PrefBlog

I’m glad to see I’m not alone in my worries over central clearing:

History tells us, using the metric of loss experience, that CCP management is strong. But history is based on a bygone era that is radically different from today’s multi-instrument, multi-national and legally complex world. As CCPs fight for membership, the danger is that the delinquent firm will gain admittance and cause the contagion we all fear. I sense already a relaxation in the risk approaches of several medium-sized firms. CCPs can protect themselves from problem members by multiple means. The most effective, but often least favored, is to avoid them like the plague! The preferred method is through credit assessment and application of tough margins. But the latter option works best in a monopoly environment and not in today’s multi-choice option of CCP selection. And, if the EU dream of full interoperability were ever to come to fruition, risks unacceptable to one CCP could well insinuate themselves, albeit with added margin, into that platform through the interoperability route.

The second great danger facing CCPs is that of instrument coverage. Traditionally, CCPs have been cautious about expanding their instrument coverage. They have focused on the liquidity of any instruments admitted to clearing. They have assessed carefully any barriers to fast liquidation if they were ever forced to unwind a position. They have sought comfort from the presence of committed parties who would be willing to adopt open positions run by a defaulting member. And they have examined the history of the instrument to ensure that they understand its performance over time in both bull and bear sessions of its existence. Such a prudent approach is, I sense, being challenged both by competitive forces but also, more significantly, by the regulatory thrust for ever more central clearing. The problem with many of the new instruments is both their esoteric nature, appeal to specialized segments of the market place and narrow base of truly committed market makers. The risk is that, in times of turmoil, they may become illiquid. The probability is that, in times of stress, many will become one-way markets. A CCP will only be low risk if it can unwind its positions and realize collateral to compensate for any shortfall with immediacy.

It was a negative day for the Canadian preferred share market, with PerpetualDiscounts losing 34bp, FixedResets down 22bp and DeemedRetractibles off 19bp. FixedResets were notable on the poor side of the Performance Highlights table. Volume was extremely high.

PerpetualDiscounts now yield 5.71%, equivalent to 7.42% interest at the standard conversion factor of 1.3x. Long Corporates now yield a little over 4.8%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 260bp, a significant widening from the 250bp reported December 4.

This entry was posted on Wednesday, December 11th, 2013 at 11:18 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.