Monday, May 14, 2012

FT Alphaville asks 'What position transparency?'

Lisa Pollack of FT Alphaville investigated JP Morgan's trade that lost $2 billion and observed
“Synthetic credit portfolio”. That’s the book where the $2bn in mark-to-market losses took place for JP Morgan, according to an announcement made on Thursday. A result which has now cost them a their AA- rating from Fitch and landed them on negative outlook with S&P, as announced late on Friday. 
FT Alphaville has analysed the credit trades that might be in that portfolio, in an attempt to reason through what may have gone on. 
The fact, however, remains that we know precious little. Why is that? Is this acceptable that after the financial crisis that this can happen to a bank, let alone a systemically important one like JP Morgan?...
Ms. Pollack points out the elephant in the room.  How is it that four plus years after the financial crisis started and market participants know precious little about the exposures on and off bank balance sheets?

Without this data, how are market participants suppose to be able to assess the risk of the banks and enforce market discipline?

Back to her post (my only added emphasis is highlighting certain key phrases).
Please, may we have some transparency 
Swaps industry organisation Isda recently had their AGM. At the meeting it was discussed how not nearly as much public price transparency is needed in the market as is popularly thought. Indeed, the FT quoted people saying things like this:
Michael Davie, head of LCH.Clearnet’s SwapClear platform, agreed that regulators, clearers and market participants must know what is going on, but public reporting isn’t essential.
Transparency for transparency’s sake, why is that inherently a good thing? In broadly subscribed retail markets it’s incredibly important, but how many people are doing 10-year Czech krona swaps?” he said.
Because the global financial markets are built on transparency.
Stephen O’Connor, chairman of the International Swaps and Derivatives Association and head of OTC clearing at Morgan Stanley, meanwhile: 
“We’re not anti-public reporting,” he said. 
 Leading Isda to conclude in their media comment
So to sum up: price transparency is not a systemic risk issue. 
Now that we bothered to tell you all of that, we’re going to say that we don’t think we’re hugely fussed about the transparency of prices either — at least not in credit derivative markets. 
As your humble blogger has repeatedly said, it is valuation and not price transparency that is important.

Valuation transparency means that investors have access to all the useful, relevant information in an appropriate, timely manner so they can make a fully informed investment decision.  In short, they need all the useful, relevant information so they can independently assess the risk and value the investment.

Only then do investors care about the price.  With their independent assessment of value, they can make buy, hold and sell decisions based on the price being shown by Wall Street.
There should be prices available, and there already are consensus prices available on multiple platforms.   
How much market participants should have to report after specific trades are done, we’re not totally sure.
When you look at reporting from a valuation transparency perspective, the answer is that each specific trade must be disclosed.

Fortunately, it is easy to report this information as this is how the data is recorded in the information systems of both the buyer and seller.
What we are sure about is that JP Morgan has proven that more disclosure is needed ....
Why? Because if the regulators aren’t up to monitoring large trades placed by a systemically important financial institutions, maybe the public will be. Or maybe shareholders will be.....
Please re-read the highlighted text as I have been making this point since the financial crisis began.
Maybe with that in hand, there can be more shouting at the regulators to use the data they already have to investigate whether any particular bank or other market participant is behind large increases in the amounts outstanding on particular types of trades.... 
Or maybe, market participants can simple enforce market discipline and not rely on the regulators for monitoring or taking action.
Maybe Isda is right and price transparency isn’t a systemic risk issue.
Price transparency is not a systemic risk issue which is why Wall Street's lobbyists made it a centerpiece of the Dodd-Frank Act.

Price transparency diverts attention from valuation transparency.  When one looks at where there is opacity in the financial system that benefits the banks, it always involves valuation transparency.

This is not a surprise because, as Yves Smith pointed out, no one on Wall Street was compensated for creating low margin, transparent products.
But JP Morgan just proved that [trade level data is]. Want to form a working group for that or what?
Sign me up for the working group!

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