Sunday, December 18, 2011

Delta One: What Does it Do?

This article appeared in The Edge, Malaysia on Nov 14, 2012
Delta One – What do they do?
By Jasvin Josen
After the episodes of the “rogue trading scandals” in Societe Generale in 2008 and UBS this year, one begins to wonder if the trouble lies with the bank trading strategies rather than the traders themselves. Both Mr Kerviel and Mr Adoboli were traders in the “Delta One” trading desk.
Terry Smith, a veteran London City broker seems to think that Delta One trading strategies are frighteningly complex. He told the Financial Times, “Management doesn’t understand what goes on in the Delta One desks. If you sat down with a CEO and asked them to explain what happens they would try but they couldn’t give you an accurate answer because they don’t understand.”
Recent efforts in re-regulation have curtailed investment banks’ involvement in hedge fund activities, private equities and proprietary trading. However many market players will concur that investment banks have found another outlet in the name of “flow prop” trading within its Delta One trading division. Yet, other industry players maintain that proprietary trading in Delta One is not new in the market, as market-making activities naturally involves hedging. Any trading desk will want to find the cheapest hedge and will have to create innovative hedges to maximise its own profits. Hence the traders will engage in all kinds of trading and arbitrage activities in various derivatives, which could be seen as proprietary trading. Although trading is done on behalf of clients and arbitrage is necessary to smoothen prices in the market, the bank is in control of how to manage its portfolio. These conducts only further blurs the definition of proprietary trading.
In this article I will describe some common trading strategies of the Delta One desk that have been prevalent in recent times.
Futures and Index Arbitrage

Structured Repo: The Emerging Norm

This article appreared in The Edge, Malysia, Sep 12, 2011
Structured Repos: The Emerging Norm
By: Jasvin Josen

Repurchase Agreements, better known as “Repos” have been around the global market for nearly a century now, as a financing tool. After all the years, it is only natural to find that Repos now  exist in many forms and are being “structured” in many ways. In this article, I will explain some interesting forms of the structured repo and conclude with some additional forms of risks that the market bears with these products.
In the most classic form, a repo is essentially a cash loan backed by collateral. The cash borrower becomes the “repo seller” who “sells” collateral to the “repo buyer” and receives cash. At the maturity of the loan (which is traditionally only a few days to a week), the repo seller “buys” back his securities and returns the cash to the repo buyer. Off course, there will be an interest element which is added on. Since it is backed by high quality collateral, the interest rate is typically lower than other forms of unsecured financing in money markets. Chart 1 illustrates this classic repo.
Chart 1 – The classic repo

The many variations
Repos are now designed to be flexible and efficient to cater for the investor’s needs, fitting in nicely as a funding element in structured deals. The following two structures will show how repos are used by investors to hedge (or in reverse, gain access to) interest rate risk and credit risk.
The Callable Repo

Auditing Derivatives: Model Validation

This article appeared in The Malaysian Accountant journal, Sep-Oct 2011 issue
Auditing Derivatives: Think of what can go wrong - Model Validation
By Jasvin Josen
Auditing derivatives, in all likelihood, is one of the most challenging areas for an auditor. I focus on thinking of what can go wrong rather than just a standard review, for, derivatives are very flexible products and thus have a great potential to flourish in a reckless way when unguarded by proper supervision and regulation.
In the last five articles, we have observed the different issues that can surface as a derivative instrument moves along the trading floor and the Controlling Group, under the watchful eyes of Risk Management (with its Value-at-Risk model) and the Valuation team.
I must introduce a last function called Model Validation. This function has long been established in investment banks in the U.S. and Europe but possibly only now taking root in Asian investment banks.