The risk of the derivatives markets destabilizing in the event of a major derivatives dealer blowing up dominated the panel sessions at the International Swaps and Derivatives Association's annual general meeting at Chicago last week, and panelists and delegates appeared united in the view that this risk is overstated and believe that dealers adequately account for it.
Kaushik Amin, ISDA board member and co-head of global interest rate products at Lehman Brothers, estimated that no single dealer holds more than 10% of the net risk transferred and said this is not enough to bring down the market.
ISDA estimates that the notional size of the derivatives market is USD170 trillion and although the actual capital at risk is far less than this amount, the sheer size of this number evokes fear in regulators and the general public alike. "The D word has become more exciting than the F word," quipped Amin.
For example, JPMorgan, the largest derivatives house in the U.S., controls around one-third of the interest rate and credit derivatives market, according to the Office of the Comptroller of the Currency. But this figure overstates the concentration of risk, asserts David Coulter, chairman of the investment banking, private equity, investment management and private banking businesses at JPMorgan. If foreign banks' exposure is factored in, JPMorgan's actual market share falls to 18% and if double counting is eliminated it drops to 13-14%, he explained.
Hung Tran, deputy director in international capital markets at the International Monetary Fund, accepted that dealers could absorb the demise of a major market maker, but said no one could predict the extent of the ensuing market disruption. It is likely, however, that some of the largest hedge funds and smaller derivatives firms would fill the breach. For example, the Amaranth Group has credit derivatives volumes similar to a mid-sized dealer, according to Karl Wachter, general counsel.
The increasing percentage of collateral banks are putting behind derivatives positions also bolsters the sanguine outlook, dealers argue. According to an ISDA survey released last week, the amount of collateral behind OTC trades increased 41% last year to some USD1.02 trillion. Robert McWilliam, executive director and head of counterparty exposure management at ABN AMRO, estimated that 80-90% of inter-dealer trades are backed up with collateral.
The collateral, however, may not cover all the risks. Patrick Parkinson, associate director at the Federal Reserve Board, welcomes the move to increase the amount of collateral, but said the derivative shops' collateral positions only cover their current exposure. He thinks dealers should add a cushion to cover marginal increases in positions. The size of the cushion would vary according to the volatility of the position.
