Credit those who are trying to bring the transparency and security of the block chain to the chaotic financial markets. They recognize the need for a reliable mechanism to prevent the type of disaster visited upon the credit default swaps (CDS) market this past weekend. A cadre of financial institutions agreed in principle to a $1.87 billion settlement for allegedly conspiring to muzzle competition in the CDS market.
The complete story behind this record settlement could take years to unravel. U.S. and European regulators are still investigating. In the meantime, the growing chorus of block chain advocates in the financial community has further reason to question the status quo while the lawyers rake it in. CDSs, a market pegged at $16 trillion in late 2014, hedge against borrower default.
Did Banks Conspire Over Credit Default Swaps?
Several big banks reached an agreement with a group of investors who claim the banks – along with Markit Group Ltd., a market-information provider – conspired to control the CDS market, according to Bloomberg. They agreed to the $1.87 billion settlement despite having previously claimed there was no antitrust conspiracy. On the contrary, they claimed they supported proposals to increase competition in the CDS market and that there’s little actual demand for exchange trading of the CDS contracts.
The banks include Goldman Sachs Group Inc., JPMorgan Chase Co., Citigroup Inc., HSBC Holdings Plc, Bank of America Corp., Morgan Stanley, Credit Suisse Group AG, Deutsche Bank AG, Barclays Plc, UBS Group AG, Royal Bank of Scotland Group Plc and BNP Paribas SA.
In September, a U.S. federal dismissed a claim that the banks colluded to monopolize CDS trading.
But the investors, who include the Los Angeles County Employees Retirement Association, claimed the financial institutions traded in a way that “kept the relevant price information in the hands of the dealer defendants, who ensured they were on one side of, and thus profited from, virtually every CDS transaction,” according to the complaint. The banks and a trade association – the International Swaps and Derivatives Association – “successfully maintained an inefficient and opaque market structure that yielded for them exorbitant profits at the direct expense of the investors”.
What The Block Chain Can Do
Those of you familiar with the block chain will recognize its application to this scenario.
The block chain provides an unbiased record of transactions. Hence, it can bring a new level of trust to business relationships and prevent disputes that fuel lawsuits and siphon untold sums of money out of the financial markets.
It won’t end contract disputes since written agreements will always be subject to interpretation. But there will be no disputing what text a contract included and at what time.
Regulators could more easily verify whether or not a transaction violates any laws.
The block chain can also shorten the settlement time for transactions. Hence, it might actually reduce some credit risks. A regulated bitcoin swap exchange could provide a more efficient way of hedging and trading.
To date, gold, loans, private shares, short-term government bonds, airline reward miles, interbank payments, property titles and diamonds all transfer on the block chain.
Swaps, for their part, could trade with bitcoin as the underlying asset. This was the purpose of TeraExchange, which CCN reported last year.
Blythe Masters Sees The Block Chain’s Potential
Blythe Masters, who helped develop the CDS market while serving as managing director at JPMorgan, recognized the block chain’s capability to bring stability and efficiency to the way assets trade when she assumed the CEO role at New York-based Digital Asset Holdings. Masters graces the cover of the October Bloomberg Markets with the headline, “It’s All About The Blockchain.”
While Masters’ claim to fame is tied to the CDS market, her reason for joining Digital Asset Holdings extends to a broad group of financial products. “Firms are dealing with greater requirements for reporting, transparency, and dissemination of data,” she said.
Costs have gone up and revenues have gone down. This technology really gets to the core of all those issues.
She says Digital Assets will allow banks, investors, and other market players to use block chain technology to change the way they trade loans, bonds, and other assets.
“I had seen the (2008) financial crisis unfold, and I had seen the credit derivatives market get operationally ahead of itself, which resulted in systemic risk counterparty exposures,” she said. “I began to believe that distributed ledgers had the capability to tackle that problem.”
To persuade institutions and regulators to change decades of systems, Masters and her compadres have a long way to go. And the introduction of the block chain could make the markets’ infrastructure even more complex than it already is, at least in the short term.
But shouldn’t the $1.87 billion settlement between the banks and the CDS investors be a wakeup call for change?
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