Traders Moved Credit Derivatives Positions Ahead of Lehman's Bankruptcy
As regulators met around the clock last weekend to sort out Lehman's future, the OTC derivatives world faced another test — reducing its exposure to the investment bank as a counterparty in credit default swaps.
Credit default swap traders headed into the office on Saturday to evaluate their exposures to Lehman Brothers, according to media reports.
"Traders who had credit default positions with Lehman Brothers as a counterparty started to transfer the transactions to other dealers last week before anybody knew the outcome of the investment bank's credit crisis," says Kevin McPartland, senior analyst at TABB Group.
Lehman was said to be a major player in the CDS market, just as Bear Stearns was, before the firm's counterparties tried to unwind their positions and transfer the contacts to other dealers. Lehman clients, including hedge funds, did trim positions last week.
"The International Swaps and Derivatives Association staged an emergency trading session on Sunday to allow dealers to prepare for the death of Lehman Brothers, a fairly large player," reported the Financial Times on Monday.
According to Rob Hegarty, managing director of TowerGroup's securities & investments and insurance practices, "There were credit default swaps changing hands ahead of Lehman's bankruptcy and that was all in anticipation of whether Lehman was going to default on payment or go into bankruptcy."
However, since the CDS market is traded over the counter between dealers and not on an exchange, there is less transparency into the positions and who owns what. "As we're seeing with AIG, another big player in the CDS market, because [CDSs] are not exchange-listed or highly liquid in most cases, the entire integrity of the instrument is based on your counterparty," says Hegarty. "That's why everyone gets very jumpy when a market like this collapses," he says.
An article in the weekend edition of the Wall Street Journal, however, suggested that firms might be willing to disclose their positions to each other because if they hold similar contracts with Lehman they could unwind them and become counterparties to each other.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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