Biggest Trade No One Remembers: '09-13 Libor swap OIS discounting + CSA
Any of the old sellside/buyside rates heads remember an article by businessweek / HFR / pension&liab / etc that detailed how Goldman was one of the first to recognized changing to OIS discounting creates a large NPV delta on "netted" LIBOR swaps and parlayed that into the biggest "trade" no one outside the industry knows about? One of my old directs that was head of a competing bulge USD swap desk at that time told me they netted around 9 yards over those 4 years along with the beneficial to sell-side CSA margin changes in 2013.
The article probably mentions/alludes to Dalinc Ariburnu or Kostas Pantazopoulos. I vaguely remember they got a lot of quotes from anonymous workers because everyone didn't want to go on record.
I found this one if anyone the has a risk.net article if anyone can be kind of enough to share the full article since I haven't had a risk sub in 4 years. I remember reading that one and knowing their "hundreds of millions" in profit was way off. If they profited 108 mil euros just off BNP , my old boss' 9bn number is probably right.
I would love to be edged by Goldman
lol
Found the PDF here for anyone else interested: OIS_gold_rush/Goldman and the OIS gold rush.pdf at 97b8eb88856db801bd956b080948fd2b65dff31a · danullm/OIS_gold_rush · GitHub
Love your work
May be over my head but what would be a real world example of how this event would go down? Having trouble understanding. They changed the discount rate and the PV is higher but how did they make all that money off it? Was it basically everyone else was discounting at a higher rate and Goldman was first to figure out they should use the lower rate or whatever?
The article macrojunkie linked on github gives the exact details of how it went down on trillions notional of all outstanding OTC interest rate swaps.
I won't touch on the multi-currency CSA margin point for simplicity. You are correct, changing the discount rate to OIS (lower rate) from LIBOR (higher rate) makes the PV higher if you're in-the-money (lower if you're otm). Before GFC swap books were a rats nest / spider web of stale offsetting swaps and some non-offsetting. It cost money and time to "collapse" the swaps and exchange real cash for the NPV calculation leading to the rats nest.
If you recognized this early (GS was building systems to value swaps at OIS starting in '05) you first orient your swap book to minimize the cost to you. For example, you have an old 10yf20y vanilla USD interest rate swap on your books for 3 years its now a 7yf20y swap and you're -$10million valued at libor and -$15mil valued at OIS discounting. If you know OIS discounting is coming, you have a couple options. You try and exit the swap with the counterparty for $10mil because they don't know it should be $15mil. If they say no, then you offer it to BNP for $11 mil and make up a plausible reason why. To the BNP trader looks like he'll immediately make $1 million with the cost of exchanging real cash in the future and dealing with that counterparty.
Since the NPV's difference is largest when OIS-LIBOR basis is widest, you try and close out +NPV packages and wait to close -NPV packages.
On top of that, if the NPVs are wrong then the margin collateral is wrong. You figure out which way your book is margin wise and hire a team of 11 lawyers combing through each margin agreement with every counterparty and make the counterparties that owe you more post more. At the same time, you don't have to post more collateral at the same rate, effectively increasing your war chest for prop trades. From the article "the bank received cash collateral of $137 billion that year, a 132% increase on the $59 billion received in 2007. Meanwhile, the amount of cash collateral posted in 2008 was $34 billion, only a 22% increase on the $27 billion posted in 2007"
Then you go out into the market and say you'll take over (novate) as counterparty on +NPV swap packages. If its worth $50mil LIBOR discounting you bid/negotiate whatever number makes sense. Do this for 2 years straight.
Then you wait for the person on the other side of the swap (usually a slow insurer/real money/company/hf) to exchange the NPVs of their swaps to clean up their books. They say they only owe $100 mil but you say its $110 mil and you have the legal receipts of counterparty's ISDA / CSA agreement in your favor - ie they're SOL.
Hope that makes sense. The article is really great you should read it if you're curious.
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