For many involved in the markets this will be a week to remember. It will be "where were you when..?" moment for some, a battle scar for others and for Lehman employees, a perhaps unimaginable experience. I hope those who lost their jobs find work and security soon.
This has tested even the most extreme disaster scenarios. On Monday 15th September, as the story unfolded, those with any exposure to Lehman were forced to run around gathering data, positions, collateral balances and read their ISDAs and any other agreements they had to find out what they could/should/had to do. You think you’re prepared, or maybe it will never happen. Maybe you never quite got round to bringing your ISDAs or CSAs into line.
As the ripples spread out round the organization and everyone wants to know what exposure you’ve got, to whom and what collateral you have. What trades are due to settle today, any payments due in? What about FFX and stock lending arrangements?
Others ask what they should do with the trades they have with Lehman. At first it doesn’t sink in, but when you tell someone for the third time "you don’t have any trades with Lehman anymore, they’re gone" the seriousness of the situation dawns upon them.
As the prices on the screens turn red and the risks you though you had covered by Lehman become real, and yours. Whatever collateral you had is quickly eroded as the markets fall.
That was just Lehman. Then the market turned on others. Who next? Who else am I exposed to? Who should I be trading with now? Will they even be around next tomorrow, next week? As the panic spreads the cost of replacement trades increases and people eye each other with suspicion. Some people move quickly; trades are replaced crystallizing the loss.
If you understood your ISDA and CSA, and could quickly lay your hands on your open positions and collateral held then you were on top of the situation. I suspect many of us were not. This was an extreme event; perhaps to be seen only once in a working lifetime. But things have changed. Ever since highly rated paper became quickly worthless, assessment of credit quality has changed. Ratings have, for some, become less meaningful. But that was for assets, not counter-parties. We’ve just seen counter-party risk materialize.
Of course, this is not normal. But I do expect changes. When fund managers buy an asset or an exposure, it is for a specific investment view. They don’t want counter-party balance sheet risk too. Collateral will be a minimum, preferably cash. But there are alternatives. Now may be the time to consider some of the exchange traded contracts, or other initiatives which offer a central counter-party. It is time for the buy side to take the lead.