What are the most commonly used derivatives

Big banks and derivative speculation

Bank secrecy, or bank client secrecy, as PR representatives of banks call it, was a competitive advantage for Swiss banks. The banks had used this strategic advantage since the Second World War, earned a lot of money and built logistically excellent and customer-friendly computer systems from which we all still benefit today. The automatic exchange of information of bank data between states, the opening due to administrative assistance and the trend to declare tax evasion as money laundering led to the erosion of banking secrecy with the help of more or less gentle international pressure.

2008 financial crisis

UBS and CS could not resist the lure of the initially profitable US mortgage market. They bought billions of inferior US mortgages wrapped in opaque packages and lost billions. Numerous banks around the world had to be bailed out by the state after the crisis, including UBS. The CS managed to pull itself out of the loop in time. The interbank traffic was on the floor, the banks no longer trusted each other.

There was a call to promote financial stability and the transparency of the financial system. An incredible legislative hustle and bustle broke out around the world. The fear of falling big banks that have to be bailed out by the state for economic reasons - too big to fail - sat in the neck of this legislation.

Derivatives - incomprehensible definitions

Switzerland joined the legislative furor on the principle of copy-and-paste. Unpronounceable names for laws were invented such as the Financial Market Infrastructure Act. The word “derivative” appears 348 times in the Federal Council's dispatch on this law.

Intransparent and complicated derivatives were one of the causes of the subprime crisis of 2008. The credit default swaps, insurance-like hedging products, which in 2008 drove the world's largest insurance company AIG into the arms of the US state, became famous. In addition to credit default swaps, the most frequently used derivative products also include interest rate and currency options, currency forwards and interest rate futures.

In its 2020 annual report, Credit Suisse Group AG defines derivative products, which are completely incomprehensible for financial laypeople, as follows:

Derivative contracts are entered into by the Group in the normal course of business for market making, position taking and arbitrage, and for our own risk management needs, primarily to mitigate interest rate, foreign currency and credit risk. "

Non-transparent rules

In order to promote transparency in derivatives transactions, Switzerland, like other European countries, has introduced a trade repository for derivatives. It is intended to promote transparency and security. A subsidiary of the Six Group keeps the register. It is limited to derivatives for companies based in Switzerland.

As of May 25, 2020, the weekly statistics of SIX Trade Repository AG showed open share derivatives of CHF 27,564,474,905,540,000 - i.e. CHF 27 million billion.

This astronomical number is terrifying. It is 39,000 times greater than the Swiss gross domestic product and thus threatens the very existence of Switzerland as a whole.

The two latest financial debacles suggest that the large SIX numbers mentioned are Archegos-like transactions.

The Archegos scandal

CS shares lost 18% in the week before Easter. Rumor has it that the bank has dumped USD 3 to 4 billion in synthetic (that is, covert) equity financing for the Archegos hedge fund. Bill Hwang, owner of the hedge fund, was reportedly convicted of financial fraud in 2012 after he was involved in an insider scandal over Chinese bank stocks. At the same time, global banks - including CS - have again concluded billion-dollar deals with him as if nothing had happened.

The magic word in the Archegos scandal is "Total Return Swaps". These are tailor-made for a customer and traded outside the stock exchange. Such businesses fly under the official radar. With this product, a hedge fund can economically acquire, for example, 30% of a listed company and the supervisory authorities do not notice it. The trick of these equity derivatives deals allows for huge speculative bets without actually buying and reporting the stocks, even though they are listed stocks.

In addition to CS, Nomura, Goldman Sachs, Deutsche Bank and Morgan Stanley also offered the Archegos hedge fund the opportunity to conduct huge speculations in stocks. It is incomprehensible that such global banks should conclude large volumes of equity derivatives with the same hedge fund without consulting each other. When US stocks Viacom CBS and Discovery came under pressure, lending banks got nervous that they all had the same collateral. Clever Goldman Sachs and Morgan Stanley sold the stocks in question in an immediate "fire sale". CS and Nomura stayed in their positions. The staid Swiss big bank fell victim in the New York shark tank.

Archegos is an example of an irresponsible financial casino unrelated to the real world. The public, politics, media and smaller banks only find out about hidden and absurd total return swaps after the bang.

The Greensill Scandal

The Greensill case has shown that the most sophisticated technological monitoring systems are of no use if the corporate management does not know what business is being carried out in the group. The Australian financier Lex Greensill, owner of a bank in Germany, had significant assets at CS, at the same time he was a loan customer and creator of an investment fund that CS placed in custody for particularly wealthy customers. His investment fund bundled receivables bought from suppliers into a package. Everything seemed to be covered by a Japanese insurance company. Due to poor communication and coordination between Australia, Tokyo, London and Zurich, this assumption turned out to be incorrect. This and financial alchemy also led to disaster in the Greensill case.

Archegos and Greensill are just the tip of the iceberg

It's not primarily about Greensill or Archegos. It's about an overbred financial system at the high finance level that learns nothing from the past, be it in bonuses, high-risk deals, high-frequency trading or deals with algorithms. Hedge funds benefit from these - and the financial institutions that make money. Not only small customers and small banks lose, but also people who think they are rich. The question is how much longer.

Politicians in federal Bern are not in a position to stand up to the excesses of financial capitalism. They are covered with vast amounts of information, their heads are not clear, they cannot tackle the big issue of financialization because of all the details.

Splitting up of the big banks - a necessity

A core problem of the big banks is that they simultaneously accept savings from the population and conduct business with non-transparent synthetic derivative transactions that belong in a different risk drawer. Non-transparent synthetic derivatives for hedge funds should be taboo for banks that accept savings. The splitting of the big banks into saver banks and speculative banks is urgently needed.

Today's typically Swiss self-regulation for the minimum protection of savers is not sufficient in a real disaster. Self-regulation is done by the private association called esisuisse, which in turn belongs to the banks. This cannot be the solution for the future.

Thinking ahead

A group led by Marc Chesney, finance professor at the University of Zurich, is taking advantage of the Swiss popular initiative and wants to introduce a micro-tax on payment transactions. Transparent information is necessary, because only informed people can make correct decisions in a democracy. Knowledge of financial transactions is in a small place. It cannot be that the population does not learn anything about the transactions taking place in high finance, except for the recurring scandals of the systemically important big banks.

Jacob Zgraggen is a member of the Micro Tax Initiative Committee (www.mikrosteuer.ch)