The Risk Management Institute of the National University of Singapore and the Global Credit Review
Dr. David M. Rowe writes, Credit Markets: Retrospect and Prospect:
How could such a facility become a standard feature of the markets for complex financial products? As Adam Smith would have said, we will not accomplish this by appealing to “the benevolence of the butcher, the brewer” or the investment banking executive. The dramatic improvement in transparency that technology now makes possible will only be fully realized and effectively maintained through appeals to self-interest. In addition to regulatory pressure, establishing such a system will require several things. First it will require a well heeled insurgent organization with little or no stake in the current market arrangements to underwrite the technical development of such a system.
The Credit Research Initiative developed by Risk Management Institute at NUS in 2009 is providing such a facility in the domain of corporate credit risk. More specifically, through an easy-to-use web portal, the PDs for nearly 50,000 firms are available for users who can give evidence of their professional qualifications to ensure that they will not misuse the data. General users without global access are restricted to a list of 2,200 firms. Full transparency is obtained by documenting the methodology and operational implementation in a tech- nical report that is accessible to all users.
Second it will require participation commitments from a core group of buy-side firms that would stand to benefit from the greater transparency, lower risk and sharper pricing that such a system would create. Finally, it will require commitment from some aspir- ing second-tier sell-side firms that would stand to benefit from a first mover advantage by being an early participant in such a transformative arrangement and the big increases in trading volume it would create.
Essential to the success of such an arrangement will be establishing sufficient trading volume and associ- ated liquidity to assure investors that they can transact in reasonable volume without significant impact on prevailing prices. Marketcore,8 an intellectual property company, has designed a patented business method to achieve this goal. It is centered on provision of time- limited transaction credits to liquidity providers. These
credits provide either discounts on future trades or privileged access to the uniquely valuable detailed data such a system makes available. In essence, the busi- ness method leverages the most valuable commodity such a system creates, namely the consistently organ- ized detailed data on the complex securities being traded, to solve the key challenge that any new trading system faces, namely building reliable liquidity.
The stars are well aligned to support such a devel- opment. One indication of this is that the first such transformation is actually in initial operation. LexisNexis has collaborated with the Council of Insurance Agents and Brokers (CIAB) and Marketcore to create the LexisNexis Insurance Exchange.9 It is initially focused on property and casualty policies but it has plans to expand into life and health as well as reinsurance. Since a similar mechanism would be equally applicable to various heterogeneous credit and derivative instruments, this might just be the begin- ning of a much broader market transformation.
If this transformation materializes, it will result in more robust and resilient credit markets. Such a structure would allow a wide variety of analysts to track and evaluate these securities based on reliable empirical data rather than on marketing hype or on complex top-down analytic techniques that are largely out of touch with the actual underlying collateral. In the end, such a structure would provide many oppor- tunities even for those sell-side firms that will resist it the most. A more transparent market built on access to reliable and up-to-date detailed data will generate demand for new and innovative hedging instruments that these firms are so well equipped to provide. Given the broad social benefits that flow from more efficient allocation of savings into real investments with the best return, we all should work to realize this vision.