Comments on: Best Securities Reform Proposal http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html Sun, 22 Nov 2009 06:06:33 -0500 http://wordpress.org/?v=2.8.4 hourly 1 By: Yves Smith http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-1005 Yves Smith Sat, 06 Oct 2007 02:58:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-1005 Anon of 10:38 AM,<br/><br/>My impression is that Cecchetti is talking about new exchanges that trade specific types of instruments.<br/><br/>There is no inherent reason why an exchange can't value a contract. In fact, it ought to be able to have better information by having all the trading in a type of instrument flow through it, rather than only a slice of the market.<br/><br/>The reason the PBs have a leg up now is that they have or can get the deal documents. Even the regulators can't obtain them (the excuse being that they aren't qualified investors. I think the Fed's New York desk ought to set up a hedge fund to solve this problem. Of course, legislation could do that too). Under an exchange scenario, the terms of all traded instruments would be public.<br/><br/>Anon of 4:17 PM,<br/><br/>Exactly, Liquidity is not the main reason (in my mind) to try to require more trading to take place on exchanges, but improved oversight. You will not create more natural buyers or sellers. <br/><br/>It is possible you will see more liquidity by virtue of lower and more explicit transaction costs (investors feel better about trading if they don't have to worry about being raped on the trade).<br/><br/> Another factor that might improve liquidity is standardization of contracts and structures, which would make the instruments more fungible. But as I said, I wouldn't count on them. Anon of 10:38 AM,

My impression is that Cecchetti is talking about new exchanges that trade specific types of instruments.

There is no inherent reason why an exchange can’t value a contract. In fact, it ought to be able to have better information by having all the trading in a type of instrument flow through it, rather than only a slice of the market.

The reason the PBs have a leg up now is that they have or can get the deal documents. Even the regulators can’t obtain them (the excuse being that they aren’t qualified investors. I think the Fed’s New York desk ought to set up a hedge fund to solve this problem. Of course, legislation could do that too). Under an exchange scenario, the terms of all traded instruments would be public.

Anon of 4:17 PM,

Exactly, Liquidity is not the main reason (in my mind) to try to require more trading to take place on exchanges, but improved oversight. You will not create more natural buyers or sellers.

It is possible you will see more liquidity by virtue of lower and more explicit transaction costs (investors feel better about trading if they don’t have to worry about being raped on the trade).

Another factor that might improve liquidity is standardization of contracts and structures, which would make the instruments more fungible. But as I said, I wouldn’t count on them.

]]> By: Anonymous http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-1002 Anonymous Fri, 05 Oct 2007 20:17:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-1002 In other words there have never been "liquid" markets in these securities, so liquidity cannot solve the problem. You merely had consensus on valuation which appears now to have gone away because the underlying asset performance is unstable. Holders might still dislike prices offered on an exchange. In other words there have never been “liquid” markets in these securities, so liquidity cannot solve the problem. You merely had consensus on valuation which appears now to have gone away because the underlying asset performance is unstable. Holders might still dislike prices offered on an exchange.

]]> By: Anonymous http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-1001 Anonymous Fri, 05 Oct 2007 20:03:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-1001 Yves- PB's have the tools to value illiquid instruments and lend against them- after all they structured them. Exchanges do not.<br/><br/>Anon- 10.38 Yves- PB’s have the tools to value illiquid instruments and lend against them- after all they structured them. Exchanges do not.

Anon- 10.38

]]> By: Yves Smith http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-1000 Yves Smith Fri, 05 Oct 2007 18:39:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-1000 I don't see the main benefit of having regulators push where possible for more trading via exchanges being an improvement in liquidity. I see it as being an improvement in transparency, that trade prices and volumes will be a matter of record. This will give the regulators vastly more insight into what is going on in these markets.. It will also transfer risk-bearing away from private institutions which are in multiple lines of business to entities that are adequately capitalized for the trading activities that happen through them. That has the secondary benefit of limiting the damage that can be done (and hence the cost of salvage) of institutions that are "too big to fail." <br/><br/>As for Anon of 10:38, I agree there are considerable practical obstacles. However, the issues you raise about margin on exchanges apply to the same degree to margin lending provided by prime brokers against these very same instruments. If PBs can lend against the, exchanges could too. And conversely, if the issues are so insurmountable that they aren't appropriate for exchange trading on margin, that begs the question of how the securities firms can be doing it properly and prudently.<br/><br/>As for corporate bonds, my impression as to why they aren't exchange traded is somewhat different. Historically, they were pretty much never traded (investors held them to maturity) so there was only occasional demand, which was satisfied by bond trading houses. Now with modern order-matching systems, if an investor was patient, he could post a price at which he'd be willing to buy or sell and see if anyone hit his bid.<br/><br/>There was serious interest in that sort of system being launched on a utility basis, a de facto exchange, in 2000-2001 (I know some of the people involved). But it seems to have been made irrelevant by the fact that investors instead used credit default swaps as a proxy for cash bond trading. I don’t see the main benefit of having regulators push where possible for more trading via exchanges being an improvement in liquidity. I see it as being an improvement in transparency, that trade prices and volumes will be a matter of record. This will give the regulators vastly more insight into what is going on in these markets.. It will also transfer risk-bearing away from private institutions which are in multiple lines of business to entities that are adequately capitalized for the trading activities that happen through them. That has the secondary benefit of limiting the damage that can be done (and hence the cost of salvage) of institutions that are “too big to fail.”

As for Anon of 10:38, I agree there are considerable practical obstacles. However, the issues you raise about margin on exchanges apply to the same degree to margin lending provided by prime brokers against these very same instruments. If PBs can lend against the, exchanges could too. And conversely, if the issues are so insurmountable that they aren’t appropriate for exchange trading on margin, that begs the question of how the securities firms can be doing it properly and prudently.

As for corporate bonds, my impression as to why they aren’t exchange traded is somewhat different. Historically, they were pretty much never traded (investors held them to maturity) so there was only occasional demand, which was satisfied by bond trading houses. Now with modern order-matching systems, if an investor was patient, he could post a price at which he’d be willing to buy or sell and see if anyone hit his bid.

There was serious interest in that sort of system being launched on a utility basis, a de facto exchange, in 2000-2001 (I know some of the people involved). But it seems to have been made irrelevant by the fact that investors instead used credit default swaps as a proxy for cash bond trading.

]]> By: Anonymous http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-999 Anonymous Fri, 05 Oct 2007 17:58:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-999 I agree with 10:38 - trading non-transparent securities on an exchange will only marginally improve liquidity. That said, has anyone studied the effect of the new, unregulated 144A exchanges? It's very possible that they do provide some benefits. I agree with 10:38 – trading non-transparent securities on an exchange will only marginally improve liquidity. That said, has anyone studied the effect of the new, unregulated 144A exchanges? It’s very possible that they do provide some benefits.

]]> By: Anonymous http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-997 Anonymous Fri, 05 Oct 2007 14:55:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-997 Exchanges are creations of regulation (SEC), so there will need to be significant discussion about who you want into these exchanges for more esoteric products, and how you would force an organization to use an exchange, rather than enter into one-on-one transactions. Sounds good in theory, but the regulatory organizations and certain laws have to be restructured. Exchanges are creations of regulation (SEC), so there will need to be significant discussion about who you want into these exchanges for more esoteric products, and how you would force an organization to use an exchange, rather than enter into one-on-one transactions. Sounds good in theory, but the regulatory organizations and certain laws have to be restructured.

]]> By: Anonymous http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal.html#comment-996 Anonymous Fri, 05 Oct 2007 14:38:00 +0000 http://www.nakedcapitalism.com/2007/10/best-securities-reform-proposal/#comment-996 Good idea, but only in theory. The exchanges are a good solution for liquid, well traded instruments. eg. the NYMEX Henry Hub gas futures traded by Amaranth. But those instruments are not a problem to begin with. The genesis of August swoon are the illiquid instruments- CDO tranches, CLO's etc. which are unique and are not held by large/diverse groups. Thus there is lack of liquidity/volume/bids/asks. The problem remains- what's the value of a particular security, how much margin should be posted against them (needs to be calculated each day) and is the margin enough to protect the counterparty. It is the same reason why corporate debt is not traded on exchange- too many different structures even for the same company. Good idea, but only in theory. The exchanges are a good solution for liquid, well traded instruments. eg. the NYMEX Henry Hub gas futures traded by Amaranth. But those instruments are not a problem to begin with. The genesis of August swoon are the illiquid instruments- CDO tranches, CLO’s etc. which are unique and are not held by large/diverse groups. Thus there is lack of liquidity/volume/bids/asks. The problem remains- what’s the value of a particular security, how much margin should be posted against them (needs to be calculated each day) and is the margin enough to protect the counterparty. It is the same reason why corporate debt is not traded on exchange- too many different structures even for the same company.

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