What we learned on TRS from the FT Comments section

It is to everyone’s benefit when capital markets professionals show how the markets really work, and sometimes they are the only people who actually know. In a recent Financial Times article on Total Return Swaps, the comments section revealed valuable inner mechanics.

During our 15 minutes of media fame last week, the FT’s Robert Armstrong wrote Archegos debacle reveals hidden risk of banks’ lucrative swaps business with a nice quote from Finadium. The article walked the line between helping educate the general public on TRS and adding technical details that market professionals would appreciate. We often find that there is no winning this game: either the public gets confused by technicalities or the professionals get annoyed at generalist commentary.

What resulted from Armstrong’s piece was comments on how the TRS market works, and these were excellent. Of note:

1. More confirmation that PBs have been pushing TRS over cash financing: “Swaps, especially, have been the darling of most PBs in the last 10 years. I have heard MDs telling their traders that if they were talking to a client wanting to trade cash and were not trying to convince them to go on swap instead they could expect to be fired. Also seen many beautiful PowerPoint presentations about how much revenue was there to be had if they enhanced their ‘synthetic PB’ offerings.”
2. Lack of reporting is a key point: “The issue is not the product, but the lack of reporting of exposure via the product (ignoring the parasitic nature of Archego’s strategy, and the IB’s aggressive risk management). Please do not miss the point. Informed reporting preferable to disinformation.”
3. Tail risk is increasingly becoming middle risk. In other words, what were thought to be extreme, unusual events are now much more common.
4. TRS data may be there if anyone might look: “Swaps must be reported to trade repositories. so the regulator has the data to see concentration risk building up. For what are the data good if nobody realizes the size of swaps from this one customer? I thought for exact this scenario to avoid it was implemented.”
5. Shariah compliant products and TRS: “I wonder how many people are aware that TRS are extensively used to make strictly non-Shariah products appear Shariah-compliant. It is not a scandal waiting to happen: it has been happening for over a decade. It will only hit the headlines when a few million Shariah investors lose their collective shirt, and then find out that their investments were not even Shariah!”
6. Many references to Long-Term Capital Management: “Anyone remember LTCM? They used TRS to get exposure to the Russian and other EMG debt instruments, which of course blew up, thereby blowing up LTCM and threatening the financial system before the Fed stepped in.
7. A Jones Day article noted a 2008 judicial case on TRS where TRS were considered equivalent to cash equities if they were to be cash settled. See The CSX Decision Regarding Beneficial Ownership and Group Formation.
8. Archegos could have produced significant cash in the price run up of VIAC but got hit as the price declined: “On the way up to $100 per share from $20 or $40 he resets the equity swaps and generates a lot of P&L into cash which he seemed to continue leveraging up. $50bn or $100bn of high priced concentrated positions and then you are all invested and one of your large positions drops from $100 to $66 you need put up margin daily to reset equity swaps.

There were also some technical corrections to the article that we agreed with, particularly on margin periods (daily, not monthly). The FT incorporated some of these corrections in the article. Nicely done, commenters.