
The BOE late to the CVA party.....
http://ftalphaville.ft.com/blog/2010/06/15/261671/of-cva-and-sovereign-cds/
The BoE, who are now the new financial regulators, seem to have spotted that derivative businesses have things called "CVA" desks which dynamically manage counterparty risk. Given that the first CVA desk started almost 15 years ago, there is a worrying lag between a key market development and policy makers catching up.
CVA desks are undoubtedly the "good guys" when it comes to derivatives trading. It should also be noted that there was a strong positive correlation between the age of a bank's CVA desk and its share price performance during the credit crunch.
Policy makers should spend considerable time in understanding what it is CVA traders do and then wholeheartedly support them. The CVA desk has arguably been the only oasis of sanity in many derivative businesses, now is the time to let these desks flex their muscles.
Happy hunting,
Andy
The BoE, who are now the new financial regulators, seem to have spotted that derivative businesses have things called "CVA" desks which dynamically manage counterparty risk. Given that the first CVA desk started almost 15 years ago, there is a worrying lag between a key market development and policy makers catching up.
CVA desks are undoubtedly the "good guys" when it comes to derivatives trading. It should also be noted that there was a strong positive correlation between the age of a bank's CVA desk and its share price performance during the credit crunch.
Policy makers should spend considerable time in understanding what it is CVA traders do and then wholeheartedly support them. The CVA desk has arguably been the only oasis of sanity in many derivative businesses, now is the time to let these desks flex their muscles.
Happy hunting,
Andy
Friday, June 4, 2010
OIS vs Libor discounting
Hi,
Blogging has been a draw upon our time that we haven't been able to afford of late but I thought I'd comment briefly on one of the issues currently rippling through the derivatives market.
Derivatives as a business model is going through something of a revolution at the moment. There are several issues which are fundamentally changing the market and keeping the risk managers busy. One of which is typically referred to as the OIS vs Libor discounting issue.
The single curve Libor valuation model, that was largely ubiquitous across the City for valuing swaps, has been exposed as being significantly flawed. One of the issues with this model is that it didn't take into account the economic impact of the requirement to post collateral at the OIS rate against a swap's mtm. This obligation has a significant impact on the true economic value of the swap and whereas in the past this obligation was effectively ignored, new valuation techniques are now springing up based on Libor indexed cash flows, discounted at OIS. While the difference between the models is typically slight for par swaps, the difference for ITM / OTM swaps can be massive. Furthermore, we all know what happened to this spread during the Lehman default, making these differences in value a potentially major problem during volatile markets.
We are consulting on this issue in a number of areas, in fact one of our employees played a key role in seeding this issue into the market over 5years ago. Perhaps not surprisingly LINKS is finding much confusion in the asset management space on this topic. Currently, LINKS is advising that this change, albeit a slow one, is almost certainly going to persist and ultimately become normal market practise. Valuing derivatives accurately is a much more complex business than people have previously assumed it to be. Discounting cash flows to accurately represent what will be in a bank account upon realisation of derivative linked cash flow is a tricky process that requires consideration of a number of complex risks beyond a simple Libor deposit rate.
The era of complexity is here to stay,
Happy hunting,
Andy Shaw
Blogging has been a draw upon our time that we haven't been able to afford of late but I thought I'd comment briefly on one of the issues currently rippling through the derivatives market.
Derivatives as a business model is going through something of a revolution at the moment. There are several issues which are fundamentally changing the market and keeping the risk managers busy. One of which is typically referred to as the OIS vs Libor discounting issue.
The single curve Libor valuation model, that was largely ubiquitous across the City for valuing swaps, has been exposed as being significantly flawed. One of the issues with this model is that it didn't take into account the economic impact of the requirement to post collateral at the OIS rate against a swap's mtm. This obligation has a significant impact on the true economic value of the swap and whereas in the past this obligation was effectively ignored, new valuation techniques are now springing up based on Libor indexed cash flows, discounted at OIS. While the difference between the models is typically slight for par swaps, the difference for ITM / OTM swaps can be massive. Furthermore, we all know what happened to this spread during the Lehman default, making these differences in value a potentially major problem during volatile markets.
We are consulting on this issue in a number of areas, in fact one of our employees played a key role in seeding this issue into the market over 5years ago. Perhaps not surprisingly LINKS is finding much confusion in the asset management space on this topic. Currently, LINKS is advising that this change, albeit a slow one, is almost certainly going to persist and ultimately become normal market practise. Valuing derivatives accurately is a much more complex business than people have previously assumed it to be. Discounting cash flows to accurately represent what will be in a bank account upon realisation of derivative linked cash flow is a tricky process that requires consideration of a number of complex risks beyond a simple Libor deposit rate.
The era of complexity is here to stay,
Happy hunting,
Andy Shaw
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