08 grudnia 2011

Re-Hypothecation kluczem do zrozumienia upadku Lehman, AIG, MF Global

Od dłuższe czasu staram się śledzić sprawę zabezpieczeń (collateral), transakcji repo oraz aktywów poza bilansowych (off balance sheet transaction), ze szczególnym uwzględnieniem ukrytej bankowości (shadow banking). Sprawę zawsze świetnie opisywała Iza Kamińska (pozdrawiam!) (bloggerka, kiedyś FT Alphaville, teraz FT (!)), zresztą nie tylko tą, a wiele innych, którymi nie zajmowały się mainstreamowe media.
Uważam, że temat Hypothecation, a raczej re-hypothecation, pod względem istotności jest tematem TOP 3, a może i TOP 2 roku 2011. Dla mnie to jedna z najważniejszych rzeczy o których dowiemy się zapewne więcej w 2012.
Niestety na chwilę obecną nie mam czasu na szersze opisanie sprawy i muszę posiłkować się materiałami w języku angielskim. Mój wpis jest zatem tekstem bardziej "zajawkowym" niż poważnym opisaniem sprawy. Materiały zlinkowane proszę potraktować jako must read (szczególnie reuters).
Na bazie wiedzy o BRAKU właściwych i porządnych zabezpieczeń na rynku, oraz powolnym upadku Shadow Banking, można śmiało stwierdzić, iż dojdzie w najbliższym czasie do rozszerzenia zakresu przyjmowanych zabezpieczeń przez ECB, i to pewnie bez żadnych kar (penalties, czy haircut). Obniżki stóp są mało istotne w obecnych czasach. To co się liczy to właśnie operacje LTRO, QE ale również przyjmowanie zabezpieczeń i udzielanie pożyczek na np 2-3 lata. Tego własnie się spodziewam po ECB, by ratować upadający euroland. Prawdopodobnie zaczną akceptować bez żadnych problemów wszelkie papiery pod zastaw, w tym akcje spółek z kategorii śmieć i do tego na 2-3 lata bez kar i ucięcia wartości. Główny powód to cichy (bo w tle i nikt tego nie widział jeszcze do pewnego czasu) upadek wielu funduszy i wybranych brokerów, oraz zanikanie zabezpieczeń jakie można by przedłożyć do FED, BoE, ECB, BoJ, SNB. Nie ma też co ukrywać, że działania QE i inne przyczyniają się do potęgowania problemu zanikania Shadow banking, poprzez znikające zabezpieczenia. Z kolei Re-hypothecation może okazać się (jeśli jeszcze się nie okazało) śmiertelną trucizną z opóźnionym czasem działania dla światowych finansów. Docelowo, może to spowodować ich załamanie.
Re-hypothecation jest kluczem do zrozumienia obecnych problemów MF Global, byłych problemów Lehman czy AIG. Przyznam szczerze, iż jestem całkowicie zdziwiony BRAKIEM wiedzy wśród większości dziennikarzy i zainteresowanych jak i normalnego spojrzenia na sprawę. To wszystko co było do tej pory prezentowane, w szczególności przez różnych blogerów, jako zwykłe oszustwo ma się nijak, bądź w małym stopniu, do sprawy. To co robił MF Global to była praktycznie zwykła praktyka, która co więcej, jest BARDZO popularna w świecie finansów, a szczególnie Londku Zdrój, który jest swoistym nieuregulowanym "hubem" przesiadkowym dla wielu funduszy. Wszystkie drogi nie prowadzą do Rzymu, wszystkie drogi prowadzą do Londynu i to on jest kluczem w zrozumieniu wielu problemów dzisiejszego świata finansów.
Stay tuned.
P.S. Tego typu procesy nie mogą być wykorzystane do day, czy swing tradingu. Ciężko je również wykorzystać w handlu w średnim terminie.

43 komentarze:

  1. Ciekawe, ciekawe, nie mogę sie doczekać rozwinięcia wpisu :)

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  2. No i proszę:
    EBC ogłasza "niestandardowe środki", by pomóc europejskim bankom
    8 Gru 2011, 15:12


    08.12. Frankfurt (PAP/Bloomberg) - Europejski Bank Centralny ogłosił "niestandardowe środki", by pomóc europejskim bankom - powiedział szef EBC Mario Draghi na konferencji prasowej.
    Środki te będą obejmować m.in. oferowanie przez EBC pożyczek dla banków z terminem spłaty trzy lata oraz złagodzenie przez bank centralny kryteriów zabezpieczenia pożyczek dla banków - ogłosił Draghi.

    Ponadto, stopa rezerw obowiązkowych ma zostać zredukowana do 1 proc. z obecnych 2 proc. Piersze działania banku będą miały miejsce 21 grudnia - dodał Draghi.

    Wcześniej w czwartek EBC obniżył benchmarkową stopę procentową w strefie euro o 25 pkt. bazowych do 1,00 proc.(PAP)

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  3. 1/2
    8 December 2011 - ECB announces measures to support bank lending and money market activity

    The Governing Council of the European Central Bank (ECB) has today decided on additional enhanced credit support measures to support bank lending and liquidity in the euro area money market. In particular, the Governing Council has decided:

    To conduct two longer-term refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year.

    To discontinue for the time being, as of the maintenance period starting on 14 December 2011, the fine-tuning operations carried out on the last day of each maintenance period.

    To reduce the reserve ratio, which is currently 2%, to 1% as of the reserve maintenance period starting on 18 January 2012. As a consequence of the full allotment policy applied in the ECB’s main refinancing operations and the way banks are using this option, the system of reserve requirements is not needed to the same extent as under normal circumstances to steer money market conditions.

    To increase collateral availability by (i) reducing the rating threshold for certain asset-backed securities (ABS) and (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. These two measures will take effect as soon as the relevant legal acts have been published.

    Modalities of the two longer-term refinancing operations with a maturity of 36 months and the option of early repayment after one year:

    The operations will be conducted as fixed rate tender procedures with full allotment. The rate in these operations will be fixed at the average rate of the main refinancing operations over the life of the respective operation. Interest will be paid when the respective operation matures.

    After one year counterparties will have the option to repay any part of the amounts they are allotted in the operations, on any day that coincides with the settlement day of a main refinancing operation. Counterparties must inform their respective NCB, giving one week’s notice, of the amount they wish to repay.

    The operations will be conducted according to the schedule shown in the table. The first operation will be allotted on 21 December 2011 and will replace the 12-month LTRO announced on 6 October 2011.
    Announcement date Allotment date Settlement date First date for early repayment Maturity date Maturity
    20 Dec. 2011 21 Dec. 2011 22 Dec. 2011 30 Jan. 2013 29 Jan. 2015 1134 days
    28 Feb. 2012 29 Feb. 2012 1 Mar. 2012 27 Feb. 2013 26 Feb. 2015 1092 days
    Counterparties are permitted to shift all of the outstanding amounts received in the 12-month LTRO allotted in October 2011 into the first 3-year LTRO allotted on 21 December 2011. Those counterparties that wish to do so are requested to notify their respective NCB by Monday, 19 December 2011.

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  4. 2/2
    Details of measures to increase collateral availability:

    In addition to the ABS that are already eligible for Eurosystem operations, ABS having a second-best rating of at least “single A” in the Eurosystem’s harmonised credit scale at issuance, and at all times subsequently, [1] and the underlying assets of which comprise residential mortgages and loans to small and medium-sized enterprises (SMEs), will be eligible for use as collateral in Eurosystem credit operations. They must also satisfy all of the following requirements:

    (a) the cash-flow-generating assets backing the ABS must all belong to the same asset class, i.e. the asset class must consist of either only residential mortgages or only loans to SMEs;

    (b) the cash-flow-generating assets backing the ABS cannot include loans which are:

    at the time of issuance of the ABS, non-performing; or

    at any time, structured, syndicated or leveraged;

    (c) the counterparty submitting an ABS as collateral (or any third party with which it has close links) cannot act as an interest rate swap provider in relation to the ABS;

    (d) the ABS transaction documents must contain servicing continuity provisions;

    (e) the ABS must fulfil all other existing eligibility requirements, except for the ratings requirement.

    To allow NCBs, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use. Details of the criteria for the use of credit claims will be announced in due course.

    Furthermore, the Governing Council would welcome wider use of credit claims as collateral in the Eurosystem’s credit operations on the basis of harmonised criteria and announces that the Eurosystem is aiming to:

    enhance its internal credit assessment capabilities; and

    encourage potential external credit assessment providers (rating agencies and providers of rating tools), and commercial banks that use an internal ratings-based system, to seek Eurosystem endorsement under the Eurosystem Credit Assessment Framework.
    http://www.ecb.int/press/pr/date/2011/html/pr111208_1.en.html

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  5. Na PiG lekko rozwinąłem sprawę.

    Najpierw bieda_inwestor:
    http://forum.gazeta.pl/forum/w,17007,131373068,131388018,Fajnie.html

    Potem moja odpowiedź:
    http://forum.gazeta.pl/forum/w,17007,131373068,131390578,5.html

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  6. 1/2
    Z Risk:
    MF Global: non-US clients caught in cross-border collateral trap

    Omnibus structure meant clearing clients of MF Global outside the US were asked to double up on collateral payments. Use of the structure for OTC markets is now in doubt
    Non-US futures clearing clients of MF Global found their collateral trapped in cross-border limbo last month following the firm's collapse, and were asked to stump up fresh assets if they wanted to port their cleared business to another firm – not all were able to do so, and some had to liquidate their positions as a result, dealers say.

    "There certainly were clients who didn't have the margin to avoid the liquidation of their positions, and we didn't entertain the prospect of allowing positions to be ported to us without the collateral being posted," says one OTC clearing risk manager at a US bank in London.
    The problems with what's known as the cross-border omnibus clearing structure mean it may not be suitable for use in the clearing of over-the-counter business, as had been planned, dealers warn. Lawyers claim an alternative structure could be designed, but as yet there are none on the table.

    The cross-border structure allows non-US customers to
    clear trades through a US clearing house. European clients, for example, are not allowed to be a client of a US futures commission merchant (FCM) and are required to access the FCM indirectly. The client would open an account with a foreign broker, which in turn has an omnibus account with its affiliate FCM. In the case of MF Global, UK clients held accounts at MF Global UK Ltd (MFGUK), which opened an omnibus account with MF Global Inc (MFGI).
    In the event of the FCM's insolvency, the foreign broker enjoys the same protections with respect to margin segregation and portability of positions as any other direct client of such FCM, but the omnibus structure contains pooled positions for all the broker's non-US clients and does not necessarily ensure those clients can port their positions or have their margin segregated from other clients within the structure.
    According to KPMG – the bankruptcy trustee of MFGUK – in the weeks after MF Global's failure, non-US clients were able to port positions to new brokers but were denied access to their collateral by the US trustee. In contrast, 60% of collateral was made available by the trustee to US clients.
    "The Securities Investor Protection Act Trustee of MFGI confirmed to the Joint Special Administrators (JSA) of MFGUK that it would allow clients who had positions within the UK omnibus account held at MFGI to transfer their positions in whole provided that no cash or collateral was moved as part of the transfer. Notice was given by the JSA to clients who had positions in the US omnibus account and a process was set up to collate transfer requests. A final deadline date of November 11 was set by the JSA of MFGUK for receipt of client transfer requests. Any requests received by the deadline were passed to the trustee for processing," says a representative of KPMG.
    The lack of protection in the omnibus structure has caused some dealers to re-examine it, given they expect it to be used in the clearing of OTC products. "We're holding fire on this and are

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  7. 2/2
    not implementing the structure as yet for OTC swaps. We're trying to figure out what the cross-regulatory streams mean and which rule should govern, and what that means for client money protections. If porting and the return of customer assets is a problem, then clients are going to think twice about using this structure. That said, the way regulations are currently written means clients might have to make use of this structure. So if a client is compelled to use it, we need to be absolutely sure what needs to happen in the event of a default," says one head of OTC clearing at a US bank.
    Lawyers are also concerned. "The problem with the structure is that the foreign broker – being a client of the FCM – should be afforded the ability to port its positions to a new clearing broker, but in a case like MF Global, where the foreign broker is also in default, it is hard to see a new FCM accepting the omnibus account of an insolvent broker given it has no idea of the composition of underlying clients in the account. Achieving portability is not at all straightforward," says one lawyer at a UK firm in London.
    But other lawyers believe that depending on the jurisdictions involved, it may be possible to create a sound legal construct both for the porting of positions and return of client assets in the OTC swaps context.
    "It is possible that in an OTC swaps context, the portability of positions in the client omnibus structure can be achieved if the correct legal construct is created," says a New York-based partner at one law firm "It would be necessary to ensure clients are able to port their positions via another foreign broker that has an omnibus account at a US FCM, and as the events of MF Global show, porting is possible. On the client assets side, it should also be possible to ensure that in the event of the default of the FCM and the foreign broker, assets bypass the foreign broker's administrators and are returned in a timely manner to the client. But as yet we haven't been asked to design such a structure".

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  8. Polecam w sprawie MFGlobal
    What the repo markets *want* the ECB to do
    Posted by Izabella Kaminska on Dec 08 12:00.
    We’ve discussed why the ECB’s policy of applying different haircuts to eurozone government debt collateral may be adding to dysfunctions in the repo market.

    It’s one reason why broadening the ECB’s list of accepted collateral to include lower-quality assets won’t make much of a difference on a policy scale.

    Now Nomura’s Fixed Income strategist Guy Mandy makes a similar argument.
    Streszczenie dalej tutaj:
    http://ftalphaville.ft.com/blog/2011/12/08/786491/what-the-repo-markets-want-the-ecb-to-do/

    Cały papier tutaj:
    http://www.scribd.com/doc/75159033/NOM-on-Eurozone-Repo?secret_password=1gldv7aa1hvzxa2tpd1w

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  9. 1/2
    Brak zabezpieczeń....

    Yes! We have no collateral today
    Posted by Izabella Kaminska on Dec 06 08:39.
    Didn’t think the quality collateral scarcity issue was a big problem?

    Seems the fast diminishing pool of ‘risk-free’ assets is a big enough issue to have the Basel Committee on Banking Supervision completely change its mind on the role of government bonds in its new banking rules.

    Bloomberg has the story here:
    http://www.businessweek.com/news/2011-12-06/basel-rules-face-change-with-no-risk-sovereign-debt-major-focus.html
    The Basel Committee on Banking Supervision, which coordinates regulations for 27 countries, may let banks use equities and more corporate debt, in addition to cash and sovereign bonds, to satisfy new short-term liquidity standards, said two people with direct knowledge of the plans who requested anonymity because the talks are private.

    The move could reduce demand for European government securities, making it harder for nations on the brink of insolvency to fund themselves. “One of the central pillars of the Basel III framework is the notion of a risk-free asset class,” said Matthew Czepliewicz, a banking analyst at Collins Stewart Hawkpoint Plc in London. “That central pillar is disintegrating. Basel is quite clearly going to have to be revised.”

    Since rules on liquidity and capital known as Basel III were approved in 2010, holders of Greek debt have agreed to a 50 percent writedown, while prices of Italian, Spanish and Portuguese bonds have fallen as yields hit euro-era highs. Regulators now face a balancing act between acknowledging investors’ loss of confidence in sovereign debt, which has contributed to a 30 percent decline in bank shares this year, and the need to avoid undermining governments’ credibility.

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  10. 2/2
    It’s worth noting that the Financial Times had said as much in September.
    http://www.ft.com/cms/s/0/ca79e2ec-d7cd-11e0-a5d9-00144feabdc0.html#axzz1ff1tphml
    Of course, it’s a wise move for more than just the fact that investors have lost confidence in a lot of sovereign debt since 2010. There was arguably never enough quality government bonds to go round in the first place. Just ask the Australian central bank.

    More corporate debt and equities being used as a liquidity buffer, meanwhile, could be just the pop the equity markets need.

    And that’s largely because the rush for quality collateral goes beyond the Basel III buffer requirements. Not only is the increased use of Central Counterparties (CCP) encumbering ever more collateral, bilateral funding markets are becoming more fussy about the sort of collateral they accept. In many cases in Europe only the best quality government paper (French and German) will do. There’s also the additional encumberance that comes with larger haircuts being charged when more risky assets are used as collateral.

    In other words, alongside this general trend towards collateralisd funding and trading, there wasn’t much room for Basel III liquidity buffers in the system.

    Which begs an important question. To what degree did these rules, designed to make the system safer, add stress to the system by heightening what was already a material collateral crunch?

    Time for Basel to think hard about what it has done.
    http://ftalphaville.ft.com/blog/2011/12/06/782081/yes-we-have-no-collateral-today/

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  11. 5 wrzesnia
    Regulators poised to soften new bank rules
    Global bank regulators are preparing to ease new rules that would require banks to hold more liquid assets to withstand a funding crunch in a crisis.
    The move follows complaints from banks that the new Basel III standards on liquidity – the first international rules of their kind – would force them to sharply curtail lending to consumers and businesses.
    The new measure, known as the “liquidity coverage ratio”, will require banks to hold enough easy-to-sell assets to withstand a 30-day run on their funding, similar to the crisis that engulfed Lehman Brothers in 2008. While the ratio does not formally take effect until 2015, banks were already struggling to amass enough cash and government bonds to meet the requirements, said analysts.
    A new report by JPMorgan estimates that 28 European banks faced a total liquidity shortfall of €493bn ($695bn) at the end of 2010 under the ratio’s current framework. Only seven of the 28 banks tested met the enhanced standards, with the leading French banks – BNP Paribas, Société Générale and Crédit Agricole – among the least prepared, with a combined shortfall of €173bn.
    In fact, the JPMorgan analysis concludes that the liquidity coverage ratio is the most “painful” piece of regulation to hit the sector, and will cost European banks nearly 12 per cent of their 2012 earnings on average.
    That compares with an expected 5 per cent hit from tougher global requirements on bank capital, and a 3 per cent reduction from the Dodd-Frank financial reform measures in the US.
    “Regulatory focus is rapidly shifting from capital at risk to liquidity risk in our view,” said Kian Abouhossein, European banks analyst at JPMorgan.
    A growing number of members on the Basel Committee on Banking Supervision, which sets the global standards, now want to soften key technical definitions in the ratio, people familiar with the discussions told the Financial Times. Those changes would have the effect of reducing how much liquidity banks have to hold, and would allow them to count more corporate and covered bonds toward the total, those people said.
    The committee staff, based in Basel, Switzerland, are gathering data on the potential impact of the ratio, and a subgroup is working on the definitions ahead of a full committee meeting this month. US and continental European regulators are expected to push for changes that would ease the impact on their banks, while the UK, which pioneered the first national liquidity rules in 2009, is said to support the status quo. No changes to the ratio have been finalised, and discussions are continuing.
    The Basel committee agreed last year to make the liquidity rules “observational” from 2011 to 2015 to give regulators time to tinker with the details.

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  12. 1/2
    As FT Alphaville has noted before, the quality collateral shortage is particularly striking in Australia, where sovereign debt levels are much smaller than the rest of AAA land.

    Manufacturing quality collateral
    Regulators are demanding that banks set aside larger amounts of high-quality liquid assets to help them withstand periods of market stress.

    The securities generally deemed acceptable are AAA-government bonds.

    The problem is, despite large stimulus-motivated issuance by AAA governments, there’s still not enough of the quality stuff to go around. Stress in collateral markets is rising as quality collateral becomes impossible to find. The quality grab is not only forcing down yields in safe haven bonds, it’s seeing the rates charged for borrowing cash against the bonds fall to all-time lows, as investors scramble to acquire securities in order to satisfy liquidity requirements. The crunch has further been heightened by the general trend towards collateralised lending and funding, usually on an overcollateralisation basis.

    As Godfried De Vidts as Chairman of ICMA’s European Repo Council told FT Alphaville this week:

    “You can’t just ask for USTs and market bunds, or else the market will grind to a halt”
    So what’s a monetary institution to do?

    As FT Alphaville has noted before, the quality collateral shortage is particularly striking in Australia, where sovereign debt levels are much smaller than the rest of AAA land.

    Naturally, it’s a problem which has caught the attention of the Reserve Bank of Australia.

    Having thought long and hard about how to overcome it, the RBA announced on November 15 that it felt the best course of action would be the creation of a brand new new facility.

    As the details noted:

    As foreshadowed last December, the Reserve Bank will provide a committed liquidity facility (CLF) as part of Australia’s implementation of the Basel III liquidity reforms. Details of APRA’s proposed implementation of the Basel III liquidity standard are being released concurrently with this announcement. For further details see Implementing Basel III liquidity reforms in Australia. The facility, which is required because of the limited amount of government debt in Australia, is designed to ensure that participating authorised deposit-taking institutions (ADIs) have enough access to liquidity to respond to an acute stress scenario, as specified under the liquidity standard.
    http://www.rba.gov.au/media-releases/2011/mr-11-25.html

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  13. 2/3
    It’s an interesting solution.

    Guy Debelle, Assistant Governor of the RBA, offers some more insight via a speech he made this week in Sydney.

    As he explains the RBA only really had three options: balance sheet expansion, dedicated debt issuance solely for the purpose of creating AAA-bonds, or the creation of the CLF:

    In addition to government debt, the Basel standard also includes balances at the central bank in its definition of high-quality liquid assets (level 1 assets in the Basel terminology). That is, the banks’ exchange settlement (ES) balances at the RBA are also a liquid asset. Hence, one possible solution to the shortage of level 1 assets would be for banks to significantly increase the size of their ES balances to meet their liquidity needs.

    While this is possible, it would mean that the RBA’s balance sheet would increase considerably.

    The RBA would have to determine what assets it would be willing to hold against the increase in its liabilities, and would be confronted by the same problem of the shortage of assets in Australia outside the banking system.

    Similarly, the government could increase its debt issuance substantially with the sole purpose of providing a liquid asset for the banking system to hold. Again, it would be confronted with the problem of which assets to buy with the proceeds of its increased debt issuance. Moreover, it would be a perverse outcome for the liquidity standard to be dictating a government’s debt strategy.

    However, the Basel Committee acknowledges that there are jurisdictions such as Australia where there is a clear shortage of high quality liquid assets. In such circumstances, the liquidity standard allows for a committed liquidity facility to be provided by the central bank against eligible collateral to enable banks to meet the LCR.
    What is the CLF? It’s basically a pre-arranged commitment by the RBA to swap liquidity in exchange for a specific quota of assets less liquid than government bonds. It is thus a guaranteed liquidity option. If you need liquidity, you will always be able to swap your illiquid securities for liquid RBA reserves for a cost of no more than 25 basis points above the target rate.

    In this way, the central bank is guaranteeing liquidity and the credit of the securities pledged, and they count as liquid reserves under Basel III.

    The fee is justified by the degree to which the market has underpriced liquidity risk in recent years:

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  14. 3/3
    However, part of the point of the new liquidity regulations is to recognise that the market has underpriced liquidity in the past. Consequently, it is appropriate to levy a fee which is greater than implied by a long run of historical data. The net outcome is thus a weighted average of a relatively low liquidity premium in normal times and a much higher liquidity premium in stressed times.

    In determining the fee, it must be remembered that ADIs will not only have the option of meeting their LCR requirements through the Reserve Bank’s liquidity facility, they will always have the option of meeting their LCR requirements through holding RBA obligations. This is because, as mentioned earlier, ES balances are also recognised as liquid assets.
    Meanwhile, because Australia suffers from the phenomenon of too many “inside” securities in one market, the judgment is that to limit exposure to competitor banks, banks will be able to submit their own securitised paper for the facility too:

    As mentioned earlier, a large share of the securities on issue in Australia are “inside” the banking system. That is, they are securities issued by the banks themselves. The available pool of outside assets in Australia which includes securities issued by supranationals and corporates is small. Hence, the primary type of asset available in the market to the banking system to meet its liquidity needs is a security issued by another bank. In our judgement, and that of APRA’s, it would be undesirable for a bank to meet its liquidity needs by significantly increasing its exposure to the rest of the banking system. If a stressed situation was to arise at one bank, the increased cross-holdings could rapidly translate this to other banks. Moreover, if the stressed bank was to meet its liquidity needs by selling its holdings of securities issued by other banks into the market, this would also serve as a possible source of contagion to the rest of the banking system.

    Thus to reduce the likelihood of systemic risk, a bank will be able to hold some share of its liquid assets in the form of self-securitised mortgages. There is a trade-off here between systemic risk and reduced “market” liquidity of the bank’s asset holdings, but the bank will have access to liquidity from the RBA with these assets. In terms of the range of assets eligible for the CLF, the RBA reserves the right to broaden that range at any time, but will give 12 months’ notice of any decision to narrow the range. The latter condition will give banks adequate time to adjust their liquids holdings in response to any change.
    All in all, another example of collateral transformation — this time on a mightily more official level. But the question is will it work?

    And more importantly, if the crisis afflicting the Eurozone is just as much about a collateral crunch and market illiquidity, to what degree could a similar facility like this work there?

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  15. 1/2
    Effectively controlling assets, MF Global edition

    MF Global lost ‘effective control’ of its sovereign bond assets. This gifted the broker some rather favourable accounting treatment. The broker’s clients, meanwhile, wanted to keep effective control of their own assets, and not just in the accounting sense, but in a very real sense.

    As creditors and clients pick over the corpse of MF Global, reaching into its pockets for anything that can compensate them, we’re learning a lot about accounting for repos, and about what does and doesn’t work when it comes to protecting client assets.

    How to lose effective control with really trying

    To quickly recap, whether a repurchase transaction is recognised as a collateralised borrowing or an outright sale of assets hinges in large part on whether the seller of assets / borrower of funds has lost or retains ‘effective control’ of the assets. At least for the purposes of accounting in the US.

    Lehman’s Repo 105 transactions took the rather interesting tack of ‘selling’ them for a price that was a bit on the low side. This meant that they had lost effective control because they would be unable to buy back the assets using the cash they’d gotten from the lender (because they were paid too little).

    If you are wondering how it could ever, ever make sense to view the world in this way, think about what would have happened if Lehman’s counterparty had filed for bankruptcy (don’t laugh). In that case, Lehman would be sitting on the cash it received and could use it to purchase similar or identical assets in the market. But as stated, Lehman wouldn’t be able to afford them. Hence Lehman must have sold the assets (at a loss). It did so anyway because the cash was sorely needed.

    A funny bit of history is that this same accounting treatment was a negative for AIG’s securities lending business. AIG was a natural holder of securities, as an insurance business. It would lend its securities for cash and then use the cash to invest in RMBS that often had a longer maturity than the loan of securities. That didn’t end well.

    But even before that, the business model of securities lending came under pressure, with AIG forced to accept less and less cash in exchange for its securities. So little, in fact, that it had to start recognising them as a sale, i.e. AIG lost effective control and had to book a loss accordingly. Though this wouldn’t be nearly as big as the losses it would incur on the RMBS.

    Hence AIG is a curious case of an organisation that wasn’t even trying to get sale recognition — which moves the transactions off balance sheet — and yet its hand was forced.

    MF Global lost effective control not because of getting too little cash (or maybe that too), but primarily because the funding for its bond holdings matured at exactly the same time as the bonds themselves did. Therefore there were no further opportunities for control of the assets.

    What do you think about the principle of ‘effective control’ now?

    This year, the Financial Accounting Standards Board has taken an axe to exactly this principle, but some argue that it doesn’t go nearly far enough. FT Alphaville agrees with the Grumpy Old Accountants who argue that one should look at the economic substance of the transaction. This could be nicknamed the No Bull$hit Approach whereby you have to acknowledge if you are still exposed to the changes in value of the asset, and/or indeed you still retain rights to coupon payments.

    What do you think, Mr. Corzine? Was MF Global still exposed to its sovereign bond holdings? From his testimony on Thursday:

    MF Global retained, however, the risk that the debt securities might default or be restructured. If the debt securities defaulted or were restructured, then MF Global would not be paid in full at their maturity, even though MF Global would still have the obligation to buy back the debt securities from the Counterparty in full (at par).
    Sounds like a “yes”.

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    How to lose effective control without really trying

    About those client assets, and another legacy of Lehman. Why, oh why, did we not learn enough about how to properly segregate assets? A bit of jargon: rehypothecation.

    Rehypothecation is where a bank/broker takes client assets and repos them out. While that sounds iffy, it was (and in many places still is) normal practice. The upside for the client is cheaper funding from the broker because the client isn’t proving to be such a burden on the balance sheet. Sure, a client may request a fully segregated account and forbid the dealer from rehypothecating, but then expect higher costs. (Unsurprisingly, clients are proving more willing to bear the higher costs these days.)

    But the terrifying thing about MF Global is that not only have a lot of the ‘missing’ client funds seemingly been lost through seemingly legit rehypothecation that clients may not have been aware of (and yes, they probably should have known better), but there’s also some cross-border arbitrage coming to light.

    As Reuters points out (and you must go read the full article for more on the scale of rehypothecation):


    Under the U.S. Federal Reserve Board’s Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client’s liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

    But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).
    The next terrifying thing is that even clearing, that great regulatory panacea, didn’t help.

    Risk points out that non-US clients of MF Global have been largely unable to move (“port” in the jargon) their positions to another Futures Clearing Merchant (FCM). This is because the FCMs that are still standing want collateral and the clients can’t access the collateral that they posted with MF Global. And without that they are having (or have already had) their positions liquidated. Risk explains how this came to be:

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    European clients, for example, are not allowed to be a client of a US futures commission merchant (FCM) and are required to access the FCM indirectly. The client would open an account with a foreign broker, which in turn has an omnibus account with its affiliate FCM. In the case of MF Global, UK clients held accounts at MF Global UK Ltd (MFGUK), which opened an omnibus account with MF Global Inc (MFGI).

    In the event of the FCM’s insolvency, the foreign broker enjoys the same protections with respect to margin segregation and portability of positions as any other direct client of such FCM, but the omnibus structure contains pooled positions for all the broker’s non-US clients and does not necessarily ensure those clients can port their positions or have their margin segregated from other clients within the structure.
    Why this is so concerning:

    The lack of protection in the omnibus structure has caused some dealers to re-examine it, given they expect it to be used in the clearing of OTC products. “We’re holding fire on this and are not implementing the structure as yet for OTC swaps. We’re trying to figure out what the cross-regulatory streams mean and which rule should govern, and what that means for client money protections. If porting and the return of customer assets is a problem, then clients are going to think twice about using this structure. That said, the way regulations are currently written means clients might have to make use of this structure. So if a client is compelled to use it, we need to be absolutely sure what needs to happen in the event of a default,” says one head of OTC clearing at a US bank.
    FT Alphaville just got an idea for the next wave of crisis porn! Clearing: How ill-thought out, uncoordinated regulation brought the system to its knees. Ok, ok, it’s not just clearing, and we’ve already been there concerning the unintended consequences of regulation…

    (Publishers welcome to inquire.)

    http://ftalphaville.ft.com/blog/2011/12/08/786771/effectively-controlling-assets-mf-global-edition/

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  18. mam co czytac :-) ale od czego jest nocka tu i tam :-) THX SIP

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  19. MF global
    Troche po polsku, temat liźnięty ale już naprowadza na cel:
    http://omnis-moriar.blogspot.com/2011/12/upadek-mf-global-druga-odsona.html

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  20. MF Global – 2008 parallels like you wouldn’t believe

    For today’s edition of history rhyming, have a look at this (seminal) piece of research from Citigroup’s Matt King.

    On September 5 2008 — just weeks before Lehman Brothers collapsed — the Citi credit strategist sent out a research note carrying the provocative title of “Are the brokers broken?” The thesis was simple: America’s broker-banks were funding nearly half their own assets through repo transactions.

    In normal times, that wouldn’t be such a problem. But in the autumn of 2008 we were already entering the abnormal. Add to that the fact that much of this repo usage was appearing off-balance sheet, and you had a rather sizable potential problem as wholesale funding markets rapidly dissipated:

    First, the pledging of collateral to brokers in such large sizes – and the fungibility of pledged collateral with their own positions – significantly improves their own ability to take short positions, make markets and provide liquidity in other markets generally. Second, these numbers imply a gross dependence on repo financing far larger than the on balance sheet numbers suggest. Suppose, for example, that counterparties were to become concerned about the stability of a broker, and became reluctant to execute trades with and place collateral with them. The broker would, of course, immediately pass on this difficulty in their refusal to provide financing to their clients. But that in turn might spark other changes in the clients’ behaviour, such as an abrupt decision to withdraw their unencumbered cash balances and place them elsewhere, and/or to move their broader business to another counterparty. The broker would probably find their ability to conduct day-to-day business providing liquidity in markets somewhat hampered, and in extremis might even start to find themselves running short of cash. If this sounds extreme, it is worth remembering that it was just such a run on cash – as a result of hedge funds moving their money elsewhere – which is thought to have precipitated the problems at Bear Stearns.
    Who provided the financing?

    Mostly custodian banks charged with repoing out their clients’ assets in return for cash. Reverse repos in which less liquid securities (ABS, CDOs or whatever) had been accepted as collateral and lent out in return for cash dried up as subprime panic set in – generating a knock-on effect on brokers.

    Or as King put it:

    What we think is driving this is an increased risk aversion by the sec[urities] lenders [i.e. custodian banks], and indeed by their own clients. As the credit crunch has unfolded, the owners of the custody portfolios, along with many other investors, have become increasingly nervous, and have started to place constraints on how their cash is reinvested. Fear that started with problems in subprime and CDOs of ABS rapidly infected many other asset classes. ABCP is a prime example.
    There are, of course, eerie echoes in the MF Global bankruptcy.

    Indeed, JPMorgan, trustee of a $1.2bn liquidity facility for MFG, has since pointed out that it had aggressively “risk managed it down” exposure to the broker – suggesting, perhaps, that this lending and funding pullback had been going on for some time. Repo lenders simply got nervous once they heard about MFG’s eurozone exposures, hiked haircuts and effectively the plug was pulled.

    The difference now is that the collateral fears centre on eurozone exposures rather than subprime. Meanwhile, the financial community has responded to the 2008 crisis (rather ironically) by largely upping its use of secured funding; everything from basic repo trades to covered bonds.

    Which makes the current sovereign debt crisis all the more tricky. There are no easy answers here. No quick shift from sketchy securities into safer government assets, nor simplistic refuge in secured stuff.

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    MF Global and echoes of Repo 105
    Posted by Izabella Kaminska on Nov 02 08:33.
    What caused MF Global’s downfall?

    According to Bradley Abelow, MF Global’s Chief Operating Officer, much of the blame may lie with Finra’s unreasonable request for MF Global to add capital to support its off-balance sheet exposure to European sovereign debt and reveal them publicly. These were, as we have discussed, structured as repo-to-maturity trades. They were also maintained off-balance sheet.

    In a personal declaration filed in Chapter 11 proceedings (H/T Zerohedge), Abelow writes:

    As a global financial services firm, MF Global is materially affected by conditions in the global financial markets and worldwide economic conditions. On September 1, 2011, MF Holdings announced that FINRA informed it that its regulated U.S. operating subsidiary, MFGI, was required to modify its capital treatment of certain repurchase transactions to maturity collateralized with European sovereign debt and thus increase its required net capital pursuant to SEC Rule 15c3-1. MFGI increased its required net capital to comply with FINRA’s requirement.
    Upon this notice, Moody’s got a little skittish. As Abelow notes:

    On October 24, 2011, Moody’s Investor Service downgraded its ratings on the Company to one notch above junk status based on its belief that MF Holdings would announce lower than expected earnings.
    But that wasn’t good enough for Finra. They wanted the exact details of the trades revealed publicly in MF Global’s October results:

    On October 25, 2011, MF Holdings announced its results for its second fiscal quarter ended September 30, 2011. The Company revealed that it posted a $191.6 million net loss in the second quarter, compared with a loss of $94.3 million for the same period last year. The net loss reflected a decrease in revenue primarily due to the contraction of proprietary principal activities.

    Dissatisfied with the September announcement by MF Holdings of MFGI’s position in European sovereign debt, FINRA demanded that MF Holdings announce that MFGI held a long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity, including Belgium, Italy, Spain, Portugal and Ireland. MF Holdings made such announcement on October 25, 2011. These countries have some of the most troubled economies that use the euro. Concerns over euro-zone sovereign debt have caused global market fluctuations in the past months and, in particular, in the past week. These concerns ultimately led last week to downgrades by various ratings agencies of MF Global’s ratings to “junk” status. This sparked an increase in margin calls against MFGI, threatening overall liquidity.
    This brought attention to MF Global’s precarious liquidity exposure to the likes of the CFTC and SEC, pushing MF Global into seeking out alternative arrangements before its liquidity position became too precarious:

    Concerned about the events of the past week, some of MFGI’s principal regulators – the CFTC and the SEC – expressed their grave concerns about MFGI’s viability and whether it should continue operations in the ordinary course. While the Company explored a number of strategic alternatives with respect to MFGI, no viable alternative was available in the limited time leading up to the regulators’ deadline. As a result, the Debtors filed these chapter 11 cases so that they could preserve their assets and maximize value for the benefit of all stakeholders.
    Specific to everyone’s concerns were, of course, were MF Global’s ‘repo-to-maturity’ sovereign debt trades.

    Anyone following MF Global’s regulatory notices would though have been able to spot their disquiet early on.

    On September 1, for example, MF Global filed the following:

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  22. 2/2
    As previously disclosed, the Company is required to maintain specific minimum levels of regulatory capital in its operating subsidiaries that conduct its futures and securities business, which levels its regulators monitor closely. The Company was recently informed by the Financial Industry Regulatory Authority, or FINRA, that its regulated U.S. operating subsidiary, MF Global Inc., is required to modify its capital treatment of certain repurchase transactions to maturity collateralized with European sovereign debt and thus increase its required net capital pursuant to SEC Rule 15c3-1. MF Global Inc. has increased its net capital and currently has net capital sufficient to exceed both the required minimum level and FINRA’s early-warning notification level.

    The Company does not believe that the increase in net capital will have a material adverse impact on its business, liquidity or strategic plans. In addition, the Company expects that its regulatory capital requirements will continue to decrease as the portfolio of these investments matures, which currently has a weighted average maturity of April 2012 and a final maturity of December 2012.
    Regulators’ concern no doubt centred around the fact that such off-balance sovereign positions could pose very real and sudden liquidity issue in terms of margin calls. They were probably also conscious of such things as Lehman’s notorious Repo 105 arrangement.

    The fact that the trades depended more on collecting premiums (by holding positions until maturity) whilst being positioned off-balance sheet — rather than outright directional moves in the underlying bonds — was neither here nor there in their eyes.

    The key problem was always going to be that the positions — be they off-balance sheet or on –were always going to be subject to cash collateral calls as and when the bonds fell in price. Or, possibly, as counterparties demanded more collateral as they sought to protect themselves from a weakening in MF Global’s positions (potentially possibly and the terms and conditions of the deals).

    Whether those margin calls would have come as quickly if those positions hadn’t of been exposed, however, we couldn’t possibly know.

    But Bethany Mclean over at Reuters — who has an excellent explanation of the accounting advantage of booking these trades as repo-to-maturity — notes how once the cat was out of the bag and prospective buyers became aware of the degree to which MF Global was throwing cash at a sinking ship, the broker-dealer’s fate became relatively inevitable:

    The actual details of the run aren’t clear yet, but according to the CFO’s affidavit, the ratings downgrades “sparked an increase in margin calls,” which drained cash. Plans to sell all or part of the business fell through, reportedly because of the discovery of the missing cash. Another part of the explanation might be that potential buyers found out just how weak the core business was.

    Of course, if Corzine made the trades for an accounting play, there’s a deeper question of why he would feel the need to do this. And isn’t that always the question in situations like this?
    As to why Corzine felt the need to do the off-balance repo deals, that’s the real question shareholders and investors should now be asking.

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    Did accounting help sink Corzine’s MF Global?
    NOV 1, 2011 16:18 EDT
    On Monday morning, MF Global, the global brokerage for commodities and derivatives, filed for bankruptcy. The firm’s roots go back over two centuries, but in less than two years under CEO Jon Corzine, whose stellar resume includes serving as the chairman of Goldman Sachs, as New Jersey’s U.S. Senator, and as New Jersey’s governor, MF Global collapsed, after buying an enormous amount of European sovereign debt. The instant wisdom is that he made a big bet as part of his plan to transform MF Global into a firm like Goldman Sachs, which executes trades on behalf of its clients, and also puts its own money at stake. Although the size of the wager has received a great deal of scrutiny, the accounting and the disclosure surrounding it have not–and may have played a role in the firm’s demise.

    In the 24 hours since the filing, more ugly questions have piled up, with the New York Times reporting that hundreds of millions of dollars of customer money have gone missing, and the AP saying that a federal official says that MF Global has admitted to using clients’ money as its problems mounted. Whether this was intentional or sloppy remains to be seen; MF Global didn’t respond to a request for comment by press time.

    At the root of MF Global’s current predicament was a simple problem: the profits in its core business had declined rapidly. That core business was straightforward, even pedestrian; what the firm calls in filings a “significant portion” of total revenue came from the interest it generated by investing the cash clients had in their accounts in higher yielding assets and capturing the spread between that return and what was paid out to clients. As interest rates declined sharply in recent years, so did MF Global’s net interest income, from $1.8 billion in its fiscal 2007 second quarter to just $113 million four years later. MF Global’s stock, which sold for over $30 a share in late 2007, couldn’t climb above $10 by 2009.

    Enter Corzine in the spring of 2010, who had just lost his job as New Jersey’s governor to Chris Christie. He was brought in by his old pal and former Goldman partner Chris Flowers, whose firm had invested in MF Global. Fairly quickly, Corzine accumulated a massive net long sovereign debt position that eventually totaled $6.3 billion, or five times the company’s tangible common equity as of the end of its fiscal second quarter. I’m told Corzine’s move was highly controversial within the firm. But no one overruled him, maybe because after all, he was Jon Corzine. In a mark of just how much Corzine mattered to the market, in early August, MF Global filed a preliminary prospectus for a bond deal, in which the firm promised to pay investors an extra 1% if Corzine was appointed to a “federal position by the President of the United States” and left MF Global.

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  24. 2/3

    Buying European sovereign debt may not have been just a bet that the bonds of Italy, Spain, Belgium, Portugal and Ireland would prove attractive. An additional allure may have been the way MF Global paid for the purchases, and thereby, the way the accounting worked. MF Global financed these purchases, as its filings note, using something called “repo-to-maturity.” That means the bonds themselves were used as the collateral for a loan, and MF Global earned the spread between the rate on the bonds, and the rate it paid its repo counterparty, presumably another Wall Street firm. The bonds matured on the same day the financing did.

    The key part is that for accounting purposes, MF Global’s filings say the transaction was treated as a sale. That means the assets and liabilities were moved off MF Global’s balance sheet, even though MF Global still bore the risk that the issuer would default; that means the exposure to sovereign debt was not included in MF Global’s calculation of value-at-risk, according to its filings. And that also means MF Global recognized a gain (or loss) on the transaction at the time of the sale. The filings do not say how much of the gain was recognized upfront. But if it were a substantial portion, then these transactions would have frontloaded the firm’s earnings. That, in turn, may have helped cover the fact that MF Global’s core business was struggling.

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    MF Global’s public filings also don’t say how much this contributed to earnings. But one indication of the size of the repo-to-maturity deals comes in this small excerpt from MF Global’s most recent 10K, under the heading of “Off balance sheet arrangements and risk”: “At March 31, 2011, securities purchased under agreements to resell and securities sold under agreements to repurchase of $1,495.7 million and $14,520.3 million, respectively, at contract value, were de-recognized.” (“De-recognized” means moved off the balance sheet.) Of that $14.5 billion, 52.6% was collateralized with sovereign debt. One way to get a sense of the ramp-up of “repo to maturity” transactions is to compare the figures to those as of March 31, 2010: The securities sold under agreements to repurchase increased by some $9 billion.

    Once the regulators and rating agencies began to zero in on all of this, it didn’t matter that the trade itself may not have been that risky. (The debt all matured by the end of 2012, and MF Global, of course, had financing in place until it matured.) But it was European sovereign debt, after all, and the trade was huge—and it appears that part of the concern may have been the accounting, and certainly the lack of disclosure. On September 1, MF Global said in a filing that the Financial Industry Regulatory Authority (FINRA) was requiring it to “modify its capital treatment” of the European sovereign debt trades. According to an affidavit filed by MF Global’s president on the day of the bankruptcy, FINRA was “dissatisfied” with the September filing and “demanded” that MF Global announce that it “held a long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity.” Words like “dissatisfied” and “demanded” aren’t good in the context of a regulator!

    By the time the market opened on Monday, October 24th, MF Global’s stock had already fallen 62% from its high of almost $10 following the announcement that Corzine was joining the firm. Then, Moody’s downgraded the firm’s debt, citing MF Global’s “inability to generate $200 million to $300 million in annual pretax earnings and keep its leverage within acceptable range.” In other words, Moody’s was concerned about the real profitability of the business. The next day, MF Global reported its $6.3 billion position, per FINRA’s demand, and also reported that it had lost almost $200 million in the quarter ended in September—in large part because the firm had reduced its deferred tax assets by $119.4 million, a sign that the accountants were saying there wouldn’t be a return to big profits any time soon. By the end of the week, all three rating agencies had downgraded MF Global debt to junk. Moody’s wrote that its downgrade “reflects our view that MF Global’s weak core profitability contributed to it taking on substantial risk in the form of its exposure to European sovereign debt.” MF Global’s stock finished the week down 67%.

    The actual details of the run aren’t clear yet, but according to the CFO’s affidavit, the ratings downgrades “sparked an increase in margin calls,” which drained cash. Plans to sell all or part of the business fell through, reportedly because of the discovery of the missing cash. Another part of the explanation might be that potential buyers found out just how weak the core business was.

    Of course, if Corzine made the trades for an accounting play, there’s a deeper question of why he would feel the need to do this. And isn’t that always the question in situations like this?

    PHOTO: Jon Corzine, MF Global Holdings Ltd. CEO, leaves the office complex where MF Global Holdings Ltd have an office on 52nd Street in midtown Manhattan, October 31, 2011. REUTERS/Brendan McDermid

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  26. 1/2
    MF Global and the repo-to-maturity trade
    Posted by Izabella Kaminska on Oct 31 19:26.
    If ever there was an example of an “overnight repo Black Swan” event, MF Global’s “repo-to-maturity” laddered trades seem to be it. Though, in this case, they’re probably better described as the realisation of the “short-term repo Black Swan”.

    A.k.a institutions’ growing tendency to risk it in the short-term repo universe, to beat the crappy returns being offered in the “risk-free” market.

    So, while most of the media has been commonly referring to MF’s sovereign bond positions as proprietary bets gone wrong, there’s more to it than just that.

    If anything this was a financing position (or liquidity trade) — not a bet on the future direction of the bonds themselves.

    What’s more, if executed properly the trade should — at least on paper – have posed little or no risk.

    The maths was simple enough. You account for the cost of borrowing funds using the bonds in question as collateral (the repo rate) versus the ultimate coupon payments received from the very same bonds.

    This is because in dysfunctional markets the repo rate can be out of kilter with the ultimate returns of the bond itself. This is especially the case if there are more counterparties willing to provide short-term liquidity in return for rates that beat the nominal risk-free return. In other words to act as pawnbrokers to the market. Alternatively, if you have a good credit standing in the market you may be able to achieve a more favourable repo rate than others.

    If everyone plays their cards right, MF Global receives financing (or liquidity) at a better rate than the market’s – since they are offsetting the repo charges with the ultimate coupon payments — and the counterparty is rewarded in basis points for holding the bond in the interim.

    Gross profit is simply total inflow minus total outflow.

    As fixed income guru Moorad Choudhry noted in the “Repo Handbook” such a trade should generally be considered low-risk since the financing profit on the bond position is known with certainty until the bond’s maturity.

    For financial institutions that operate on an accruals basis rather than market-to-market basis, the trade can guarantee a profit and not suffere any losses in the interim while they hold the bond.
    In other words, mark-to-market ought not be a concern. As long as the bond pays out at the price you bought if for (which it will if it is held to maturity), it should not be considered a risky position.

    As can be seen from MF Global’s earnings statement, MF was indeed counting on the EFSF guarantee to ensure that this would be the case:

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    As of September 30, 2011, MF Global maintained a net long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity (repo-to-maturity), including Belgium, Italy, Spain, Portugal and Ireland. The laddered portfolio has an average weighted maturity of October 2012 and an end date maturity of December 2012, well in advance of the expiration of the European Financial Stability Facility in June 2013. (see supplemental table for further details)

    “Over the course of the past year, we have seen opportunities in short-dated European sovereign credit markets and built a fully financed, laddered maturity portfolio that we actively manage. We remain confident that we have the resources and expertise to continue to successfully manage these exposures to what we believe will be a positive conclusion in December 2012,” Mr. Corzine concluded.
    On top of that — just in case an unexpected default risk came its way — MF Global had actually hedged the $6.3bn position with a $1.3bn short French government bond trade.

    So what on earth went wrong?

    Italy and Belgium are, after all, still very unlikely to default before the end of 2012. There is no reason, therefore, why the bonds shouldn’t payout.

    Which leaves only the possibility of some skittish repo counterparties suddenly getting cold feet and pulling out (or demanding a greater proportion of over-collateralisation with respect to the loan.

    If repo contracts were completely reneged upon, this would not only have left MF with a sudden liquidity issue — especially if they couldn’t find a fresh counterparty — but also with a sudden need to mark-to-market the bonds.

    Indeed as Reuters reported on Monday:

    Last week, counterparties likely pressed MF Global to post more collateral on derivatives trades and may have started reducing the company’s repo financing lines, market sources said.
    We’re not sure exactly how easy it is to undo a “repo-to-maturity” trade, but it does leave us wondering who exactly those counterparties might have been.

    Update 9.30pm GMT: As Kamekon points out below, in most circumstances — depending on the terms and conditions — repos would be subject to regular margin calls or “loan repayments” which re-establish the original repo ratio. Either way, a fall in the value of the bonds could create a major liquidity drain for MF Global. Though these sorts of liquidity risks should have been accounted for in VaR calculations. Much harder to anticipate would have been a complete disappearance of willing counterparties.

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  28. European bet triggered MF Global’s demise

    The demise of MF Global was triggered by a risky bet that sought to exploit the difference between the cost of its borrowings and the interest payments on European sovereign debt.

    The bank’s fall has been popularly linked to the broker-dealer’s foray into proprietary trading and straightforward directional bets on Eurozone sovereign bonds. But its bets were based on a more complex arbitrage strategy that eventually left it carrying losses on a net $6.3bn exposure to Italian, Belgian, Spanish, Portuguese and Irish debt.


    In its October 25 earnings statement, MF Global used one of the more arcane and inelegant terms in the credit market lexicon to describe these bets – “repo-to-maturity” trades.
    These trades sought to take advantage of the European financial stability facility’s guarantee, expiring in June 2013. This guarantee meant that MF Global could be sure of the coupon payments on bonds it bought.
    So the bank bought a swath of European bonds offering high yields and maturities ending no later than December 12 with so-called “repo” financing – a method of funding common in financial markets where one party agrees to sell and repurchase an asset, such as bonds, at a pre-determined price.
    Like other repo deals, MF Global used the bonds themselves as collateral. The twist from usual repo deals, which can be unwound at any point, was that the bets had a fixed term – the maturity of the bonds.
    The positive side of this was that MF Global was seeking to lock in returns, the gap between the funding cost and the coupon rates.

    However, the trade’s greatest folly was that as the market prices of the bonds fell sharply, it would have to pay higher amounts of collateral, soaking up its liquidity. Jon Corzine, the company’s chief executive, noted in the October 25 statement that the company felt confident it would have the resources and expertise to manage these exposures until their maturity.
    However, as concerns about MF Global itself spread, it also came under greater demands for collateral from counterparties on trades. These concerns escalated after Moody’s Investors Service warned on October 27 that MF’s positions may have exposed the firm to a heightened risk of loss of client and counterparty confidence
    Moorad Choudhry, head of business treasury at Royal Bank of Scotland, explained in his book The Repo Handbook that one of the main reasons for entering into repo-to-maturity is to fix a funding rate against the return on the asset. If you can ensure a good rate, then on paper the trade can work out to earn easy basis points.
    “In theory, this guarantees a positive return, provided the return from the asset exceeds the funding cost for the term of the trade,” he wrote.
    But some market experts suggested the trade made little sense and was as risky as a directional bet, if not more.
    “It’s no good having a straight position if you can’t wear the unrealised volatility on a day-to-day basis,” the same market expert said.
    Lena Komileva, chief economist and managing director at G7 Market Economics, said: “Since the heydays of securitisation, banks have continuously confused operational risk for market risk – leveraging off high-yielding but illiquid assets has a damaging effect on both a bank’s capital and on market liquidity.”

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    The overnight Black Swan
    Posted by Izabella Kaminska on Aug 31 12:52.
    It used to be that lending was done on unsecured term durations, all the time.

    Then we had the credit crunch, and unsecured term lending died.

    Then everyone started lending on a collateralised basis. Term collateral rates became more meaningful than unsecured rates.

    And then — eventually — the collateral rate became more meaningful on an overnight basis too, leading some countries to even invent collateralised benchmarks like Ronia — the UK’s Repurchase Overnight Index Average.

    But along with all this came an important side development too.

    The rise of the collateral swap. Also known as a long-dated repo.

    The premise was simple. Prudent institutions flush with top quality government bonds (or even cash) wanted to secure a better rate of return — on a still relatively low-risk basis. We’re talking insurance firms, pension funds and other low-risk asset managers.

    They weren’t keen to lend unsecured, that was for sure. But they were prepared to engage in collateralised swap deals with cash-strapped investment banks or the shadow banking industry (who were looking for cheap funding) — gaining extra yield on their low-yielding ‘safe’ securities by indirectly funding more risky investments elsewhere. The shorter the duration of the loan the safer.

    The shadow banking community thus inadvertently got drawn into being an intermediary agent, acting as a go-between in the channeling of cash into higher yielding investments like junk bonds, mortgage debt and emerging market securities (and sometimes even peripheral European debt).

    Though, even now, very little is known about the nature, popularity and size of such deals. But they do encompass many forms, that we know.

    A draft paper by Dan Awrey entitled “Complexity, Innovation and the Regulation of Modern Financial Markets” and dated August 25, 2011 attempts to shed some more light.

    As he notes, these so far are known to be the characteristics:

    A collateral swap is essentially a form of secured lending whereby one counterparty transfers relatively liquid assets to another in exchange for a pledge of less liquid collateral. In a typical collateral swap, a bank holding a portfolio of ABS or other securitizations will transfer these assets to a pension fund or insurance company which, in exchange for a periodic fee, will deliver a portfolio of more liquid collateral such as high-grade government or corporate bonds.

    The pension fund or insurer thereby receives a higher yield on its (ostensibly) safe investments, while the bank obtains access to a portfolio of liquid assets which it can then re-pledge to obtain funding from central banks and other sources which, in the wake of the GFC, have been less willing to accept ABS and other securitizations as eligible collateral. The development of collateral swaps is thus, in effect, an innovative response to both the post-crisis funding constraints on banks and the need to satisfy new liquidity requirements soon to be imposed under Basel III.
    And these are the issues he identifies:

    Collateral swaps contribute to the complexity of modern financial markets in at least three ways. First, the collateral swap market is extremely opaque. Nobody knows with any certainty, for example, how big this market is, who the major players are, or the size of the aggregate exposures. As a result, it is exceedingly difficult to ascertain the nature and extent of the attendant risks. Second, given the identity of the counterparties, collateral swaps seem destined to strengthen the interconnections between (1) banking markets and (2) insurance and pension markets. Finally, as described above, collateral swaps are a reflexive response to changes in the post-crisis market and regulatory environment.
    Some commentators (among them FT Alphaville) have noted this is almost akin to the privatisation of liquidity ops.

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  30. 2/2
    Others go as far as to say, it’s the key reason why the Fed is likely to shy away from QE3. It’s depending on exactly these processes to get the money flowing into riskier assets.

    After all, consider all those zero-yielding (or worse still, fee incurring) deposits currently being gathered at prudent and low-risk institutions. Eventually the need for yield will overcome capital preservation behaviour (is the hope).

    As Perry Mehrling, professor of Economics at Barnard College, Columbia noted earlier this month:

    Basically, the ZIRP provides strong incentive for carry trades of all kinds. If you can borrow at zero, and can roll your borrowing for two years, then anything with a positive yield looks good. If a hedge fund borrows at zero and buys MBS, that is QE1 private-style. If a hedge fund borrows at zero and buys long-dated Treasuries, that is QE2 private-style.

    The difference is that, since the Fed is not doing the trade on its own balance sheet, it has no control over which trades get made. Private speculators can also buy yen or Swiss francs, and central banks intent on preventing currency appreciation are forced to take the other side of the speculation, so doing their own QE. And speculators can also buy gold, or indeed any other asset, so long as expected capital gains exceed storage costs.

    Another difference is that private-style QE gets financed with private money expansion (private debt secured by the asset purchased) rather than public money expansion (Fed debt which is bank reserves). From this perspective, private-style QE3 looks like a repurposed shadow banking system. As everyone now knows, the collateral that stood behind the original shadow banking system turned out not to be the AAA credit it was claimed to be. But, at the time, demand for private money backed by that dodgy collateral was sufficiently strong that there were strong incentives not to look too closely.
    Though, as and when things get riskier, there’s also a critical downside to this development. Private money has no obligation to keep funding. It can pull its money sharply and quickly.

    What’s more, if and when it’s tempted back into the lending market the duration of such long-term collateral swaps is likely to get shorter. You’re still happy to lend for yield, just for a shorter duration.

    Professor Lew Spellman, for example, has noted that in many ways it’s the development of a shorter, even overnight, term collateral swap market (especially when conducted with the shadow banking community) that could create an entirely brand new black-swan risk.

    An overnight funding squeeze which emerges almost from nowhere, or what you could call a totally unanticipated overnight black-swan event. Demand deposit risk, squared

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  31. 1/2

    Shadow banking and the seven collateral miners
    Posted by Izabella Kaminska on Dec 09 09:48.
    In the words of Goldman Doc, Morgan Grumpy, JP Happy, Bank of Sleepy, Barclays Bashful, Sneezy Citi, and Dopey Deutsche:
    We dig dig dig dig dig dig dig from early morn till night
    We dig dig dig dig dig dig dig up everything in sight
    We dig up diamonds by the score
    A thousand rubies, sometimes more
    But we don’t know what we dig ‘em for
    We dig dig dig a-dig dig
    Collateral mining: one of the most overlooked and least understood bank funding sources in the financial system.

    The concept stems from the latest IMF working paper, entitled ‘The non-bank-bank nexus and the shadow banking system‘, by Zoltan Pozsar and Manmohan Singh,

    http://www.imf.org/external/pubs/ft/wp/2011/wp11289.pdf

    in which they describe how asset managers have come to replace traditional creditors — primarily households — as the key financiers to the banking system.

    Asset managers, from hedge funds and ETFs, to pension funds and insurance firms, have become the ‘ultimate sources of collateral’ for the so-called shadow banking system. Via the process of rehypothecation the practice leads to long complicated collateral chains and something the authors describe as ‘reverse maturity transformation’.

    This is the process by which asset managers (especially real money asset managers), who are traditionally known to make long-term investment assets, voluntarily transform their long term assets into short-term liabilities (the sort that commercial banks would ordinarily create by taking in retail deposits).

    The tendency to load up on short-term liabilities is due to a number of factors, but mostly managers’ desire to boost returns — something they can do by engaging in securities lending, a process which sees them receive cash collateral in exchange for the securities they loan. It’s a win-win situation, since the access to cash helps them manage the liquidity needs of their funds more easily.

    But the asset management’s cash exposure has also gone on to influence the funding patterns of the financial system at large.

    This is because asset managers generally want to reinvest the cash while they hold it. Their preferences are for non M2-type investments (that is, not investing in bank deposits) since their primary aim is to receive interest on the cash they hold as collateral, but to limit unsecured exposure to the banking system. As Pozsar and Singh note, no risk manager would sign off on significant unsecured bank exposures via uninsured deposits.

    Since principal protection and interest are seen as key, this has tended to see the cash reinvested over extremely short durations in paper that’s as high-yielding and ‘safe’ as possible. Generally the preference is towards short-term publicly guaranteed debt such as Treasury bills and privately guaranteed wholesale funding instruments, such as repos. We’ve described it as the possible makings of an ‘overnight’ black swan.

    As Pozsar and Singh explain:

    The money demand aspect of the asset management complex is an often overlooked feature of modern finance. It involves massive volumes of reverse maturity transformation, whereby significant portions of long-term savings are transformed into short-term savings. It is due to portfolio allocation decisions, the peculiarities of modern portfolio management and the routine lending of securities for use as collateral. This reverse maturity transformation occurs in spite of the long-term investment horizon of the households whose funds are being managed. This reverse maturity transformation is the dominant source of marginal demand for money-type instruments in the financial system.
    The flipside to the arrangement, of course, sees asset managers’ longer-term investments return to the system.

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  32. From the perspective of the dealer community, the hunt for collateral has actually become something akin to a goldmining operation, say the authors:

    Banks (especially dealers) intermediate the collateral world to provide funding, settle trades, enhance returns for clients, and hedge counterparty risks on OTC derivatives. Obtaining collateral is similar to mining. It involves both exploration (looking for deposits of collateral) and extraction (the “unearthing” of passive securities so they can be re-used as collateral for various purposes in the shadow banking system).
    The most valuable collateral being seen as the sort which can be re-used and re-pledged time and time again, a fact which leads to extremely long collateral chains, as illustraed here (click to enlarge):
    http://av.r.ftdata.co.uk/files/2011/12/collateral-chain.jpg

    Since it’s hard to track the linkages of this sort of reverse transformation and re-use of collateral, the authors say the process can have implications on our understanding of financial institutions’ balance sheets and the measurement of financial and monetary aggregates.

    In other words, it can greatly obscure the picture.

    Collateral crunches — or simply, a sudden lack of acceptable collateral in the system — can in this way also lead to much greater funding stresses than might otherwise be expected.

    According to the authors, at the end of 2010 there was something like €5,800bn in off-balance sheet items of banks related to these sort of collateral mining operations and collateral re-use.

    As they noted in the report:

    While down from about $10 trillion at year end-2007, this remains very large, with micro-prudential and macro-prudential implications.
    That makes the role of the central collateral desks, sometimes home to the banks’ ‘delta one’ operations, known for collateral ‘sweating’ strategies, one of the most important organs in a bank’s structure.

    Most importantly, the desks link everything from demand for funding and collateral, to investment strategies and trading flows. It’s also why dysfunctions in repo markets can have such far reaching effects.

    And why broker-dealers might end up invested in riskier than expected sovereign debt positions, with missing client funds to boot (potentially encumbered elsewhere).

    The authors’ recommendations to regulators:

    Regulators may need to reconsider and fine-tune the leverage definitions of banks to incorporate collateral chains due to the sizable volumes of pledged collateral that churn between banks and nonbanks. For example Lehman, at the eve of its bankruptcy (end- 2007), had $800 billion in pledged collateral that could be repledged in Lehman’s name, while its balance sheet size was only about $700 billion.
    Quite.

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  33. 1/2
    Nomura on Draghi’s failure to address the collateral problem
    Posted by Izabella Kaminska on Dec 09 11:19.
    There are a growing number of voices suggesting that much of the Eurozone funding crisis could be simmered by addressing one of its most identifiable symptoms. The quality collateral crunch in the system.

    As we’ve noted before, there are many reasons to think that the trend towards ‘quality’ collateralised funding is having as much of an impact on the valuation of bonds in both private and central bank funding markets, as the perception that European sovereigns might be insolvent.

    Given that fact, the likes of Nomura’s Guy Mandy, as well as Christian Hellwig Professor of the Toulouse School of Economics and Thomas Philippon of the Stern School of Business, NYU writing on VoxEu, believe a credible solution that could help soothe funding tensions — at least in the immediate future — would be the decision for the ECB to issue ECB bills or for Treasuries to unite in the issuance of Eurobills.

    The idea — similar to the Fed’s cooperation with the Treasury in its Supplementary Financing Progamme – would be to provide the collateral markets, which are crying out for investable high-grade securities, with a form of positive-yielding and collective eurozone ‘quality’ asset.

    Needless to say, Draghi failed to announce any such measures this week, a fact which could disappoint collateral markets, according to Mandy:

    Changes to the ECB’s extraordinary measures fell short of improving the level of high quality eligible collateral and solving other issues such as unproductive excess reserves that we had hoped for.
    That said, there are some measures which could be considered helpful, among them the option to pay back long term funds after one year and the improvement on the breadth of eligible collateral for public repo.

    As Mandy explains:

    The changes are marginally positive however, with further improvement on the breadth of eligible collateral for public repo, particularly in the case of ABS for peripheral banks. There was a noticeable lack of action on haircuts on sovereign bonds, though if this were to occur it would be unlikely to occur before a “fiscal compact” is reached amongst European politicians.

    The dropping of the reserve ratio from 2% to 1% is positive for weak banks, but will likely increase cash on deposit with the ECB from strong banks.

    The new 3yr LTRO, with a 1yr payoff option is also a positive move and we would expect a large take up at this operation. The additional liquidity will boosts banks’ solvency, from a liquidity stand point rather than balance sheet solvency.

    —–

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  34. The flexibility of early repayment after one year, effectively an American option, is very valuable. This means that ‘if’ the sovereign stress/economic situation improves to a point where unsecured funding becomes the normality rather than the exception collateral isn’t encumbered for the full three years. At the same time if the European economic backdrop improves and inflationary pressures rise coupled with the ECB increasing the policy rate institutions are not locked into paying a rate which is indexed to this policy rate.
    As regards the removal of fine tuning operations, this proves interesting only in that it shows that the operations have now become useless at trying to influence Eonia, which is continuing to trade at a signifcant spread to the policy rate.

    On the reserve ratio cut, meanwhile, Mandy is of the opinion that while it might help the weak banks in the system, it may do little to discourage the liquidity hoarding behavior of the larger institutions:

    The ECB is lowering the required reserve ratio from 2% to 1% from 18 January 2012. The cutting of reserves leads to a lower mandatory pull of cash into the ECB through the reserve maintenance period (average reserve requirement for current maintenance period is €207bn), which is positive for weaker banks. The reserve requirement is based on the level of short term liabilities at the end of the month two months prior to the maintenance period. In times liquidity/credit crises short term liabilities tend to go up, with this generally being more acute for weaker banks.

    As it is a lagging calculation, we may have just started seeing the incremental add over the next few periods. So the dropping from 2% to 1% should cushion this rise While the requirement reduction will leave more cash in the system, the excess liquidity increase via strong banks is still likely to be put on deposit with the ECB, while the financial system remains stressed.
    Which is why, from the perspective of the collateral markets at least, the best move would have been the announcement of ECB bills, says Mandy.

    In our view, a complementary solution to the high quality collateral shortage for private repo and the reduction of unproductive excess reserves would be to issue ECB bills. This provides a liquidity drain as well as high quality collateral.

    Net net we think the ECB missed a crucial opportunity to provide a solution to the acute shortage of high quality collateral in the European private repo market, the details of which we outlined in our note on Monday.
    Conclusion: it’s a Draghi fail.

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  35. Trystero na blogi.bossa.pl zajawkowo też:

    Co się stało z pieniędzmi klientów MF Global?
    Autor: Trystero | Tagi: Jon Corzine, MF Global, rehypotekacja, system finansowy | 2011.12.11

    Bankructwo MF Global to ósme największe bankructwo w historii USA. Myślę, że pozostałoby kolejnym przykładem ‘tradycyjnych’ patologii w sektorze finansowym gdyby nie drobny fakt: MF Global ‘zapodział’ około 1,2 mld USD pieniędzy swoich klientów.


    To fundamentalna sprawa ponieważ przynajmniej teoretycznie, w biznesie brokerskim pieniądze klientów brokera i pieniądze brokera powinien oddzielać Chiński Mur. Krótko mówiąc, zwykło się uważać, że broker nie ma prawa używać pieniędzy klientów do finansowania, zabezpieczania transakcji zawieranych na własny rachunek.
    http://blogi.bossa.pl/wp-content/uploads/2011/12/MF-global-lewar.jpg
    Innymi słowy, to zupełnie normalne, że zlewarowana na poziomie 33 do 1 instytucja finansowa angażuje się w ryzykowną transakcję której podstawą są obligacje państw, których prawdopodobieństwo bankructwa wynosi kilkadziesiąt procent. To normalne, że szef tej instytucji składa rezygnację, publicznie oświadcza, że jest mu bardzo przykro i zatrzymuje wszystkie pieniądze zarobione w okresie gdy kierował swoją firmę ku katastrofie. ‘Zgubione’ 1,2 mld USD pieniędzy klientów zmienia wszystko.

    więcej z komentarzami u autora wpisu:
    http://blogi.bossa.pl/2011/12/11/co-sie-stalo-z-pieniedzmi-klientow-mf-global/

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  36. @MFG:

    Ocena bilansu ryzyk
    Upadek MF Global zwrócił uwagę na problem rehipotekowania zabezpieczeń. Okazuje się, że firmy przyjmujące zabezpieczenie, szczególnie jeżeli były w Wielkiej Brytanii mogły nim dowolnie dysponować, na przykład pozyskać finansowanie przekazując to zabezpieczenie dalej, do innej firmy, która mogła zrobić tak samo. MFW szacuje, że wygenerowany w ten sposób lewar wynosił cztery do jednego. Oznacza to, że bezpieczne finansowanie, które były postrzegane jako zabezpieczone aktywami, zostało przez proces rehipotekowania przekształcone na finansowanie pozbawione zabezpieczenia w około 75 procentach. W przypadku implozji sektora bankowego może to spowodować olbrzymie straty, bo nie będzie można odzyskać zabezpieczeń. Problem może się nasilić gdy agencje ratingowe obniżą ratingi krajom strefy euro, gdyż ilość aktywów o wysokim ratingu które mogą być zabezpieczeniem dla transakcji jeszcze bardziej spadnie.


    Nadchodząca implozja sektora bankowego w Europie jeszcze bardziej pogłębia ryzyka głębokiej i długotrwałej recesji. To oznacza dalsze kłopoty z refinasnowaniem długu wielu krajów, w tej sytuacji sensowne wydają się pozycje long CDS w tych krajach i SHORT na obligacjach i indeksach giełdowych, które nie wyceniają jeszcze w całości skali spowolnienia.

    W minionych dekadach główne pary walutowe czasami były determinowane przez różnicę stóp procentowych, a czasami przez różnicę we wzroście gospodarczym. W mojej ocenie te modele będą obecnie dawały błędne wskazania, ponieważ kluczowa jest premia za default risk, która wkrótce dramatycznie wzrośnie w strefie euro (po fali obniżek ratingów które według zapowiedzi agencji będą miały miejsce w Q1′2012). Dlatego w perspektywie 6-12 miesięcy dolar powinien umocnić się do euro. Paradoksalnie, dolar umocnił się po obniżeniu ratingu dla USA przez SandP, ponieważ zostało to odebrane jako wzrost ryzyka globalnego kryzysu, a to z kolei najbardziej zaszkodzi Europie, która ma najmocniej zalewarowane banki. Dolarowi mogą zaszkodzić tylko bardzo złe dane ekonomiczne.

    Europie zaszkodzi również zbliżająca się fala protekcjonizmu. Szwajcaria rozważa zawieszenie swobody przepływu kapitału (zapowiadałem to na tym blogu jakieś pół roku temu), żeby powstrzymać umacnianie franka, ponieważ wskaźniki wyprzedzające zapowiadają nadchodzącą recesję, a mocny frank może ją jeszcze pogłębić. Podobne metody, tylko zatrzymujące oszczędności w kraju, mogą wkrótce zastosować Grecja i Włochy, jeżeli run na banki w tych krajach będzie się nasilał (w Grecji mamy już run detaliczny, we Włoszech na razie hurtowy).

    Dla Polski oznacza to poważne problemy, ponieważ mamy wielka ujemną pozycję inwestycyjną netto, a prognozowane deficyty na rachunku bieżącym jeszcze ją pogłębią. Dlatego złoty może być jedną z najsłabszych walut w 2012 roku, wbrew coraz częstszym interwencjom rządu i NBP.
    http://www.rybinski.eu/?p=3427&lang=pl

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  37. The awards curse strikes at JP Morgan…
    Posted by Tracy Alloway on Jun 04 08:55.
    Last Friday:

    [The Banker Innovation in Banking Technology Awards 2010]

    Chair’s Choice and Innovation in Custody and Securities Services

    Winner: JPMorgan (Worldwide Securities Services)

    Project: Rehypothecation Program

    The process of rehypothecation allows institutions – in many cases hedge fund clients – to extract greater value from their collateral by reusing this collateral elsewhere in the market, increasing liquidity and reducing collateral costs. But the little-known practice gained a bad press in the aftermath of Lehman Brothers’ collapse, as many hedge funds discovered their assets to be legally trapped within the bank’s insolvent estate.

    Against this backdrop, JPMorgan’s forward-thinking Rehypothecation Program stood out, directly addressing market misgivings regarding the practice while simultaneously allowing the practice to be safely extended to the benefit of clients. Winner of both this year’s Chair’s Choice and Innovation in Custody and Securities Services, JPMorgan Rehypothecation Program supports the multi-asset class, unlimited re-use of collateral.
    This Friday:

    The record £33.3m [FSA] fine imposed on JPMorgan for failing to keep billions of dollars of client money in separate accounts underscores an industry-wide problem that has embarrassed UK regulators and is likely to lead to several more enforcement cases.

    The Financial Services Authority has required banks, brokers and insurance companies to segregate client assets since 2002, and it also requires auditors to certify that the assets are being handled properly.

    But events of the past few years have proved those guarantees to be hollow. In 2008, the collapse of Lehman Brothers left clients in the lurch and unable to recover their money without a protracted court battle.
    Ouch.
    http://ftalphaville.ft.com/blog/2010/06/04/251846/the-awards-curse-strikes-at-jp-morgan/

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  38. polecam!
    1/2
    The Fed, MFG and Reg. T
    I think there is sufficient evidence today to conclude that Re-Hypothecation is at the root of the customer losses at MFG. This Reuters story started the discussion on re-hypothecation. There have been several additional articles on this at Zero Hedge, (link, link) and FTAlphaville (link, link). Let me add one additional bit of info.

    The Canadian customers of MFG got their money back within 10 days of the MFG bankruptcy. The accounts that have lost money are either USA or UK based. In Canada, re-hypothecation is not permitted. I got these comments from a Canadian MFG account holder:

    The trustee where segregated MF Global Canada customers' funds were held was RBC Dominion Securities. I don't think any of these funds ever left the trustee in Canada. Likelihood is if they left, the Canadian government would have made the parent Royal Bank of Canada eat up the losses and make full restitution.
    We shall see in the coming weeks if, in fact, re-hypothecation is the cause of the problems. I’m convinced it is.

    The rules on broker's ability to A) Hypothecate and B) Re-hypothecate in the USA are spelled out in Reg T. This set of rules has been established by our good friends at the Federal Reserve Bank. Let me provide some telling words on this re Reg. T rule 15c3-3: (emphasis mine/Link)



    • Except as otherwise agreed in writing by the OTC derivatives dealer and the counterparty, the dealer may repledge or otherwise use the collateral in its business;

    • In the event of the OTC derivatives dealer's failure, the counterparty will likely be considered an unsecured creditor of the dealer as to that collateral;

    • The Securities Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.) does not protect the counterparty.

    Well there you have it. Reg. T does permit the broker to “repledge” (AKA re-hypothecate). In the event of default by the broker, the counterparty will be considered an unsecured creditor. (AKA customers lose money). And SIPC provides zero protection to account holders in the event of a broker default.

    For me, there is sufficient information to conclude that Reg. T is flawed and must be changed. I have to believe there is any army of lawyers over at the Federal Reserve looking into this as I write and they are struggling with what they can do to “fix” the problem.

    For sure a fix is required. MFG has not, as yet, morphed into a systemic problem. But we are getting closer by the day. The Fed is aware of this. The risk is that customers start to withdraw funds and assets from other brokers. The deleveraging this would cause would be catastrophic. A significant chunk of the shadow banking system (about $10 trillion) is dependent on the liquidity that is created by hypothecation. (The situation is bigger and more problematic in the UK)

    http://4.bp.blogspot.com/-WKOjebbFhOg/TuYGlCFoJjI/AAAAAAAAC4I/cR3yq4yVXdU/s1600/bullard-WSJ.png
    A month ago Fed governor James Bullard stated on CNBC that the issues with MFG did not constitute a systemic problem. I wrote about this at the time Bullard made those comments. I made a public bet with Bullard (a six pack of beer) that he would be forced to eat his words. I never did hear from him.

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  39. 2/2
    I’m re-doubling the bet this AM. If Reg. T is confirmed to be the source of customer losses at MFG then Reg. T will have to be gutted. The changes will have to take place fairly quickly. The consequences across all markets of these changes could prove to be a devastating blow.

    The nice folks at the FRB are having a big meeting this week. Reg. T and MFG will almost certainly be on the agenda. I have to believe all those smart folks at the Fed have figured out that we have a problem. We may well get some announcement on this topic by Friday.

    Any changes to Reg. T will have profound effects on global markets. Not only the exchanges/asset prices will be affected, this has the potential to derail the global economy. We are already in a very dangerous liquidity situation. If the Fed is forced to change margin rules, liquidity will dry up for an extended period of time. Forced changes in Reg. T will prove to be a Black Swan event.



    Note:

    Should we get a confirmation of the foregoing discussion and the Fed is forced to react and make regulatory changes, there will be significant long term implications for the Fed. The Fed will have to shoulder the blame for the flaws in Reg. T. They will also have to take responsibility for the broader economic consequences that will surely follow those changes.

    The possibility exits for the Fed to lose any credibility they may still have in the US and abroad. The completely unregulated Federal Reserve may lose its independence as a result.

    There are big downsides to significant revisions to margin rules. The upside is that the Fed’s supreme power over the global economy would be finally checked.
    http://www.zerohedge.com/contributed/fed-mfg-and-reg-t

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  40. The real story of the present is the shadow banking system, the unstable and massive repo market, and the apparent daisy chain of hyper-rehypothecated collateral. It looks like the sound bite version amounts to the fact that the European banking system is on the leading edge of collapse for the whole system. These institutions are by all evidence now badly deficient of the three hallmarks of real banks--deposits, capital and collateral.
    BNP-Paribas is the classic example: $2.5 trillion of asset footings vs. $80 billion of tangible common equity (TCE) or 31X leverage; it has only $730 billion of deposits or just 29% of its asset footings compared to about 50% at big U.S. banks like JPM; is teetering on $500 billion of mostly unsecured long-term debt that will have to be rolled at higher and higher rates; and all the rest of its funding is from the wholesale money market , which is fast drying up, and from repo where it is obviously running out of collateral.

    Looked at another way, the three big French banks have combined footings of about $6 trillion compared to France's GDP of $2.2 trillion. So the Big Three french banks are 3X their dirigisme-ridden GDP. Good luck with that! No wonder Sarkozy is retreating on France's AAA and was trying so hard to get Euro bonds. He already knows he is going to be the French Nixon, and be forced to nationalize the French banks in order to save his re-election.

    By contrast, the top three U.S. banks which are no paragon of financial virtue--JPM, BAC, and C--have combined footings of $6 trillion or 40% of GDP. The French equivalent of that number would be $45 trillion. Can you say train wreck!

    It is only a matter of time before these French and other European banks, which are stuffed with sovereign debt backed by no capital due to the zero risk weighting of the Basel lunacy, topple into the abyss of the shadow banking system where they have funded their elephantine balance sheets. And that includes Germany, too. The German banks are as bad or worse than the French. Did you know that Deutsche Bank is levered 60:1 on a TCE/assets basis, and that its Basel "risk-weighted" assets are only $450 billion, but actual balance sheet assets are $3 trillion? In other words, due to the Basel standards, which count sovereign and other AAA assets as risk free, DB has $2.5 trillion of assets with zero capital backing!

    This is all a product of the deformation of central banking and monetary policy over the last four decades and the destruction of honest capital markets by the monetary central planners who run the printing presses. Furthermore, this has fostered monumental fiscal profligacy among politicians who have been told for years now that the carry cost of public debt is negligible and that there would always be a central bank bid for government paper. Perhaps we are now hearing the sound of some chickens coming home to roost.

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  41. Zostawiając na boku zawiłości prawne związane z rehypothecation i innymi cudami współczesnej wirtualnej ekonomii, polecam uwadze wszystkim, a w szczególności tym, którzy uważają że w aferze MFGlobal nic wielkiego się nie stało, bo to normalna praktyka rynkowa była (tak tak SiP - do Ciebie piję;-), najnowsze wpisy na blogu blog Anny Barnhardt http://barnhardt.biz/

    Dla niewtajemniczonych, Anna Barnhardt to właścicielka firmy brokerskiej Barnhardt Capital Management, która zwinęła interes pod wpływem wydarzeń związanych z upadkiem MFGlobal. Słynny jej list do inwestorów z 17/11 można przeczytać np. tutaj http://www.theblaze.com/stories/going-galt-hedge-broker-shuts-down-firm-with-chilling-letter-about-the-market/.

    Polecam szczególnie wpis z jej bloga z 20/12 pt."I'm Calling for a General Financial Market Strike":

    "(...) all notions of personal property rights were essentially destroyed when the MF Global “trustee” began seizing customers’ gold and silver bullion held in storage if that bullion was purchased through contracts brokered by MF Global. In case you’re not following, let me restate. MF Global customers who traded in precious metals and actually took delivery and OWNED bullion, as in outright, free and clear OWNERSHIP, complete with a warehouse receipt (aka title) with SERIAL NUMBERS designating exactly which physical bars they OWNED, and were PAYING RENT to STORE their own property in a “secure” VAULT, complete with statements indicating that these storage fees were paid in full, are having THEIR PROPERTY THAT THEY OWN AND ARE PAYING RENT TO STORE CONFISCATED by the MF Global trustee in order to feed the gaping maw that is the MF Global “estate”.
    This would be EXACTLY like if you rented a little storage space at one of the thousands of storage facilities that dot this nation, and stored a car there. I used to do exactly this when I had multiple cars. Imagine the owner of the storage facility went bankrupt. Now imagine that a “trustee” SEIZED YOUR CAR, sold it, and used YOUR PROPERTY to feed the storage franchise owner’s BK. Nevermind that you had an explicit RENTAL AGREEMENT and that you had receipts proving that you were paying monthly rent on said storage space, and that you could produce clear title to the car showing that you owned it, and that the VIN numbers matched."

    Oraz to:
    "Also announced over the weekend was the jaw-dropping, yet illuminating fact that the MF Global bankruptcy was fraudulently, nefariously and illegally drawn up as a Chapter 7 BK for a SECURITIES DEALER and NOT a commodity brokerage as it should have been. Look, MF Global was the second-largest non-bank FCM in the United States next to NewEdge which is the old FIMAT. If MF Global wasn’t an FCM, then there are no FCMs. Of course it was an FCM. It had $7.2 billion in customer seg funds as of August 31, 2011. And yet MF Global was immediately, from the get-go, put into Chapter 7 BK as a SECURITIES FIRM. This is fraud. MF Global’s BK should have OBVIOUSLY been established under Subchapter IV of the Chapter 7 code as a COMMODITY BROKERAGE.

    Why wasn’t this done? Because in a Subchapter IV liquidation of a commodity brokerage firm, guess who is absolutely and unequivocally at the front of the line? You guessed it: the CUSTOMERS. In the Chapter 7 liquidation of a securities firm, guess who goes to the front of the line? Uh-huh. The “creditors”, aka the counterparties on the firm’s proprietary positions. As in . . . J.P. Morgan, et al. "

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