It’s been some time since our last post. It would be nice to think that’s because everyone’s been reading the sober facts and analysis available on the ISDA website, but we’re realists here at media.comment, and a new article written by former Commodity Futures Trading Commission (CFTC) commissioner Bart Chilton shows hyperbole is very much alive and kicking.
The article in question focuses on credit derivatives, and claims that certain behaviors in that market could lead to an “onslaught” similar to the financial crisis.
Now, let’s be very clear. Manipulation and fraud are illegal, and there are regulations in place in the US prohibiting those activities. If there is any wrongdoing, then it should be investigated by federal authorities at the Securities and Exchange Commission (SEC) and/or the CFTC.
Mr. Chilton points out that credit derivatives serve a legitimate and important purpose, and raises concerns about events that risk compromising the reliability of this market. We couldn’t agree more. Where there are concerns that certain behaviors threaten the integrity and smooth functioning of the market, both the industry and regulators have moved to respond. For ISDA’s part, a working group of buy- and sell-side participants is currently looking at potential changes to the Credit Derivatives Definitions to address narrowly tailored credit events.
But to claim the markets are on the brink of another crisis as a result?
Let’s just pause for a second and sort out the facts from the rhetoric.
First, about the market. Derivatives regulated by the CFTC – including credit derivatives – have undergone major changes since the crisis to make the markets safer and more transparent. All trades have to be reported to trade repositories, and regulators have full access to that information. All standardized transactions have to be cleared; non-cleared trades have to meet new margin requirements. That means whether cleared or non-cleared, trades are backed by high-quality collateral to mitigate any losses.
The SEC is in the process of implementing similar regulatory requirements, but single-name credit default swap trades are already typically subject to daily valuation and variation margin posting as a matter of market practice.
Second, about the process. Mr. Chilton refers to the ISDA Determinations Committees (DC) and the ISDA auction. Quick fact check: ISDA does not participate in or run the auctions, has never had a vote on the committees themselves and – as of October – no longer serves as DC secretary.
Putting that aside, the article calls on the DCs to “come out of the shadows”. Well, the votes of each DC member firm are already made public, and statements are typically published that give insight into how a determination was reached. A supermajority – 12 out of the 15 DC member firms – is required for a determination, meaning no single firm can influence the result. When a supermajority is not achieved, the decision is passed to an independent panel of experts – which is, ironically enough, the case for some of the deliverable obligations in the Sears case, which is the subject of the article.
No one claims the DC process is perfect – in fact, there have been modifications along the way to strengthen governance and mitigate potential conflicts of interest. But that’s very different to claiming the entire market is on the brink of more “excruciating” economic pain.
So, let’s do without the flowery language, the embellishments and the exaggeration and go back to facts.