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A Tough Saddle to Mount (from June, 2008 Risk Magazine)

A Tough Saddle to Mount
ISDA's Chairman, Eraj Shirvani, talks to Alexander Campbell of Risk Magazine

Eraj Shirvani has his work cut out. Having succeeded Jonathan Moulds as chairman of the International Swaps and Derivatives Association in April, Shirvani takes up the reins in the midst of the worst financial crisis of the past decade, and at a time of heightened regulatory scrutiny. Despite this, he is optimistic about the task ahead. "When the industry has been under so much strain, it's hard to talk about success - but recent events have redoubled our faith in our risk systems," says Shirvani, also London-based head of European and Pacific credit sales and trading at Credit Suisse. "Counterparty risk management has done its job, the system has survived despite people's fears of dislocations, and the stock market and most of the institutions have remained intact." In fact, fears the complex structured derivatives markets would be the primary cause of any crisis turned out to be misplaced, he says. "The lesson is that we tend to overlook the most obvious areas of risk. Really it was the asset-backed commercial paper market seizing up and repo lines being pulled - the problems were in cash securities. The more sophisticated, supposedly less transparent areas actually kept working."

In particular, he contrasts the continuing growth of the credit derivatives market - which grew 81% last year to reach $62.2 trillion in notional outstanding - with the sudden draining of liquidity in the cash market. "Credit derivatives were often the only way to hedge or express a view when the cash market seized up," he notes. However, this growth means it is more urgent than ever to tackle the back-office problems that have plagued the credit derivatives market. "It's no secret it has posed challenges for all market participants," Shirvani says. "Trying to keep up with the growth has been a strain on everyone's resources. It's indefensible to say we don't need better infrastructure - I spend 30-35% of my time dealing with infrastructure issues."

But most of the strategic building blocks needed to resolve this problem are now either in place or under construction, says Shirvani. In a letter to the Federal Reserve Bank of New York, sent on March 27, the major dealers promised to submit 90% of trades eligible for electronic confirmation within one day of trade date and to match 92% of within five days by July. Cash settlement will also be written into the Isda master agreement by the end of the year, and steps are under way to automate the submission of novation requests via electronic platforms. "The vision is straight-through processing of every trade to the Depository Trust and Clearing Corporation's Trade Information Warehouse. That would mean trades take not days but hours or even minutes to process, which is an absolute necessity," says Shirvani. And once the vision is achieved for the credit derivatives market, he's confident it can be applied with only minor adjustments to other less advanced sectors, such as equity derivatives. Equity derivatives will be more resistant to standardisation than credit, Shirvani admits - they are far more diverse, and electronic confirmation is far rarer than in the credit derivatives market.

Like his predecessor, Shirvani is keen to exert Isda's influence in the nascent derivatives markets of Asia, particularly India and China. "There's huge interest in Asia," he says. But the infrastructure there is far from ideal - equity derivatives traders within China have the choice of two master agreements for trades within the country, as well as the Isda master agreement for cross-border trades, creating significant documentation risk for investors. "That's not the right way for a nascent market to begin," he points out. "We should be able to standardise some of the deals, but we will never completely eradicate the lack of standardisation, because that's where the innovation is, and the industry has to respond to new complex problems. But it's in all our interests to get the infrastructure in place, because the sooner we get the operational risk under control, the sooner we can spend more time on the leading edge of innovation, instead of spending so much time dealing with the infrastructure."

This article first appeared in the June, 2008 issue of RISK magazine. It is reproduced here by kind permission of the publisher.

[emphasis mine]
 
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