Template:Triplecocktail why should i pay your hedging costs

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.