Swap termination, SA-CCR and the AFM’s push for fair treatment

The week on Risk.net, September 5-11, 2020

Will the exit price be right in new Isda docs?

Industry body is updating unloved procedure for valuing terminated swaps

AFM seeks to ‘level playing field’ for venues and vendors

Dutch regulator suggests some liquidity aggregators should be classified as OTFs

BofA becomes first US bank to adopt SA-CCR

Move cut leverage exposure by $66 billion, but other banks wary of trade-offs

---

COMMENTARY: Fear is the key

Market practitioners have known for centuries that there was more to economics than the rational pursuit of advantage. “Sentiment was somewhat weak on the Exchange today”, ran the caption to a 1920s cartoon in Punch, depicting two tail-coated traders sobbing in each other’s arms. And the breakthrough of behavioural economics was finding ways to bring this sentimental element into mathematical – and, in particular, computer – simulations of the economy.

This week, Risk.net talked to one of the pioneers of agent-based modelling, New York University epidemiology professor Joshua Epstein.

Previous interviews with academics have looked at the roles of overconfidence and regret, or the potential for macrocosm and world-in-a-bottle simulations of the global economy; Epstein though is more interested in fear. Rising and falling levels of fear lead to changes in behaviour as an epidemic grows. People avoid contact when afraid and then re-emerge from their homes once their fear is replaced by complacency, potentially triggering a second wave of disease.

Epstein hasn’t yet exported his model to the economics department, but it’s easy to see its potential. A model using agents with modules governing economic gain, fear, and perhaps some other known behavioural traits (regret or envy?) would come much closer to an accurate representation of trader behaviour. Used by financial markets regulators, it could be a valuable tool for modelling and guarding against panics, bank runs and liquidity crises.

Deployed by the traders themselves, of course, it would suffer the same fate as other market models – the advantage it provided would be gradually eroded away. Traders guided by the model would become less panicky, less fearful, less greedy – and less human. And behavioural finance would slowly move towards obsolescence.

---

STAT OF THE WEEK

August’s largest loss event occurred at Citi, which accidentally wired $900 million to creditors of cosmetics giant Revlon. The two sides were already locked in a dispute over a soured loan to the private equity-backed firm. As of August 21, Citi has not recovered a total of $520.4 million, for which the bank is now suing the lenders involved.

 

QUOTE OF THE WEEK

“I would estimate – gut feeling – probably only 25% of them understand total loss-absorbing capacity and how it works. Most of them have a very hazy knowledge of it, and very few of them think regulators would actually allow a major financial institution to fail” – Stuart Graham, Autonomous Research, speaking at a Financial Stability Board virtual workshop, at which the global watchdog was warned investors still assume governments would bail out a large bank rather than bail in bondholders through a new class of senior debt designed for that purpose.

Further reading

• Regulation

Reg AT withdrawal could delay a Biden agenda for the CFTC

• 11 Sep 2020

• Risk Quantum

JP Morgan shook up market risk stress tests in Q2

• 10 Sep 2020

• Risk management

US regulator may bend on margin rule for segregated accounts

• 10 Sep 2020

• Risk Quantum

Barclays led UK banks in growing CDS book through Covid shock

• 09 Sep 2020

• Risk Quantum

France, Germany lead EU on MREL debt sales

• 08 Sep 2020

• Risk management

LCH to accept Sing dollar bonds as collateral

• 08 Sep 2020