AIG fallout increases calls for counterparty disclosure

Beleaguered insurer American International Group (AIG) bowed to political demands that it release a list of its biggest bank counterparties on March 15, leading some analysts and commentators to press for greater counterparty risk disclosures by firms generally.

"Our decision to disclose these transactions was made following conversations with the counterparties and the recognition of the extraordinary nature of these transactions," said Edward Liddy, AIG's New York-based chief executive, in a statement. The list's publication also followed consultation with the US Federal Reserve, which has propped up the firm since an initial $85 billion was extended to it in return for a 79.9% stake on September 16 last year.

AIG's disclosure shows that between September 16 and December 31, 2008, AIG Financial Products paid out a total of $22.4 billion in collateral on credit default swap (CDS) trades with its top 20 financial counterparties. Just under half of this was concentrated between four firms, including Deutsche Bank, Goldman Sachs, Merrill Lynch and Societe Generale. Among AIG's other large CDS counterparties were Calyon, Barclays and UBS.

During the period, AIG also paid out $9.5 billion on its asset-liability management business and $15.2 billion on maturing debt, the firm revealed. In addition, it paid $5 billion into a special-purpose vehicle (SPV), known as Maiden Lane, through which AIG will wind-down its exposure to collateralised debt obligations of asset-backed securities (CDOs of ABSs). On November 10, the Fed announced it would contribute up to $30 billion towards the SPV, which was empowered to buy a maximum of $70 billion of CDOs of ABSs on which AIG wrote protection.

From its inception to the end of last year, the disclosure shows, the SPV paid out $27.1 billion to various counterparties - the majority of which went to Deutsche Bank, Goldman Sachs, Merrill Lynch and Societe Generale. Elsewhere, the firm disclosed that payments to a range of counterparties facing AIG's stricken securities lending business totalled $43.7 billion from September 18 to December 12, the top beneficiaries of which were Barclays and Deutsche Bank (see figure 1).

As well as invoking fury from the US Congress about the extent of payments to foreign counterparties, the moves also prompted some analysts to call for similar reports of large counterparty concentrations at other firms in order to temper systemic risk. "You could draw the parallel that we would expect a manufacturer to disclose to us if a significant proportion of its client base was a single business. If a significant proportion of its business was related to a single counterparty, that would be useful information too," says Brian Yelvington, New York-based strategist at research firm CreditSights.

Yelvington believes disclosure of exposures above a certain level could have drawn attention to the size of AIG's structured credit exposure, and would have made counterparties think twice about laying off the risk on similar transactions with the firm. The difficulty would be finding the right level at which such disclosures become necessary, he adds: "On the one hand, you want the information, and on the other hand, you don't want to hamstring the companies."

James Lam, Boston-based president of James Lam & Associates, agrees, saying a fuller disclosure of counterparty exposures would give market participants a better idea of counterparty risks and possible conduits for systemic risk. "If you have an exposure to counterparty A and you realise that counterparties B and C also have exposure to counterparty A, you would have a better idea of what your real exposure is," he remarks.

While some companies would be wary of giving away too much information in case market participants trade against them, Lam believes the idea of disclosing more about counterparty exposures is a practical one. "You could give broader information about your top 10 counterparties, and based on the exposures and credit ratings of your counterparties, you could give your expected loss and what your capital allocation might be, without giving away the exact details of transactions," he says.

With work towards central clearing of CDSs advancing in the US and Europe, others suggest build-ups of counterparty concentrations would be better supervised and curtailed by a central clearer. Such a clearing house would have the ability to set high margin requirements for sizable counterparty concentrations involving correlated transactions. But while clearing is being implemented for standardised single-name CDS and index trades, market participants say it is unlikely to ever encompass the kind of tailored deals that led to AIG's downfall.

Mark Pengelly.

See also:

• AIG dismantled risk controls on CDS portfolio, says Greenberg

• US to restructure AIG bailout after $61.7 billion Q4 loss
  
  
• New York Fed buys AIG assets at half price
  
  
• Treasury and Fed help AIG lay-off CDO risk
  
  
• Going the wrong way