I am one of the world’s best worriers,” says Gerry Corrigan, the 64-year-old Goldman Sachs managing director and former New York Fed president. That helps explain why, after Thanksgiving dinner at his weekend home in Massachusetts last fall, Corrigan decided to reconvene the Counterparty Risk Management Policy Group, a collection of high-powered bankers formed in 1999 after the near-collapse of Long-Term Capital Management.
The group’s report on that hedge fund’s follies helped change the way the Street manages risk. For one thing, banks and brokerage firms pulled back on the leverage they would extend to hedge funds. A financial disaster set the last CRMPG agenda; this time around it’s the fear of one.
The group’s 273-page report, released July 25 (and available at www.crmpolicygroup.org), reiterates some of the first study’s conclusions but also contains several fresh recommendations that are likely to be adopted quickly. For instance, the CRMPG proposes ending the practice of assigning trades to a third party without consent from the original counterparty; this can make it hard for firms to monitor their credit exposure.
The report urges other steps, however, that may encounter resistance from banks, prime brokerages and especially hedge funds. “I wasn’t born yesterday,” says Corrigan. “Some of this will happen quite naturally. Other parts will require further nudging.”
One definite candidate for nudging: The group wants to enhance market participants’ ability to gauge the creditworthiness of their trading partners by requiring them to disclose to banks and prime brokerages more details of their trading philosophies, risk management systems and market positions. Hedge funds that balk -- and most are notoriously secretive -- could find themselves losing access to markets and funding in moments of stress. And if they lack sufficient capital to support leveraged positions that go sour, the funds could suffer liquidations and big losses. Several funds experiencing such a plight at once could destabilize the markets.
The report also says the notion of prime brokerages’ reporting the aggregate positions of all their clients in certain markets is worth exploring. Such “large exposure” reporting could help identify situations that pose systemic risks. Still, what regulators should do with such information is a subject of debate.
Surely, more than a few hedge funds will bristle at both recommendations. Worried that banks or market players will decode and copy their sophisticated proprietary trading models, they are loath to reveal any particulars about their strategies. If certain prime brokers start requiring extensive disclosure, wary hedge funds may seek out less demanding intermediaries.
Other CRMPG proposals may lead to foot-dragging because they are expensive or require industrywide coordination. For example, the group urges immediate action to resolve a big backlog of unprocessed credit derivatives trades, the side effect of a market that has outgrown its back-office support. More than a mere matter of good housekeeping is at issue here. In periods of uncertainty an accumulation of unconfirmed trades could damage confidence in this $8.4 trillion market, undermining liquidity and sending prices tumbling.
In Corrigan’s eyes this is a clear and present danger. “I don’t want to hear anything about how that is going to cost money,” he barks. “You’re damned right it’s going to cost money. Now write the check. That’s a no-brainer.” His group proposes that the market eventually institute automated straight-through processing.
The CRMPG ought to know something about market risk. Among the group’s members are Lehman Brothers chief risk officer Thomas Russo and his counterpart at J.P. Morgan Chase, Don Wilson; GM Asset Management CEO Allen Reed; and Scott Evans, investment chief for TIAA-CREF.
The group also has enough friends in high places to give it a quasiregulatory cast: Well before the CRMPG embarked on its latest report, Corrigan sounded out New York Fed president Tim Geithner, Goldman Sachs chief executive Hank Paulson (his boss) and other Wall Street CEOs on their support for further study and proposals. Geithner has already called a September 15 meeting of major banks and regulatory agencies to discuss practices in the credit derivatives market.
