Template:M intro isda Party A and Party B: Difference between revisions

First, customers are trading their capital, dealers are not. Dealers are [[delta-hedge]]d against every customer. They are not “the other side of the trade”. A dealer’s “position” against a given client being “under water” in itself does not change the dealer’s risk of insolvency.  Of course, dealers ''do'' present a risk of insolvency, and customers will have tolerate so much exposure to that risk, but the customer has other levers to manage that risk. They can close out their position, take profits and re-establish the position the new level, for one thing. That enables the dealer to close out its hedge, pass on the hedge gains and reset hedges and initial margin at the higher level. This is not the same has paying the mark-to-market of a unrealised swap. To be sure, customers might not ''like'' doing this — realising a taxable gain and having to stump up more [[initial margin]] when you re-establish the position blows, for sure — but none of these are good reasons for anyone but the customer concerned. Withholding variation margin on profitable positions giving customers the choice: keep your position open and your money with the dealer and live with its solvency risk, ''or book your gain and get your money back and start again — encourages prudent behaviour. If nothing else it incentivises customers to diversify their risk. And it does not automatically lever up the customer’s portfolio. For what do we think the customer will ''do'' with all that free cash VM its dealer keeps sending it?  If it was planning to just sit on it, wouldn’t just — ''leave it at the bank''?

Secondly, dealers and banks are already capitalised and regulated for systemic risk. There are already constraints on how they must operate, and how much capital they must hold against the contingency of portfolio losses. It holds this capital, in large part, to protect against the risks presented to it ''by its customers''. Customers like thinly capitalised, highly-levered investment funds.  

That risk is amplified if dealers must post cash reflecting their clients’ unrealised gains on a derivative portfolio already 70% financed by that very dealer. It's just mad: “Hi. You owe me 70pc of the value of the stock you bought largely with my money, and you want  ''me'' to pay you margin if the stock goes up?

Now you might make the case that this capital regulation has been a bit of disaster, and some have<ref>Notably Gerd Gigerenzer, who has tracked the expansion in length of the Basel accords against the persistent rate of bank failure.</ref> but one lot of crappy regulations is not a prescription for ''more'' crappy regulations. Especially not when they undermine the first lot.