If another financial institution the size of Lehman Brothers failed, the biggest step forward in terms of resolution would be the moves since the crisis to have derivatives centrally cleared.
At the time of Lehman’s demise, the bank had more than 900,000 derivatives exposures, only a small portion of which were exchange traded; the majority were complex, over-the-counter instruments. Holders of the small number of standardised options, futures and swaps traded on exchanges were the lucky ones – they were mostly resolved in less than two months.
This is a key finding of a new report from Fitch Ratings called Lessons from Lehman Brothers’ Resolution. While stating that the risks of huge market disruptions from the failure of a large financial institution have not disappeared, Fitch acknowledges the improvements that have been made, especially in the area of derivatives. But the rating agency is still cautious about how well the desired cross-border co-operation between different regulators would work in a crisis.
“... the size and complexity of large and highly interconnected institutions and the continuous evolution of financial products will raise new and unanticipated problems that will have to be addressed in the heat of a systemic crisis,” says the report.
On the derivatives front, the more progress regulators can make in standardising contracts and moving them to central clearing platforms, the easier any future wind down would be. But Fitch points out the challenges in this approach – “contract standardisation and the risk of large jumps in pricing present challenges, and a significant amount of long-dated legacy over-the-counter contracts are likely to remain outside central counterparty platforms in the medium term”. We have come a long way but there is still a long way to go.
Brian Caplen is the editor of The Banker.
