ALAMEDA, Calif. — Every firm in California’s bond underwriting pool will be required to file quarterly reports on its municipal credit default swap activities, Treasurer Bill Lockyer announced Friday, while also urging the imposition of federal and international rules to limit “naked trading” of municipal CDS.
Lockyer Friday released responses from six Wall Street investment banks to follow-up questions the treasurer’s office asked them after an earlier exchange of questions and answers about the municipal CDS market.
Even though two of the banks reported making proprietary trades betting against California credit, the treasurer reiterated his initial conclusion from March, that CDS trading on California bonds is not significant enough to cause concern at this time, and that banks have not bet against the credit quality of California general obligation bonds “to any meaningful extent.”
The six banks queried were JPMorgan, Barclays, Citi, Goldman, Sachs & Co., Bank of America Merrill Lynch, and Morgan Stanley.
Citi reported two proprietary trades on bonds with a $10 million face value, actually buying protection on $5 million in November 2009, and selling protection on $5 million in February to close out the first trade. The trades were conducted outside the purview of Citi’s municipal securities division, Howard Marsh, the division’s head, wrote in his letter to Lockyer.
Goldman Sachs reported four trades, with a $35 million face value, by a municipal proprietary trading desk that closed in 2009.
Lockyer also reiterated his earlier conclusion that the naked trading of CDS that are not tied to an underlying bond position has the potential to harm California taxpayers.
“Unchecked speculation opens the door to market manipulation that could artificially inflate perceived credit risk and increase taxpayers’ borrowing costs on bonds,” he said in a news release Friday. “Reducing leverage opportunities will make it harder for speculators to game the system and hurt taxpayers.”
Lockyer wants Congress to include a ban on naked municipal CDS trades in financial regulatory reform legislation. Absent that, he said Friday, he favors reducing leverage through “effective and enforceable capital requirements.”
In their most recent responses, all six banks said they were unable to provide information about the extent to which their market-making activities facilitated trades of naked California CDS.
“A participant in a financial markets transaction, be it a derivative transaction or a transition in cash assets such as bonds or equity securities, does not typically disclose to its counterparty why it is participating in that transaction,” Jes Staley, JPMorgan investment bank chief executive, wrote in his May 26 response to Lockyer. “Confidentiality of investment decision-making contributes significantly to the efficient operation of financial markets.”
Lockyer sent his initial round of questions on municipal CDS to the six banks in late March, and posted those responses in April.
Every bank in the state’s bond underwriting pool, which currently numbers 86, will have to file quarterly reports on its municipal CDS activity starting in 2011, Lockyer said.