Satyajit Das , the author of recently published ‘Extreme Money: The Masters of the Universe and the Cult of Risk’ has been giving interviews in support of his book. We think Das is one of the best analysts out there on derivatives and risk management. In his interview with Jeremy Grant of the FT Das made some very important points about Central Counterparties (CCPs). We summarize below:
1.) CCPs address counterparty risk and systemic risk and are a great idea, but the execution has been awful.
2.) What goes into the CCPs: everyone wants to be “the exception to the rule” and only part of the market will end up being cleared.
3.) Put anything in a CCP and it will have to be risk managed – many transactions won’t qualify since they are too complex. There are lots of problems with collateralized swaps.
4.) Margining: if you don’t have transparent traded prices, how do to determine initial variation margin amounts?
5.) Central Banks are sucking money out of the system: CCPs takes margin out, as do higher capital requirements, liquidity controls on banks, the closing down of shadow banking, and increasing liquidity controls on insurance companies. No one has ever added everything up. It will be a huge problem.
6.) Das supports the internationalization of CCPs: in an ideal world there is but one CCP. He thinks the BIS should take the lead, but notes that the US believes in private sector initiatives. Eventually there could be 10-20 different CCPs.
7.) Interoperability agreements between CCPs and problems with where the collateral will flow will trigger cross-border bankruptcy issues. Das called this “the elephant in the room”.
8.) Regulators struggle with the desire to keep the concentration of broker/dealer derivative houses (there are 10-12 major players) so they can keep track of whom the relevant parties are, but know this is an acceptance of “too big to fail”.
9.) The G-20 accepted central clearing without understanding the details. The end result is not a more robust system, just a more complicated one
Finadium wrote about some of these issues in Central Credit Counterparties, Margin and the Challenge of Collateral Management and Capital Charges for Margin, Securities Lending and Repo: A Guide for Banks, Their Clients and Counterparties