Thursday 26th November 2015
NEWS TICKER, November 24th 2015: New research from the Consilium Strategic Land Fund suggests 19% of estate agents and property developers expect it to become ‘much easier’ to obtain planning permission to build residential homes over the next three years. 56% think it will become ‘slightly easier’ and only 6% believe it will become harder to obtain. Given the UK needs to build around 250,000 new homes a year to meet growing demand, 21% of those interviewed think the level of government incentives to encourage residential property building will increase dramatically over the next 10 years, and a further 70% think they will increase ‘slightly’. Given this, 82% of estate agents and property developers expect the number of homes built in 2020 will be higher than in 2014. When looking at the South East, which is the main focus of the Fund, the corresponding figure is 79% - On the basis of a final compliance notice from the institutions, the Eurogroup Working Group (EWG) agreed late on Friday that the Greek authorities have now completed the first set of milestones and the financial sector measures that are essential for a successful recapitalisation process. The agreement paves the way for the formal approval by the ESM Board of Directors today for disbursing the €2bn sub-tranche linked to the first set of milestones. It also makes subsequent case-by-case decisions by the ESM Board of Directors on the transfer to the HFSF of the funds needed for the recapitalisation of the Greek banking sector out of the €10bn earmarked for this purpose - The performance of the UK credit card asset-backed securities (ABS) market remained positive during the three months ended August 2015, according to the latest indices published by Moody's. Total delinquencies decreased slightly to 1.54% of the outstanding balance in August 2015 from 1.64% in May 2015 and 1.82% in August 2014. The charge-off rate also decreased to 2.65% in August 2015 from 2.83% in May 2015 and 2.79% a year earlier. The payment rate decreased to 17.47% in August 2015 from 18.56% in May 2015 and 21.72% in August 2014 - ETF Securities Group has listed 18 new 3x short and leveraged commodity ETPs and six new 5x short and leveraged currency ETPs on the LSE today. 2015 has seen increased volatility across currencies and commodities and investors globally have demonstrated an increased interest in short and leveraged ETPs, with ETF Securities own platform experiencing US$135mn of inflows year to date. ETF Securities was the first provider to list European currency ETPs in 2010 and is now the first provider to list 5x short and leveraged currency ETPs on the London Stock Exchange having already launched 3x short and leveraged commodity and 5x short and leveraged currency products in Italy and Germany earlier this year. “We are listing these new short and leveraged products on the London Stock Exchange in response to a strong demand from investors. We have seen tremendous growth in our short and leveraged platform across Europe over the last few years.” says Townsend Lansing, executive director – head of short / leveraged & fx platforms, ETF Securities (UK) Limited. “2015 has been a year of heightened currency volatility. We believe the additional leverage will first and foremost allow investors to use the currency products to hedge currency risk as well provide additional opportunities to trade on a short term basis with a competitive total cost of ownership.” - GoldenSourcea provider of Enterprise Data Management (EDM) and Master Data Management (MDM) solutions for the securities and investment management industry, says that Cattolica Assicurazioni has selected its Market Data Solution to efficiently deliver robust pricing and accelerate reporting capabilities for Solvency II. GoldenSource will provide Cattolica with a complete solution for constructing and disseminating fully audited data sets which validates and cleanses multiple sources, ensuring accuracy and timeliness in product control and reporting. After a rigorous evaluation process, GoldenSource was selected due to the completeness of the solution, ease of use and its rapid implementation capabilities - Yes Bank, one of several of India’s private banks, recently signed an agreement with the London Stock Exchange (LSE) regarding the listing of green bonds and equity instruments to raise funds for clean energy infrastructure. The bank has announced plans to list green bonds on LSE worth $500m by December 2016. Yes Bank issued the country’s first green bond in February this year in which it raised $150m. A second green bond issue, floated in partnership with the International Finance Corporation (IFC), raised almost $50m. The Indian Import-Export Bank also raised $500m through the first dollar-denominated green bonds issued in India, and is also expected to issue more bonds raising up to $1.5bn over the next two to five years – Was last week a turning point? The US Fed has given its clearest sign yet that it might raise rates in December, as it notes that inflation looks to be reappearing. However, with global growth continuing to slow, a rate rise is not without risks. After a torrid start to fall, Australian shares closed at their highest level in about a month as a brightening economic outlook buoyed consumer stocks and countered pressure from falling commodity prices. The S&P/ASX 200 rose 20.3 points, or 0.4%. Elsewhere, it a mixed, but not altogether a depressing picture. The Shanghai Composite Index closed down 0.6%, amid expectations that a four-month moratorium on public listings could lift soon, triggering investors to sell current holdings. Hong Kong's Hang Seng Index fell 0.4%. South Korea's Kospi rose 0.7%. Markets in Japan were closed for a holiday. The Straits Times Index (STI) ended 14.42 points or 0.49% lower to 2903.49, taking the year-to-date performance to -13.72%. The top active stocks today were DBS, which declined 0.71%, NOL, which gained4.46%, SingTel, which declined1.03%, OCBC Bank, which declined1.23% and UOB, with a 1.25% fall. The FTSE ST Mid Cap Index declined 0.13%, while the FTSE ST Small Cap Index declined 0.45%. Expectations of higher rates strengthened the dollar against most currencies in trading today with the euro falling to a seven-month low at $1.0599, no surprise when you couple the promise of a US rate rise with the ECB holding out for more easing. ECB President Mario Draghi said Friday that the bank stands ready to deploy its full range of stimulus measures to fight low inflation. A stronger dollar also pressured several commodities, which are priced in the currency. Earlier Monday, three-month aluminum prices on the London Metal Exchange fell to their lowest level since May 2009, to $1,438 a metric ton. The price later edged up to $1,441.50. Brent crude oil, the global benchmark, was down 1.8% at $43.84 a barrel. Prices of West Texas Intermediate fell 3.1% to $40.62 a barrel, after falling below $40 a barrel last week. Gold prices fell 0.5% at $1,070.60 a troy ounce - The European Council says it has extended the mandate of the European Union Special Representative (EUSR) for the South Caucasus and the crisis in Georgia until 28 February 2017. Herbert Salber was appointed in July last year. EUSRs promote the EU's policies and interests in troubled regions and countries and play an active role in efforts to consolidate peace, stability and the rule of law. The first EUSRs were appointed in 1996. Currently, nine EUSRs support the work the High Representative of the Union for Foreign Affairs and Security Policy, Federica Mogherini - Taiwan's Ministry of Economic Affairs (MOEA) approved 3,118 foreign direct investment projects (except from China) with a total value of $3.689bn in January-October 2015, respectively increasing 6.34% and decreasing 6.77% on year, according to MOEA statistics released on November 20th. In the same period, MOEA approved 378 outward direct investment projects (except in China) proposed by Taiwan-based companies or individuals with a total value of $9.4bn, respectively dropping 5.74% and growing 40.42% on year. Also in January-October, MOEA approved 135 investment projects proposed by China-based enterprises with a total value of $134.27m. On the other hand, there were 276 approved projects of direct investment in China proposed by Taiwan-based companies or individuals with a total amount of $8.723bn, slipping 17.61% and rising 11.43% respectively on year. Taiwan's Ministry of Economic Affairs (MOEA) approved 3,118 foreign direct investment projects (except from China) with a total value of $3.689bn in January-October 2015, respectively increasing 6.34% and decreasing 6.77% on year.

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Rehypothecation revisited Photograph © Sureshr/, supplied March 2013.

Rehypothecation revisited

Tuesday, 19 March 2013
Rehypothecation revisited Under the right circumstances, rehypothecation—leverage derived from the re-use of existing client collateral—can provide brokers with optimised borrowing opportunities, while giving lenders a reduction in transactional costs. If handled improperly, however, the process can easily go awry—and in a pretty big way. How do you ensure you get it right? US Editor, Dave Simons gives us his view.

Under the right circumstances, rehypothecation—leverage derived from the re-use of existing client collateral—can provide brokers with optimised borrowing opportunities, while giving lenders a reduction in transactional costs. If handled improperly, however, the process can easily go awry—and in a pretty big way. How do you ensure you get it right? US Editor, Dave Simons gives us his view.

Five years ago last month I sat down with Kevin Davis inside the Manhattan offices of ill-fated futures brokerage MF Global, as the soon-to-be ex-chief executive officer laid out his plans for the newly launched spin-off of Britain’s Man Group.

Describing the income MF Global’s team pulled in through clearing and execution regardless of which way the markets went, Davis concluded that “any news is good news—whether it’s good, or bad.” Just days later, one of Davis’s minions, Brent Dooley, who worked out of the firm’s Memphis office, went home and, in a single evening, racked up a $141m loss while recklessly trading wheat futures out of his own account, using the Chicago Mercantile Exchange’s (CME’s) order-entry system. By the time our inconveniently scheduled March cover story was out, MF Global’s shares were already off 70%; months later Davis was done, Dooley was on his way to court—and incredibly that was just the beginning.

Two years later the company, now under the direction of Jon Corzine, the former governor of New Jersey, began an estimated $6.3bn wager on the bonds of various indebted European nations as part of an aggressive campaign to restore shareholder value. Still in a weakened state following the Dooley affair, the company never­theless employed various hyper-leveraged strategies that by all accounts included the process known as rehypothecation—off balance-sheet leverage derived from the re-use of existing client collateral.

Totally legit (in the United States, brokerages are allowed to pledge up to 140% of client’s liabilities), rehypothecation nevertheless has its share of pitfalls, including the need for borrowers to post additional margin on a moment’s notice in order to mollify dubious creditors and regulators.

James MalgieriJames Malgieri, head of service delivery and regional management for BNY Mellon’s Global Collateral Services business.Though Corzine’s bet was right on the money—at maturity all of his eurobond picks paid in full—unfortunately he, nor anyone else at MF Global, would be around to claim victory. Kneecapped by a swift succession of credit downgrades and margin calls, MF Global collapsed in October 2011; unable to raise cash fast enough to stay afloat. Along the way an ­estimated $1.6bn in client assets went missing; miraculously, a court ruling finalised just last month paved the way for nearly all of the misappropriated funds to be returned to its rightful owners.

MF Global was hardly the first to give rehypothecation a bad name (that list includes the mother of all meltdowns, Lehman), but in its wake critics have called for a thorough re-examination of rehypothecation regulation. To sceptics, rehypothecation is part of the same freewheeling, risk-taking environment that made it possible for a lone impulsive trader to deal a near-fatal blow to a $1.4bn operation, then allow a seasoned veteran to come in and finish the job.

For starters, under rehypothecation it is possible for pledged collateral to be co-mingled with other assets on the balance sheet. Keeping pledged and non-pledged securities independently domiciled is key to preventing client assets from being re-hypothecated, say reform advocates, who see a need for greater clarity around asset segregation. A likely byproduct of current regulatory efforts, then, will be a true segregation of client collateral, thereby making it more difficult for unwanted rehypothecations to occur.

In the recent Commonfund Institute report Managing Counterparty Risk in an Unstable Financial System, David Belmont, chief risk officer for Wilton, Connecticut-based financial-services firm Commonfund, noted a conspicuous lack of clarity around the types of assets used for rehypothecation. This has fueled demand for increased broker reporting, says Belmont, “including daily reports on where their assets are being held and which have been lent out or re-hypothecated.”

Benefits—and drawbacks
Even so, proponents believe that rehypothecation can still be an attractive proposition for brokers who are keen on optimising borrowing opportunities, as well as lenders seeking a reduction in transactional costs. To avoid the mistakes of the past and maintain the integrity of the re-pledged collateral, rehypothecation requires the presence of transparent, fully automated monitoring systems and operational practices, including the use of segregated accounts.

Judson BakerJudson Baker, product manager for Northern Trust’s asset-servicing division.Under rehypothecation, “if someone is pledging a bond as collateral, the receiver of the collateral may be able to onward pledge that specific bond to satisfy a margin demand from a separate party,” says Judson Baker, product manager for Northern Trust’s asset-servicing division. “They are essentially using the bond as if it were their own to help meet a margin call, as opposed to using their own trading assets for that margin requirement.”

While reducing initial trade costs and related funding transactions, rehypothecation also facilitates increased velocity and liquidity around financing transactions, says Jean-Robert Wilkin, head of collateral management and securities lending products at Clearstream. “ICSD triparty agents [such as] Clearstream have offered collateral re-use for years, in a manner that is very transparent and is based exclusively on the settlement of securities which are subject to transfer of ownership,” says Wilkin. Rather than question the integrity of rehypothe­cation, industry members “should be able to clearly demonstrate its proper usage, including the manner in ­collateral information is reported to all  involved.”

Since cash can be easily segregated from other assets, rehypothecation issues are less likely to arise. Things can become a bit trickier, however, once securities come into the mix. As such, a number of funds remain dead-set against using rehypothecation, due in large part to the inefficiencies involved. “They would simply rather use funds that are more accessible to them,” says Baker.

If recent history is any judge, rehypothecation has the capacity to create more problems than it solves. ­“Rehypothecation requires that you have processes in place that allow you to easily track the whereabouts of that collateral,” says Baker. “And if your exposure to the first party swings to the point that they need to call in the collateral, you then have to then find an acceptable substitute to bring to Firm B in order to return the initial asset. Operationally, that can be a bit tedious.”

Throw in a few extra nuances, and suddenly you’ve got the makings a quasi-serious settlement-risk issue. “For instance, when substituting collateral, some firms will insist that the re-pledged asset be of like value, and require that the asset is in their possession before they agree to release the asset. That’s when things can become operationally painful—particularly if all the right pieces don’t immediately fall into place.”

For lending agents, rehypothecation does increase the amount of securities available for loan purposes, and as such could conceivably create more revenue, concurs Claire Johnson, head of marketing and product for CIBC Mellon. Providing access to higher-quality ­collateral is yet another potential benefit, adds Johnson, particularly at a time when US Federal Reserve asset purchases and sovereign-debt downgrades are making collateral harder to come by.

Claire JohnsonClaire Johnson, head of marketing and product for CIBC Mellon.Nevertheless, CIBC Mellon believes the risks outweigh the benefits, and, in line with Canada’s general regulatory stance, does not rehypothecate collateral within its lending program. “We have taken the position that the prospective risks associated with having to unwind a multi-level series of collateral trades mean potential delays,” notes Johnson, “which could create challenges or even exposures in a rapidly-changing market environment. Operationally, the collateral could be substituted at any time, and on the loan side we would have to recall it. So there are also potential relationship and reputation concerns in terms of lending out clients’ collateral.”

Rehypothecation for Transformation
In contrast, using rehypothecation as part of a broader collateral-transformation strategy, whereby an equity or lower-quality bond is upgraded in order to meet a margin requirement, has been generally well-received within the markets. “Dealers, clearing firms and custodians have all been seriously looking into this area,” says Baker. “At Northern Trust we have a very strong securities-lending arm, and because this process heavily leverages lending operations, we feel it is a natural fit for us. There are a number of ways for us to make this work—we can act as repo agent, serve as the trade counterparty, as well as line up clients who are holding long positions and are willing to pledge assets in return for higher yield.”

Going forward, this will require that banks such as Northern Trust keep a much closer watch on liquidity ratios, as well as the credit on both sides of the trade, all the while carefully ­monitoring counterparty activities. “While it may be a slightly different form of monitoring than we typically undertake, it’s not a new kind of service altogether,” notes Baker. “As a result, we feel we are in a much better position coming into this, compared to those who may be just starting from scratch.”

Recognising the need to corral risk associated with rehypothecation, custody providers have increasingly extolled the virtues of tri-party ­arrangements, using an integrated prime-custody offering to connect prime brokerages with fund-manager clients.

Rather than risk having their assets subjected to rehypothecation in the first place hedge funds have increasingly sought out zero-margin, long-only prime-custody accounts. At present nearly one in two hedge funds with assets under management (AUM) in excess of $1bn maintain prime-custody arrangements, according to a BNY Mellon/Finadium report issued last fall, up sharply from just 15% five years ago.

The bottom line, says James ­Malgieri, head of service delivery and regional management for BNY Mellon’s Global Collateral Services business, is that one cannot rehypothecate collateral without having the consent of the client. “If you buy stocks on margin in the US, you are required to sign a rehypothecation agreement that allows your broker to re-use those securities in order to raise financing,” says Malgieri. “This puts the onus on the lender to ask questions regarding the broker’s intent to rehypothecate, including with whom, what, when and how.”

As many of the problems associated with rehypothecation have been the result of introducing an “outside” third party, using a custodian as collateral agent gives clients the assurance that their assets will at least stay within the program, says Malgieri. “The key feature here is the ability to control the pledged assets—and in this situation, the collateral agent has the ability to bring bona fide transparency to the rehypothecation process. If you look back at some of the defaults that have occurred in situations where the dealer had the right to rehypothecate, very often the clients didn’t actually know where the rehypothecated securities were headed. Again, if a client is willing to post collateral to be re-used, they had better find out why and what the broker is going to do with it.”

With proper transparency in place and the right kinds of questions asked, rehypothecation can achieve its stated goal of providing added efficiency, as well as more favorable lending terms for the client. “And keeping the ­rehypothecation within network is obviously key to this effort,” says Malgieri.”

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