On his blog, JP Koning discusses the versatility of cheques:
A cheque instructs a bank to transfer deposits.
It is a derivative on bank deposits.
A post dated cheque serves as debt instrument, e.g., vis-a-vis pay day lenders.
An uncashed cheque may serve as money if marked “to bearer” or endorsed by the recipient. Laws grant cheques currency status.
A cheque may be used for payments even if other payment mechanisms break down. During the Irish banking strike of 1970, “for six months post-dated cheques circulated as the main form of money.”
A cheque can be used by the unbanked.
This combination of negotiability, robustness, openness, and decentralization means that long before bitcoin and the cryptocoin revolution, we already had a decentralized payments system that allowed pretty much everyone to participate and, indeed, fabricate their own personal money instruments! …
… a whole language of cheques has emerged, allowing for significant customization. By putting crossings on cheques, like this the cheque writer is indicating that the only way to redeem it is by depositing it, not cashing it. This means that the final user of the cheque will be easy to trace, since they will be associated with a bank account. Affix the words non-negotiable within the cross on the front of the cheque and it loses its special status as currency. Should it be stolen and passed off to an innocent third-party, the victim can now directly pursue the third-party for restitution. To even further limit the power of subsequent users to use the cheque as money, the writer can indicate the account to which the cheque must be deposited. This language of checks can be used not only by those that have originated the cheque, but also by those that receive it in payment. On the back of any check, any number of endorsements can be written, effectively allowing for the conversion of someone else’s payment instructions into your own unique medium of exchange.
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?