...the problem is that there is no uniform way to execute and confirm CDS trades. The same problem exists to a lesser extent for plain interest rate swaps and other derivatives. I work at a hedge fund that trades CDS and we often get confirms for credit default trades weeks after they occur...and when we assign the trades and tell the original counterparty who they now face, the info is often lost. We'll get a call a month later asking about the trade we assigned away. The problem could be big if there are a series of defaults...I could see traders trying to get out of trades for which there are no confirms. Also, there could be discrepencies about who owes who money. Basically it would just be a mess. BTW the problems with CDS have absolutely nothing to do with leverage.
exactly. it's a headline fed into a very volatile sentiment environment. can't say that looks like complacency to me.
the do. it's called MAD (mutually assured destuction). if one of these morons dk's a trillion dollar trade, they'll be eaten alive and picked clean. the net hit will be substantially smaller, lawyers will get substantially richer, some (probably NY) attorney will have his political career boosted, the dow will correct to 7000, and the press will have something to talk about for months. There will be screaming buys.
I have been trading credit derivatives for a number of years. The problem is real, although fairly easily fixable. The main problem is documentation, and errors in documentation can cause a problem with leverage. First, a little about credit derivatives (we will just utilize a typical CDS contract here - but any of the more esoteric instruments - FTDs, etc. - suffer the same problems). A CDS contract works in much the same way as an interest rate or FX swap. Two counterparties agree on terms and money changes hand on terms agreed to in the contract. The primary difference is the custom language used. Typically firms agree on an ISDA and CSA terminology that is mutually beneficial and fairly easy to settle. The problem is, though there is a standard ISDA and no one uses it - everyone has custom terms. The other problem is that CDS has a specific reference obligation and, unlike most swaps, requires custom documentation for each transaction. This is an enormous pain in the a**. Contrast this with a standard corporate bond. If I buy or sell XYZ 7.5s of 2010, I will confirm with the other trader/salesperson and then - LATER THAT DAY - my backoffice will confirm with their backoffice. Everyone goes home square. With a CDS however, the backoffice confirmation does not occur until many days later. Normally within 30, but still, that is a long time. This causes two problems. The first is obvious. If there is a trade error, one firm or the other may fail on a payment. Obviously this is bad. The other is slightly less obvious, but potentially more dangerous. Each relationship with a counterparty requires a credit line. In order for a firm - say Deutsche Bank - to do business with ABC Hedge Fund (or any counterparty for that matter), DB has to give them a credit line. For this, DB needs some transparency as to what sort of shape ABC Hedge Fund is in financially. They do this by knowing what positions (w/i a backoffice/credit function) ABC Hedge Fund has on. But the two firms communicate backoffice to backoffice. And if the trade hasn't been confirmed, well, guess what - it really doesn't exist. Arguably an honest firm will go ahead and disclose their true positions. One who is in a corner, however, has a disincentive to do so. If you are down, banks might not continue your credit line and thus you can't dig your way out of the hole. There is also a delay in what we call "assignments" or "give ups". When A buys protection from B and then B buys protection from C, typically what happens is that B will assign A to face C. This usually happens when a fund does a transaction with a bank, then offsets it with another transaction with another bank and tells the banks they face each other - most always with some cash payment made or rec'd by the fund. Additionally, there have been problems with the way contracts are interpreted. This came up years ago when the default wave of 01 and 02 occurred, as well as misunderstandings recently, such as those with Kerr McGee's restructuring. Not necessary to go into all of this here, but there have been bumps on the road. What would solve this? Faster settlement for one. More homogeneous contracts would help. An exchange (sacrilege for bond traders) would also be stellar. But my real guess is that the Fed will pressure banks to speed up settlement and confirmations in order to provide better visibility for credit officers. Crazy stuff, eh?
http://www.thememoryhole.org/corp/finance/sec_amex_report.htm See link. The *existing* problems in the *plain-vanilla, listed* derivatives markets cannot be solved - which should be the simplest case for enforcement. Does not bode well for an instant fix in a much bigger, more complex marketplace.
================= Wilburbear; Agree with the latter, and on the former, think until AMEX does fix it perhaps???,; private sector fixed it and its called ISE, & its called BOX Apismoclam; Sound like you figured on that scenerio some time; not a prediction, but because of October type crashes, was figuring on about a max correction of 25% or 10% on QQQQ. You could very well be right on about 30%; high probability ,wouild have a nice uptrend /rally afterwards.
I've seen some of the backoffice paperwork (had to do some the other day).... 45 pages for ONE trade. A whole lot of cutting and pasting goes on, a very delicate tightrope.