Why is the regulation of “swaps” important to failing systemically significant institutions?
Have you ever considered how much faith and confidence play a role in the financial sector?  The calling in of swaps could cause issues similar to a Bank Run, which may or may not involve others coming into play.  While this is cleaning up the mess from a few years ago, there is something to be said for how complicated are various financial instruments in this situation. If you want something similar to ponder, what would make any institution be considered major and would this be agreed by various countries given how connected things are within the world?  What makes an institution major in the United States may not be quite the same standards in Brazil and this where one has to consider how to maintain faith in the system that could unravel rather badly if everyone tries to cash out at the same time.  The Bank Run link above is something to consider that could cause a bank that appears fine to suddenly have speculators cause more disruptions which isn't likely to help.  The global credit markets aren't likely to freeze overnight and thus there can be the question how does this get handled if another mess could arise. The idea here is to set up the framework to prevent the panic that could lead to a global depression.  The idea is to create for derivatives something similar to the stock market's trading curbs that exist to contain panic on a macro level.  The psychology is quite important in figuring out how to handle the obligations of a company that was perceived to be infallible as well as making sure what is agreed works across various cultures and currencies.
"When you invest in an S&P500 index fund that is priced in USD, the only major risk you bear is the risk associated with the equity that comprises the index, since both the equities and the index fund are priced in USD. The fund in your question, however, is priced in EUR. For a fund like this to match the performance of the S&P500, which is priced in USD, as closely as possible, it needs to hedge against fluctuations in the EUR/USD exchange rate. If the fund simply converted EUR to USD then invested in an S&P500 index fund priced in USD, the EUR-priced fund may fail to match the USD-priced fund because of exchange rate fluctuations. Here is a simple example demonstrating why hedging is necessary. I assumed the current value of the USD-priced S&P500 index fund is 1,600 USD/share. The exchange rate is 1.3 USD/EUR. If you purchase one share of this index using EUR, you would pay 1230.77 EUR/share:  If the S&P500 increases 10% to 1760 USD/share and the exchange rate remains unchanged, the value of the your investment in the EUR fund also increases by 10% (both sides of the equation are multiplied by 1.1):  However, the currency risk comes into play when the EUR/USD exchange rate changes. Take the 10% increase in the price of the USD index occurring in tandem with an appreciation of the EUR to 1.4 USD/EUR:  Although the USD-priced index gained 10%, the appreciation of the EUR means that the EUR value of your investment is almost unchanged from the first equation. For investments priced in EUR that invest in securities priced in USD, the presence of this additional currency risk mandates the use of a hedge if the indexes are going to track. The fund you linked to uses swap contracts, which I discuss in detail below, to hedge against fluctuations in the EUR/USD exchange rate. Since these derivatives aren't free, the cost of the hedge is included in the expenses of the fund and may result in differences between the S&P500 Index and the S&P 500 Euro Hedged Index.  Also, it's important to realize that any time you invest in securities that are priced in a different currency than your own, you take on currency risk whether or not the investments aim to track indexes. This holds true even for securities that trade on an exchange in your local currency, like ADR's or GDR's. I wrote an answer that goes through a simple example in a similar fashion to the one above in that context, so you can read that for more information on currency risk in that context.  There are several ways to investors, be they institutional or individual, can hedge against currency risk. iShares offers an ETF that tracks the S&P500 Euro Hedged Index and uses a over-the-counter currency swap contract called a month forward FX contract to hedge against the associated currency risk. In these contracts, two parties agree to swap some amount of one currency for another amount of another currency, at some time in the future. This allows both parties to effectively lock in an exchange rate for a given time period (a month in the case of the iShares ETF) and therefore protect themselves against exchange rate fluctuations in that period.  There are other forms of currency swaps, equity swaps, etc. that could be used to hedge against currency risk. In general, two parties agree to swap one quantity, like a EUR cash flow, payments of a fixed interest rate, etc. for another quantity, like a USD cash flow, payments based on a floating interest rate, etc. In many cases these are over-the-counter transactions, there isn't necessarily a standardized definition.  For example, if the European manager of a fund that tracks the S&P500 Euro Hedged Index is holding euros and wants to lock in an effective exchange rate of 1.4 USD/EUR (above the current exchange rate), he may find another party that is holding USD and wants to lock in the respective exchange rate of 0.71 EUR/USD. The other party could be an American fund manager that manages a USD-price fund that tracks the FTSE. By swapping USD and EUR, both parties can, at a price, lock in their desired exchange rates.  I want to clear up something else in your question too. It's not correct that the ""S&P 500 is completely unrelated to the Euro."" Far from it. There are many cases in which the EUR/USD exchange rate and the level of the S&P500 index could be related. For example: Troublesome economic news in Europe could cause the euro to depreciate against the dollar as European investors flee to safety, e.g. invest in Treasury bills. However, this economic news could also cause US investors to feel that the global economy won't recover as soon as hoped, which could affect the S&P500.  If the euro appreciated against the dollar, for whatever reason, this could increase profits for US businesses that earn part of their profits in Europe. If a US company earns 1 million EUR and the exchange rate is 1.3 USD/EUR, the company earns 1.3 million USD. If the euro appreciates against the dollar to 1.4 USD/EUR in the next quarter and the company still earns 1 million EUR, they now earn 1.4 million USD. Even without additional sales, the US company earned a higher USD profit, which is reflected on their financial statements and could increase their share price (thus affecting the S&P500). Combining examples 1 and 2, if a US company earns some of its profits in Europe and a recession hits in the EU, two things could happen simultaneously. A) The company's sales decline as European consumers scale back their spending, and B) the euro depreciates against the dollar as European investors sell euros and invest in safer securities denominated in other currencies (USD or not). The company suffers a loss in profits both from decreased sales and the depreciation of the EUR.  There are many more factors that could lead to correlation between the euro and the S&P500, or more generally, the European and American economies. The balance of trade, investor and consumer confidence, exposure of banks in one region to sovereign debt in another, the spread of asset/mortgage-backed securities from US financial firms to European banks, companies, municipalities, etc. all play a role.  One example of this last point comes from this article, which includes an interesting line: Among the victims of America’s subprime crisis are eight municipalities in Norway, which lost a total of $125 million through subprime mortgage-related investments. Long story short, these municipalities had mortgage-backed securities in their investment portfolios that were derived from, far down the line, subprime mortgages on US homes. I don't know the specific cities, but it really demonstrates how interconnected the world's economies are when an American family's payment on their subprime mortgage in, say, Chicago, can end up backing a derivative investment in the investment portfolio of, say, Hammerfest, Norway." Edit: This is paywalled so I pasted it here.  LONDON—The synthetic CDO, a villain of the global financial crisis, is back.  A decade ago, investors’ bad bets on collateralized debt obligations helped fuel the crisis. Billed as safe, they turned out to be anything but. Now, more investors are returning to CDOs—and so are concerns that excess is seeping into the aging bull market.  In the U.S., the CDO market sunk steadily in the years after the financial crisis but has been fairly flat since 2014. In Europe, the total size of market is now rising again—up 5.6% annually in the first quarter of the year and 14.4% in the last quarter of 2016, according to the Securities Industry and Financial Markets Association.  Collateralized debt obligations package a bunch of assets, such as mortgage or corporate loans, into a security that is chopped up into pieces and sold to investors.  The assets inside a synthetic CDO aren’t physical debt securities but rather derivatives, which in turn reference other investments such as loans or corporate debt.  During the financial crisis, synthetic CDOs became a symbol of the financial excesses of the era. Labelled an “atomic bomb” in the movie “The Big Short,” they ultimately were the vehicle that spread the risks from the mortgage market throughout the financial system.  Synthetic CDOs crammed with exposure to subprime mortgages—or even other CDOs—are long gone. The ones that remain contain credit-default swaps referencing a range of European and U.S. companies, effectively allowing investors to bet whether corporate defaults will pick up.  Desperate for something that pays better than basic government bonds, insurance companies, asset managers and high-net worth investors are scooping up investments like synthetic CDOs, bankers say, which had largely become the preserve of hedge funds after 2008.  Investment banks, which create and sell CDOs, are happy to oblige. Placid markets have made trading revenue weak this year, and such structured products are an increasingly important business line.  Synthetic CDOs got “bad press,” says Renaud Champion, head of credit strategies at Paris-based hedge fund La Française Investment Solutions. But “that market has never ceased to fully function,” he added.  These days, Mr. Champion still trades synthetic CDOs, receiving a stream of income for effectively insuring against a sharp rise in European corporate defaults.  Many investors, though, still view the products as unnecessarily complex and are concerned they may be hard to offload when markets get choppy—as they did in the last crisis. From the DepthsThe amount outstanding of European collateralized debt obligations has been growing again after years of shrinking.  “We don’t see that demand from our clients and we wouldn’t recommend it,” said Markus Stadlmann, chief investment officer at Lloyds Private Banking, citing concerns over the products’ lack of transparency and lack of liquidity, meaning it could be hard to offload a position when needed.  The return of synthetic CDOs could present other risks. Even if banks are currently less willing to loan money to help clients juice returns, credit default swaps can be very leveraged, potentially allowing investors to make outsize bets.  Structured products accounted for nearly all the $2.6 billion year-on-year growth in trading-division revenue at the top 12 global investment banks in the first quarter, according to Amrit Shahani, research director at financial consultancy Coalition.  “There has been an uptick in interest in any kind of yield-enhancement structure,” said Kokou Agbo-Bloua, a managing director in Société Générale SA’s investment bank.  The fastest growth this year has come in credit—the epicenter of the 2007-08 crisis. The top global 12 investment banks had around $1.5 billion in revenue in structured credit in the first quarter, according to Coalition, more than doubling since the first quarter of 2016. Structured equities are largest overall, a business dominated by sales of derivatives linked to moves in stock prices, with revenue of $5 billion in the first quarter.  “The low-yield environment hurts,” said Lionel Pernias, a credit-fund manager at AXA Investment Managers. “So there are a lot of asset owners looking at structured credit.”  These days, the typical synthetic CDO involves a portfolio of credit-default swaps on a range of companies. The portfolio is sliced into tranches, and investors receive payouts based on the performance of the swaps. Those investors owning lower tranches tend to get paid more but are subject to higher losses if the swaps sour. Structured GrowthBank revenues from structured products such as collateralized debt obligations are rising faster than conventionaltrading of stocks, bonds and currencies.  For instance, an investor can sell insurance against a pick-up in defaults in the lowest—or “equity”—tranche of the iTraxx Europe index, a widely traded CDS benchmark that tracks European investment-grade companies. In return, the investor will receive regular payments, but those will shrink with every company default and stop altogether once 3% of the portfolio has been wiped out through defaults.  During the financial crisis, synthetic CDOs based on standardized indexes like iTraxx Europe suffered losses as traders expected defaults to pick up. Investors who held on, though, have since done “great,” says Mr. Champion.  Investors who agreed to insure against a rise in defaults for 10 years on the equity tranche of the iTraxx Europe index in March 2008 have made roughly 10% a year, according to an analysis of data from IHS Markit . That’s despite defaults from two companies in the index: Italian lender Monte dei Paschi di Siena and Portugal Telecom International Finance BV.  In contrast, investors who sold insurance on tailored CDOs packed with riskier credits—such as Icelandic banks or monoline insurers—would have been on the hook for losses.  Synthetic CDOs have evolved since the crisis, bankers say. For instance, most are shorter-dated, running up to around two to three years rather than seven to 10 years. Some banks will only slice and dice standardized CDS indexes that trade frequently in the market rather than craft tailored baskets of credits.  There are also fewer banks involved in arranging these trades. Those active include BNP Paribas SA, Citigroup Inc., Goldman Sachs Group Inc., J.P. Morgan Chase &amp; Co. and Société Générale.  Postcrisis regulations have forced banks to set aside more capital against these transactions and use less leverage. That has encouraged banks to parcel out the risk to clients rather than keeping it on their own books.  “There is a lot more regulation and scrutiny and a lot less leverage,” said Mr. Agbo-Bloua.  Mr. Champion says he only trades tranches based on standardized CDS indexes, which he says are easier to buy and sell than more tailored products. Currently, he sees value in selling default protection on super-senior tranches.  Mr. Champion said he has to lay down only around $1 million in upfront margin costs on a $100 million trade of this kind.  “The cost of leverage in the derivatives space is very low,” he said.  Any expectations of default rates picking up could inflict losses on synthetic CDOs, though at the moment analysts forecast they should decline. Still, the memory of how the market behaved in the immediate aftermath of the financial crisis is likely to keep many investors on the sidelines.  “If you’re the person responsible for buying the synthetic CDO that suddenly goes wrong, your career risk is bigger than if you’d bought a plain vanilla bond that goes wrong. It has a bad name,” said Ulf Erlandsson, a portfolio manager at start-up hedge fund Glacier Impact, who until recently oversaw credit for one of Sweden’s public pension funds. I've spoken with a number of expatriates in Canada and Canadian bankers over the past few days.  Here's what I've been able to piece together. This was surprising to me.  As I understand it, the only sure-fire way to wire transfer funds from an arbitrary bank to another arbitrary bank on a different continent on the first try  is by using the IBAN number of the destination account.  IBAN seems to be the only account number format that is anywhere close to a worldwide standard.  If the destination account does not have an IBAN number (like those in Canada and USA), then you rely on a degree of wisdom on the part of the sending bank(er) to format your numbers (account/institution/transit/etc) in such a way that the transfer successfully reaches the destination account. If any given sending bank has not sent funds to another given non-IBAN bank recently, then there is an element of uncertainty as to how the destination account's numbers have to be entered into the sending bank's system.  The de facto practice seems to be to develop the wisdom of what works and what doesn't by attempting to transfer small sums until they succeed.  Then the sending bank uses the exact same method to transfer the large sum as they used for the small sum that succeeded. It seems like there are some things you can do pro-actively increase your odds that a wire transfer to a non-IBAN account will succeed.  Ultimately you want to provide four different pieces of information that are especially important for non-IBAN wire transfers: All of your numbers in all applicable compositions - Wire transfer number formats are often actually multiple fundamental numbers that are concatenated, prefixed, and suffixed.  I suspect that some wire transfer senders actually need to enter the fundamental numbers separately or in different compositions.  Suppose the sending bank needs, for example, the institution identifer.  The ABA routing number does contain, among other things, the institution identifier.  However, you should provide the institution number separately in your wire transfer instructions because the sending bank might need the institution number and will probably have no idea how to extract it from the ABA routing number. For Canada, I think the number you should provide are as follows: Generally, anyone can. Selling them is an interesting point, as the buyer has a counterparty risk that you won't be able to pay at the term of the contract. So, if I was a vendor buying a derivative in my example, I would definitely get that derivative from a bank as opposed to my friend Jim Bob. Especially in cases of bespoke derivatives, it doesn't make sense for anyone except people who have material interest to by it, as the expectation value of the hedge is negative. Essentially, you're more likely to lose money than gain money from a hedge. The exception is when you have information above that of the market, which could allow for a positive return. That is the reason that people advocate for derivatives as mechanisms of price discovery, because large imbalances aren't likely to form when someone could arbitrage or even just take positions when the market goes out of whack. That only really works in publically traded markets, however, bespoke derivatives don't really contribute to better pricing afaik.  Of course, that's the simple explanation to a huge, complex, and varied field. Certainly, speculators exist, particularly in the more commoditized derivatives. Especially in the leadup to the financial crisis, large amounts were spent on exotic derivatives that blew up in people's faces. The easiest thing to say about them is that they are double edged swords. In theory, they're fantastic, as it allows risk to be spread around to people that want it. It should lead to a safer system, as hedged comapnies are less exposed to shocks and are more resilient. But in practice, we've alao seen them used as risk concentrators (AIG). We've seen cases where correlations arise that weren't assumed before, and what used to be manageable positions become lead weights. We've seen the dangers that large systemically important financial institutions have when they are a counterparty to tens of trillions in notional derivatives, as when they fail the risk of failure is over every derivative they are counterparty to, not just the hedged exposure.   Sorry, this is more than you asked for. I tend to get carried away. Everyone understands the necessity of those bailouts today. But I still contest that they were a net negative for the common man and a HUUUUUUUUUGE positive for the bank executives. In fact, the fallout from it - the conceptualisation of TBTF and GSIB etc - is basically a blank check for these banks. Oh yes, so many stringent regulations that we know for a fact that these banks will flout at the first opportunity available to them. And then, assuming it doesn't bring the global economy to its knees, someone will slap a billion dollar fine on them and let them go on their merry way. &gt; I'd be interested in seeing a little more on the regulatory aspects of derivative contracts.  The most relevant regulatory push is with Dodd Frank in how it regulates swaps.  There are a myriad of rules around swaps of all kinds due to DF, whether they be interest rate swaps, fx swaps, commodity swaps, etc.  In a nutshell, DF requires certain reporting and transparency requirements for swaps (not to be confused with futures contracts, which are heavily regulated as well).  At some point most swaps that can be done on a cleared basis will have to be done on a cleared basis (versus bilateral swaps, which is simply one counterparty entering into a swap agreement with another counterparty, meaning each c/p is exposed to the other's credit worthiness).   DF is a long, boring read, but that is what is most relevant if you want to understand how swaps are being regulated and will be regulated going forward. "This is the best tl;dr I could make, [original](http://www.imf.org/en/Publications/WP/Issues/2017/09/29/Interconnectedness-of-Global-Systemically-Important-Banks-and-Insurers-45223) reduced by 58%. (I'm a bot) ***** &gt; Interconnectedness among global systemically important banks and global systemically important insurers has important financial stability implications.  &gt; This paper examines connectedness among United States, European and Asian GSIBs and GSIIs, using publicly-available daily equity returns and intra-day volatility data from October 2007 to August 2016.  &gt; Lastly, the paper demonstrates significant influence of economic policy uncertainty and U.S. long-term interest rates on total connectedness among systemically important institutions, and the important role of bank profitability and asset quality in driving bank-specific return connectedness.   ***** [**Extended Summary**](http://np.reddit.com/r/autotldr/comments/73blof/imfinterconnectedness_of_global/) | [FAQ](http://np.reddit.com/r/autotldr/comments/31b9fm/faq_autotldr_bot/ ""Version 1.65, ~219245 tl;drs so far."") | [Feedback](http://np.reddit.com/message/compose?to=%23autotldr ""PM's and comments are monitored, constructive feedback is welcome."") | *Top* *keywords*: **connectedness**^#1 **important**^#2 **among**^#3 **paper**^#4 **GSIBs**^#5" "There are few cases where trades were reverted because of a ""technical issues"", for example: When BATS did its IPO its price went down to a few penny due to a computer glitch, because of that the regulators allowed the trades to be reversed as if nothing happened. I think that some trades during the flash crash of the 6 May 2010 were reversed too. However, if the act is clearly fraudulent, they can try to sue the responsible. If a tribunal were to condemn him to reimburse them and that he has enough money to pay for it, they could get their money back. But think of Madoff, the people that invested with Madoff didn't have their investment reversed as Madoff didn't have the money to pay them back. The sames goes with most of criminal, crooks and even rogues traders. Finally, before thinking of reverting anything, there are laws about financial firms to make them implements proper checks to avoid that kind of fraudulent activities as they are responsible for most of the operational risk, especially when it could impact both the firm and their clients. And if the firm doesn't comply with those laws, they are unlikely to get the tribunal on their side if a problem arise."