Tag Archives: Derivatives market

Survey: Market Surprised By Negative Derivative Perception

The market participants are very surprised by the negative perception of credit derivatives, as expressed by politicians, regulators, the media, internet blogs, and others. They find the extent of blame attributed to credit derivatives, for either causing the market meltdown or otherwise negatively affecting market dynamics, mostly misplaced, the latest Global Credit Derivatives Survey by Fitch Market Research show.

“Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as toxic.”

Fitch Ratings

“The rapid growth of the credit derivatives (CDx) market prior to 2007, its absolute size as measured by gross notional amounts, and its perceived role in the current global financial crisis have led to intense scrutiny and much debate among market participants, regulators and policy makers about the need for significant change in market practices and on ways to strengthen regulatory oversight. This year’s survey was undertaken in the midst of significant and transformational changes taking place within the CDx market,” Fitch Market Research writes.

This year’s survey, which is the seventh conducted by Fitch, includes 29 banks from 10 countries.

The survey was undertaken in the midst of significant and transformational changes taking place within the CDx
market and therefore focuses on some of these key issues in addition to traditional themes such as:

* Surprises and challenges for the CDx market from the perspective of market participants.
* The current state of the market, including key growth trends.
* A brief sector review of banks and insurance companies.

Market Shrinks By 64%

The overall market for credit derivatives (CDx) shrunk to $1,8 trillion in 2009 from $5,1 trillion in 2008, the survey show.

The 29 banks surveyed by Fitch had a notional sold volume of CDx contracts totaling $10.6 trillion at year-end 2009, and a notional bought volume of $10.9 trillion at year end 2009.

(The notional amount refers to the par amount of credit protection bought and sold.)

“The decline in both sold and bought (24% for sold, 22% for bought) notional amounts as compared to 2008 reflects a combination of factors,” Fitch writes and points at the following:

1. Industry initiatives to ‘compress’ and ‘tear up’ CDx transactions that eliminate redundant offsetting contracts (while compressions replace offsetting redundant contracts with a smaller number of replacement contracts, tear-ups eliminate them).

2. A reduction in overall trading activity which is partially attributable to risk aversion, deleveraging within the broader financial sector, and a cautious approach to the CDx market in the face of heightened regulatory uncertainty.

3. Increased use of collateral and netting agreements.

4. The fact that Fitch’s survey sample for the two years differed somewhat.

The survey also confirms that trading for profit is still the main motivator in the derivative market – not the insurance that the instruments originally is designed for.

The Survey Highlights

* Regulation in general was one of the most often cited challenges, with commentary ranging from the prospects of dealing with regulatory perceptions of the market to being over-regulated on several fronts.

* Ninety-six percent of market participants surveyed agree that central clearing is called for, and most believe it would reduce systemic risk. However, there was less of a consensus among survey respondents as to the desirability of having multiple clearing houses or the exchange trading of CDx.

* Some survey respondents were surprised at the extent to which the market meltdown or negative dynamics were attributed by market observers to the use of CDx.

* Hedging, basis trades, the traded indices, and sovereign strategies were all noted by market participants as those that grew over the last year. On the downside, CDOs and more leveraged structures were mentioned as laggards.

* At year-end 2009, single-name CDS and indices continued to dominate the market; while both products make up more than 90% of the total CDx market, it is notable that on a relative basis the use of indices has fallen for the first time.

* The development of the sovereign CDS market in terms of volumes and general relevance was noted by respondents, with 89% expecting sovereign CDS use to grow in the future.

* The top 10 counterparties comprised 78% of the total exposure in terms of the number of times cited, up from the 67% reported last year, reflecting the dominant role of banks and dealers as counterparties and the consolidation of counterparties post-crisis.

* While the banks surveyed by Fitch saw a decline in both sold and bought positions, they continued to have relatively balanced portfolios in the aggregate. Although some banks shifted from being net protection sellers to net protection buyers, there were no significant movements in the other direction.

* Sixty percent of survey respondents acknowledged the growing importance of the risk management function within banks and the role of the chief risk officer, compared with 40% in the previous year.

* Given the concentrated nature of the CDx market, the continued importance of counterparty risk management was highlighted by 53% of survey respondents. The most recent findings matched the results seen two years earlier.

Biggest Surprise: Public’s Perceptions

There has been no shortage of commentary regarding CDx from market observers such as politicians, regulators, the media, Internet blogs, and others.

Among the bigger surprises noted by several respondents was the extent of blame attributed to CDx for either causing the market meltdown or otherwise negatively affecting market dynamics, and a seeming lack of understanding of the role/mechanics of CDS in general.

“One respondent commented on the apparent lack of distinction between structured finance products (e.g. RMBS securities) and CDS. Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as “toxic,” Fitch says.

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Read the full post and download the full Fitch report, “Global Credit Derivatives Survey”, at The Swapper.

Related by the Econotwist:

Killing My CDS Softly

The Alchemists of Wall Street

Spec-Grade Liquidity Worsens

Flight to Mystery

Bank Funding Crunch Deepens as Swap Rates Soar

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

Proposal For New Single European Bond

Big Banks Block OTC Clearing in “Proxy War”

Unintended Consequences of Reform Hinder ABS Issuance

S&P’s: Future Is Unclear for European RMBS

Naked self-interest

US Bank TruPS CDO Defaults Near 14% on Deferral Transfer Spike

How To Create A 3 Trillion Dollar Bubble And Burst It

So, You Thought BP Was An OIL Company?

Response To The BP Derivatives Story

Living In A Derivative World

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Comments Off on Survey: Market Surprised By Negative Derivative Perception

Filed under International Econnomic Politics, National Economic Politics

Survey: Market Surprised By Negative Derivative Perception

The market participants are very surprised by the negative perception of credit derivatives, as expressed by politicians, regulators, the media, internet blogs, and others. They find the extent of blame attributed to credit derivatives, for either causing the market meltdown or otherwise negatively affecting market dynamics, mostly misplaced, the latest Global Credit Derivatives Survey by Fitch Market Research show.

“Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as toxic.”

Fitch Ratings


“The rapid growth of the credit derivatives (CDx) market prior to 2007, its absolute size as measured by gross notional amounts, and its perceived role in the current global financial crisis have led to intense scrutiny and much debate among market participants, regulators and policy makers about the need for significant change in market practices and on ways to strengthen regulatory oversight. This year’s survey was undertaken in the midst of significant and transformational changes taking place within the CDx market,” Fitch Market Research writes.

This year’s survey, which is the seventh conducted by Fitch, includes 29 banks from 10 countries.

The survey was undertaken in the midst of significant and transformational changes taking place within the CDx
market and therefore focuses on some of these key issues in addition to traditional themes such as:

* Surprises and challenges for the CDx market from the perspective of market participants.
* The current state of the market, including key growth trends.
* A brief sector review of banks and insurance companies.

Market Shrinks By 64%

The overall market for credit derivatives (CDx) shrunk to $1,8 trillion in 2009 from $5,1 trillion in 2008, the survey show.

The 29 banks surveyed by Fitch had a notional sold volume of CDx contracts totaling $10.6 trillion at year-end 2009, and a notional bought volume of $10.9 trillion at year end 2009.

(The notional amount refers to the par amount of credit protection bought and sold.)

“The decline in both sold and bought (24% for sold, 22% for bought) notional amounts as compared to 2008 reflects a combination of factors,” Fitch writes and points at the following:

1. Industry initiatives to ‘compress’ and ‘tear up’ CDx transactions that eliminate redundant offsetting contracts (while compressions replace offsetting redundant contracts with a smaller number of replacement contracts, tear-ups eliminate them).

2. A reduction in overall trading activity which is partially attributable to risk aversion, deleveraging within the broader financial sector, and a cautious approach to the CDx market in the face of heightened regulatory uncertainty.

3. Increased use of collateral and netting agreements.

4. The fact that Fitch’s survey sample for the two years differed somewhat.

The survey also confirms that trading for profit is still the main motivator in the derivative market – not the insurance that the instruments originally is designed for.

The Survey Highlights

* Regulation in general was one of the most often cited challenges, with commentary ranging from the prospects of dealing with regulatory perceptions of the market to being over-regulated on several fronts.

* Ninety-six percent of market participants surveyed agree that central clearing is called for, and most believe it would reduce systemic risk. However, there was less of a consensus among survey respondents as to the desirability of having multiple clearing houses or the exchange trading of CDx.

* Some survey respondents were surprised at the extent to which the market meltdown or negative dynamics were attributed by market observers to the use of CDx.

* Hedging, basis trades, the traded indices, and sovereign strategies were all noted by market participants as those that grew over the last year. On the downside, CDOs and more leveraged structures were mentioned as laggards.

* At year-end 2009, single-name CDS and indices continued to dominate the market; while both products make up more than 90% of the total CDx market, it is notable that on a relative basis the use of indices has fallen for the first time.

* The development of the sovereign CDS market in terms of volumes and general relevance was noted by respondents, with 89% expecting sovereign CDS use to grow in the future.

* The top 10 counterparties comprised 78% of the total exposure in terms of the number of times cited, up from the 67% reported last year, reflecting the dominant role of banks and dealers as counterparties and the consolidation of counterparties post-crisis.

* While the banks surveyed by Fitch saw a decline in both sold and bought positions, they continued to have relatively balanced portfolios in the aggregate. Although some banks shifted from being net protection sellers to net protection buyers, there were no significant movements in the other direction.

* Sixty percent of survey respondents acknowledged the growing importance of the risk management function within banks and the role of the chief risk officer, compared with 40% in the previous year.

* Given the concentrated nature of the CDx market, the continued importance of counterparty risk management was highlighted by 53% of survey respondents. The most recent findings matched the results seen two years earlier.

Biggest Surprise: Public’s Perceptions

There has been no shortage of commentary regarding CDx from market observers such as politicians, regulators, the media, Internet blogs, and others.

Among the bigger surprises noted by several respondents was the extent of blame attributed to CDx for either causing the market meltdown or otherwise negatively affecting market dynamics, and a seeming lack of understanding of the role/mechanics of CDS in general.

“One respondent commented on the apparent lack of distinction between structured finance products (e.g. RMBS securities) and CDS. Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as “toxic,” Fitch says.

Receiving several mentions in this category were surprises related to the perceptions of regulators.

Other comments were wide-ranging, from those related to Basel II reforms, to calls for a central clearinghouse/exchange.

Of all surprises related to the past year’s events, those related to sovereigns were among the most prominent.

In particular, the growth of the sovereign CDS market in terms of volumes and general relevance was noted by a number of respondents.

Other responses pointed to the sovereign crisis in a general sense, but without a specific tie-in to CDS.

Beyond sovereign trading action, comments related to spread action in general garnered the most number of responses as being surprising, ranging from volatility that was greater than expected, to shifts in the basis between CDS and cash
instruments, to the spread rally that followed the depths of the credit crisis.

Fitch have also asked market participants specifically what they believe is the impact of CDS has been on the broader marketplace.

While some survey respondents noted that various market observers have blamed CDS for exacerbating or significantly contributing to the recent credit crisis, this is the view of the market participants themselves.

The King of Derivatives

The survey also disclose who’s the biggest player in this market.

The title as King of Derivatives 2010 belongs – indisputable – to JP Morgan Chase & Co.

For more interesting reading, here’s the full report “Global Credit Derivatives Survey” from Fitch.

Related by The Swapper:

Killing My CDS Softly

The Alchemists of Wall Street

Spec-Grade Liquidity Worsens

Flight to Mystery

Bank Funding Crunch Deepens as Swap Rates Soar

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

Proposal For New Single European Bond

Big Banks Block OTC Clearing in “Proxy War”

Unintended Consequences of Reform Hinder ABS Issuance

S&P’s: Future Is Unclear for European RMBS

Naked self-interest

US Bank TruPS CDO Defaults Near 14% on Deferral Transfer Spike

How To Create A 3 Trillion Dollar Bubble And Burst It

So, You Thought BP Was An OIL Company?

Response To The BP Derivatives Story

Living In A Derivative World

9 Comments

Filed under Uncategorized

Response To The BP Derivatives Story

The recent post “So, You Thought BP Was An OIL Company?” is currently the most read story ever published at the Econotwist’s Blog. And of course there’s been some comments. There’s particularly one comment I can’t refrain from replying to.

It can be found at Seeing Alpha:

“That article is about as credible as me writing about nuclear technology. Off-balance sheet transactions? SPEs? Interest Rate and Currency Swaps? Has that idiot even looked at a Annual report for BP? Does the moron know the difference between mark-to-market and accrual accounting? Does he understand that Enron and Lehman were both ‘paper’ companies vs. BP which owns $billions in physical assets. And what actual substance other than quoting some Moody’s % is he actually providing? Sure the derivatives market is $trillions, but most of that is paper (i.e. debt securities and currencies which DWARF energy derivatives). In a word, simply a fool that’s probably talking his book…..”

Well. I’m the idiot/moron/fool who wrote the article in question.

This idiot has in fact read several of BP’s annual reports, and let me quote from the 2009 annual:

Derivatives:

Gas and power marketing and trading activity is undertaken market both BP production and third-part natural gas, support LNG activities and manage market price risk as well as to create incremental trading opportunities through the use of commodity derivative contracts. Additionally, this activity generates fee income and enhanced margins from sources such as the management of price risk on behalf of third-party customers. These markets are large, liquid and volatile.”

“In connection with the above activities, the group uses a range of commodity derivative contracts and storage and transport contracts. These include commodity derivatives such as futures, swaps and options to manage price risk and forward contracts used to buy and sell gas and power in the marketplace. Using these contracts, in combination with rights to access storage and transportation capacity, allows the group to access advantageous pricing differences between locations, time periods and arbitrage between markets.”

BP has been able borrow with AAA yield anywhere on the curve and lend to less credit worthy entities at attractive spreads. These lending differentials are the fuel of the $430 trillion Interest Rate Swap OTC market.

BP has been able to spin off $20 billion of earnings for the last 5 years, and $15 billion in cash last year.

Accounting

“Natural gas futures and options are traded through exchanges, while over-the-counter (OTC) options and swaps are used for both gas and power transactions through bilateral and/or centrally cleared arrangements.”

These contracts (OTC) are typically in the form of forwards, swaps and options. Some of these contracts are traded bilaterally between counterparties; others may be cleared by a central clearing counterparty. These contracts can be used for both trading and risk management activities. Realized and unrealized gains and losses on OTC contracts are included in sales and other operating revenues for accounting purposes.”

This moron does in fact know the difference between mark-to-market and accrual accounting, and why the OTC contracts are included in “sales and other operating revenues for accounting purposes,” which totaled $213 billion in 2009, in where sale of crude oil through spot and term contracts amounted to $35, 6 billion.

Off-Balance Sheet

BP uses derivative instruments to manage the economic exposure relating to inventories above normal operating requirements of crude oil, natural gas and petroleum products as well as certain contracts to supply physical volumes at future dates. Under IFRS, these inventories and contracts are recorded at historic cost and on an accruals basis respectively. The related derivative instruments, however, are required to be recorded at fair value with gains and losses recognized in income because hedge accounting is either not permitted or not followed, principally due to the impracticality of effectiveness testing requirements.”

“Gains and losses on these inventories and contracts are not recognized until the commodity is sold in a subsequent accounting period.”

According to the 09 annual statements, financing agreements of $6, 48 billion is held off balance sheet.  Additionally, the BP group has issued third-party guarantees with amounts outstanding at $319 million of liabilities of jointly controlled entities and associates, and $667 million in respect of other third parties – also off balance sheet.

Contagion

BP’s subsidiaries in the Gulf – Arosa Funding Limited, Halliburton, Anadarko Petroleum, Transocean Inc., and Cameron International – are all placed under credit watch with negative outlook.

BP own (fully or partly) 3.689 refineries around the word, and 22.400 retail sites. These retail sites are not just gas stations, but increasingly expanding into new areas like food and clothing.

This fool does in fact understand the difference between Enron, Lehman, Bear Stearns and BP. But he also sees the similarities; these companies failed because their primary assets deteriorated rapidly, which in turn triggered materialization of their exposure to the derivative market, resulting in insolvency and finally default.

BP may have billions in physical assets, so did Enron, but this fool have also noticed that the market value of the company (and its assets) have been cut in half since April 20.

Liquidity

BP borrowed $11 billion in 2009, and have (as of January 2010) $34, 6 billion in debt – most of it cut in pieces and sold worldwide through their banking network as a mighty fine collection of collateralized, securitized, synthesized and highly leveraged fixed income assets.

BP’s issue of CSOs equals 18% of the global total rated by Moody’s.

BP’s credit rating has been cut to junk by Fitch, to BBB from AA. As a result, the price of BP’s Credit-default Swaps has jumped to nearly 600 bps, up from 44.

One of BP’s 5-year bond series, maturing in 2012, was recently trading with a yield of 9, 48%.

And on top of this, BP is supposed to come up with another $50 billion to clean up the oil spill, as public pension funds are preparing to sue the company for the money they’ve lost by investing in BP shares.

Now, before you call someone an “idiot”, a “moron” or “fool”, be sure you know what you’re talking about, or you will be the one ending up looking stupid….

SOURCES:

(1)   06-21-10 BP’s Bankruptcy Would Impair 117 (18% Of Total) Collateralized Synthetic Obligations, Lead To Pervasive Losses Zero Hedge

(2)   06-16-10 BP CDS Curve Goes Nuts, 1 Year Passes 1,000 Bps, No Offers In Market Zero Hedge

(3)   06-25-10 BP Getting Crushed: What Does its ‘Yield Inversion’ Mean? WSJ

(4)   06-28-20 Interactive timeline: BP oil spill disaster Financial Times

(6)   06-25-10 BP reassures on cash pile as shares plunge Financial Times

(7)   06-18-10 Macondo, in historical Hollywood context FT Alphaville

(8)   06-10-10 BP short interest, other facts and stuff (updated) FT Alphaville

(9)   06-24-10 BP Bankruptcy in U.K. Is Obama’s Worst Nightmare Caroline Baum  Bloomberg

(10) 06-21-10 BP and Anadarko turn on each other FT Alphaville

(11) 06-20-10 Internal BP Document Confirms Matt Simmons’ Worst Case Prediction Of Spill Rate Of 100,000+ Barrels Per Day Zero Hedge

(12) 07-01-10  ”Sultans Of Swap” Tipping Point

(13) 02-26-10 BP Annual Report 2009

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Filed under International Econnomic Politics, National Economic Politics