Those who know me, know well my love of China. Here is a first hand insight from a fine journalist:
http://www.creditwritedowns.com/2010/08/whither-china.html
Sunday, 15 August 2010
Wednesday, 28 July 2010
Take Off
It has been an eyewateringly happy week for holders of financial institution equity. Bank stocks soared. There are two key reasons for the volte face in sentiment towards the sector. First, and most important, the Basel Committee has greatly watered down the content of Basel III, the latest incarnation of the international accord to regulate prudential capital in the FIG sector. No longer will minority interests be deductions (cue Barclays take-off), no longer will deferred tax credits be ineligible capital (cue Jap banks soaring), and no longer will the net stable funding regimen be implemented as originally planned. The NSFR threatened to require banks in Europe to raise 3 trillion euros before its implementation, which was planned for [tbc]. Removing this vast debt raising pressure from the sector has vastly alleviated its funding needs, and means that there is now a fair prospect of the wall of investor money being mobilised to meet the still hefty refinancing cliff that loom.
The second fillip to the sector, less widely reported, is that covered bonds have been included in banks' eligible 'liquidity buffer', albeit as 'level 2' assets with a 40% concentration cap. Assuming HM Treasury does not - perversely - prosecute its formerly announced position of precluding them, this is a major boost to the banks ability to raise secured funds in the covered bond mart by cementing the position of the bank buying base. Covered bonds will be a big feature of the issuance landscape in H2.
There remain ominous threats on the horizon, however. The pending debt refinancing needs across the eurozone are still disarming, and the competition from sovereigns seeking funds from the same investor base will be significant. The position of eurozone sovereigns themselves also remains parlous. Even after several years of austerity, the Greek debt load will still exceed 150% of GDP, and the interest burden alone on that debt will exhaust much of the domestic financial resources of Greece. How long will the Greek punters bear the turns of the rackscrews?
The second fillip to the sector, less widely reported, is that covered bonds have been included in banks' eligible 'liquidity buffer', albeit as 'level 2' assets with a 40% concentration cap. Assuming HM Treasury does not - perversely - prosecute its formerly announced position of precluding them, this is a major boost to the banks ability to raise secured funds in the covered bond mart by cementing the position of the bank buying base. Covered bonds will be a big feature of the issuance landscape in H2.
There remain ominous threats on the horizon, however. The pending debt refinancing needs across the eurozone are still disarming, and the competition from sovereigns seeking funds from the same investor base will be significant. The position of eurozone sovereigns themselves also remains parlous. Even after several years of austerity, the Greek debt load will still exceed 150% of GDP, and the interest burden alone on that debt will exhaust much of the domestic financial resources of Greece. How long will the Greek punters bear the turns of the rackscrews?
Wednesday, 7 April 2010
Regulation 17g-5
Regulation 17g-5 should be striking fear into the heart of all European and American financial institutions. Yet not a whisper in the quality broadsheets. That is why this blog exists - can you afford not to be a follower?
Let me set the scene. Banks are simple in essence. They accept deposits, and use these to fund assets. Deposits are liabilities, and these must equal assets for the balance sheet to balance - that is, a bank can only lend what it has received. That's a gross simplification, but a useful heuristic for understanding the hyper-leveraged spaghetti credit-mess that banks have become entangled in. Let me explain.
Bearing in mind this simple asset/liability bank model, the Bank of England provides a useful graph of the 'funding gap' in its December 2009 Financial Stability Report:
(http://www.bankofengland.co.uk/publications/fsr/2009/fsrfull0906.pdf - p32)
The funding gap is is the simple difference between retail deposits on the one hand, and balance sheet assets on the other. The 'gap' must be filled by wholesale funding. That is to say, retail deposits make up only a portion of the liability side of the balance sheet and wholesale funding (money markets, pension funds, asset managers etc) must provide funding to fund the rest of the assets on the balance sheet; failing which, the bank is insolvent. Retail deposits became a progressively smaller portion of ballooning FIG balance sheets over the last decade of loose monetary policy. Wholesale funding, driven largely by the aggressive growth of securitisation markets, provided the balance.
The report only provides figures for the UK. The picture globally is similar, scaled up commensurately.
Crucially, central banks stepped in to plug the funding gap in the wake of the Great Contraction. In 2006, global ABS issuance was over $1.5trillion. In 2008, it was only $181bn - a huge fall-off. As a result, guarantee schemes saw c£134bn of Bank of England guaranteed debt issued by UK banks, and eur438bn across Europe supported by the European Central Bank. At the same time, UK banks lodged assets for which they could not find funds with the Bank of England, raising c£190bn in liquid funds (through the Special Liquidity Scheme). European banks raised an additional circa eur800bn. The numbers stack up alarmingly.
Those same central banks are now looking to normalise market operations and exit their positions. That means there is over 1.4 trillion of sovereign supported bank paper coming up for refinancing in the next 3 years. One of the reasons for the hasty exit is that sovereigns are running large budget deficits and gross national debt positions - central bank funding adds to the debt load, hence the political will to return banks to normal operations. Strong signs of economic recovery are providing impulsion. I will not recite the numbers since you can read about it in the pink pages every day - instead, let me return to Regulation 17g-5 and why it threatens to deliver a nuclear blast to the growing economic recovery.
Late last year, the Securities & Exchange Commission of the United States issued a release announcing changes to rule 17g-5 of the Securities Exchange Act 1934. The changes apply to asset backed transactions rated by a nationally recognised statistical rating organisation. In brief, the changes require the arranger of any rated asset backed deal (mortgage securitisations/RMBS, CMBS, ABS, covered bonds even) to publish on a password proteced website all information, written or oral, provided to the rating agencies retained. Other NRSO rating agencies will then be able to access the website. The aim appears to be break up the Moodys/S&P/Fitch oligopoly by giving other agencies access to data received by the big three.
In the words of one securitisation attorney, 'we may as well pack up our pens'.
Remember, the change requires all comms to be recorded - even phone calls - and logged on the website. Worse yet, it appears to capture so called Reg S deals if one of the big three is rating the trade - that is to say, even if the deal is a Dutch mortgage bond, arranged and issued by a Dutch bank, and sold to Dutch investors; if it's rated by one of the big three (as all ABS deals are in developed markets) it's caught. Yet further, it appears to capture covered bonds - the mainstay of European funding for financial institutions and a key propellor for the recovery. And to cap it all, it appears to apply to existing deals as much as new deals - no grandfathering relief for outstanding ABS deals. From June 2nd, they will be caught.
Aside from the extraordinary practical difficulty and risk of recording all comms of any kind with the big three, there is a vast question mark over what the other rating agencies will do with the website data. What would happen if they used such disclosures to take adverse ratings action?
All this is of fundamental significance. The funding gap makes one thing quite transparent: the secured financing markets are still on their knees with only a limited number of real money investors on hand to finance all those assets sitting on central bank balance sheets. The wall of money is simply not as big as the refinancing cliff. Despite all the rhetoric of requiring banks to exit central bank funding schemes, with no investor base to pick up the slack, central banks will only drive financial institutions into insolvency if they do deliver on the rhetoric.
At the same time, the SEC delivers a rabbit punch to the solar plexus of secured financing markets. It is difficult not to think that the left hand knows not what the right hand does. That will be no epiphany to market pundits. But it is no less alarming for it.
This is only the most extreme example of the tension that has been growing in credit markets since phase two of the crisis began. Regulatory overkill is in huge supply - uncertainty over hybrid capital, complex liquidity regulations obliging banks to term-out funding, endless initiatives to add questionable transparency to ABS through loan level diligence schemes - all these threaten to destroy the prospect of secured financing markets recovering; yet they must recover if the funding gap is to be plugged, or even partially plugged.
Sadly, shortly after stabilising the cardiac arrest, the surgeon has begun to remove the intravenous fiscal drip of central bank liquidity. At the same time, the nurse is punching the patient in the gut - as close to his febrile heart as he can. If the patient lapses into arrest again, the hospital should be sued for negligence.
Alas, the hospital may turn out to be utterly bankrupt. Creditors, beware.
Let me set the scene. Banks are simple in essence. They accept deposits, and use these to fund assets. Deposits are liabilities, and these must equal assets for the balance sheet to balance - that is, a bank can only lend what it has received. That's a gross simplification, but a useful heuristic for understanding the hyper-leveraged spaghetti credit-mess that banks have become entangled in. Let me explain.
Bearing in mind this simple asset/liability bank model, the Bank of England provides a useful graph of the 'funding gap' in its December 2009 Financial Stability Report:
(http://www.bankofengland.co.uk/publications/fsr/2009/fsrfull0906.pdf - p32)
The funding gap is is the simple difference between retail deposits on the one hand, and balance sheet assets on the other. The 'gap' must be filled by wholesale funding. That is to say, retail deposits make up only a portion of the liability side of the balance sheet and wholesale funding (money markets, pension funds, asset managers etc) must provide funding to fund the rest of the assets on the balance sheet; failing which, the bank is insolvent. Retail deposits became a progressively smaller portion of ballooning FIG balance sheets over the last decade of loose monetary policy. Wholesale funding, driven largely by the aggressive growth of securitisation markets, provided the balance.
The report only provides figures for the UK. The picture globally is similar, scaled up commensurately.
Crucially, central banks stepped in to plug the funding gap in the wake of the Great Contraction. In 2006, global ABS issuance was over $1.5trillion. In 2008, it was only $181bn - a huge fall-off. As a result, guarantee schemes saw c£134bn of Bank of England guaranteed debt issued by UK banks, and eur438bn across Europe supported by the European Central Bank. At the same time, UK banks lodged assets for which they could not find funds with the Bank of England, raising c£190bn in liquid funds (through the Special Liquidity Scheme). European banks raised an additional circa eur800bn. The numbers stack up alarmingly.
Those same central banks are now looking to normalise market operations and exit their positions. That means there is over 1.4 trillion of sovereign supported bank paper coming up for refinancing in the next 3 years. One of the reasons for the hasty exit is that sovereigns are running large budget deficits and gross national debt positions - central bank funding adds to the debt load, hence the political will to return banks to normal operations. Strong signs of economic recovery are providing impulsion. I will not recite the numbers since you can read about it in the pink pages every day - instead, let me return to Regulation 17g-5 and why it threatens to deliver a nuclear blast to the growing economic recovery.
Late last year, the Securities & Exchange Commission of the United States issued a release announcing changes to rule 17g-5 of the Securities Exchange Act 1934. The changes apply to asset backed transactions rated by a nationally recognised statistical rating organisation. In brief, the changes require the arranger of any rated asset backed deal (mortgage securitisations/RMBS, CMBS, ABS, covered bonds even) to publish on a password proteced website all information, written or oral, provided to the rating agencies retained. Other NRSO rating agencies will then be able to access the website. The aim appears to be break up the Moodys/S&P/Fitch oligopoly by giving other agencies access to data received by the big three.
In the words of one securitisation attorney, 'we may as well pack up our pens'.
Remember, the change requires all comms to be recorded - even phone calls - and logged on the website. Worse yet, it appears to capture so called Reg S deals if one of the big three is rating the trade - that is to say, even if the deal is a Dutch mortgage bond, arranged and issued by a Dutch bank, and sold to Dutch investors; if it's rated by one of the big three (as all ABS deals are in developed markets) it's caught. Yet further, it appears to capture covered bonds - the mainstay of European funding for financial institutions and a key propellor for the recovery. And to cap it all, it appears to apply to existing deals as much as new deals - no grandfathering relief for outstanding ABS deals. From June 2nd, they will be caught.
Aside from the extraordinary practical difficulty and risk of recording all comms of any kind with the big three, there is a vast question mark over what the other rating agencies will do with the website data. What would happen if they used such disclosures to take adverse ratings action?
All this is of fundamental significance. The funding gap makes one thing quite transparent: the secured financing markets are still on their knees with only a limited number of real money investors on hand to finance all those assets sitting on central bank balance sheets. The wall of money is simply not as big as the refinancing cliff. Despite all the rhetoric of requiring banks to exit central bank funding schemes, with no investor base to pick up the slack, central banks will only drive financial institutions into insolvency if they do deliver on the rhetoric.
At the same time, the SEC delivers a rabbit punch to the solar plexus of secured financing markets. It is difficult not to think that the left hand knows not what the right hand does. That will be no epiphany to market pundits. But it is no less alarming for it.
This is only the most extreme example of the tension that has been growing in credit markets since phase two of the crisis began. Regulatory overkill is in huge supply - uncertainty over hybrid capital, complex liquidity regulations obliging banks to term-out funding, endless initiatives to add questionable transparency to ABS through loan level diligence schemes - all these threaten to destroy the prospect of secured financing markets recovering; yet they must recover if the funding gap is to be plugged, or even partially plugged.
Sadly, shortly after stabilising the cardiac arrest, the surgeon has begun to remove the intravenous fiscal drip of central bank liquidity. At the same time, the nurse is punching the patient in the gut - as close to his febrile heart as he can. If the patient lapses into arrest again, the hospital should be sued for negligence.
Alas, the hospital may turn out to be utterly bankrupt. Creditors, beware.
Friday, 19 March 2010
Solvency II
As regards the welter of regulatory reforms that are afoot in the world of financial capital and liquidity, little press ink has been spilled on the new Solvency II regime. Solvency II will set out new, strengthened EU-wide requirements on capital adequacy and risk management for insurers with a view to reducing the likelihood of an insurer failing. Dull stuff, you may think.
In its current draft, however, it threatens to toss a grenade in an abstruse but highly lucrative niche of FIG funding - German registered bonds.
German insurance companies are a key buyer of bonds that are constituted in registered form, as opposed to bearer bonds. Bearer bonds are technically transferable through delivery of the bond itself. In practice, such bonds are locked in a vault with a custodian and interests in the bearer bond are transferred electronically through Euroclear and Clearstream. Registered bonds, in contrast, are constituted so that ownership is transferred through entries on a central register. In practice, therefore, little distinguishes the bearer bonds from registered bonds, although certain legal and tax consequences spin on the difference.
By virtue of a local accounting idiosyncracy, German insurance companies enjoy an economic advantage by investing in registered bonds. Under German GAAP, the bonds may be accounted for at amortised cost - whereas bearer bonds are normally marked-to-market, putting volatility into the profit and loss statement.
The loss of this accounting perq would be significant. There are over 500 insurance and pension funds in Germany with about eur540bn to invest in fixed income, of which eur300bn is invested in registered notes. It's a big industry.
So although the grenade is sitting on the draft statute books ticking away, it's unlikely that you'll see it detonate over the pink pages any time soon. That kind of financial clout at the heart of the EU is a powerful lobby. Expect the Solvency II threat to fizzle out before it becomes a mainstream newstory. But if it doesn't.....you read it here first.
In its current draft, however, it threatens to toss a grenade in an abstruse but highly lucrative niche of FIG funding - German registered bonds.
German insurance companies are a key buyer of bonds that are constituted in registered form, as opposed to bearer bonds. Bearer bonds are technically transferable through delivery of the bond itself. In practice, such bonds are locked in a vault with a custodian and interests in the bearer bond are transferred electronically through Euroclear and Clearstream. Registered bonds, in contrast, are constituted so that ownership is transferred through entries on a central register. In practice, therefore, little distinguishes the bearer bonds from registered bonds, although certain legal and tax consequences spin on the difference.
By virtue of a local accounting idiosyncracy, German insurance companies enjoy an economic advantage by investing in registered bonds. Under German GAAP, the bonds may be accounted for at amortised cost - whereas bearer bonds are normally marked-to-market, putting volatility into the profit and loss statement.
The loss of this accounting perq would be significant. There are over 500 insurance and pension funds in Germany with about eur540bn to invest in fixed income, of which eur300bn is invested in registered notes. It's a big industry.
So although the grenade is sitting on the draft statute books ticking away, it's unlikely that you'll see it detonate over the pink pages any time soon. That kind of financial clout at the heart of the EU is a powerful lobby. Expect the Solvency II threat to fizzle out before it becomes a mainstream newstory. But if it doesn't.....you read it here first.
Monday, 15 March 2010
In defence of bankers - big bankers
The Fleet Street commentariat is foaming at the jaw lambasting and lampooning all things banking. Even the venerable Financial Times regularly features critical comment deriding this blogger's chosen profession. I might not be doing God's work, I think, as I read this invective. But I am doing something useful. Let me recapitulate - for it is no time to capitulate.
Depositors rely on banks to park their cash and provide a return. On the faith that not every depositor requires its funds at the same time - which in normal market conditions is the case - banks use depositors' cash to help consumers and businesses invest. They provide international payment systems facilitating 730 million payments a day. They provide services to individuals and companies to manage financial risk. They help governments finance their expenditure. And so on. These are important fiscal services with real societal value. The fulcrum of this business model is confidence. Where risk is properly managed, confidence is maintained and banks are able to provide these services to promote economic growth and the prosperity of nations.
2008 saw a catastrophic rupture of this business model. Almost half of the increase in economic value contributed by banks in the UK (wages and gross profits) from 2001 to 2007 was blown in short measure through the extraordinary fiscal measures taken by the Bank of England in the last two years (source: Financial Times Monday 15 March, pace John Cassidy). This was not, however, some grand scheme cooked up by the soi disant masters of the universe to steal taxpayers' coin for a generation to come. And it was not the work of the average common-or-garden banker fresh out of school with the opportunity of social mobility ahead of him or her. There was a great deal of ingenuity invested in circumventing prudential governance, but it was - in my experience at least - done with rigorous intellectual effort (within the white-swan logic that informed it) and honesty; not as a dubious scam to enrichen the incumbents. There were sharp practices, and there were extraordinary errors of judgement. Politicians, clergy and multi-millionaire footballers are all human alike. But it is the politics of envy to tar banks - and bankers - with one dark brush. Banks are ultimate meritocracies, places where nought but commitment and ability determine success. The best banks - Goldman Sachs and Barclays - rely on enfranchising the best qualities in their people, in a co-operative team oriented endeavour to manage risk but maximise returns. The work they do is valuable work that confers real social benefit. Mistakes were made. But let us not throw the baby out with the bathwater and over-regulate the City - and its talent pool - out of existence; or out of the country, at any rate.
Consider a multinational pharmaceutical. It borrows from a bank. It also taps capital markets for diverse funding (capital markets remained open when loan markets shut down). It raises debt and equity in multiple global locations. It manufactures and sells, buys raw materials and trades cross border. Its purpose is to produce medicine that benefits human kind. Only a bank can provide the fiscal services to meet the needs just articulated. And only an integrated global bank can do so effectively.
Banks enable consumers to buy homes and other assets, and small businessess that require debt to grow. Banks provide services to enable pension funds to meet their pension liabilities. Banks can assume risk and distribute it more widely. Only global banks can provide liquidity to large sovereign nations. Asian, European and Middle Eastern buyers of sovereign debt require banks to intermediate their capital to invest in, for example, US and European sovereign debt. Without this facility, the cost of borrowing rises and higher taxes or lower public spending ensues. Followed by lower economic growth.
So let's not hang the bankers out to dry. It may seem obtuse, but England would be poorer yet without its financial capital. Those outside the rareified universe of investment banking will beg to differ. Whether we let them win the argument remains to be seen.
Depositors rely on banks to park their cash and provide a return. On the faith that not every depositor requires its funds at the same time - which in normal market conditions is the case - banks use depositors' cash to help consumers and businesses invest. They provide international payment systems facilitating 730 million payments a day. They provide services to individuals and companies to manage financial risk. They help governments finance their expenditure. And so on. These are important fiscal services with real societal value. The fulcrum of this business model is confidence. Where risk is properly managed, confidence is maintained and banks are able to provide these services to promote economic growth and the prosperity of nations.
2008 saw a catastrophic rupture of this business model. Almost half of the increase in economic value contributed by banks in the UK (wages and gross profits) from 2001 to 2007 was blown in short measure through the extraordinary fiscal measures taken by the Bank of England in the last two years (source: Financial Times Monday 15 March, pace John Cassidy). This was not, however, some grand scheme cooked up by the soi disant masters of the universe to steal taxpayers' coin for a generation to come. And it was not the work of the average common-or-garden banker fresh out of school with the opportunity of social mobility ahead of him or her. There was a great deal of ingenuity invested in circumventing prudential governance, but it was - in my experience at least - done with rigorous intellectual effort (within the white-swan logic that informed it) and honesty; not as a dubious scam to enrichen the incumbents. There were sharp practices, and there were extraordinary errors of judgement. Politicians, clergy and multi-millionaire footballers are all human alike. But it is the politics of envy to tar banks - and bankers - with one dark brush. Banks are ultimate meritocracies, places where nought but commitment and ability determine success. The best banks - Goldman Sachs and Barclays - rely on enfranchising the best qualities in their people, in a co-operative team oriented endeavour to manage risk but maximise returns. The work they do is valuable work that confers real social benefit. Mistakes were made. But let us not throw the baby out with the bathwater and over-regulate the City - and its talent pool - out of existence; or out of the country, at any rate.
Consider a multinational pharmaceutical. It borrows from a bank. It also taps capital markets for diverse funding (capital markets remained open when loan markets shut down). It raises debt and equity in multiple global locations. It manufactures and sells, buys raw materials and trades cross border. Its purpose is to produce medicine that benefits human kind. Only a bank can provide the fiscal services to meet the needs just articulated. And only an integrated global bank can do so effectively.
Banks enable consumers to buy homes and other assets, and small businessess that require debt to grow. Banks provide services to enable pension funds to meet their pension liabilities. Banks can assume risk and distribute it more widely. Only global banks can provide liquidity to large sovereign nations. Asian, European and Middle Eastern buyers of sovereign debt require banks to intermediate their capital to invest in, for example, US and European sovereign debt. Without this facility, the cost of borrowing rises and higher taxes or lower public spending ensues. Followed by lower economic growth.
So let's not hang the bankers out to dry. It may seem obtuse, but England would be poorer yet without its financial capital. Those outside the rareified universe of investment banking will beg to differ. Whether we let them win the argument remains to be seen.
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