On the anniversary of Lehman’s collapse, a stunning trader default in Norway rattles nerves

Are clearing houses too big to fail?
Are clearing houses too big to fail?
Image: Reuters/Lucas Jackson
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A wrong-way bet by one of Norway’s most successful traders has caused a stunning default, ripping through safeguards at the exchange where he was trading. The episode, coming just days before the 10-year anniversary of the collapse of Lehman Brothers, shines a light on the post-crisis infrastructure that’s meant to prevent defaults from spinning out of control.

Einar Aas was unable meet the margin requirements on Nasdaq’s markets for trading power contracts this week. He was betting on German and Nordic power derivatives, a position that was hit by the “extraordinary fluctuation” in the spread between the contracts, Nasdaq said. The default forced commodities companies who are part of Nasdaq’s clearing house, as well as the exchange itself, to close a €114 million ($133 million) hole in contingency funds.

Aas’s default underscores the importance of clearing houses, which act as an intermediary between traders and take collateral to offset risks. One of the lessons of the Lehman-linked crisis was that the interconnected derivatives holdings between banks and big insurance companies were too complex to manage and oversee. It was feared that a default (paywall) by one major institution would cause a chain reaction, taking other vital financial companies with it.

Clearing houses are intended to solve that. They seek to balance the risks between counterparties while also making traders’ positions more transparent. Financial regulators have sought to drive trillions of dollars of derivatives (used to hedge or bet on everything from energy to changes in interest rates) into these institutions to help manage the risks.

Clearing houses are now pillars of the post-crisis system; the downside is that they also concentrate an immense amount of risk, making them truly too big to fail.

Following Aas’s default, Nasdaq’s clearing house’s €7 million default fund was consumed, and the insolvency also cut through €107 million of its €166 million mutual default fund that clearing house members are required to contribute to. Aas, who may have to file for bankruptcy and was barred from the exchange, will lose the €36 million he provided as additional margin, according to the Financial Times (paywall). The 47-year-old had reportedly been buying and selling in the Norwegian market on his own account since 2005.

“This is exactly the kind of event that the fund, and a clearing house, is designed to handle,” a Nasdaq spokesman said.

The incident is far from the systemic panic the world faced a decade ago. However, the notion that a single trader could wipe out so much of a clearing house’s protective funds is sure to get the attention of government watchdogs. The timing is also an eerie reminder of the risks that are still embedded in the financial system.