Tuesday, September 28, 2010

TABB Says Launch of CFD Clearing Service to Thrive Under New EU Derivatives Regulation; Buy-Side Firms to Benefit

In new research published today, TABB Group explains how a new Contracts-for-Difference (CFD) clearing service set to launch before the end of 2010 by LCH.Clearnet and Chi-X Europe is well timed as European regulators look to move derivatives into a centralized clearing model.

A centrally cleared Contract-For-Difference (ccCFD) is a CFD/equity swap that is initiated as an over-the-counter (OTC) trade and is brought on-exchange and cleared through a central clearing counterparty (CCP) instead of as a bilateral agreement. Clearinghouses and execution facilities are entering the space to benefit from expected growth in CFDs, proposed regulatory changes, and address buy-side concerns surrounding OTC counterparty risk.

According to Will Rhode, a research analyst in TABB’s London office and author of “Centrally Cleared CFDs: A Buy-Side Perspective,” centrally-cleared CFDs (ccCFDs) will add to the size of the overall CFD market, which TABB forecasts at a compound annual growth rate (CAGR) of 23% with notional amounts reaching £1.1 trillion by 2012, with ccCFDs estimated at £110 billion of the overall market.

The new joint initiative, Rhode explains, aims to benefit from expected growth in CFD, the proposed regulatory changes (on September 15, the European Union’s “European Regulation on OTC Derivatives, Central Counterparties and Trade Repositories” ruling proposed mandatory CCP clearing for eligible OTC derivatives) and address buy-side concerns surrounding over the counter (OTC) counterparty risk.

Describing the new service, Rhode points out that while it will not have a formal exchange listing, it will offer a wholesale, standardized CFD product in a central clearing counterparty model with a complete post-trade transparency. Set for a soft launch in the fourth quarter this year at a time when first adopters and allocated clearing members (ACMs) test the waters, he says, the new ccCFD service, which is not expected to ramp up until early in 2011,has the approval of HM Revenue & Customs (HMRC), effectively legitimising tax uncertainty around CFDs.

“The new ccCFD service,” he says, “will appeal to long-only asset managers on the prowl for risk management tools (and currently use single-stock futures), UCITS III funds seeking counterparty credit risk mitigation models, statistical arbitrage hedge funds looking for tax certainty and retail aggregators facing capital adequacy regulation.” In the event that European regulators force CFDs into a central counterparty (CCP) clearing house, he adds, TABB, expecting ccCFDs will ultimately replace the existing OTC CFD market, estimates that the ccCFD market place will grow dramatically, reaching £245 billion in 2011, rising to £440 billion in 2012.

“At TABB,” says Rhode, “we expect that the success of the service will be influenced heavily by the extent of impending regulation. We will see either OTC CFDs forced into a clearing model or, at the very least, make it more capital intensive, in effect more expensive, to provide OTC CFDs.”

The 19-page report with 15 exhibits, based on conversations with long only asset managers, hedge funds, retail aggregators, prime brokers, clearing houses and exchanges, provides a detailed description of the types of firms that may be attracted to a clearing service for CFDs, and their respective motivations for doing so. It also examines key regulatory developments and their potential implications for the new service’s launch.

The report is available for immediate download by all TABB Research Alliance Equity clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, please visit http://www.tabbgroup.com, or write to info@tabbgroup.com.

Monday, September 27, 2010

FDIC Board Approves Final Rule Regarding Safe Harbor Protection for Securitizations (FDIC)

The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved a final rule to extend through December 31, 2010, the Safe Harbor Protection for Treatment by the FDIC as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection With a Securitization or Participation. Under this safe harbor, all securitizations or participations in process before the end of 2010 are permanently grandfathered under the existing terms of 12 C.F.R. Part 360.6.

When a safe harbor was initially adopted in 2000 for securitizations and participations, the FDIC provided important protections for securitizations and participations by confirming that in the event of a bank failure, the FDIC would not try to reclaim loans transferred into such transactions so long as an accounting sale had occurred. In June of last year, however, the Financial Accounting Standards Board ("FASB") finalized modifications to the accounting treatment for such transactions through Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 ("FAS 166") and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) ("FAS 167"). Following the November 15, 2009 effective date of these changes, most securitizations no longer meet the off-balance sheet standards for sale accounting treatment and, as a result, no longer comply with the preconditions for the application of the original FDIC safe harbor.

The FDIC Board had previously extended the protections twice, with the last set to expire on September 30, 2010. The final rule is substantially similar to the March 11, 2010, extension.

"This rule has been in process for nearly a year, and the industry should have no problem adjusting to it by the time the safe harbor expires at the end of the year," said FDIC Chairman Sheila C. Bair. "A fair balance has been struck between protecting the FDIC's Deposit Insurance Fund and allowing participants to adjust to a safer, more transparent securitization market. We want the securitization market to come back, but in a way that is characterized by strong disclosure requirements for investors, good loan quality, accurate documentation, better oversight of servicers, and incentives to assure that assets are managed in a way that maximizes value for investors as a whole. Importantly, the rule is fully consistent with the clear mandate of the Dodd-Frank Act to apply a 5% risk retention requirement unless sufficiently strong underwriting standards are in place to counter incentives for lax lending created by the originate to distribute model. We look forward to working with our colleagues in developing those standards. Once in place, our rule will automatically conform to the interagency regulations."

The FDIC safe harbor regulation fully conforms to the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and addresses issues of particular interest to the FDIC in its responsibilities as deposit insurer and receiver for failed insured institutions. In order to ensure that the safe harbor regulation fully conforms with the risk retention regulations required by the Dodd-Frank Act, the FDIC's new safe harbor rule provides that, upon adoption of those interagency regulations, those final regulations shall exclusively govern the risk retention requirement in the safe harbor regulation.

# # #

Attachment: Safe Harbor Extension Final Rule - PDF (PDF Help)

Friday, September 24, 2010

Bank of America Merrill Lynch Announces Formation of Global Futures and Derivatives Clearing Services

NEW YORK, Sep 23, 2010 (BUSINESS WIRE) -- Bank of America Merrill Lynch ("BofA Merrill") is pleased to announce the formation of the Global Futures and Derivatives Clearing Services (GFDCS) group. This global initiative is in anticipation of the substantial growth in OTC derivatives clearing and the tremendous demand for education and related services from the company's institutional investor and corporate clients.

GFDCS builds off the company's highly rated Futures business -- known for its excellence in clearing services and access to more exchanges than any other broker -- to provide agent-clearing services for rates, currencies, credit, equities and commodities derivatives. The GFDCS group will operate as part of BofA Merrill's industry-leading Global Markets Financing and Futures platform (GMF&F), which includes prime brokerage and services.

Bob Burke and Gonzalo Chocano have been named co-heads of the GFDCS group, reporting to Denis Manelski and Syl Chackman, co-heads of GMF&F.

"Establishing an industry-leading derivatives clearing service is a top priority for our Global Markets business. Every client we serve will be impacted by the financial reforms transforming the OTC derivatives market," said Tom Montag, president of Global Banking and Markets. "We are committing considerable resources to all areas of the business to ensure our client clearing services are best-in-class."

The launch of BofA Merrill's GFDCS platform follows a yearlong planning effort, including feedback from more than 3,000 clients who have attended educational seminars and one-on-one briefings.

"Bank of America Merrill Lynch is taking an important leadership role in educating the industry and dealing with issues surrounding OTC derivatives clearing," said Mike Roberge, president of Mass Financial.

"Bank of America Merrill Lynch was one of the first dealers to recognize and prepare for the transformation of the derivatives clearing market. We are grateful that they stepped up to the plate as testing agent on behalf of many market participants," said Martha Tirinnanzi, chairperson of the clearinghouse working group of the Federal Housing Finance Agency, at an industry conference held earlier in the year.

S&P Launches “Understanding Ratings” Web Site

NEW YORK (Standard & Poor's) Sept. 21, 2010--Standard & Poor's Ratings Services, one of the world's leading credit rating agencies, today launched "Understanding Ratings," a new information and education resource for investors that can be found at UnderstandingRatings. The Web site brings together, free of charge, articles, videos, podcasts, and educational guides to provide insights into what credit ratings are (and what they are not), the processes by which Standard & Poor's produces ratings, and how those ratings have performed over time.

"Discussions with investors around the world over the past two years have consistently highlighted their desire for more transparency about how ratings are determined," said Bruce Schachne, Vice President of Market Development at Standard & Poor's. "Credit ratings continue to serve as benchmarks for creditworthiness, and investors continue to utilize credit ratings and research as part of their investment decision making processes. Investors seek a better understanding of how Standard & Poor's arrives at its ratings--what the methodologies are, what role the analysts play in the process, and how ratings perform. UnderstandingRatings was designed to meet the information and ratings transparency needs of the investment community, particularly pension funds and plan sponsors. Moreover, our ratings and research are aimed at helping investors better identify and understand credit risks."

UnderstandingRatings focuses on three core elements of credit ratings:
  • Criteria used to determine ratings and analytics;
  • Ratings performance; and
  • People--the 1,300 Standard & Poor's analysts around the globe who rate debt securities.
To explain these areas, Standard & Poor's rating analysts, credit officers, ratings executives and other staff address topics such as:
  • The ratings process and the processes we have put in place to support the independence of ratings;
  • The specific methodologies used to analyze various asset classes such as corporate bonds, municipal bonds,structured finance, and sovereign debt;
  • The ways in which ratings performance can be measured and compared;
  • An evaluation of the performance of ratings in various asset classes over the past several years;
  • The role of the analyst and rating committee in arriving at ratings, and
  • Standard & Poor's credit outlook for various industries, sectors, countries, and regions.
In addition, the site allows users to download Standard & Poor's "Guide to Credit Rating Essentials" and "Guide to Ratings Performance," which explain key concepts of credit ratings in simple, accessible language.

Ratings performance has been a particular area of heightened investor focus over the past two years.

"In the wake of the financial crisis, there has been much discussion about the performance of credit ratings," said Deven Sharma, President of Standard & Poor's. "Earlier this year, we conducted a comprehensive review of credit ratings, and the review demonstrated that ratings, for nearly all asset classes, performed broadly as expected in the face of the extreme stresses of the past two year, with the exception of ratings on certain U.S. residential mortgage-related securities. Through the 'Guide to Ratings Performance' and other materials on UnderstandingRatings, we address the questions that investors have posed regarding recent ratings performance, deliver facts and data on how ratings have, in fact, performed, and also provide details on the changes that Standard & Poor's has made based on lessons learned from the recent financial crisis."

UnderstandingRatings is the most recent initiative in Standard & Poor's ongoing investor outreach program, which also includes conferences, seminars, live video Web casts, teleconferences, mobile applications (including our successful CreditMatters iPhone app available free of charge through iTunes). Standard & Poor's also conducts countless meetings and calls between Standard & Poor's analysts and investors each year.

Wednesday, September 22, 2010

Completing CVA and Liquidity: Firm-level positions and collateralized trades

by Chris Kenyon of DEPFA Bank Plc.

Abstract: Bilateral CVA as currently implement has the counterintuitive effect of pro ting from one's own widening CDS spreads, i.e. increased risk of default, in practice. The unified picture of CVA and liquidity introduced by Morini & Prampolini 2010 has contributed to understanding this. However, there are two significant omissions for practical implementation that come from the same source, i.e. positions not booked in usual position-keeping systems. The first omission is firm-level positions that change value upon firm default. An example is Goodwill which is a line item on balance sheets and typically written down to zero on default. Another example would be firm Equity. The second omission relates to collateralized positions. When these positions are out of the money in future, which has a positive probability, they will require funding that cannot be secured using the position itself. These contingent future funding positions are usually not booked in any position-keeping system. We show here how to include these two types of positions and thus help to complete the unified picture of CVA and liquidity.

For a particular large complex financial institution that profited $2.5B from spread widening we show that including Goodwill would have resulted in a $4B loss under conservative assumptions. Whilst we cannot make a similar assessment for its collateralized derivative portfolio we calculate both the funding costs and the CVA from own default for a range of swaps and find that CVA was a positive contribution in the examples.

Download here: www.defaultrisk.com/pp_liqty_52.htm

Friday, September 10, 2010

The 2010 Tahawwut Master Agreement: Paving the Way for Shari'Ah-Compliant Hedging

By Richard Fagerer, Michael E. Pikiel Jr., and Michael J.T. McMillen, Fulbright & Jaworski L.L.P.

Abstract: Modern Islamic finance remains in its infancy, having emerged only in the mid-1990s. Despite exceptional growth rates, Islamic finance is essentially devoid of derivatives products, in part due to doctrinal constraints and due in part to the infancy of the industry. In March of 2010, after years of effort, the International Swaps and Derivatives Association (ISDA) and International Islamic Financial Market (IIFM) released The 2010 Tahawwut Master Agreement for the standardized effectuation of certain swaps and derivative transactions that are compliant with the principles of Islamic Shari`ah. This paper analyzes certain provisions of The 2010 Tahawwut Master Agreement and compares those provisions with ISDA’s 2002 Master Agreement.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1670118

Thursday, September 9, 2010

CFTC, SEC to Host Public Roundtable to Discuss Swap Data, Swap Data Repositories and Real Time Reporting

Staff from the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) will hold a public roundtable on September 14, 2010, to discuss issues related to swap data repository (SDR) registration, functions and responsibilities, the mechanics of data reporting, models for real time public reporting and the effect of transparency on liquidity of block trades and large transaction sizes.

The roundtable will assist both agencies in the rulemaking process to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The roundtable will be held in the Lobby Level Hearing Room at the CFTC’s Headquarters, Three Lafayette Centre, 1155 21st Street, NW, Washington DC. The discussion will be open to the public with seating on a first-come, first-served basis. Members of the public also may listen by telephone and should be prepared to provide their first name, last name and affiliation.

U.S./Canada Toll-Free: (866) 312-4390 begin_of_the_skype_highlighting (866) 312-4390 end_of_the_skype_highlighting

International Toll: (404) 537-3379 begin_of_the_skype_highlighting (404) 537-3379 end_of_the_skype_highlighting

Conference ID: 98801653

A transcript of the public roundtable discussion will be published on the CFTC’s website. Members of the public wishing to submit their views on the topics addressed at the roundtable may e-mail their submissions to the e-mail addresses provided on the CFTC’s website on the Swap Data Repositories Registration Standards and Core Principle Rulemaking page, Interpretation & Guidance page, Data Recordkeeping & Reporting Requirements page or Real Time Reporting page, or through the comment form or e-mail address for roundtable comments provided on the SEC website.

All submissions provided to either the CFTC or the SEC in any electronic form or on paper will be published on the website of the respective agencies, without review and without removal of personally identifying information.

Agenda for the Joint CFTC-SEC Public Roundtable Discussion

8:45 a.m.

Opening Statements by CFTC and SEC Staff

9:00 a.m.

Panel One – SDR Registration, Functions and Responsibilities

Duties of SDRs in addition to those required by the Dodd-Frank

The most efficient and effective way for SDRs to execute their statutory duties

How to implement the confirmation function under Dodd-Frank—to what extent and under what circumstances will SDRs be expected to do trade confirmations

10:45 a.m.


11:00 a.m.

Panel Two – Mechanics of Data Reporting

Type of data reported by SDRs, derivatives clearing organizations (DCOs), designated contract markets (DCMs), swap execution facilities (SEFs), swap dealers and major swap participants (MSPs)

Parties responsible for reporting of swap and security-based swap data

Means by which mandatory reporting may be made Reporting of swap and security-based swap transactions executed or cleared on an electronic platform

The time by which swap and security-based swap transactions must be reported

Handling of data corrections

Reporting of life cycle events

Reporting of past transactions

12:45 p.m.

Lunch Break

1:45 p.m.

Panel Three – Models for Real-Time Transparency and Public Reporting

Benefits of real time reporting of swaps and security-based swaps transactions

Entities responsible for reporting

Data elements

Ensuring anonymity of market participants

The meaning of “real-time”

Appropriate media for real-time reporting of swap and security-based swap transaction data

Feasibility/desirability of a consolidated tape or ticker for swaps and security-based swaps

3:30 p.m.


3:45 p.m.

Panel Four – Effect of Transparency on Liquidity: Block Trade Exception

Defining block trades and large transaction sizes for swaps and security based swaps

Determining an appropriate delay for reporting block trades and large transactions

Effects of transparency on post-trade liquidity

Responsibility for determining minimum block sizes and large transaction sizes for reporting purposes

5:30 p.m.

Roundtable concludes

Wednesday, September 8, 2010

Alternatives to the Use of Credit Ratings in OCC Regulations

The Office of the Comptroller of the Currency (OCC) is seeking comment on two advance notices of proposed rulemaking regarding alternatives to the use of credit ratings in the OCC’s regulations. These advance notices are issued in response to section 939A of the Dodd–Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010.1 Section 939A requires the OCC and other federal banking agencies to review regulations that (1) require an assessment of the credit-worthiness of a security or money market instrument and (2) contain references to or requirements regarding credit ratings. In addition, the agencies are required to remove such references and requirements and replace them with substitute standards of credit-worthiness. In developing substitute standards of credit-worthiness, each agency is required to take into account the entities it regulates and, to the extent feasible, seek to establish uniform standards.

Use of Credit Ratings in Regulatory Capital Standards

The federal banking agencies (the OCC, Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision) currently use credit ratings issued by nationally recognized statistical rating organizations (NRSROs) in their risk-based capital standards. These standards reference credit ratings in four general areas: (1) the assignment of risk weights to securitization exposures under the general risk-based capital rules and advanced approaches rules; (2) the assignment of risk weights to claims on, or guaranteed by, qualifying securities firms under the general risk-based capital rules; (3) the assignment of certain standardized specific risk add-ons under the agencies’ market risk rule; and (4) the determination of eligibility of certain guarantors and collateral for purposes of the credit risk mitigation framework under the advanced approaches rules. In 2008, the agencies issued a notice of proposed rulemaking that sought comment on implementation in the United States of certain aspects of the standardized approach in the Basel Accord. The Basel standardized approach for credit risk relies extensively on credit ratings to assign risk weights to various exposures.

The agencies have issued a joint advance notice of proposed rulemaking (ANPR) to solicit comment and information as they begin to develop alternatives to the use of credit ratings in their capital rules (Capital ANPR). The Capital ANPR solicits input on alternative standards of credit-worthiness that could be used in lieu of credit ratings in those rules and asks for comments on a range of potential approaches, including basing capital requirements on more granular supervisory risk weights or on market-based metrics. The comment period for the Capital ANPR closes on October 25.

Use of Credit Ratings in Other OCC Regulations

The noncapital regulations of the OCC include various references to and requirements for use of credit ratings. These references include:

  • Investment Securities—The OCC’s investment securities regulations at 12 CFR 1 use credit ratings as a factor for determining the credit quality, liquidity/marketability, and appropriate concentration levels of investment securities purchased and held by national banks. For example, under these rules, an investment security must not be “predominantly speculative in nature.” The OCC rules provide that an obligation is not “predominantly speculative in nature” if it is rated investment grade or, if unrated, is the credit equivalent of investment grade. “Investment grade,” in turn, is defined as a security rated in one of the four highest rating categories by two or more NRSROs (or one NRSRO if the security has been rated by only one NRSRO). Credit ratings are also used to determine marketability in the case of a security that is offered and sold pursuant to Securities and Exchange Commission Rule 144A. In addition, credit ratings are used to determine concentration limits on certain investment securities.
  • Securities Offerings—Securities issued by national banks are not covered by the registration provisions and SEC regulations governing other issuers’ securities under the Securities Act of 1933. However, the OCC has adopted part 16 to require disclosures related to national bank-issued securities. Part 16 includes references to “investment grade” ratings. For example, section 16.6, which provides an optional abbreviated registration system for debt securities that meet certain criteria, requires that a security receive an investment grade rating in order to qualify for the abbreviated registration system.
  • International Banking Activities—Pursuant to section 4(g) of the International Banking Act (IBA), foreign banks with federal branches or agencies must establish and maintain a capital equivalency deposit (CED) with a member bank located in the state where the federal branch or agency is located. The IBA authorizes the OCC to prescribe regulations describing the types and amounts of assets that qualify for inclusion in the CED, “as necessary or desirable for the maintenance of a sound financial condition, the protection of depositors, creditors, and the public interest.” At 12 CFR 28.15, OCC regulations set forth the types of assets eligible for inclusion in a CED. Among these assets are certificates of deposit, payable in the United States, and banker’s acceptances, provided that, in either case, the issuer or the instrument is rated investment grade by an internationally recognized rating organization, and neither the issuer nor the instrument is rated lower than investment grade by any such rating organization that has rated the issuer or the instrument.

The OCC has issued an ANPR soliciting comment on alternative measures of credit-worthiness that may be used instead of credit ratings in the above regulations (Investment Securities and Other Regulations ANPR). The ANPR seeks comments on criteria that the OCC should consider when developing such measures and outlines a range of alternatives for replacing references to credit ratings in part 1. The comment period for the Investments and Other Regulations ANPR closes on October 12.

Further Information

For information or questions on the Capital ANPR, contact Mark Ginsberg, Risk Expert, Capital Policy Division, (202) 874-5070, or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, (202) 874-5090. For information or questions on the Investment Securities and Other Regulations ANPR, contact Michael Drennan, Senior Advisor, Credit and Market Risk Division, (202) 874-4564, or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, (202) 874-5090.

Timothy W. Long
Senior Deputy Comptroller for Bank Supervision Policy
and Chief National Bank Examiner
Attachments: Joint Capital ANPR
OCC Investments and Other Regulations ANPR

Wednesday, September 1, 2010

DBRS Requests Comments on Proposed Unified Interest Rate Model Methodology

DBRS Ratings Limited (DBRS) is requesting comments on the proposed rating methodology for its Unified Interest Rate Model. Comments should be received on or before October 29, 2010. Please submit your comments to the following e-mail address: dbrsmodelcomments@dbrs.com. DBRS will publish a final methodology following the review and evaluation of all submissions.

The methodology describes the DBRS’ process for the generation of consistent interest rate stresses across currency markets as well as markets which do not have underlying term structures.

Risky Funding: A unified framework for counterparty and liquidity charges

By Massimo Morini and Andrea Prampolini of Banca IMI

Abstract: Standard techniques for incorporating liquidity costs into the fair value of derivatives produce counter-intuitive results when credit risk of the counterparty (CVA) and of the investor (DVA) are added to the picture. Here, Massimo Morini and Andrea Prampolini show that a consistent framework can only be achieved by giving an explicit representation to the funding strategy, including associated default risks.

Download here: www.defaultrisk.com/pp_liqty_50.htm