Systemic risk
n The TRADE Derivatives forum
Prior to the collapse of Lehman Brothers, there
was already regulatory concern
on both sides of the Atlantic
that innovation was running
ahead of existing operational
procedures in the OTC derivatives markets. Trade confirmations could wait weeks if not
months for completion. As
2007 turned to 2008, concerns
about the proper documentation and risk management for
OTC derivatives trading gave
way to concerns about wider
systemic problems in the
financial markets.
Just as the Great
Depression changed forever
the outlook of those that lived
JEFF GOOCH
continued
This is a massive step forward for the industry.
The second change is
transparency. In 2008, there
were no trade repositories as
now defined. Though there
was a trade confirmation
warehouse operated by The
Depository Trust and Clearing
Corporation, but regulators had
no visibility of which counterparties or instruments were
involved with trades. This led
to another key concern of the
crisis – that participants themselves didn’t know the extent of
their counterparty risk and had
to assume the worst.
The big change after
Lehman Brothers’ collapse was
reporting, on a voluntary basis,
of all trades by the banks to
regulators and that’s now being
locked in through the Dodd-Frank Act in the US and the
European markets infrastructure regulation in Europe.
The third problem in those
days was that most counter-
parties faced each other in
bilateral trades. That created a
number of interdependencies
that were hard for regulators
to understand and manage.
Additionally, a lot of those
exposures were not collater-
alised, which led to unwieldy,
large exposure. This was the
problem with AIG, which had
massive exposures with banks
that had very infrequent col-
lateral calls.
Today, market participants
are much more focused on
posting collateral daily so the
exposures are not large. Also,
clearing has been mandated
in most markets to stop firms
directly facing each other in the
first place.
Some people debate whether
central clearing makes things
safer or not, and it’s always
a difficult thing to work out.
However, what it does mean is
there’s a lot more transparency
about the relationships and
it’s easier for the regulators to
intervene to try and sort things
out rather than have to deal
with the bilateral issues that
used to exist.” n
“
CHARLES
MARSTON
CEO, Calypso Technology
Systemic risk
n The TRADE Derivatives forum