Streetwise Professor

Kudos to Jeremy Grant at FT’s Trading room, who published not one, not two, but three articles expressing serious reservations about clearing mandates.  One is by Sanjit Das, another by Shearman and Sterling attorney Barney Reynolds, and the third byReuben Lee.   Each echoes points I’ve been making over the last 20 months.

The Reynolds piece was interesting, though I don’t quite track his claim that end user clearing will result in said end users posting collateral to a clearing house, and to the dealer it trades through, to cover the dealer’s collateral costs.  But Reynolds does make a key point: namely, that the impacts of clearing on the normal day to day operations of the market should be taken into account, not just the systemic risk implications.   He says that clearing rules should be set “with a view to preserving commercial hedging activity, not merely with a view to protecting financial institutions from another black swan event.”

Since it is quite possible that CCPs are vulnerable to black swan events, systemic risk considerations are close to a push.  This means that the efficiency effects of clearing under normal market conditions should be given considerable weight, and as Reynolds argues, and as I argue, OTC bilateral dealings have clear advantages on this score.

But it doesn’t really matter, does it?  The clearing train has probably left the station, both in the US and Europe.  A clearing mandate is in both bills currently being merged in conference between House and Senate, so it’s a done deal here, and the European Commission has made it plain that it will require the bulk of deals to be cleared.

It would have been nice if people had spoken up rather earlier, when it was possible to influence the debate.  As it is, I don’t think it’s an exaggeration to say that I was nearly alone, at least among academics, in my criticism of clearing mandates when they were first mooted.  And who am I, anyways?  People have finally figured out that this is a big deal, and that Sorcerer’s Apprentices may wreak havoc with ill considered rules on clearing.  So they are saying this now, but now is too late.

This is, to my mind, a black mark against the academic community.  It has, for the most part, paid virtually no attention to matters of market infrastructure, despite their crucial importance; the subject has been relegated to, at best, specialty journals, and often not even there.  My stock remark in this regard is that in the military it is said that amateurs talk tactics, professionals talk logistics, and in finance professionals talk counterparty risk and how to manage it, but academics are amateurs who ignore it by and large.  At the margin, the value of an imperfect paper on clearing or counterparty risk is far greater than the value of yet another paper on testing asset pricing models or on some aspect of corporate finance.  But that value isn’t recognized, and such things are devilishly hard to get published, so that Nth paper on asset pricing or capital structure gets written and perhaps published.  As a result, academics have far too little to say, and hence far too little influence, on what is perhaps the most important of the seismic changes that will take place in financial markets by legislative fiat.

(As an aside, some academics have weighed in on clearing issues late in the game, including some very prominent ones.  Much of what they have to say is an embarrassment, unfortunately.)

At best, serious thinking and research might affect the implementation of the clearing regulations.  Legislation will leave a lot of the specifics to regulators like the CFTC (God help us all), and perhaps some serious academics could lead to Pareto improvements by weighing in now, even at this late date.

* This is one of my grandfather’s expressions. (He had many, which I have appropriated, often to the mystification of those to whom I am speaking.) It always mystified me, so I asked him to explain it.  Apparently there was a product to treat baldness, back in the 30s or 40s, called Herpicide.  (Yeah, like I’d put something with THAT name on my head.)  Apparently you had to use it just when you were starting to lose your hair; it wouldn’t work–they said–if you waited too long.  To make the point, they ran an ad campaign with pictures of cue-ball headed men, with the caption “It’s A Little Late for Herpicide.”  So now you know.