What Price Transparency?

Price transparency in the OTC derivatives markets was one of the most widely discussed – and widely reported – topics at ISDA’s 27th Annual General Meeting last week. Here’s the Financial Times on the issue:

A theme of the ISDA conference, which includes large dealers as well as users of derivatives, is that while central clearing reduces systemic risk, regulators should not impose new rules on how derivatives trade, because it could disrupt those established markets and reduce trading volumes.

“Listed and over-the-counter markets are completely different, and it’s important that lawmakers and regulators keep this in mind,” said Mr O’Connor.

He added that the industry was open to more public reporting, but with restrictions such as not revealing the size of very large trades or delaying trade reporting. “We’re not anti-public reporting,” he said.

Mr Gensler said that public transparency after trades was key to reducing systemic risk, by making it easier for clearing houses to ask traders to post additional margin during the day.

So who’s right?

Enter Craig Pirrong, the “Streetwise Professor.” Professor Pirrong disagrees that pre-trade transparency helps to reduce systemic risk: “CCPs will obtain the prices of deals cleared through them, that they can use to determine marks on a periodic basis. Moreover, they have access to information from member firms that will permit marking deals to market. Pre-trade transparency is particularly irrelevant in this context.”

It’s a view echoed by those in the know. As the FT noted,

Michael Davie, head of LCH.Clearnet’s SwapClear platform, agreed that regulators, clearers and market participants must know what is going on, but public reporting isn’t essential.  “Transparency for transparency’s sake, why is that inherently a good thing? In broadly subscribed retail markets it’s incredibly important, but how many people are doing 10-year Czech krona swaps?”

So to sum up: price transparency is not a systemic risk issue. ISDA supports taking steps that reduce those risks, as evidenced by the progress made in clearing and compression and in building trade repositories. The former reduce counterparty risk and the latter increase regulatory transparency.

When it comes to market structure changes, however, we believe the benefits of those changes should outweigh their costs. We don’t think the impact of the rules relating to mandatory trade execution in the US meet that benchmark. The evidence indicates that prices in major segments of the OTC derivatives markets are very competitive and are accessible in many ways (via dealer quotes and screens). These markets are already liquid, competitive and transparent — qualities that are absolutely necessary for markets to function efficiently and effectively.