As we peel back the layers of exposure from the US financial crisis and look to the potential impact from the impending financial market fall out in Europe, it is abundantly clear regulators and policy makers here are wanting to deal with fail safe mechanisms in this acute period of economic recovery while working on forward treatment plans for the regulation of financials, not the least of which is the derivatives markets. What we are experiencing is not all about Europe. It is some assurance that Treasury secretary Tim Geitner recently pegged the outside aggregate US Financial Institution exposure to Europe around $300B, while recently, Mr. Fink from Blackrock threw out a $350B number. Nonetheless, it is possible that regulatory requirements in the derivatives area will create affective obsolescence of certain products in the US market. Some of the recent settlements and filings in this market give credence to this theory. Given the earnings report of MF Global today, you have to wonder that considerable additional disruption to the financial sector products is pending, independent of their exposure in Europe, and it is not priced into the wider market yet. In this way, regulators may be learning that the litigation and Dodd-Frank Act implementations may create more unintended consequences for the financial institutions of course but could extend well into the traditional financing, hedging and transfer of risk mechanisms employed by other sectors using the derivatives market. The degrees of risk from financial leverage and revenue generation capability for companies operating in and through capital markets to finance operations and hedge risk could be materially impacted by changes in regulation.
So today I thought I would put up a quick post on this.
Here is an October snapshot of derivatives market exposure by segment based upon approximately 500 corporate and institutional names in the Americas market with the balance of exposures contained in the single names category. Many of these categories are also tied into the considerable challenge our economy is experiencing with real estate. For example in the category of consumer goods we found more than 20% of the large named entity derivatives exposure tied into home builders. Additionally the RMBS, CMBS and CDS on Loans and Credit Index Options (Swaptions) are broken out by product.
The data give gross and net notional exposures. A parallel example in the CDS market, is that the gross amount of contracts outstanding are not necessarily reflective of actual debt when they are called as many have historically offset CDS and derivative market positions with opposite positions. Plus, triggering credit events under different contracts may vary. We know from recent rulings that hedging credit risk is going bye bye. You could argue that once a firm has to disclose what they are hedging with their counter position, you effectively lose the ability to speculate on that risk and the competitive differentiation. But if we got called with concentration risk in multiple sectors, beyond real estate, it could be more than an interesting economic recovery based upon net notional exposures across the corporates. An example illustrates how these gross, notional and ultimately net exposures play out. For example CDS contracts for a firm were estimated at about $400B while their firm total debt was about $155B and only about $7B was needed to settle their CDS obligations.
Here we have broken out the financial services market into sub-segments among approximately 75 firms.
Here are 10 single entity players in the financials sector. Not surprising that a recent private mortgage insurer receivership was reported while peers in this category are currently impacted by the mortgage crisis. It is noted that no granular information on the underlying financial institution contracts are provided. This data does not therefore represent any specifics on any particular institution’s underlying portfolio or concentration risk.
All of the above chart information is provided as a courtesy from raw excel data provided by DTCC (Depository Trust and Clearing Corporation). We have not independently verified the accuracy or completeness of the data set. This information was excerpted current as of October 24 2011 on the DTCC website. We attribute all copyrights and data extracted here to DTCC. For more information visit www. dtcc.com
Hope this is helpful…
That’s all for now…
—PS
