Price transparency brought to opaque swaps markets

Financial regulators, particularly the CFTC, are calling bringing price transparency to the opaque swaps markets a pivotal moment in the regulation of Wall Street.

Regular readers know that that there are two types of transparency:  valuation and price.  It is valuation transparency that is the important form of transparency.

As everyone knows, the investment cycle has three steps:  value the security; solicit a price for the security from Wall Street; and then make an investment management decision to buy, hold or sell the security.

Without valuation transparency, it is impossible to value the security and go through the investment process.

Without valuation transparency, the act of buying or selling the security is simply blindly betting.

So the question is, is there any reason to get excited about bringing price transparency to the opaque swaps market?

No.  In fact, price transparency makes the problems in this market worse.  Price transparency by itself suggests that the casino is somehow not just for gambling.

As discussed by Ben Protess in a NY Times Dealbook article,

After spending two years and millions of dollars to temper a regulatory crackdown, the world's biggest banks are now resigned to a wave of new oversight.

This assumes that the banks did not get exactly what they wanted.  Price transparency has not been the problem in the swaps market as buyers and sellers could always call multiple banks for quotes.

By New Year's Eve, 65 banks had registered their derivatives business with regulators and turned over heaps of real-time trading data to outside warehouses, fulfilling a central rule of the Obama administration's financial regulatory overhaul. 

Late on Wednesday, a warehouse also posted an early batch of data online, shining a rare spotlight on an opaque business that blew up in the 2008 financial crisis. 

The changes, regulators say, signal a pivotal moment in the fight over Wall Street regulation. 

Until now, regulators had little authority and little information to scrutinize the minutiae of derivatives trading, a vast market that totals more than $600 trillion.

Actually, the regulators have always had access to reams of information.  They simply had to ask for it from the banks as the regulators are entitled to know each bank's exposures.

"They are an historic change for the markets that will benefit the public and the economy at large," Gary Gensler, chairman of the Commodity Futures Trading Commission, the architect behind the derivatives overhaul, said in a statement....

Why?  What data will the public get that is useful for valuing these securities?

The new oversight is a major component of the Dodd-Frank Act, the Wall Street regulatory overhaul passed after the financial crisis. The law took particular aim at derivatives, which proved pernicious in the crisis. 

Banks had bought billions of dollars in derivatives as dubious insurance on mortgage-backed investments. 

When the investments soured, the American International Group lacked the capital to honor agreements with the banks, prompting a $180 billion government bailout of the giant insurance company.

So the important data is what each firm's exposure is.  After all, who cares what price the derivatives that blew up AIG were purchased/sold at.  What was relevant was AIG's exposure to losses if the sub-prime mortgage market blew up.

Does the data being disclosed to the market allow market participants to know what is currently on JP Morgan's or Goldman Sach's balance sheet and who their counter-parties are?

Hoping to prevent such calamities, lawmakers spelled out a plan in Dodd-Frank to require derivatives dealers to register with Mr. Gensler's agency. Under the law, the banks and hedge funds must also open up their trading books to regulators and the broader public.

So all market participants are going to be able to see each bank and hedge fund's trading book?

The oversight, carried out through new rules written at Mr. Gensler's agency, developed in fits and starts. At times, a plan that was supposed to kick in during 2011 seemed like it might never take effect. 

The delay was in part a result of an aggressive lobbying campaign on Wall Street, which dispatched lawyers and lobbyists to temper the overhaul. In turn, Mr. Gensler's agency conceded modest changes and postponed the oversight for several months.... 

Wall Street has been aggressively lobbying since before the Dodd-Frank Act was passed.  With the exception of the Volcker Rule and the Consumer Financial Protection Bureau, the act appears to have been written by the industry for the industry.

The banks must also turn over in real-time the data from their trading book.

 And what data from their trading book must be disclosed?

The disclosures, posted on the Web site of the Depository Trust and Clearing Corporation, a data warehouse, include the volume, time and price of each derivatives trade....

Data that is focused on price transparency and not valuation transparency.  Remember, part of valuation transparency is knowing what the exposure to losses is for the counter-party.

The spreadsheet, regulators say, presents the public with its first window into the swaps market. While the public is blocked from viewing the identity of the trader, regulators have access to that information.

This is a classic example of Wall Street protecting the opacity that it profits from.

The data that is being made available relates to price only.  This is of limited benefit as the last price could represent the price that the biggest fool was willing to buy or sell at.

To a buyer or seller who is willing to pick up the phone and call several firms, they can get all the price quotes they want.  Price disclosure simply saves them the hassle of making several calls.

The only market participants who have access to the identity of the trader, which is data needed for valuation, are the regulators.

Wall Street has nicely protected opacity in the swaps market by making it impossible for the market participants who need the valuation data to have access to the data they need by giving the regulators an information monopoly.  A monopoly that the regulators will be very reluctant to give up.

"Real-time reporting brings transparency to the formerly opaque swaps market," Mr. Gensler noted.

As currently being implemented, it only brings price transparency.  The regulators with their information monopoly are helping to keep the swaps market opaque from the perspective of valuation transparency.