I think you're barking up the wrong tree slightly here. The issue with LCH isn't compression trades, which are just a tidying up operation and have a small (and reducing) effect over time. The risk models have the usual issues with backward looking windows etc., but every major bank (and most HFs) do the same thing. In my experience, the risk models in the clearing houses are actually more sophisticated than those in the banks.
They're still not 'correct', if there is such a thing, but no worse than for bilateral trades, and for the regulators value at risk is the only game in town anyway. They do the typical stress tests the banks do, and they're pretty heavily monitored, again more than any bank I've worked at.
The real issues are the transformation of market risk into liquidity risk, which will be the cause of any eventual failure. A market shock leads to cash margin calls which need to be paid almost immediately and potentially causing a downward spiral as clearing members need cash fast. The LCH is not obliged to pay out margin on 'winning' portfolios in this way.
During Brexit Friday they drained massive liquidity from the market without returning any on the other side. In fact they made multiple intra day calls if I remember correctly and got a slap on the wrist from the bank.
The second issue is one you mentioned in the comments, the management of a default. I have spoken to several bank 'risk managers' with some responsibility in this area, and none of them had the foggiest idea of how that will operate, or what the clearing house rule book says they are entitled to do (anything they like). They are in for a massive shock if it ever happens, that kind of event for a large bank will be carnage.
If the dangers of clearing is your thing, Craig Pirrong is the go-to guy. He's been writing about the possible liquidity spiral since it was mandated. He's pretty spot-on I think.
I asked my self, why was Lehman not a problem, but a small trader in Norway was?
Many many people have told me that compression is actually makes the system safer, but in practice it allows margin to be paid back to the investor, while not reducing any directional risk in markets. I think compression makes things "simpler" but not necessarily "safer". When I read about Lehman in the article above, it is clear there was too much margin at the clearinghouse - but that it what made them safe. Redundancy.
Remove the redundancy, it is cheaper to trade - but the system is not safe. Clearinghouse had no problems during the GFC, and now problems are recurring. And compression is definitely one cause.
Craig and I look to be singing from the same hymn sheet!
That's not really apples and apples though. What matters is the directionality of the portfolio, size relative to the overall market and how the market realises vs the initial margin held against it. The Lehmans book could have been relatively risk flat, I've no idea.
OTC swaps are margined for 5 days of risk, futures only 2. Auctioning a large swap book (in those days) is easier than power futures. They are impossible to margin correctly, and one spike can wipe out the entire margin.
There's also a larger probability of a default auction failure. There will be a smalll number of participants, and who is going to take the trades when they are positioned the other way, and make themselves flat? Maybe you get lucky and someone lets you out at a high price, but not if they need the hedge. A swap book you've got a better chance because a dealer may take it at a generous enough level where they can hedge and work it over time.
Remember though the CCP was a lot smaller before mandatory clearing., and some portfolios are a lot more directional now because of the CH basis. I don't know how they margined swaps before 08, maybe it was a lot more conservative. But then that's a matter for margining appropriately, not indirectly hacking the margin by not netting off correctly.
I don't think compression is that big of a deal really. After all, wasn't trade assignment where you could step out of a pair of bilateral trades and leave two other counterparties facing each other, just the same thing?
Anyway, it's all a rabbit hole. Craig is definitely the guy to read if you want to know about clearing's many many flaws
Hi Russell, interesting article, and your point on the LCH "repricing" the risk in gilts -- that is, changing margin requirements based on historical vol lookbacks -- intuitively makes sense for why it would cause a dearth of buyers and a market dislocation.
However, based on my experience trading IR derivates at a major NY hedge fund and interacting with LCH, I don't think your point on compression trades is accurate. Imagine there are 3 banks that all trade GBP IRS with each other. Bank A pays fixed with Bank B. Bank B pays fixed with Bank C. And Bank C pays fixed with Bank A. All for the same notional, say $1tn. Then each bank has, on it's books, a payer and receiver of $1tn and, therefore, net 0 interest rate exposure. However, they have immense ($1tn) notional exposure and counterparty exposure and thus would have to post margin with each other based on the large ($1tn) notional. Now comes along LCH, which steps in as counterparty to all trades. So each bank has a payer and receiver versus not different counterparties, but a single counterparty being LCH for the exact same amount, and both LCH and each of the banks agrees to just tear up the contracts and return the margin. Therefore the total outstanding notional in the market goes from $3tn down to 0, and all the associated margin is returned to the individual banks. Therefore, compression trades do, in fact, reduce outstanding notional exposure, which is why margin is returned.
Please tell me if I am missing something in your argument on compression trades.
Essentially this process used to take place prior to LCH as well when hedge funds wanted to "clean up" their books. We would send out large packages of net zero risk trades (but against different counterparties) for pricing so that a single bank would step in as the single counterparty and effectively tear up the excess notional that came from facing different counterparties on offsetting risk.
When I first looked at compression trades I would have agreed with you. But the more I thought about it - the more I realised it increased risk.
Let me explain my line of thinking.
So in the "pre-compression centrally cleared era" there are a bunch of unnecessary trades that existed- the circular trades described above. If one member goes bust, the cleraringhouse can take the positions and auction them. Now as there are plenty of unnecessary circular trades, there will be plenty of members who can come in on both sides to clear the portfolio. This is what happened with Lehman - which had huge notional - but LCH was able to settle all its trade only using 1/3 or its margin.
Now when you centrally clear, you get rid of all these circular trades, and you end up with less notional. In IR markets this has meant the markets have become increasing bifurcated. I can dig up the BIS note that shows this.
What that means, is that positioning it increasingly similar across similar market participants, so that if one member gets in trouble, all similar members get in trouble. Also as there are no circular trades, there are less margin for all members. This is what we saw with Nasdaq Oslo, and what I think we saw with LCH.
It actually a simple question of risk. If redundnant notional is cancelled (which for the system had no risk) we are also getting rid of redundant margin. But if total risk is constant (by defintion) but total system margin is falling, then the system must get more risky - by definition. Its like the old hedge fund saying - only selling reduces risk - hedging increases risk.
Its not my area of expertise - but I would say market action seems to bare my analysis out.
Hi Russell, thanks for clarifying. I now understand what you mean, and I agree with you. I was earlier treating risk as amorphous and not making the important distinction between market risk and counterparty risk.
Central clearing -- specifically compression trades -- reduce counterparty risk by eliminating the complex web of multi-counterparty positions, but increase market risk for many of the reasons you mentioned.
Before central clearing, different legs of a net zero market risk position could face different counterparties and therefore counterparty risk meant that your net zero market risk position may not be so in practice (esp when the shit hit the fan and one side moved significantly).
This specter of counterparty risk has three important dampening effects on the market risk of participants (and the market as a whole):
1. Since a lot of margin is tied up in these circular trades that are net zero market risk, the amount of net direction risk borne by each participant was a fraction of the gross notional they held. Said another way, the amount of net direction risk that could be supported by a given amount of margin was significantly lower than post central clearing since most of that margin was tied up in the circular trades.
2. Since counterparty risk could suddenly turn a net zero market risk position into a large direction position, participants generally tended to be more conservative in their net and gross exposure.
3. Really a corollary of 2. in that since participants directly faced each other, they tended to have much greater visibility into the market (and counterparty) exposure of other participants and thus, presumably, the market as a whole was not as crowded.
Once you introduce central clearing and compression trades, you do away with counterparty risk (in theory, if the clearing house is setting margin thoughtfully, but that is a discussion for another time), but you change the market risk dynamics as follows:
1. Since all circular trades are just torn up and no longer require any margin usage, all available margin can be gainfully employed towards directional risk. Therefore, a given amount of margin can -- post-clearing and post-compression -- support significantly greater direction risk than it could before (where a lot of it was tied up in circular trades).
2. Since all participants face the clearing house and, in theory, have no counterparty risk, their risk appetite would naturally increase.
3. Again, a corollary to 2. in that since participants face the clearing house and lack visibility into the position of other participants, this arrangement could significantly increase crowding.
All correct. The final problem is that when a member can't meet a margin call the ccp takes the position and tries to sell the position in the market- everyone is similarly positioned so cant bid... which.cause prices to fall more creating more margin call etc...
With all due respect as I am new to your newsletter, I don’t believe this is accurate. The reduction of gross notional in clearinghouses was a response GFC changes to how banks are capitalized, notables SLR as a backstop to risk based capital and potential GSIFI capital add ons based on a battery of metrics based on complexity, reach and size. Keeping gross notional sitting around for the sake of attracting capital add ons doesn’t make sense and starves the productive deployment of that capacity to other parts of the global economy that needs it. The clearinghouse facilitated this reduction, but didn’t force it. To put in simple terms if I owe you $20 and you owe me $20 should we just call it even? Unwinding Lehman Brothers derivative book was very complicated, even know their net risk to the street was negligible (I did it for a bank). If this had been cleared it would have been much simpler even without compression. Now, clearinghouses can cause forced selling if a member doesn’t have the liquidity to maintain its exposure, as was the case with MF Global. If you can’t make a margin call your collateral will be sold to protect the clearinghouse and its members. If the assets posted are the same ones causing your financial stress or stress in the market, they will be sold into a weak market, thus potentially causing more stress.
What’s the alternative? Isn’t that a bailout (govt, private, or hybrid). When borrowers default on their mortgage, the collateral is taken and sold. When tax payers don’t pay taxes, assets are
seized and auctioned/ wages garnished. No intent to be snarky but what should lenders/clearing houses do?
The way clearinghouses are set up.is that they almost guarantee default. And when one member defaults it then requires all remaining members to stump up cash.
So if the idea was to get rid of too big to fail - then clearinghouse model makes it impossible to let anyone fail
I originally thought as you do, but then I read this report from BIS in 2018. When I dug into, I realised clearinghouse set risk in a pro cyclical manner almost inviting risk.
As I researched it more, I realised it was not just niche clearinghouses, but big ones too. This was confirmed by the joint paper by the biggest users of clearinghouse saying they did not understand how they priced risk. The Goldman author made the margin call on AIG in the GFC, so he knows about risk and margin.
The biggest problem is clearinghouse set risk wrong, and also mutualise risk across all users by having virtual unlimited access to members balance sheets.
I would recommend looking at all my clearinghouse posts - I have been looking at this for the best part of 5 years.
I look forward to reading your prior material - thank you. I don’t disagree that margin/var methodologies can be pro cyclical. Hence the proposed shifts in methodology on the banking side from var to expected shortfall.
Re the mutualization of risk, the goal is to protect customers vs members (FCM/clearing banks). This is clear in the waterfalls which generally use defaulting members resources first, clearinghouse second, the guarantee fund (other members) 3rd and then assessment powers 4th.
As the members pointed out, they are not happy with this waterfall structure, as they bear the risk of the clearinghouse mispricing risk.
Personally, I think the regulators misdiagnosed the GFC. It was driven by rating agencies, Freddie Mac and AIG. The investment banks knew that MBS were mispriced, but the agencies mispriced the risk, and AIG sold them credit protection, and so they ran a huge arbitrage business. It failed when AIG looked like it was going to go bust, which meant all the investment banks became unprotected.
If I was in charge I would get rid of the rating agencies. The market does their job for them, and is much better at it. Then everyone would know that higher yields meant more risk, rather than delude themselves that a AAA rated product with a high yield must be a safe bet.
I would also bring about a 10% deposit limit, so that bank failure could be tolerated - but regulators love power, and they love having fewer companies to regulate, so I dont see that change coming
So what this means in this backwards market is that clearinghouse are naturally pro cyclical. Well performing assets continue to get lower and lower margin, until it breaks down, and then margins will rise and rise and rise. Bonds remain a short
The problem with all of this is 4-5% yield on a 10 year bond is not that high. 1-2% was anomalously low. What private sector people did when yields were 1-2% to gear up returns is hardly the BoE's concern as long as the market is clearing and there is no systemic collapse risk.
My real issue is that the reform to move clearinghouses to the centre of the financial system was to reduce the need for bailouts - but in practice it requires constant bailouts. The way they run the system is bonkers - and the main banks know it too. Read this:
I think you should look more at QE leakage, xboder flows and its repatriation as rates in UK, EU, Jap, Taiwan, Korea go up. UK is at the point in terms of yields where the outflows are getting brought back I think, ie Cable has bottomed albeit energy and Ukraine can cause some tape bombs.
I highly doubt a clearing house would disorderly fail, it would be bailed out. Its not he govt/ BoE job to micro manage participants or rescue their equity if they go wrong.
You used to trade sectors including insurers, and definitely John horseman did. Any views on insurer capital base erosion given fixed income and risky assets have fallen heavily this year and there is probably some way to go?
I think you're barking up the wrong tree slightly here. The issue with LCH isn't compression trades, which are just a tidying up operation and have a small (and reducing) effect over time. The risk models have the usual issues with backward looking windows etc., but every major bank (and most HFs) do the same thing. In my experience, the risk models in the clearing houses are actually more sophisticated than those in the banks.
They're still not 'correct', if there is such a thing, but no worse than for bilateral trades, and for the regulators value at risk is the only game in town anyway. They do the typical stress tests the banks do, and they're pretty heavily monitored, again more than any bank I've worked at.
The real issues are the transformation of market risk into liquidity risk, which will be the cause of any eventual failure. A market shock leads to cash margin calls which need to be paid almost immediately and potentially causing a downward spiral as clearing members need cash fast. The LCH is not obliged to pay out margin on 'winning' portfolios in this way.
During Brexit Friday they drained massive liquidity from the market without returning any on the other side. In fact they made multiple intra day calls if I remember correctly and got a slap on the wrist from the bank.
https://www.risk.net/risk-management/2474560/lch-under-scrutiny-after-outsized-brexit-margin-calls
The second issue is one you mentioned in the comments, the management of a default. I have spoken to several bank 'risk managers' with some responsibility in this area, and none of them had the foggiest idea of how that will operate, or what the clearing house rule book says they are entitled to do (anything they like). They are in for a massive shock if it ever happens, that kind of event for a large bank will be carnage.
If the dangers of clearing is your thing, Craig Pirrong is the go-to guy. He's been writing about the possible liquidity spiral since it was mandated. He's pretty spot-on I think.
https://streetwiseprofessor.com/clearing-is-not-a-harmless-bunny-i-told-you-that-i-told-you-that-i-told-you-ad-infinitum-that-i-told-you-so/
My interest in clearinghouses began in reading this article : https://www.bis.org/publ/qtrpdf/r_qt1812x.htm
I asked my self, why was Lehman not a problem, but a small trader in Norway was?
Many many people have told me that compression is actually makes the system safer, but in practice it allows margin to be paid back to the investor, while not reducing any directional risk in markets. I think compression makes things "simpler" but not necessarily "safer". When I read about Lehman in the article above, it is clear there was too much margin at the clearinghouse - but that it what made them safe. Redundancy.
Remove the redundancy, it is cheaper to trade - but the system is not safe. Clearinghouse had no problems during the GFC, and now problems are recurring. And compression is definitely one cause.
Craig and I look to be singing from the same hymn sheet!
That's not really apples and apples though. What matters is the directionality of the portfolio, size relative to the overall market and how the market realises vs the initial margin held against it. The Lehmans book could have been relatively risk flat, I've no idea.
OTC swaps are margined for 5 days of risk, futures only 2. Auctioning a large swap book (in those days) is easier than power futures. They are impossible to margin correctly, and one spike can wipe out the entire margin.
There's also a larger probability of a default auction failure. There will be a smalll number of participants, and who is going to take the trades when they are positioned the other way, and make themselves flat? Maybe you get lucky and someone lets you out at a high price, but not if they need the hedge. A swap book you've got a better chance because a dealer may take it at a generous enough level where they can hedge and work it over time.
Remember though the CCP was a lot smaller before mandatory clearing., and some portfolios are a lot more directional now because of the CH basis. I don't know how they margined swaps before 08, maybe it was a lot more conservative. But then that's a matter for margining appropriately, not indirectly hacking the margin by not netting off correctly.
I don't think compression is that big of a deal really. After all, wasn't trade assignment where you could step out of a pair of bilateral trades and leave two other counterparties facing each other, just the same thing?
Anyway, it's all a rabbit hole. Craig is definitely the guy to read if you want to know about clearing's many many flaws
Hi Russell, interesting article, and your point on the LCH "repricing" the risk in gilts -- that is, changing margin requirements based on historical vol lookbacks -- intuitively makes sense for why it would cause a dearth of buyers and a market dislocation.
However, based on my experience trading IR derivates at a major NY hedge fund and interacting with LCH, I don't think your point on compression trades is accurate. Imagine there are 3 banks that all trade GBP IRS with each other. Bank A pays fixed with Bank B. Bank B pays fixed with Bank C. And Bank C pays fixed with Bank A. All for the same notional, say $1tn. Then each bank has, on it's books, a payer and receiver of $1tn and, therefore, net 0 interest rate exposure. However, they have immense ($1tn) notional exposure and counterparty exposure and thus would have to post margin with each other based on the large ($1tn) notional. Now comes along LCH, which steps in as counterparty to all trades. So each bank has a payer and receiver versus not different counterparties, but a single counterparty being LCH for the exact same amount, and both LCH and each of the banks agrees to just tear up the contracts and return the margin. Therefore the total outstanding notional in the market goes from $3tn down to 0, and all the associated margin is returned to the individual banks. Therefore, compression trades do, in fact, reduce outstanding notional exposure, which is why margin is returned.
Please tell me if I am missing something in your argument on compression trades.
Essentially this process used to take place prior to LCH as well when hedge funds wanted to "clean up" their books. We would send out large packages of net zero risk trades (but against different counterparties) for pricing so that a single bank would step in as the single counterparty and effectively tear up the excess notional that came from facing different counterparties on offsetting risk.
Hi RR,
When I first looked at compression trades I would have agreed with you. But the more I thought about it - the more I realised it increased risk.
Let me explain my line of thinking.
So in the "pre-compression centrally cleared era" there are a bunch of unnecessary trades that existed- the circular trades described above. If one member goes bust, the cleraringhouse can take the positions and auction them. Now as there are plenty of unnecessary circular trades, there will be plenty of members who can come in on both sides to clear the portfolio. This is what happened with Lehman - which had huge notional - but LCH was able to settle all its trade only using 1/3 or its margin.
Now when you centrally clear, you get rid of all these circular trades, and you end up with less notional. In IR markets this has meant the markets have become increasing bifurcated. I can dig up the BIS note that shows this.
What that means, is that positioning it increasingly similar across similar market participants, so that if one member gets in trouble, all similar members get in trouble. Also as there are no circular trades, there are less margin for all members. This is what we saw with Nasdaq Oslo, and what I think we saw with LCH.
It actually a simple question of risk. If redundnant notional is cancelled (which for the system had no risk) we are also getting rid of redundant margin. But if total risk is constant (by defintion) but total system margin is falling, then the system must get more risky - by definition. Its like the old hedge fund saying - only selling reduces risk - hedging increases risk.
Its not my area of expertise - but I would say market action seems to bare my analysis out.
Hi Russell, thanks for clarifying. I now understand what you mean, and I agree with you. I was earlier treating risk as amorphous and not making the important distinction between market risk and counterparty risk.
Central clearing -- specifically compression trades -- reduce counterparty risk by eliminating the complex web of multi-counterparty positions, but increase market risk for many of the reasons you mentioned.
Before central clearing, different legs of a net zero market risk position could face different counterparties and therefore counterparty risk meant that your net zero market risk position may not be so in practice (esp when the shit hit the fan and one side moved significantly).
This specter of counterparty risk has three important dampening effects on the market risk of participants (and the market as a whole):
1. Since a lot of margin is tied up in these circular trades that are net zero market risk, the amount of net direction risk borne by each participant was a fraction of the gross notional they held. Said another way, the amount of net direction risk that could be supported by a given amount of margin was significantly lower than post central clearing since most of that margin was tied up in the circular trades.
2. Since counterparty risk could suddenly turn a net zero market risk position into a large direction position, participants generally tended to be more conservative in their net and gross exposure.
3. Really a corollary of 2. in that since participants directly faced each other, they tended to have much greater visibility into the market (and counterparty) exposure of other participants and thus, presumably, the market as a whole was not as crowded.
Once you introduce central clearing and compression trades, you do away with counterparty risk (in theory, if the clearing house is setting margin thoughtfully, but that is a discussion for another time), but you change the market risk dynamics as follows:
1. Since all circular trades are just torn up and no longer require any margin usage, all available margin can be gainfully employed towards directional risk. Therefore, a given amount of margin can -- post-clearing and post-compression -- support significantly greater direction risk than it could before (where a lot of it was tied up in circular trades).
2. Since all participants face the clearing house and, in theory, have no counterparty risk, their risk appetite would naturally increase.
3. Again, a corollary to 2. in that since participants face the clearing house and lack visibility into the position of other participants, this arrangement could significantly increase crowding.
Thanks again for clarifying.
Best,
Raja
All correct. The final problem is that when a member can't meet a margin call the ccp takes the position and tries to sell the position in the market- everyone is similarly positioned so cant bid... which.cause prices to fall more creating more margin call etc...
Also ccp cant go bust.. so price risk poorly
With all due respect as I am new to your newsletter, I don’t believe this is accurate. The reduction of gross notional in clearinghouses was a response GFC changes to how banks are capitalized, notables SLR as a backstop to risk based capital and potential GSIFI capital add ons based on a battery of metrics based on complexity, reach and size. Keeping gross notional sitting around for the sake of attracting capital add ons doesn’t make sense and starves the productive deployment of that capacity to other parts of the global economy that needs it. The clearinghouse facilitated this reduction, but didn’t force it. To put in simple terms if I owe you $20 and you owe me $20 should we just call it even? Unwinding Lehman Brothers derivative book was very complicated, even know their net risk to the street was negligible (I did it for a bank). If this had been cleared it would have been much simpler even without compression. Now, clearinghouses can cause forced selling if a member doesn’t have the liquidity to maintain its exposure, as was the case with MF Global. If you can’t make a margin call your collateral will be sold to protect the clearinghouse and its members. If the assets posted are the same ones causing your financial stress or stress in the market, they will be sold into a weak market, thus potentially causing more stress.
Sorry for the long post.
As an aside, as the BIS note points, taking collateral and selling in market when you dont make margin, actually makes the problem worse, not better.
What’s the alternative? Isn’t that a bailout (govt, private, or hybrid). When borrowers default on their mortgage, the collateral is taken and sold. When tax payers don’t pay taxes, assets are
seized and auctioned/ wages garnished. No intent to be snarky but what should lenders/clearing houses do?
The way clearinghouses are set up.is that they almost guarantee default. And when one member defaults it then requires all remaining members to stump up cash.
So if the idea was to get rid of too big to fail - then clearinghouse model makes it impossible to let anyone fail
I originally thought as you do, but then I read this report from BIS in 2018. When I dug into, I realised clearinghouse set risk in a pro cyclical manner almost inviting risk.
https://www.bis.org/publ/qtrpdf/r_qt1812x.htm
As I researched it more, I realised it was not just niche clearinghouses, but big ones too. This was confirmed by the joint paper by the biggest users of clearinghouse saying they did not understand how they priced risk. The Goldman author made the margin call on AIG in the GFC, so he knows about risk and margin.
https://www.goldmansachs.com/media-relations/press-releases/current/multimedia/ccp-paper.pdf
The biggest problem is clearinghouse set risk wrong, and also mutualise risk across all users by having virtual unlimited access to members balance sheets.
I would recommend looking at all my clearinghouse posts - I have been looking at this for the best part of 5 years.
Russell
I look forward to reading your prior material - thank you. I don’t disagree that margin/var methodologies can be pro cyclical. Hence the proposed shifts in methodology on the banking side from var to expected shortfall.
Re the mutualization of risk, the goal is to protect customers vs members (FCM/clearing banks). This is clear in the waterfalls which generally use defaulting members resources first, clearinghouse second, the guarantee fund (other members) 3rd and then assessment powers 4th.
As the members pointed out, they are not happy with this waterfall structure, as they bear the risk of the clearinghouse mispricing risk.
Personally, I think the regulators misdiagnosed the GFC. It was driven by rating agencies, Freddie Mac and AIG. The investment banks knew that MBS were mispriced, but the agencies mispriced the risk, and AIG sold them credit protection, and so they ran a huge arbitrage business. It failed when AIG looked like it was going to go bust, which meant all the investment banks became unprotected.
If I was in charge I would get rid of the rating agencies. The market does their job for them, and is much better at it. Then everyone would know that higher yields meant more risk, rather than delude themselves that a AAA rated product with a high yield must be a safe bet.
I would also bring about a 10% deposit limit, so that bank failure could be tolerated - but regulators love power, and they love having fewer companies to regulate, so I dont see that change coming
ex post facto information. where else are their systemic risks to monitor for now and in the future ?
seems this weak spot is similar to 2008 - no way to unwind 30:1 .
So what this means in this backwards market is that clearinghouse are naturally pro cyclical. Well performing assets continue to get lower and lower margin, until it breaks down, and then margins will rise and rise and rise. Bonds remain a short
The problem with all of this is 4-5% yield on a 10 year bond is not that high. 1-2% was anomalously low. What private sector people did when yields were 1-2% to gear up returns is hardly the BoE's concern as long as the market is clearing and there is no systemic collapse risk.
My real issue is that the reform to move clearinghouses to the centre of the financial system was to reduce the need for bailouts - but in practice it requires constant bailouts. The way they run the system is bonkers - and the main banks know it too. Read this:
https://www.goldmansachs.com/media-relations/press-releases/current/multimedia/ccp-paper.pdf
Basically saying the GS, JPM et al dont understand how clearinghouses price risk - and what more protection from clearinghouses going bust...
I think you should look more at QE leakage, xboder flows and its repatriation as rates in UK, EU, Jap, Taiwan, Korea go up. UK is at the point in terms of yields where the outflows are getting brought back I think, ie Cable has bottomed albeit energy and Ukraine can cause some tape bombs.
I highly doubt a clearing house would disorderly fail, it would be bailed out. Its not he govt/ BoE job to micro manage participants or rescue their equity if they go wrong.
Clearinghouses cant go bust - but compulsory capital calls mean bankruptcy at one member passes financial risk to all members. Its a bad system
You used to trade sectors including insurers, and definitely John horseman did. Any views on insurer capital base erosion given fixed income and risky assets have fallen heavily this year and there is probably some way to go?
sorry - no view on insurers at the moment!
Great piece. This centralization creates enormous systemic risk fat out in the tail. It looks ‘nicer’ and more ‘efficient’ but it’s risky nonetheless
What do you think is the solution Russell? Are we going back to OTC trading and counter-parties?
Risk takers need to be price setters... but politics is tricky on this one