Posts this month
A blog on financial markets and their regulation
The unredacted Volume 5 of the Lehman examiner’s report released earlier this week provides details about how CME handled the Lehman default by auctioning the positions of Lehman to other large dealers. The table below summarizes the data given in the report.
|Asset Class||Negative Option Value||Span Risk Margin||Total Collateral||Price paid by CME to buyer||Loss to Exchange||Percentage Loss to Exchange||Loss to Lehman|
|Interest Rate Derivatives||93||130||223||333||110||49%||240|
|Total auctioned by CME||451||1195||1646||1539||-107||-6%||1088|
|Natural Gas Derivatives sold by Lehman itself||482||129||611||622||11||2%||140|
The negative option value is as the close of business before the Lehman bankruptcy and the loss to Lehman is computed as the excess of the price paid by CME to the buyer over this negative option value. Futures positions are presumably assumed to have zero value after they have been marked to market. On the other hand, CME incurs a loss only if it pays a price in excess of the collateral provided by Lehman. For comparison purposes, the same computation is done for the positions sold by Lehman itself, though, in this case, the exchange does not make any profit or loss.
What I find puzzling here is that in the case of interest rate derivatives, CME had to pay the winning dealer a price of about 1.5 times the collateral available. Had it not been for excess collateral in other asset classes, the CME might have had to take a large loss. Was the CME seriously undermargined or was the volatility in the days after Lehman default so high or was this the result of a panic liquidation by the CME?
We do have an independent piece of information on this subject. LCH.Clearnet in London also had to liquidate Lehman’s swap positions amounting to $9 trillion of notional value. LCH has stated here and here that the Lehman “default was managed well within Lehman margin held and LCH.Clearnet will not be using the default fund in the management of the Lehman default.”
A number of questions arise in this context:
In the context of the ongoing debate about better counterparty risk management (including clearing) of OTC derivatives, I think the regulators should release much more detailed information about what happened. Unfortunately, in the aftermath of the crisis, it is only the courts that have been inclined to release information – regulators and governments like to regard all information as state secrets.