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COMMENTARY: Don’t fight the basis
In the early days of the push for central clearing of derivatives, participants warned about the risk of a basis developing between quoted prices at different central counterparties (CCPs). Their fears were realised in 2015 when prices diverged between US dollar rate swaps at CME Group and at LCH.Clearnet’s SwapClear. Further swaps bases have since appeared for euro swaps (between SwapClear and Eurex) and Japanese yen swaps (between SwapClear and the Japan Securities Clearing Corporation, or JSCC).
The yen swaps basis may have been the third to emerge but it was unusual not just because of its sheer size – a price difference of 2bp is chunky for dollar and euro swaps – but also because it has now bled through into the market for a non-cleared product, namely yen swaptions. It’s not clear when the swaptions basis first appeared, but at one point in recent months, some dealers realised the LCH-cleared yen swaps were more volatile than their JSCC-cleared equivalent, and began to reflect this in their pricing for physically delivered versions of the non-linear product.
The story took a fresh turn this week, though, when Risk.net revealed Japanese broker Totan had started offering screens showing the basis from March 7 – and had taken them down again shortly after. Totan isn’t commenting on the decision, but it’s understood to have followed feedback from dealers.
Market participants offer differing guesses as to what happened, with some claiming the swaptions basis had not been trading enough to make the screens reliable. Many others believe the real motivation had more to do with the fact that some dealers had not yet remarked their books to reflect the basis, and were sitting on potentially large losses that would crystallise if price verification teams had seized on the new prices.
All of this has echoes of the emergence of the very first cleared swaps basis. At the time, losses for some individual US dollar swaps books were estimated to be as high as $20 million – enough to wipe out a year’s profit for some players. And one trader explained the panic and indecision that ensued when the prices first started to diverge, and then went wider – and wider.
“What’s happening is you are running your portfolio and are marking at 0.15bp mid because you don’t know if it’s flat or at 0.3bp, and someone lifts it at 0.3bp – and then there’s an offer behind at 0.5bp and that gets taken and then you’ve got an offer at 0.75bp and that gets taken. And then you stop and look at your portfolio and it’s a case of “Oh my God, I’ve got a multi-trillion dollar portfolio that I was marking at 0.15 and it’s now trading nine-tenths of a basis point higher,’” he said.
Some yen swaptions desks may have found themselves in a similar position last month. The lessons: a CCP basis can appear in products that don’t clear; and, when a basis does appear, don’t fight it.
STAT OF THE WEEK
Goldman Sachs’ market risk surged in the first quarter to its highest level since early 2015 on the back of higher client activity and market volatility. The US dealer’s total firmwide average daily value-at-risk stood at $73 million in the three months to March 31, 2018, up from $54 million in the previous quarter and from $64 million year-on-year.
QUOTE OF THE WEEK
“It is not acceptable the ECB holds supervisory powers, either directly or indirectly, but has very little clue what the national authorities find” – Sven Giegold, Green MEP