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Notionals on a swap have nothing to do with their risk exposure, but they have everything to do with clickbaiting the public and getting politicians elected.

dang 4y ago
Can you explain more? When a story is clickbait, it's helpful if knowledgeable people help the rest of us understand.
- fnordpiglet 4y ago
  Yes sorry I was going to do that as an edit after I had a chance to read other comments. First, the article meanders through a lot of unrelated stuff like crypto markets and interest rates and inflation. These add nothing to the subject, please do not be confused by it. Second, what’s being quoted is a notional on a swap, which is the reference amount being indexed on in the contract. Some background: There are different types of swaps, some of which have been standardized via ISDA agreements, or are being cleared on an exchange or other multiparty platform that provides some standardization and doesn’t require a “bilateral” contract that’s between two counter parties, often paired by a securities market maker - but historically they’re “over the counter” and bilateral in that there’s no market or exchange, it’s just an agreement. I’m that agreement or contract there’s a reference currency pair in the case of fx swaps. Say it’s USD/EUR - I.e., the exchange rate between USD and Euros. The notional is the amount of that indexed pair. They’re are often enormous amounts. Much more money than either actually have on hand. But, they’re often used against things like non repatriated earnings - which can be enormous. Those earnings are never involved in the contract mind you, but are instead referenced as the notional. The two counter parties in the contract agree to swap a risk in a swap. Typically they can be conceived of the seller gives the buyer currency at the current exchange rate. The buyer simultaneously issues forward contracts to the seller. The difference between the two is the swap point. This swap point is where profit and losses lie, and it’s a very small percentage of the notional. I’m not as familiar with OTC swaps in FX, but typically there’s no need to actually swap assets but rather agree to pay the PNL without owning the underlying assets. What’s at risk is the payouts, which are no where near the notional value of the swap. The article however implies notional values are somehow debt owed. They further imply that they’re “hidden,” but generally bilateral contracts aren’t disclosed securities by many participants in the market. The real ask is embedded deep in the article which is BIS wants to see more of these transactions settled via a standardized clearing house or exchange that usually have reporting requirements. The BIS is worried this returns us to some of the opacity before the financial crisis. As someone who worked many years as a quant in the space of credit default swaps, which has largely standardized to my understanding, I do not agree. OTC has its place and cleared has its place. Some markets don’t have a successful place to clear in the open. But it’s not hiding anything, and it’s absolutely not hiding debt, nor are these instruments dangerous.
  - kasey_junk 4y ago
    Currency swaps range the gamut from _extremely_ short period swaps (read hours to days) to very long period swaps (I've never heard of one bigger than 5 years but they may exist). The short period swaps are almost pure liquidity imbalance mitigation techniques. It's cheaper and less risky to do than the equivalent bridge loan plus fx transaction. In these cases the notional really is fully owed on a future leg, but a) its a really small number and b) the counterparty risk is miniscule. These happen a lot. Large treasury groups may be making hundreds of swaps a day if they have lots of multi-currency cash flows, so the notionals can add up even though the actual dollar amounts per swap are small. The longer period swaps I have a lot less expertise in, but in my experience they are modeled like CDS' and your premise is right. The notional largely doesn't matter as its the cash flow that is at risk. As far as I know, in _neither_ case do people write the legs as 'debt'.
    - fnordpiglet 4y ago
      I’d note too the issue the BIS has is with the amount of notional in off clearing house deals. I would expect long dates swaps would benefit from standardization and clearing, but that it’s too expensive and tedious to do cleared deals on short dated instruments. Does that map with your intuition?
      - kasey_junk 4y ago
        Sounds right, but i have so little experience with long dated swaps that I'm hesitant to say. Even a ~year long swap feels very strange to me as someone coming from the much more short dated world. Thats actually my biggest gripe about the report, they are treating the whole market as monolithic when its anything but.
- kasey_junk 4y ago
  80T in 'debt' is not 'debt' in the way most lay people would call debt (in fact most industry people would not consider this debt at all). Further, the lead about 'pension funds' is just a straight up bad pull quote. The BIS report uses a pension fund as one type of financial institution that uses swaps, without singling them out specifically. A better headline would be "Central Banks should spend more time researching US Dollar domination of FX/Currency Swap market)".
  - fnordpiglet 4y ago
    From the summary of the section of the report I think this is the extent of the BIS concern - a move away from cleared to otc bilateral agreements dilutes the utility of post financial crisis asset reporting. This is not an exciting topic, and can’t sell advertisements. “”” In the FX space, an accelerating shift towards less “visible” trading venues and bilateral trading may reduce the information content of prices and the network benefits of integrated markets. “”” They are spot on here. But there’s no doomsday coming from having prices off market or integrated markets. These issues are issues of efficiency rather than doom and gloom. My revised headline would be: “Reporting quality in FX Swaps is reduced by use of Over The Counter bilateral agreements instead of clearinghouse.” But no one will buy Herbalife with that headline.

dang 4y ago

Can you explain more? When a story is clickbait, it's helpful if knowledgeable people help the rest of us understand.

fnordpiglet 4y ago
Yes sorry I was going to do that as an edit after I had a chance to read other comments. First, the article meanders through a lot of unrelated stuff like crypto markets and interest rates and inflation. These add nothing to the subject, please do not be confused by it. Second, what’s being quoted is a notional on a swap, which is the reference amount being indexed on in the contract. Some background: There are different types of swaps, some of which have been standardized via ISDA agreements, or are being cleared on an exchange or other multiparty platform that provides some standardization and doesn’t require a “bilateral” contract that’s between two counter parties, often paired by a securities market maker - but historically they’re “over the counter” and bilateral in that there’s no market or exchange, it’s just an agreement. I’m that agreement or contract there’s a reference currency pair in the case of fx swaps. Say it’s USD/EUR - I.e., the exchange rate between USD and Euros. The notional is the amount of that indexed pair. They’re are often enormous amounts. Much more money than either actually have on hand. But, they’re often used against things like non repatriated earnings - which can be enormous. Those earnings are never involved in the contract mind you, but are instead referenced as the notional. The two counter parties in the contract agree to swap a risk in a swap. Typically they can be conceived of the seller gives the buyer currency at the current exchange rate. The buyer simultaneously issues forward contracts to the seller. The difference between the two is the swap point. This swap point is where profit and losses lie, and it’s a very small percentage of the notional. I’m not as familiar with OTC swaps in FX, but typically there’s no need to actually swap assets but rather agree to pay the PNL without owning the underlying assets. What’s at risk is the payouts, which are no where near the notional value of the swap. The article however implies notional values are somehow debt owed. They further imply that they’re “hidden,” but generally bilateral contracts aren’t disclosed securities by many participants in the market. The real ask is embedded deep in the article which is BIS wants to see more of these transactions settled via a standardized clearing house or exchange that usually have reporting requirements. The BIS is worried this returns us to some of the opacity before the financial crisis. As someone who worked many years as a quant in the space of credit default swaps, which has largely standardized to my understanding, I do not agree. OTC has its place and cleared has its place. Some markets don’t have a successful place to clear in the open. But it’s not hiding anything, and it’s absolutely not hiding debt, nor are these instruments dangerous.
- kasey_junk 4y ago
  Currency swaps range the gamut from _extremely_ short period swaps (read hours to days) to very long period swaps (I've never heard of one bigger than 5 years but they may exist). The short period swaps are almost pure liquidity imbalance mitigation techniques. It's cheaper and less risky to do than the equivalent bridge loan plus fx transaction. In these cases the notional really is fully owed on a future leg, but a) its a really small number and b) the counterparty risk is miniscule. These happen a lot. Large treasury groups may be making hundreds of swaps a day if they have lots of multi-currency cash flows, so the notionals can add up even though the actual dollar amounts per swap are small. The longer period swaps I have a lot less expertise in, but in my experience they are modeled like CDS' and your premise is right. The notional largely doesn't matter as its the cash flow that is at risk. As far as I know, in _neither_ case do people write the legs as 'debt'.
  - fnordpiglet 4y ago
    I’d note too the issue the BIS has is with the amount of notional in off clearing house deals. I would expect long dates swaps would benefit from standardization and clearing, but that it’s too expensive and tedious to do cleared deals on short dated instruments. Does that map with your intuition?
    - kasey_junk 4y ago
      Sounds right, but i have so little experience with long dated swaps that I'm hesitant to say. Even a ~year long swap feels very strange to me as someone coming from the much more short dated world. Thats actually my biggest gripe about the report, they are treating the whole market as monolithic when its anything but.
kasey_junk 4y ago
80T in 'debt' is not 'debt' in the way most lay people would call debt (in fact most industry people would not consider this debt at all). Further, the lead about 'pension funds' is just a straight up bad pull quote. The BIS report uses a pension fund as one type of financial institution that uses swaps, without singling them out specifically. A better headline would be "Central Banks should spend more time researching US Dollar domination of FX/Currency Swap market)".
- fnordpiglet 4y ago
  From the summary of the section of the report I think this is the extent of the BIS concern - a move away from cleared to otc bilateral agreements dilutes the utility of post financial crisis asset reporting. This is not an exciting topic, and can’t sell advertisements. “”” In the FX space, an accelerating shift towards less “visible” trading venues and bilateral trading may reduce the information content of prices and the network benefits of integrated markets. “”” They are spot on here. But there’s no doomsday coming from having prices off market or integrated markets. These issues are issues of efficiency rather than doom and gloom. My revised headline would be: “Reporting quality in FX Swaps is reduced by use of Over The Counter bilateral agreements instead of clearinghouse.” But no one will buy Herbalife with that headline.