The International Swaps and Derivatives Association (ISDA) has systematically struck out at critics of sovereign credit-default-swaps (CDS) and other over-the-counter (OTC) derivatives products, to defend the market’s already compromised reputation.
ISDA, the New York-based trade body representing more than 800 OTC derivatives market participants in 57 countries, has revealed a more visible public presence recently, amid growing concern that political interference from Brussels in the Greek debt restructuring has undermined the credibility of sovereign CDS as a credit risk management tool for banks and investors.
In an escalation of its name-and-shame campaign against journalists, who ISDA claims are exaggerating the danger posed by CDS, the group last month criticised five recent articles in the financial press.
Statements such as "don’t stir the pot if you don’t understand the ingredients", and "it’s time to stop the nonsense" left little ambiguity over ISDA’s position.
The group claimed the newspapers' self-proclaimed derivatives experts – who see another round of severe losses, bank failures and economic hardship coming from the role played by CDS in the European sovereign debt crisis – exhibited poor technical understanding of the product.
Clearly a source of embarrassment for several leading US financial publications, ISDA’s press offensive claimed a lack of awareness on the part of some writers of primary data sources such as the Depository Trust & Clearing Corporations’ CDS Trade Information Warehouse, as well as corporate finance fundamentals.
A recent release, for example, criticizes an intentional conflation of bond repurchase agreements (repos) with OTC derivatives published in The New York Times.
At the same time, the organization is attempting to highlight the positives in the derivatives market, and last month published the results of its investigation into the relative loss severity between plain vanilla and structured credit derivatives between 2007 and the first quarter of this year.
According to the new study, structured CDS on monoline exposures were responsible for losses of $54bn among US and international banks, with just four banks accounting for $43bn, or 80% of the total damage.
Vanilla credit derivatives, meanwhile, contributed relatively lower losses of $2.7bn.
“The news that plain vanilla derivatives caused relatively insignificant losses among international banks during the financial crisis is another piece of evidence about where the risks are in our market place,” says Conrad Voldstad, ISDA’s departing Chief executive officer, in response to the OTC derivatives industry determined to strip out what it sees as the most onerous elements of Dodd-Frank ahead of implementation.
“While we support clearing, the current proposals only cover plain vanilla products and insist on very expensive initial margins for products where the loss potential is not all that great. The more that regulators, participants and the press know about the market, eventually people will move away from the sound bites and start to look at the numbers.”
Unfortunately for ISDA, sovereign debt has replaced structured finance as the hot issue at the centre of the financial crisis, and the organization’s focus on a story from three years ago seems strangely at odds with a market wholly preoccupied by the prospect of sovereign default and the break up of the eurozone.
Moreover, the ISDA leadership has been roundly criticized for dropping the ball on the sovereign CDS issue. Its decision to pre-empt the determination committee’s vote on whether the Greek restructuring will trigger sovereign CDS continues to draw a lot of flack and leaves a question mark over the product’s use as credit insurance.
Although ISDA’s determination committee will not vote until the details of the Greek rescue package are finally made public, at the end of October, the organization revealed in an online Q&A:
“Based on what we know now, it appears from news reports that the eurozone proposal involves a voluntary exchange that would not be binding on all holders. As such, it does not appear to be likely that the eurozone proposal will trigger payments under existing CDS contracts. However, whether or not it does so will be decided by the DC on the basis of the specific facts, if a request is made to them.”
Despite the caveat in the third sentence, the first two points have come back to haunt ISDA and the sovereign CDS market. Subsequent attempts by ISDA to explain the determination committee process have only served to highlight the initial faux pas.
Voldstad says he has been surprised by the frenzy around what he says amounts to a "relatively small credit event".
“Compared with the notional bond market, Greek sovereign CDS does not represent a big risk concentration,” says Voldstad. He also says that as much as "99% of dealer exposures are collateralized with cash”.
| Net notional volumes of sovereign CDS |
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| Source: DTCC |
For more in-depth coverage and interviews on this subject, check out the full story in the December issue of Euromoney magazine.