Speaking of Jamie Dimon’s appearance at Davos, he called upon a rethink of the Central Clearing System for OTC Derivatives that everyone wants to see in play.
The clearing and settlement area is the plumbing of financial service, where all risks of sellers or buyers defaulting are managed by the clearer acting as the buyer to the seller and the seller to the buyer.
By having a Central CounterParty (CCP) for clearing, the market has confidence.
Unfortunately, in the case of OTC Derivatives, such as Credit Default Swaps (CDS) there was no CCP.
As a result, there was panic and fear after the collapse of Lehmans as every $1 billion in CDS contracts outstanding could lead to
losses of between $18 to $22 billion for all the counterparties involved. The fear was also that the clearing systems might not cope, but they managed nicely as recounted in this FT article.
The DTCC for example, announced that they had sorted out half a trillion dollars worth of Lehman contracts within six weeks of the collapse. In reality, this meant the DTCC sorts out all of the exposures related to the investment bank and its counterparties, netting down positions, becoming the buyer to every seller and the seller to every buyer.
After this debacle, everyone has since been talking about creating a CCP for these products, as one did not exist for OTC Derivatives, and there are four groups scurrying around to do this:
- CME Group and Citadel;
- Eurex Clearing, part of Deutsche Börse;
- IntercontinentalExchange (ICE) with The Clearing Corporation; and
- NYSE Euronext and LCH.Clearnet, Europe’s largest clearing systems.
According to the BBC’s Robert Peston** however, Jamie Dimon decided to pour doubt over the creation of the CCP for OTC.
Mr. Peston reports that Jamie Dimon told the World Economic Forum’s governors’ meeting not to put too much faith in the creation of a central clearing system, because it would mean banks would think less about who they were buying, selling, lending and investing to and with. He claimed that the current crisis was caused by banks not knowing their customers and that the more banks are protected and insured against losses on lending, the more they will lend irresponsibly.
Maybe Mr. Dimon has this view as his bank is one of the largest traders in OTC Derivatives, with $87 trillion in derivatives and $10 trillion in CDS?
Related blog posts on the subject of clearing and settlement:
JP Morgan’s premature evacuation
A borderless, neutral single market for securities across Europe
What’s the solution for Clearing & Settlement?
Clearing and Settlement: it’s time for action
Will our Clearing and Settlement ever be transparent?
‘Clearing and settlement barriers removed in 2008’
** The March issue of GQ Magazine finds Robert Peston is more powerful in Britain than Alastair Darling, our Chancellor.