In a Bank of England Financial Stability Paper, Olga Cielinska, Andreas Joseph, Ujwal Shreyas, John Tanner and Michalis Vasios analyze transactions on the Swiss Franc foreign exchange over-the-counter derivatives market around January 15, 2015, the day when the Swiss National Bank de-pegged the Swiss Franc. From the abstract:
The removal of the floor led to extreme price moves in the forwards market, similar to those observed in the spot market, while trading in the Swiss franc options market was practically halted. We find evidence that the rapid intraday price fluctuation was associated with poor underlying market liquidity conditions, in particular the limited provision of liquidity by dealer banks in the first hour after the event. Looking at longer-term effects, we observe a reduced level of liquidity, associated with an increased level of market fragmentation, higher market volatility and an increase in the degree of collateralisation in the weeks following the event.
In the FT, Jim Brunsden reports that the European Commission’s 2013 proposal to install a financial transactions tax has not made much progress. At least nine countries have to sign up.
The report highlights that key differences remain on how to craft exemptions from the tax, including the problem of how to shield transactions in other non-participating EU countries such as Britain. Other splits concern how to protect market-making activities by banks, and also what carveouts should apply for derivatives that are used by traders to hedge risk when they buy sovereign debt.
Philip Stafford and Tracy Alloway report in the FT that under the stewardship of the International Swaps and Derivatives Association, large banks
have agreed to give up their rights to immediately end derivatives contracts with crisis-hit rivals after global regulators pressed for an industry cross-border agreement to stop counterparties terminating deals with troubled institutions.
The agreement covers 90% of the OTC derivatives market. Incentives to live up to it are weak; not amending one’s contracts with counter parties amounts to the dominant strategy in a prisoners’ dilemma situation. Moreover, institutional investors may have fiduciary duties to end their contracts if a counter party defaults so attaining the cooperative equilibrium may not be possible without legal changes.
DN: But if the initiative succeeds, could it undermine the effective seniority status of derivatives?