The Future of the
OTC Derivatives Market
Presentation to BM&FBOVESPA
4th International Financial and Capital Markets Conference
Eraj Shirvani
ISDA Chairman
Managing Director and Head of Fixed Income for EMEA Region
Credit Suisse
About ISDA
ISDAs Focus: Identify and reduce sources of risk in
the privately negotiated derivatives business
Founded in 1985; represents participants in the privately negotiated
derivatives industry
Over 830 member institutions from 57 countries on six continents:
One of the largest global financial trade associations, by number of
member firms
Members include most of the world's major derivatives dealers, as
well as many businesses, governmental entities and other end users
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About OTC Derivatives
Bilateral privately negotiated contracts
Typically customized to meet particular needs of end-users
Not securities like bonds or notes
Simple confusion
CDS vs. CDO and "derivative securities"
Risk-shifting, not capital-raising, tools
Important role in global economy
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About OTC Derivatives
Derivatives are an integral risk management
tool for the worlds leading companies
Netherlands 100
Used by over 94% of Canada 100
Fortune 500, Switzerland 100
and 60% of Britain 100
mid-sized companies France 100
Japan 100
Germany 97
US 90
South Korea 87
Percent using
derivatives China 62
0 20 40 60 80 100
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About OTC Derivatives
Understanding Notional Amounts Outstanding
Notional Amount $450 trillion
Measure of outstandings, not exposure
Gross Mark to Market Value $9 to $27 trillion
Estimated to be 2 to 6% of notional
Net Credit Exposure $4.5 trillion
After netting and before collateral
Estimated to be less than 1% of notional
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About OTC Derivatives
Collateral Further Reduces Credit Exposure
Vast majority of derivatives exposure is collateralized
87% of over 150,000 collateral agreements in place are
ISDA agreements
66% of OTC derivative credit exposure is now covered
by collateral compared with 29% in 2003
65% of all OTC derivatives trades are subject to
collateral agreements, compared with 30% in 2003
Among large dealers, the median coverage is 87%
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Credit Default Swaps Market Trends
$70
$60
$50
US$ trillion
$40
$30
$20
$10
$0
2001 2002 2003 2004 2005 2006 2007 2008 6/30/2009
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What Is the True Level of CDS Exposure?
Gross vs. net notional
Reference Entity Gross Notional Net Notional
(USD EQ) (USD EQ)
Single-Name $15.2 trillion $1.4 trillion
Index/Tranche $11.1 trillion $1.1 trillion
Total $26.3 trillion $2.5 trillion
Source: DTCC Trade Information Warehouse, as of Aug. 8, 2009
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Key CDS Questions
1. Did CDS cause the financial crisis?
2. Did CDS pose systemic risks during the
financial crisis?
3. How has the CDS market performed
during the market turmoil?
4. What improvements are underway?
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Did CDS Cause the Financial Crisis?
Credit Default Swaps are NOT the cause of
the Financial Crisis.
Poor lending decisions, principally in housing finance,
are the root cause
CDS are risk-shifting tools. Companies couldand diduse CDS
to manage risk to powerful effect
CDS is not a primary driver behind lending decisions
not a no-cost option
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Did CDS Pose Systemic Risk
During the Financial Crisis?
Bear Stearns
Problems related to a lack of confidence from lenders
Classic liquidity squeeze; relied too much on short-term funding
Lehman Brothers
From March to September, market concerns had shifted from
counterparty exposure to reference entity exposure
Gross notional exposure on Lehman was $72 billion but net
notional was $5 billion
Bankruptcy created no systemic fault lines
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How Has the CDS Market Performed
During the Market Turmoil?
CDS business has functioned well
CDS market remained open activity robust
Only credit product consistently available
to allow firms to transfer risk
In past year, over 40 credit events
All were managed in an orderly fashion
with no major disruptions
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What about AIG?
The failure of AIG reflects failures in how.
the company managed its mortgage risks and exposure
regulators (OTS) supervised those risks
the company managed its collateral and liquidity
the rating agencies rated mortgage risks and capital adequacy
AIG was clearly an outlier in many of its
business practices and policies
we must not be overwhelmed by the fact that one high profile
financial institution, AIG, made a bad investment decision, using
derivatives to guarantee mortgages that went sour.
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What Improvements Are Underway?
Industry-led efforts to identify & reduce sources of risk
Central counterparty clearing of standardized
transactions
Since 2005, industry participants have been working towards
implementing a central clearing house for credit derivative
transactions
Approx. US$1.7 trillion of CDS have been cleared in North America
since March
Approx. 38 billion of CDS have been cleared in Europe since July
Reduction of CDS notional size by approx. half
Portfolio compressions /trade tear ups
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What Improvements Are Underway?
Industry-led efforts to identify & reduce sources of risk
Stronger trade / default settlement processes
The Big Bang Protocol
Determinations Committee comprising dealers and buy-side
More than 40 Credit Events processed globally since Oct 2008
Electronic processing and matching of confirmations
Collateralized portfolio reconciliation
Confirmation backlog reductions
Greater transparency
More open industry governance structure
Publication of aggregate market data
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Snapshot of Todays Existing option
Potential option
OTC Infrastructure
Equities FX Rates Credit Commodities
Liffe BClear LCH SwapClear LCH SwapClear ICE US Trust CME ClearPort
LCH SwapClear CME ICE Clear Europe LCH
Central IDCG Eurex ICE Clear
CME ECC
Clearing LCH Paris SA NOS Clearing
APX
Bloomberg Bloomberg Bloomberg GFI Trading Technologies
ICAP GFI Deriv/SERV ICAP Fastfill
Electronic TFS Volbroker Tradeweb MarketAxess NGX
Tullet Trade Blade ICAP Creditex EBS
Execution EBS Tullet Phoenix LME Select
FXAII Trayport
Reuters Bloomberg
Markit Wire Swift MarketWire T-Zero E-confirm
Matching/ Deriv/SERV CLS Trade Express Markit Wire EFET
Confirmation Deriv/SERV SWIFT
DTCC TIW DTCC TIW DTCC TIW DTCC TIW DTCC TIW
Trade LCH SwapClear LCH SwapClear LCH SwapClear Econfirm
Repository MarkitServ Database MarkitServ Database MarkitServ Database
TriOptima TriOptima TriOptima
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ISDA CDS Marketplace Website
ISDACDSmarketplace.com
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ISDA CDS Marketplace Website:
Single Name Reference Entities
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ISDA CDS Marketplace Website:
Top 10 CDS Positions
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Current Public Policy Initiatives
Broad consensus amongst policy makers
(US Treasury, FRBNY, EC, FSA) and
industry around the world on key issues
Appropriate regulation for all financial institutions that may
pose a systemic risk to the financial system
Stronger counterparty risk management (including
clearinghouses)
Improved transparency
Strong, resilient operational infrastructure
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Three Levels of Transparency in the
U.S. Treasury Proposal
Risks Valuation/ Supervisory/
Investor/Market
Counterparty Risk
Transparency
Transparency Transparency
Solutions Central Clearing Price Operational
Buy-side Transparency Measurements
Segregation/ On-Exchange / Trade
Clearing Electronic Repository
Collateral Execution
Management
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Current Public Policy Issues
Preserving flexibility to tailor solutions to meet the needs
of customers is essential
Efforts to mandate that privately negotiated derivatives
business trade only on an exchange would reduce their
availability
Banning naked shorting via CDS would adversely
impact the credit markets
Need for cross-border regulatory coordination
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OTC Derivatives: The Road Ahead
Privately negotiated derivatives will remain vital risk
management tools
Industry's trading and operational infrastructure is strong
and resilient
Financial innovation spreads to more asset classes, more
geographies
ISDA and the industry are committed to working together to
make further progress
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