Template:Triplecocktail why should i pay your hedging costs: Difference between revisions
Jump to navigation
Jump to search
Amwelladmin (talk | contribs) Created page with "===“Why should I pay your hedging costs? I have no control over them” argument is bogus=== Sniffy buyside counsel — especially ISDA specialists who have adapted to [[PB]..." |
Amwelladmin (talk | contribs) No edit summary |
||
| Line 1: | Line 1: | ||
=== | ===The bogus “why should I pay your hedging costs? I have no control over them” argument=== | ||
Sniffy buyside counsel — especially ISDA specialists who | Sniffy [[buy-side|buyside]] [[counsel]] — especially hardcore ISDA specialists who are new to [[PB]] and don’t yet really understand it, might try suggesting a [[dealer]]’s hedging costs are its problem. This argument is bogus. [[Synthetic PB]] is just [[cash brokerage]] done with [[derivatives]] — the [[dealer]] hedges [[delta-one]] and has no skin in the game as it is simply executing a client order. The client would wear such costs in a cash trade — the [[dealer]] is an agent, after all — and the format of the transaction doesn’t make a difference. Okay: a [[Counterparty|swap counterparty]] is not in any legal sense an [[agent]] — that is axiomatic — but the trade is [[riskless principal]], which is agency from an economic perspective. | ||
*The [[ | *The [[dealer]] owes [[best execution]]. That means, (subject to contrary instructions) it has to interrogate all [[venue]]s and get the best possible price. | ||
*Under [[best execution]] rules the client may instruct the | *Under [[best execution]] rules the client may instruct the [[dealer]] to exclude certain [[venue]]s and [[dealer]]s. | ||
*To comply with best execution, the | *To comply with best execution, the [[dealer]] must configure its [[order router]] to accommodate the client’s preferences. | ||
*But excluding a venue impacts the quality of the available execution (whenever the excluded venue had the best price, you’d miss it). | *But excluding a [[venue]] impacts the quality of the available execution (whenever the excluded [[venue]] had the best price, you’d miss it). | ||
*By not excluding the venue, therefore, you ''benefit'' from the venue being present (as long as it doesn’t fail) every order you place. | *By not excluding the [[venue]], therefore, you ''benefit'' from the [[venue]] being present (as long as it doesn’t fail) every order you place. | ||
*Trades settle [[DVP]] so there is [[market risk]] in replacing the trade, not [[credit risk]]. | *Trades settle [[DVP]] so there is [[market risk]] in replacing the trade, not [[credit risk]]. | ||
*The market risk could be significant: failure of a venue will heavily impact [[liquidity]] and market [[volatility]] for a period. | *The market risk could be significant: failure of a [[venue]] will heavily impact [[liquidity]] and market [[volatility]] for a period. | ||
*Asking the | *Asking the [[dealer]] to underwrite a market loss when a [[venue]] or [[intermediate broker]] fails while getting the benefit its best pricing as long as it does not is asking for a free option on your own execution risk. | ||
Latest revision as of 09:29, 15 March 2019
The bogus “why should I pay your hedging costs? I have no control over them” argument
Sniffy buyside counsel — especially hardcore ISDA specialists who are new to PB and don’t yet really understand it, might try suggesting a dealer’s hedging costs are its problem. This argument is bogus. Synthetic PB is just cash brokerage done with derivatives — the dealer hedges delta-one and has no skin in the game as it is simply executing a client order. The client would wear such costs in a cash trade — the dealer is an agent, after all — and the format of the transaction doesn’t make a difference. Okay: a swap counterparty is not in any legal sense an agent — that is axiomatic — but the trade is riskless principal, which is agency from an economic perspective.
- The dealer owes best execution. That means, (subject to contrary instructions) it has to interrogate all venues and get the best possible price.
- Under best execution rules the client may instruct the dealer to exclude certain venues and dealers.
- To comply with best execution, the dealer must configure its order router to accommodate the client’s preferences.
- But excluding a venue impacts the quality of the available execution (whenever the excluded venue had the best price, you’d miss it).
- By not excluding the venue, therefore, you benefit from the venue being present (as long as it doesn’t fail) every order you place.
- Trades settle DVP so there is market risk in replacing the trade, not credit risk.
- The market risk could be significant: failure of a venue will heavily impact liquidity and market volatility for a period.
- Asking the dealer to underwrite a market loss when a venue or intermediate broker fails while getting the benefit its best pricing as long as it does not is asking for a free option on your own execution risk.