Dealer banks are accomplishing their withdrawal from FICC and the eurodollar necessities of dark leverage in the typical corporate fashion. For one, there is attrition as past derivatives trades simply runoff or mature. Second, banks have been engaging in what are called compression trades to an enormous degree, the money dealing equivalent of synergy. Finally, dealers have been studious and careful in not replacing many or any of those volume reductions.
The compression trend is revealing in many ways the internals at work in this eurodollar withdrawal. The vast majority of the processing in compression has been the dedicated work of one firm working in total obscurity and anonymity (outside, of course, those working deep inside FICC desks and taking part). And that is part of the ongoing problem in all things “dollar”, since it indicates yet more unseriousness on the part of economics and the commentary that is left wanting for it.
In the middle of August last year, a Swedish firm practically nobody has ever heard of issued a press release announcing that it had a primary hand in extinguishing half a quadrillion dollars in notional principal outstanding. That was, of course, a cumulative total dating back to the launch of TriOptima’s “compression service” in 2003. Nonetheless, that the banking system globally might be shed of anything approaching a quadrillion is cause for notice. [emphasis in original]
As you might expect, the “demand” for TriOptima’s compression services suddenly and sharply spiked around 2008. ICAP (TriOptima’s parent) reports that for calendar year 2007 there were $17.6 trillion in notional trades submitted and accepted for elimination; that included a negligible amount of credit default swaps. The following year, one that will never be associated with voluntary and orderly shifts in anything related to finance, there were a stunning $45.0 trillion in compression submissions, including, tellingly, then $2.5 trillion in CDS – as if banks were abruptly careful about such things when they clearly were not only the year before.
These numbers have only grown to the point that compression services offered through LCH and Euroclear are, again, far more than half a quadrillion by now in 2015. Compression trades, however, are just the “what” and speak nothing about the “why.” That has been left, as noted earlier today, as a great mystery to the mainstream that sees only the color of Janet Yellen’s fairy tale sky as its financial backdrop. The change in demand for compression starting in 2008 is all you really need to know, especially as the banks themselves have reported nothing but gross declines since then.
While this compression view tells us a great deal about how dealers are accomplishing their exit, there is more to it, creating an important window into an unappreciated (read: nobody has any idea this took place) shift in the internal eurodollar/wholesale mechanics themselves. Compression trading is not plug_and_play, though the literature assigned to describe it sometimes gives that impression. Far from it, banks have to endure sometimes radical alterations in order to complete their participation.
The reason for that is straightforward by what compression actually is. Dealer banks have duplicative and redundant positions in their derivative books, sometimes to the point of holding opposite positions at the same time.
TriOptima’s great value is in finding derivative contract duplications that can be eliminated without any shift in the nature of the net position. You cannot, of course, simply eliminate a contract before maturity without ramifications in terms of risk parameters not to mention counterparty interests. Compression trades have the effect of matching characteristics, under defined tolerances, so that the net effect is to remove “unnecessary” contracts that provide no value or service either by “tear up” or offsetting. After the compression trading is done, by algorithm (which is why there is basically only one company in this business), the bank notices no effect on its book.
But in order for that to actually work, there has to be some critical mass of derivatives trades in the potential compression “pool” meaning heavy participation from within the bank as well as among dealer peers: the greater that potential pool the more likelihood the mathematics can find redundancy and cancelation. As stated above, however, to accomplish such efficiency has meant widespread and significant alteration.
That comes in the form of aggregation in one method or another. Dealer banks have multiple “desks”, and often multiple trading units for each desk, each with their own mandates and tolerances. That is how one bank can take exactly opposite positions at any one time; and we want them to do so since that is the essence of money dealing itself, to provide liquidity mostly without expressing too much of a trading opinion.
In general terms, though, compression trading has altered that deeply embedded behavior and replaced it (probably too strong of a suggestion) with that tendency toward unified aggregation. That has been accomplished as a fully practical matter, as dealer banks themselves testified to a few years ago:
Barclays has instilled trade life-cycle discipline not only in operations but also in trading, which helped create a consistent culture throughout Barclays that values compression. Barclays has a one-book approach in some currencies and currently has technology initiatives in place to expand its breadth. Barclays further maximizes the benefits of compression with specialist teams meeting before and after each cycle to apply custom risk tolerances designed to fit the currency and risk appetite at that time. The evaluations and risk impacts from previous completed cycles are documented and actioned which effectively create progressive improvements. In 2011, as a result of compression, Barclays Capital terminated $6.4 trillion of notional principal from SwapClear, doubling the amount from 2010 in both nominal and line item terms.
JP Morgan demonstrated a step further, where dealer desks are almost consolidated into an overall bank portfolio.
J.P. Morgan has taken a comprehensive approach to counterparty and market risk by utilizing the one-book approach to IRS. The vast majority of transactions with third parties executed by any of J.P. Morgan’s trading desks are rebooked into a central book. This means multiple desks may execute IRS but all the benefits from compression and risk offsetting can be managed centrally. It has taken some time and investment for the infrastructure to be established, but management firmly believes it is working.
That means, in pure dealer terms, dealer banks aren’t acting in purely dealer mechanics. As JP Morgan declares above, “risk offsetting can be managed centrally.” If the bank takes an active approach to altering “risk” behavior in that centralization, it would have the effect of spreading that risk alteration across all its desks and dealer activities. The implications of that should be obvious.
As TriOptima advertises, their compression “pool” consists of 200 financial institutions worldwide as well as operating in 27 different currencies. Thus, you can begin to appreciate the unification as eurodollar, or “dollar”, becomes still further literally intangible. In other words, under a unified book approach with highly centralized risk management, the effects in one denominated currency book might then affect risk behavior spread among other currencies. In that form, the “dollar” isn’t even truly in dollars at all, but as a universal, wholesale expression of wholesale finance that preexists such denominating (how far banking has strayed from actual money).
That is why, I believe, we can see, for example, European problems of European economy and finance directly translate into at least dollar denominations of money dealing (I am thinking directly about when the ECB announced its negative deposit rate at the start of June 2014 and not long thereafter, coincidentally, the “dollar” started “rising” and FICC became even more of pronounced distaste overall and globally). It is but one more example of the deep systemic links that have erased the bright boundaries between geographically distinct systems and even economies; boundaries that are still considered relevant and sacred to orthodox economics and monetary central planning.
For our purposes in November 2015, this is yet another avenue to explain how and why the world is not behaving as intended and expected. If compression trading required such a huge investment not just in terms of any bank’s income statement but as a matter of operational alterations so significant in scope, what does that say about the eurodollar itself post-crisis?
Economists excuse the events of the past year as if some cosmic coincidence of unrelated timing and kind (such as October 15, 2014, being the whole task of computer trading rather than the unkind and dangerous illiquidity that betrays common conditional assessment) yet the steady drumbeat of dissonance is this very withdrawal of eurodollar FICC, the guts of the global “dollar.” If the Swiss National Bank was forced off its peg to the euro, the “dollar” was at its very heart and Deutsche Bank’s regrets undoubtedly a good part of the specific means. When the People’s Bank of China was likewise forced to “devalue”, it had nothing to do with actual devaluation and everything to do with the drastically unmanageable price of “dollars” Chinese banks were being forced to pay to maintain their wholesale short position. There was not enough FICC banking to maintain order, as the world was proved only two weeks thereafter.
It is literally money supply without anything close to resembling money. Prior to 2008, as compression trading itself proves, banks’ only concern was expansion in all forms and methods; now, they are careful to invest and re-orient in manners that are anathema to the pre-crisis mantra. That includes more than a simple element of unification that itself may contain negative factors, from a systemic money dealing perspective, that aren’t well understood because they are completely unexamined. In fact, you might suggest, as I would, that this alteration in internal behavior may actually contribute, asymmetrically, to the destabilization as at least a greater intrusion apart from purely money dealing factors and intentions.
From this point, yet again, you can also understand the great mystification currently under way even as it is a part of the same that nearly ruined it all in 2008. Standing above the surface of ocean, looking down upon its glassy and reflective surface, you might wonder what monsters and creatures lie beneath. Economists are content to remain in wonder always above the generic surface, never taking the slightest effort to dive in and start toward understanding the deep and masterful complexity of how it all actually works. That is damning enough as it is, but then they have the gall and pusillanimity to blame the ocean when nothing turns out as they suggest and intend.
This takes us far, far beyond the fact there hasn’t been actually money in many decades. These are not dollars and it is getting to the point where “dollar” may no longer capture the full extent of the financial alterations. As noted this morning, Alan Greenspan was absolutely positive that the entire financial world worked upon dependent stratification based on some “riskless” interest rate. He, and his successors, intentionally intruded with which to yield precision and control on that point; causing only massive and continuous malfunction pretty much since (and going back to at least 1995, which he himself recognized in his own fog of hubris). Standing aghast at what all that has wrought, you have to wonder if there is even “riskless” to begin with.
That was always the critique of a world without money, without anchor for valuation and honest trade. This relativity we are seeing in the eurodollar is purely a matter upon that view, as taking away the anchor has opened the pathology toward no longer being able to suggest any reference at all in anything. Function has been distilled purely as an essence of that relativity, which makes for not just difficult operation but maybe even impossibly so. Any truly scientific discipline would have at least noticed, but ideology in economics prevents even contemplation. It is not a science, and that has very real implications.
“Everybody in the fixed-income market should care about this,” she said…
“Traditional pricing and relative-value rules are breaking down,” said David Goodman, head of global capital markets strategy at Westpac Banking Corp…
“This is not really just a somewhat esoteric story about interest-rate derivatives,” strategists led by Joshua Younger wrote in a Nov. 6 report. “Moves in spreads should be viewed as symptomatic of deeper problems.”
Yep, and now it’s far too late to be starting some inquisition. The time for that would have been 1995, if not 1979. By even August 9, 2007, the point of no return had long since passed.