Friday 6th May 2016
NEWS TICKER: Moody's says it has downgraded the ratings of Exeltium SAS's €1,000m 15 year floating rate bank term loan (Facility A), €155m 15 year floating rate institutional term loan (Facility B1) and €280m 15 year fixed rate institutional term loan (Facility B2), together, the senior debt, to Baa3, from Baa2. The senior debt matures in June 2030. Moody's has also downgraded the rating of Exeltium's €153m subordinated bonds, the junior bonds, maturing in December 2031 to B3, from Ba3. The outlook on the ratings is stable. The downgrade of the senior debt ratings reflects, says Moody’s, wholesale electricity market price falls in France, resulting in a material risk that Exeltium's customers will opt out of electricity purchases from 2020 to 2024 and a fall in the weighted average credit quality of clients to Baa3, from Baa2 and iii) the weakened credit quality of the put counterparty, a large French industrial rated Ba2 negative that is obliged to purchase 51% of volumes subject to Client opt-out (the Put Option). Moody's has also revised its French wholesale electricity price assumptions downwards, reflecting the current price environment and Moody's assumption that lower prices will be sustained. The industrial logic of the project is significantly weakened in a low electricity price environment. In Moody's revised base case, the rating agency assumes that clients would opt-out of electricity purchases between 2020 and 2024. Over this period, Moody's assumes that just over half of Exeltium's electricity would be sold under the Put Option, with the remainder sold at market rates. - CORPORATE REPORTING - Lufthansa Group says is maintaining its full-year earnings forecast for an adjusted EBIT which is “slightly above” the previous year’s €1.8b, after reducing its operating losses for the first quarter, having introduced substantial cost cuts and despite a decline in revenues. The firm’s adjusted EBIT loss for the three months to the end of March fell by more than two-thirds to €53m ($61m). Revenues fell slightly to €6.9bn because of pricing pressures in the group’s passenger airlines, says chief financial officer Simone Menne. Lufthansa’s passenger airline division improved its adjusted EBIT by €244m and that for Austrian Airlines was up by €23m. However, currency effects, however, dragged on the result at Swiss International Air Lines, where adjusted earnings fell by €28m. However, the firm issued a health warning that its forecast does not take into account any negative effects of possible strike actions and that it does not expect that pricing pressures will ease any time soon. Lufthansa Group turned in a net loss of €8m, compared with a €425m profit last year, but stresses that this included a large benefit from transactions relating to US carrier JetBlue Airways. Taking this into account, it says, the first quarter net result equates to an improvement of €70m. - SOVEREIGN DEBT - THE UK’s DMO says the auction of £2.5bn of 1.5% treasury gilt 2026 says bids worth £4.473bn were received for the offer of which £2.125bn was sold to competitive bidders and £374m sold to gilt edged market makers (GEMMs). An additional amount of the Stock totalling up to £375.000 million will be made available to successful bidders for purchase at the non-competitive allotment price, in accordance with the terms of the information memorandum. Higher priced bids came in at £98.566, providing a yield of 1.653% and the lowest accepts was £98.526, providing a yield of £1/656% - CYBER SECURITY - Global Cyber Alliance, an organisation founded by the New York County District Attorney's Office, the City of London Police and the Center for Internet Security, say they will collaborate with M3AAWG to push the security community to more quickly adopt concrete, quantifiable practices that can reduce online threats. The non-profit GCA has joined the Messaging, Malware and Mobile Anti-Abuse Working Group, which develops anti-abuse best practices based on the proven experience of its members, and M3AAWG has become a GCA partner for the technology sector – ASSET MANAGEMENT JOBS - IFM Investors today announced the appointment of Rich Randall as Global Head of Debt Investments. Mr. Randall takes on this senior leadership role from his prior position as Executive Director of Debt Investments, which he had held since joining IFM Investors in 2013. Randall replaces Robin Miller, who will semi-retire from IFM Investors after a 17-year association with the company. Miller will remain with IFM Investors and will transition to the role of Senior Advisor and Chair of Investment Committee within the organisation. In his new role, Randall will manage IFM Investors’ global debt investment teams and maintain the organization’s global debt investment process and relationships with investors. He will also oversee the sourcing of infrastructure debt opportunities internationally. He will continue to be based in IFM Investors’ New York offices and will report directly to CEO Brett Himbury – ACQUISITIONS - Intercontinental Exchange says it has backed off from its counterbid for the London Stock Exchange. In a statement issued by ICE, chief executive Jeffrey Sprecher says LSEG did not provide enough information to make an informed decision on the value of the merger. "Following due diligence on the information made available, ICE determined that there was insufficient engagement to confirm the potential market and shareholder benefits of a strategic combination. Therefore, ICE has confirmed that it has no current intention to make an offer for LSEG – POLITICAL RISK – Global risk analysts Red24 reports that political parties, including the National Movement for the Organisation of the Country (MONOP) and the Fanmi Lavalas party, held a series of demonstrations in Port-au-Prince, yesterday. The action was launched to show support for the Commission to Evaluate Haiti Elections (CIEVE), a body established to verify the 2015 elections. The latest call to action came amid heightened tensions between the aforementioned political parties and former president Michel Martelly's Parti Haitien Tet Kale (PHTK), which launched general strikes against CIEVE on 2 May. Further opposition party-led demonstrations are expected to continue in the near-term due to the indefinite postponement of the country's 24 April run-off election and issues surrounding the evaluation of the 2015 elections – INDEX TRADING – Investors have not yet leant into the wind as a ruff of mixed data discombobulated markets yet again, with a lacklustre Asian trading session. More pertinently perhaps, investor sentiment is hanging in advance of tomorrow’s US labour market report. Peter O’Flanagan ClearTreasury reports that uncertainty around Brexit has impacted business sentiment in the UK and “if we are seeing this filter through into Q2 data there may well be additional downside for UK data until we have a referendum result. That may not be an end to the uncertainty as the “Out” campaign appears to be gathering some momentum. Depending on what poll you look at, it would appear the “uncertain” portion of the polls is narrowing, and while the position is currently still far too close to call by looking at the polls, bookies are still favouring the ‘In’ campaign with a 75% probability of remaining”. In the Asian trading session meantime, Japanese stock indexes fell to three week lows, and in line with sentiment this year, the yen has touched yet another 18-month high against the dollar, no doubt testing the resolve of the central bank not to act, despite stating that the yen is way over-priced. The Nikkei225 was down 3.11% today. The Hang Seng ended down 0.37%, while the Shanghai Composite rose marginally by 0.23%. The ASX All Ordinaries ended 0.17% higher, though the Kospi fell 0.49% and the FTSE Bursa Malaysia dropped 0.75%. The Straits Times Index (STI) ended 0.53 points or 0.02% lower to 2772.54, taking the year-to-date performance to -3.82%. The top active stocks today were SingTel, which gained 0.53%, DBS, which declined 2.22%, OCBC Bank, which declined 1.06%, UOB, which declined 1.04% and Wilmar Intl, with a 0.57% advance. The FTSE ST Mid Cap Index declined 0.27%, while the FTSE ST Small Cap Index rose 0.01%. OIL PRICES RISE - The story today was oil as prices climbed in the Asian session, with the Brent crude price breaking through $45; wildfires in Canada were behind the rise. Wildfires look to be burning out of control in the Alberta oil sands region of Canada, which mines and ships heavy crude to the US. Oil companies there have reduced operations as non-essential employees are evacuated. Moreover, US oil output fell last week by more than 100,000 barrels a day to 8.83m, its lowest level since September 2014, though inventories continue to rise. US benchmark West Texas Intermediate for delivery next month was up $1.19, or 2.7%, at $44.97 while Brent prices for July supply rose 94 cents to $45.56. The price of oil has rallied recently because of the 400,000 bpd cut in US oil output (IEA data), US dollar weakness and Asian demand optimism. The next OPEC meeting scheduled for June 2nd will likely be another watershed, as all recent meetings have been. One beneficiary of the recent rally in oil prices is Russia, where the ruble has appreciated 14% against the US dollar this year. As well, investor sentiment towards Russia risk is highly influenced by the oil price. Year-to-date the dollar-denominated Russia RDX equity index is up 25%, and that compares with a gain of 6% for the MSCI EM Index and 1% for the S&P 500 Index reports Chris Weafer at macro-advisory.com. Weafer says the current oil price also makes the removal of financial sector sanctions less urgent for 2016 and eases both short-term geo-political and economic pressure on the Kremlin and reduces social stability concerns. “Oil should rise by [the end of the decade] but be less important by mid-next decade. Medium-term, an oil price rally to over US$100 per barrel is perfectly feasible due to the combination of steadily rising Asia demand (in particular) and the lack of investment by the oil majors since late 2014. Longer-term, the age of oil, or the importance of oil, may already be over or significantly in decline. The strong growth in alternative energy and the commitments made as part of the Paris Agreement make that a very high probability”. Gold is still seen under pressure this morning, say Swissquote’s Michael van Dulkin and Augustin Eden in their morning note today, which they attribute as usual to “pre Non-Farms trading (or lack thereof). We’re of the opinion, however, that employment is OK in terms of the US economic picture such that while there will be short term volatility around it, there’s little point giving this print much attention. Better to concentrate on US inflation data which, if it starts rising, could boost Gold (an inflation hedge) much more efficiently. There is, after all, a fair amount of concern that current easy US monetary policy could lead to inflation overshooting the 2% target when it does finally pick up.” In focus today, UK Services PMI (flat).

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The Knotty Question of Regulation

Tuesday, 01 July 2008
The Knotty Question of Regulation First came the collapse of its hedge funds; then the mammoth losses tied to mortgage-portfolio write downs. In March, dark clouds circling over Bear Stearns’ Manhattan headquarters suddenly collapsed into a vortex that reduced the former investment giant to a near-worthless pile of debris. Were it not for the sudden resourcefulness of the New York Federal Reserve, things may have turned out even worse. Now a chorus of finger-pointing regulators insist that investment banks be held accountable--before another Bear is let loose. From Boston, Dave Simons reports. http://www.ftseglobalmarkets.com/
First came the collapse of its hedge funds; then the mammoth losses tied to mortgage-portfolio write downs. In March, dark clouds circling over Bear Stearns’ Manhattan headquarters suddenly collapsed into a vortex that reduced the former investment giant to a near-worthless pile of debris. Were it not for the sudden resourcefulness of the New York Federal Reserve, things may have turned out even worse. Now a chorus of finger-pointing regulators insist that investment banks be held accountable--before another Bear is let loose. From Boston, Dave Simons reports.
On the weekend of March 14th , the New York Federal Reserve gave its blessing (in the form of a $30bn no-risk financing agreement) to JP Morgan Chase & Co to acquire the remains of the 84-year-old Bear Stearns for a mere $2 per share, later sweetened to $10. The takeover bid was officially approved by shareholders in late May. Speaking shortly after the crisis was resolved, US Treasury Secretary Henry Paulson noted that the Bear Stearns episode “raises significant policy considerations that need to be addressed.” The collapse, said Paulson at the time, underscores the rapidly changing role of non-bank financial institutions as well as the interconnectedness among all financial establishments. These changes “require us all to think more broadly about the regulatory and supervisory framework that is consistent with the promotion and maintenance of financial stability,” he added.

Just as last summer’s illiquidity-fueled downdraft prompted calls for universal limits on leveraging, the Bear Stearns experience has critics taking aim at current regulatory standards. These they argue are in need of a substantial overhaul. An important question arising from this development is: how best to carry out these measures? Another is: if those measure are a good idea, why have they not been addressed sooner?



US Federal Reserve Bank chairman Ben Bernanke vigorously defends the Bear bailout, noting that “recent events have demonstrated the importance of generous capital cushions for protecting against adverse conditions in financial and credit markets”. Detractors offer a much less sanguine assessment. One notable hand-wringer is former St. Louis Fed president William Poole, who thinks that, “It is appalling where we are right now … we’ve become a backstop [sic] for the entire financial system.”

Indeed, by all accounts the Fed checkbook may be in for more plundering in the coming weeks and months. In May, Congress put in an emergency call, imploring the Fed to swap Treasury notes for bonds backed by student loans. And with the peak of the credit crisis still months (or perhaps even years off according to some experts) the Fed may have to contend with many more foundering companies arriving in the dead of night, cap in hand. Was the Fed correct in intervening on Bear’s behalf? John Halsey, a former senior managing director at Bear Stearns, says that, given the circumstances, the Fed had to take action. Had Bear failed, says Halsey, “Our financial system would have failed as well. The dollar, already weakened, would have plummeted, and it would have hastened the inevitability of the dollar’s demise as the world’s reserve currency. Stocks would have dropped, markets would have crashed and stopped trading. In effect, Bear shareholders were sacrificed for the good of the system. That said, I do not think it will have much effect on decision making or risk taking.”

The Fed’s willingness to get behind one near disaster after another fails to address some key underlying issues: namely lack of transparency, as well as the enormous complexity of modern financial products, that has rendered normal pricing metrics obsolete. JPMorgan’s valuation gyration over Bear Stearns’ share price is the latest evidence that all is not right. “Free markets can only function in a system where a company’s creditworthiness can be assessed independent of a letter grade supplied by a rating agency,” remarks Jacki Zehner, founding partner of Circle Financial Group, a New York-based private wealth management operation. In reality, says Zehner, this is simply no longer the case. “Before one can declare that this financial crisis is over, the markets have to be able to make this kind of assessment. Unfortunately, we are not there yet.”

Though the Fed may have had little choice but to step in on Bear’s behalf given the magnitude of the counterparty risk, other companies in a similar predicament but with a slower bleed rate may not be as fortunate. Says Erik Sirri, director of the Securities and Exchange Commission’s (SEC’s) trading and markets division, “I think when one of these firms gets into trouble rapidly, liquidity support is needed.” Should that unraveling occur more slowly, however, “that liquidity support may not be needed.”

“Others will fail, though it is not clear what will happen when they do,” says Zehner. “I believe the Fed can and will prevent any sort of systemic collapse which they may have witnessed had they not come to the rescue of Bear. But there will be more problems. Exactly how and where is a difficult bet indeed.”

In the aftermath of Bear, slower client activity, below-normal principal and proprietary trading results and losses from the tightening of structured credit liabilities are just a few of the factors weighing on the investment-banking industry, notes analyst William F Tanona in a recent research paper. Some have been more generous than others. In contrast to Oppenheimer & Co. analyst Meredith Whitney’s assessment of Citigroup’s “antiquated and disparate systems and technology,” Ladenburg Thalmann’s financial institutions analyst Richard Bove sees a much brighter future for the bank. Bove notes that Citi’s turnaround potential is “so significant, it could carry the stock to multiples of its current price.”

While the longer-term picture may be positive--particularly given the prospect of further Fed interventions nonetheless, US banks are in all likelihood looking at a prolonged period of belt tightening and super-scrutiny. “It is truly amazing to see how slow analysts have been in bringing down earnings estimates for the investment banks,” says Halsey. “Of course, at some point soon the bulls will probably be able to point to some very favourable year-over-year comparisons. But the fact remains that the entire sector is going to have to learn to live with much less leverage--and that many of their biggest earning sectors will never recover.”

Is reform needed?

It was the late economist Hyman Minsky who suggested over 20 years ago that “in a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators.” While it may be impossible to prevent changes in the structure of portfolios from occurring, said Minsky, “if the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy.”

Speaking at a conference held in Minsky’s honour, Paul McCulley, managing director of fixed-income specialist PIMCO, said that recent events demonstrate how little attention has been paid to Minsky’s words over the last two decades. While initiatives such as Basel I and most recently Basel II may be a step in the right direction, “neither of those arrangements fundamentally addresses the explosive growth of the shadow banking system,” thinks McCulley, referencing the radically leveraged, off-balance sheet vehicles that were so successful in helping institutions sidestep imposed limitations.

To make matters worse, regulators have consistently turned a blind eye to the goings-on within the investment-banking sector, even as the crisis in liquidity was growing more palpable. Their inaction prior to last summer’s meltdown left the banking system vulnerable to the catastrophic run on liquidity that set the stage for innumerable hedge-fund collapses, and ultimately the fall of Bear Stearns, say observers.

In an effort to deflect further criticism, the SEC has wasted little time getting on the case, and has already made clear its intentions to increase the transparency of liquidity and capital positions held by the likes of Morgan Stanley, Lehman Brothers and Merrill Lynch through its consolidated supervised entities (CSE) program. SEC chairman Christopher Cox said the commission wants the changes to take affect prior to the implementation of the new internationally accepted standards for capital and liquidity as set forth in Basel II. Cox has admitted that insufficient regulatory standards in all likelihood helped foster the conditions that led to the Bear crisis. “It’s difficult for anyone to say the system worked or that the regulatory gap that exists in statute lacks any consequence,” said Cox.

Halsey, however, calls the commission’s sudden interest “laughable.” “Where were they when these problems were developing?” he asks. As it relates to the current real estate crisis, “the SEC, banking regulators and especially the Fed were absolutely facilitators to the mess. Alan Greenspan’s legacy has been destroyed.”

To begin to remedy the situation, all institutions that are given access to the Fed’s discount window “must at the same time have pari passu regulatory oversight,” argues McCulley. While banks will undoubtedly balk at such an arrangement, they may have little choice but to play ball. After all, offers McCulley, “if you have access to the Fed’s discount window, the Fed should (and will, I strongly believe) have the power to supervise and regulate your business.” Such increased oversight could take the form of raising core capital requirements, while increasing risk and liquidity management, he adds.

Although regulators appear anxious to expand their legal authority over the investment banking sector, it’s up to lawmakers to ensure that it happens. Speaking before a Senate panel in May, former Clinton administration SEC chairman Arthur Levitt said that “Congress must face these conflicts of interest issues head on, or at least empower the SEC with the proper oversight and disciplinary powers that will enable them to do the job.” As for the near-term direction of the investment banking sector as a whole, Halsey believes that a fundamental shift has already occurred, one that favours the likes of JPMorgan over Goldman Sachs and Morgan Stanley. While product innovation will once again take place and attract new talent and capital, “it will take years for that to happen. In the meantime, the likes of CDOs, CDSs and all mortgage-related trading will deliver a fraction of the profits that stoked Wall Street for so long.” Accordingly, Halsey sees the prospect for a significant brain drain from the various institutions as return on capital founders. “Bright, hungry guys will continue to leave to pursue innovation and profits at hedge funds. That will hurt banks and investment banks alike.”

Can increased regulation be truly effective so long as institutions are allowed to stay one step ahead through the creation of the kind of product embellishments that helped precipitate the crisis in the first place? Absolutely not, says Halsey. Wall Street can afford to hire the best and the brightest and spend more on financial innovation than regulatory bodies can budget for, says Halsey, and as a result, no individual or group can effectively anticipate innovation. Hence, the need for broad, highly flexible guidelines that can compensate for these future product developments.

“As a young guy at Bear, I remember thinking how creative the people who structured collateralised mortgage obligations (CMOs) must have been to come up the concept of interest only strips (IOs) and principal only strips (POs),” recalls Halsey. “By the time they had become commonplace, we were already onto trading inverse floaters. It quickly became apparent that if you could imagine a cash flow of any kind--backed by any kind of credit; then you could create a bond that mimicked such a cash flow. In short, the possibilities of creating new products with unknowable risks when applied to the financial system are endless.”

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