ISDA protocol as an option - Risk article

Risk published today an article titled "Cherry-picking fears [...] Isda protocol and traders warn of gaming the system"

Some extracts of the article are:

"[...] may have realised that signing left them in a difficult commercial position as they’d effectively made a free offer for their counterparties to adhere to [...] if and when it suits them,” says [...]. “Yet those banks couldn’t force anyone to adhere or agree bilaterally to [...] – so the protocol was operating on a one-way basis [for them].”

this means the signed-up banks have essentially given clients a free option that allows them to cherry-pick by working out if they’re going to win by adhering to the protocol or not.

“Imagine you have a large portfolio involving two counterparties who are hedging each other, and your risk-sensitivity exposure is at zero. You have $1 billion coming in on one side and $1 billion coming out on the other side. You’re thus perfectly hedged – until one counterparty suddenly stops [...],” says [...].

“Some market participants haven’t signed up to the protocol as they don’t ever want to [...],” says [...]. “If you haven’t signed the protocol, then it allows you to game the system because you can look at your portfolio and decide whether it would be beneficial or not to sign.”

The withdrawal of some dealers might also dissuade some clients from signing up. A counterparty might have a balanced book of unresolved CSAs with its banks and may be overall neutral about adhering to the protocol but, says [...], “if adherence now will only resolve some of [...], then signing may complicate the situation for them”.



I could have written the same text, replacing the [...] with something related to ISDA fallback protocol.

By the way the article was about negative rates in CSA collateral remuneration. But the point is that if this one sided option is true for negative rate, it is true also for the fallback. I guess we will see more articles on that very soon, in line with my post "ISDA Fallback as an option.

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