Discredit derivatives
Discredit derivatives are a class of derivatives invented by pioneering derivatives guru and amateur crime novelist Hunter Barkley to allow alternative investment funds, who had lazily committed to environmental, social, and corporate governance standards in their prospectuses as a cheap way of wowing virtue-signalling investors, not realising that anyone would really object to massively profitable leveraged investments in firearms, narcotics and financial weapons of mass destruction. This they largely held true — no-one does care about that in the City — until the European Commission got in on the act and hold European-regulated hedge funds to account for false advertising if they claimed the sanctimony of ESG on paper but ignored it in practice.
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Barkley’s idea was simple: if it was okay to extract the crappy credit profile from a portfolio of mortgages off and lay that off on someone with “sufficiently deep market expertise and advanced models to bear the risk indefinitely”,[1] why not do the same thing with the unwanted ignomy of outrageous investments?
Barkley began to construct instruments — at first, simple put options — laying off the shame on those who could most easily wear it; namely — and this was Barkley’s real genius — the very badly-run, environment-wrecking corporates that were polluting the hedge fund portfolios in the first place. The hedge fund would write an at-the-money stigma put to, for example, the Golden Crown Palm Oil Company of Sudan Pty. Ltd. (and for which it would ask little by way of premium; after all, really, what did Golden Crown care? It was ripping up the Bandingilo national park already, so what is a little more remorse?), thus getting rid of the fund’s disgrace for investing in that very company.
Objections came soon enough that this was obviously circular, but Barkley swiftly pointed out that, well, so too was debt value adjustment hedging, and everyone seemed cool with that for a good few years, didn’t they?[2] Slowly, the product began to catch fire. “Soon it was blazing like the Amazon jungle!” Barkley would later fondly recall.
Eventually, though, people started to bridle — I mean, could the Golden Crown Palm Oil Company of Sudan Pty Ltd really take its own discredit back, and thereby exonerate the denizens of Mayfair of their ESG obligations? — so Barkley refined the offering by combining it with another of his innovations: cross-political currency “discredit swaps” where, for example, a natural wilderness gas fracking conglomerate could swap its embarrassment at precipitating a series of minor earthquakes on the local Inuit people, with a pornographic film distributor's regret for generating artificial losses to gain tax relief for its celebrity investors. So Now Hackthorne Capital Advisors Master Fund III LLP[3] could lay off its porno-tax shame to Golden Crown — a palm oil producer, so not implicated in onanistic or fiscal wrongdoing — who would in turn swap that porn discredit out with Antwerp Fruity Motion Pictures B.V. in return for its own environmental embarrassment risk, which Antwerp had acquired by selling a put rto Snowy Mountain Partners LLC, being another hedge fund in the same pickle as Hackthorne, only long palm oil and not smut.
Thus the so-called “Discredit Default Swaps” were born.
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References
- ↑ Yes, I know what you are thinking: a sleepy Landesbanken from Lower Saxony would be exactly such a someone, right?
- ↑ Indeed, it kept a phalanx of financial institutions out of technical insolvency — and their DVA traders handsomely remunerated — for a good three or four years after the worst excesses of the credit crunch.
- ↑ I had seven goes on the hedge fund name generator before I came up with a fictional hedge fund name that wasn’t actually a real hedge fund name, by the way. Honestly, hedgies: what about some imagination?