Nov. 10, 2022
November 10, 2022 Dear SEC: Common cause failure. One thing fails and the whole system fails - this is the biggest risk to our markets. When everything is linked - everything is at risk. Derivative markets can link things that would otherwise be disconnected. Bundling through ETFs and other vehicles links things that would otherwise be disconnected. Swaps can link things that are otherwise disconnected. The risk here is that one company fails that these entangling links can drag down sectors or even the economy. During 2008 we are told that sub-prime loans were blended with good loans as a version of 'dilution is the solution to pollution'. Get the bad stuff off your books by blending the dross in with the good stuff. Whether intended or not the consequence of those actions was to link things that should have not been linked creating system wide risk. Forcing full and regular disclosure will ensure that the network of connections is at least visible and players such as Archegos (and now maybe Credit Suisse) cannot continue to overleverage and threaten the system. Should these contracts all be valued accurately and regularly - therefore subjecting all parties to regular scrutiny of their capital reserves and leverage? Of course they should. Take for example Bullet Swaps. Inherent in the bullet swap is a two year grace period (for most contracts) where no 'truth' of the real value of the swap needs to be recorded. Everything happens at the end of the contract. This causes double problems. First - your contact looks good and any losses will not reflect in your capital requirements until the contracts are closed. In other words you can leverage up for two years before being held to account. Your apparent leverage and your actual leverage can be vastly different. And excess leverage creates risk. The second risk is if the bullet swap goes backwards (e.g. a short bullet contract where the security went the other way). Now you had hidden, unlimited downsize risk for two years. What do most gamblers do when their bet is going wrong? Double down. The moral hazard of hidden positions is clear. More leverage equals more profit (if it all goes well). More opacity equals more time (to fix things if they are not going well). More hidden positions create system-wide risk and put Main Street on the chopping block. I support your proposal. It's a start.