German banking system, causes for concern

The international financial system suffered fresh convulsions yesterday it emerged, that Germany’s IKB Deutsche Industriebank, one of the country’s leading small business lenders, had a huge exposure to high-risk sub-prime mortgages – mortgages which are made to borrowers with weak credit histories – in the United States. Defaults on these housing loans recently had reached a 10-year high, driving down the value of bonds backed by mortgages.

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Repricing of debt and equity issues

In the current market, not a day goes by without news that the financing of another high-profile acquisition or buyout has run into trouble. The collapse of the US sub-prime mortgage market has wreaked havoc in the leveraged loans sector, as banks such as Citigroup, RBS and JPMorgan have suddenly found themselves stuck with private equity-related debt sitting on their balance sheets as a result of underwritten but as yet unsyndicated loans.

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Regulatory frameworks for financial derivatives


The Obama administration on May 13th unveiled a sweeping plan to regulate over-the-counter derivatives in an attempt to seize greater control over an opaque market that has been blamed for exacerbating the financial crisis.

The move is intended to increase transparency and reduce risk in a market that is worth more than $680,000bn but has so far been largely unregulated. Many problems like accounting rules for derivatives have to be solved.

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Credit Default Swaps: central clearing yes, exchange trading no

According to BIS figures in notional terms the volumes of credit default swap (CDS) fell by 26.9% in the second halve of 2008 to $ 41.9 trillion. In December 2006 it amounted to $ 28.65 trillion, but then almost doubling to 57.89 trillion at the end of 2007.
The turn-around occurred against a background of severely strained credit markets combined with increased multilateral netting of offsetting positions by market participants. Single-name contracts declined to $25.7 trillion while multi-name contracts, a category that includes CDS indices and CDS index tranches, saw a decrease to $16.1 trillion. According to BIS figures of the total credit default swap volume some 60% were contracts with reporting dealers and 39% with other financial institutions. Non-financial customers held only a mere 1%.

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Making rules for central counter parties clearing of OTC derivatives

The G 15 (major global) banks dealing in  interest-rate and credit-derivatives plan to funnel nearly all swap transactions throughclearinghouses by the end of 2009.
The banks wrote on September 8th  to the Federal Reserve Bank of New York Tuesday that they will centrally clear interest rate  derivatives and credit default swaps.  The former will be done beginning December , the latter beginning October. As to the credit default swaps each G15 member (individually) commits to submitting 95% of new eligible trades (calculated on a notional basis) for clearing beginning October 2009.  At that time the G15 members (collectively) also commit to clearing 80% of all eligible trades (calculated on a weighted average notional basis).  Furthermore they will issue performance metrics that address both new transactions and the outstanding trade population on a monthly basis.  Read More →

Monetary policies in times of turmoil

The current weakness in the US financial markets has recently been magnified overseas as panic spread to foreign investors with exposure to U.S. asset backed debt. The recent sell off in global stocks was in general liquidity-driven and a consequence of mispriced risks in the US sub-prime, derivatives and international currency markets. Initially many investors, particularly those using leverage, were forced to meet margin calls by selling assets to raise cash. Since the assets causing the problems had little, if any, value, they were forced to sell other assets instead, causing prices to fall sharply. In addition, the increased risk aversion that followed led to de-leveraging of other speculative positions like for instance the yen carry trades; speculative-grade corporate bond issuance ground to a halt; and the asset-backed commercial paper market seized up, even for high-quality investors. Read More →