Last week I attended a hearing of the European Parliament ECON committee discussing a report prepared by Werner Langen MEP on OTC derivatives. It clashed with the Senate grilling of Goldman Sachs and was a lot less fiery but there are still interesting parallels.
The ECON hearing allowed various industry representatives to make scripted submissions Blythe Masters of JPMorgan was by far the most interesting followed by questions from the MEPs. Some of the questioning revealed a worrying lack of understanding. One of the most persistent themes was the proportion of speculative trading versus trading for hedging purposes. The underlying theme was that speculation is bad and it was repeatedly stressed that corporates and financial end-users are using OTC derivatives for hedging purposes. It doesnt seem to be well understood that it takes two to tango a corporate cant hedge its risk unless a dealer counterparty is willing to trade and take on the risk. Having taken on the trade a dealer is likely to trade with another dealer to hedge some of its risk position. Is this latter trade a hedging transaction or speculation? It is clearly a risk-management trade but Im not sure the politicians would agree.
There were also many questions about the CDS market and its relationship with the current Greek debt crisis the implication being that CDS products have either created or exacerbated the issue. Blythe Masters countered that CDS products dont create budget deficits and stressed that CDS can be used for both speculative and hedging purposes. She made her point very well but Im not sure the audience was really listening.
The parallels with the Senate hearing on Goldman Sachs are that politicians can sometimes take a very unexpected approach. One senator harangued the panelists for operating in an unregulated market. Whether or not you agree that the market was unregulated (I dont) it isnt Goldman Sachs fault that regulators were ineffective. This is akin to telling Lewis Hamilton that hes driving too fast.
Returning to OTC derivatives the way forward seems quite clear. Trading on exchanges no. CCP usage yes (but dont try and define standardized set a percentage target instead). Mandatory transaction reporting for all products/all markets yes. Trade repositories yes (preferably one per asset class globally). Incentives for better collateral management and margining for non CCP trades yes. Scope inclusion criteria should be based on risk position, not on status as a dealer, financial end-user or corporate.
I suggest there is probably 90% agreement on the above so lets get moving.