Category: Financial Markets

LIBOR Transition Creates Uncertainty for SF Market

Replacing LIBOR presents challenges for the structured finance (SF) market that are likely to be addressed in the context of industry-wide initiatives, Fitch Ratings says.

The long lead time and a desire to avoid disruption to floating-rate bond markets such as SF should support the transition to standard benchmarks as successor reference rates. The impact on SF will depend on which rates are adopted, how consensual the process is across all market participants, and how they deal with technical and administrative challenges.

LIBOR is the reference rate for SF bonds and related derivatives contracts in several large SF markets. Almost all of the USD450 billion of US CLO notes outstanding reference LIBOR, as do USD186 billion of US sub-prime/Alt-A RMBS and USD24 billion of US prime RMBS. US student loan ABS commonly reference LIBOR. Elsewhere, nearly all UK RMBS reference Libor. Some underlying loans, such as leveraged loans, US hybrid adjustable-rate mortgages, US student loans, and auto loans, reference LIBOR.

Panel banks will maintain LIBOR until end-2021. This gives capital markets four-and-a-half years to agree a successor regime for the bulk of bonds currently linked to LIBOR, enabling a coordinated transition to as few benchmarks as needed. This would avoid costly ad hoc negotiations and potentially complicated bespoke transaction amendments. Loan markets may follow suit, although the risk of fragmentation geographically and by asset class could create SF basis risk in respect of existing loans, or alter the level of credit-enhancing excess spread.

There are practical challenges in co-ordinating transition. Voting rights in SF transactions, in some cases requiring majority consent of all classes of notes, may complicate any amendment process and even increase the scope for inter-creditor disputes. Trustees will also have an important role in determining what conditions are placed on transaction parties. These challenges will require effective use of the long lead time available.

To preserve liquidity, we think bond markets will generally follow initiatives in the derivatives market, where funding is hedged and discount rates determined. The International Swaps and Derivatives Association is examining fall-back provisions in LIBOR swap contracts, and working groups in some jurisdictions have recommended alternative near-risk free reference rates for the derivatives market, including the Sterling Overnight Index Average (SONIA) in the UK and the Broad Treasuries Repo Financing Rate in the US.

But it remains unclear whether the eventual successors to LIBOR will be overnight rate benchmarks or forward rate benchmarks, how far this will vary from country to country, and whether loan markets will adopt the same reference rates at the same time (reducing basis risk). At the heart of these questions is the effect on the value of currently contracted interest payments.

Any move to replace LIBOR with a benchmark that increased interest costs, particularly for retail borrowers, would face political objections. But a reduction in interest earned could also face opposition. Balancing these interests may prompt efforts to adjust margins to leave loan and bond coupons unchanged. Challenges coordinating the transition for assets and liabilities could leave SF transactions with basis risk, or change the level of excess spread. Possible consequences for ratings would also depend on the weighted average life remaining after 2021.

Commercial borrower behaviour may contribute to these risks. For example, some commercial real estate and leveraged loans include fall-back provisions aimed at managing temporary disruptions in LIBOR determination (such as polling a small panel of banks). These could make it harder to co-ordinate the transition for underlying loans and SF bonds, particularly in the leveraged loan market.

Unlike floating-rate commercial mortgages, leveraged loans are typically not hedged against interest rate risk, and may have more latitude in diverging from standardised successor benchmarks emerging from the derivatives market. If leveraged loan borrowers felt it was in their commercial interests to argue that fall-back provisions apply, basis risk would arise if CLOs moved to more liquid successor benchmarks.

After LIBOR

RBA Deputy Governor Guy Debelle spoke about Interest Rate Benchmarks at FINSA today. He made three points:

First, the longevity of LIBOR cannot be assumed, so any contracts that reference LIBOR will need to be reviewed.

Second, actions to ensure the longevity of BBSW are well advanced. While these changes entail some costs, the cost of not doing so would be considerably larger.

Third, consider whether risk-free benchmarks are more appropriate rates for financial contracts than credit-based benchmarks such as LIBOR and BBSW.

Today I am going to talk again about interest rate benchmarks, as recently there have been some important developments internationally and in Australia. These benchmarks are at the heart of the plumbing of the financial system. They are widely referenced in financial contracts. Corporate borrowing rates are often priced as a spread to an interest rate benchmark. Many derivative contracts are based on them, as are most asset-backed securities. In light of the issues around the London Inter-Bank Offered Rate (LIBOR) and other benchmarks that have arisen over the past decade, there has been an ongoing global reform effort to improve the functioning of interest rate benchmarks.

I will focus on the recent announcement by the UK Financial Conduct Authority (FCA) on the future of LIBOR, and the implications of this for Australian financial markets. I will then summarise the current state of play in Australia, particularly for the major interest rate benchmark, the bank bill swap rate (BBSW). Our aim is to ensure that BBSW remains a robust benchmark for the long term. I will also discuss the important role for ‘risk-free’ interest rates as an alternative to credit-based benchmarks such as BBSW and LIBOR.

The Future of LIBOR and the Implications for Australia

LIBOR is the key interest rate benchmark for several major currencies, including the US dollar and British pound. Just over a month ago, Andrew Bailey, who heads the FCA which regulates LIBOR, raised some serious questions about the sustainability of LIBOR. The key problem he identified is that there are not enough transactions in the short-term wholesale funding market for banks to anchor the benchmark. The banks that make the submissions used to calculate LIBOR are uncomfortable about continuing to do this, as they have to rely mainly on their ‘expert judgment’ in determining where LIBOR should be rather than on actual transactions. To prevent LIBOR from abruptly ceasing to exist, the FCA has received assurances from the current banks on the LIBOR panel that they will continue to submit their estimates to sustain LIBOR until the end of 2021. But beyond that point, there is no guarantee that LIBOR will continue to exist. The FCA will not compel banks to provide submissions and the panel banks may not voluntarily continue to do so.

This four year notice period should give market participants enough time to transition away from LIBOR, but the process will not be easy. Market participants that use LIBOR, including those in Australia, need to work on transitioning their contracts to alternative reference rates. This is a significant issue, since LIBOR is referenced in around US$350 trillion worth of contracts globally. While a large share of these contracts have short durations, often three months or less, a very sizeable share of current contracts extend beyond 2021, with some lasting as long as 100 years.

This is also an issue in Australia, where we estimate that financial institutions have around $5 trillion in contracts referencing LIBOR. Finding a replacement for LIBOR is not straightforward. Regulators around the world have been working closely with the industry to identify alternative risk-free rates that can be used instead of LIBOR, and to strengthen the fall-back provisions that would apply in contracts if LIBOR was to be discontinued. The transition will involve a substantial amount of work for users of LIBOR, both to amend contracts and update systems.

Ensuring BBSW Remains a Robust Benchmark

The equivalent interest rate benchmark for the Australian dollar is BBSW, and the Council of Financial Regulators (CFR) is working closely with industry to ensure that it remains a robust financial benchmark. BBSW is currently calculated from executable bids and offers for bills issued by the major banks. A major concern over recent years has been the low trading volumes at the time of day that BBSW is measured (around 10 am). There are two key steps that are being taken to support BBSW: first, the BBSW methodology is being strengthened to enable the benchmark to be calculated directly from a wider set of market transactions; and second, a new regulatory framework for financial benchmarks is being introduced.

The work on strengthening the BBSW methodology is progressing well. The ASX, the Administrator of BBSW, has been working closely with market participants and the regulators on finalising the details of the new methodology. This will involve calculating BBSW as the volume weighted average price (VWAP) of bank bill transactions. It will cover a wider range of institutions during a longer trading window. The ASX has also been consulting market participants on a new set of trading guidelines for BBSW, and this process has the strong support of the CFR. The new arrangements will not only anchor BBSW to a larger set of transactions, but will improve the infrastructure in the bank bill market, encouraging more electronic trading and straight-through processing of transactions. The critical difference between BBSW and LIBOR is that there are enough transactions in the local bank bill market each day relative to the size of our financial system to calculate a robust benchmark.

For the new BBSW methodology to be implemented successfully, the institutions that participate in the bank bill market will need to start trading bills at outright yields rather than the current practice of agreeing to the transaction at the yet-to-be-determined BBSW rate. This change of behaviour needs to occur at the banks that issue the bank bills, as well as those that buy them including the investment funds and state treasury corporations. The RBA is also playing its part. Market participants have asked us to move our open market operations to an earlier time to support liquidity in the bank bill market during the trading window, and we have agreed to do this.

While we all have to make some changes to systems and practices to support the new methodology, the investment in a more robust BBSW will be well worth it. The alternative of rewriting a very large number of contracts and re-engineering systems should BBSW cease to exist would be considerably more painful.

The new regulatory framework for financial benchmarks that the government is in the process of introducing should provide market participants with more certainty. Treasury recently completed a consultation on draft legislation that sets out how financial benchmarks will be regulated, and the bill has just been introduced into Parliament. In addition, ASIC recently released more detail about how the regulatory regime would be implemented. This should help to address the uncertainty that financial institutions participating in the BBSW rate setting process have been facing. It should also support the continued use of BBSW in the European Union, where new regulations will soon come into force that require benchmarks used in the EU to be subject to a robust regulatory framework.

Risk-free Rates as Alternative Benchmarks

While the new VWAP methodology will help ensure that BBSW remains a robust benchmark, it is important for market participants to ask whether BBSW is the most appropriate benchmark for the financial contract.

For some financial products, it can make sense to reference a risk-free rate instead of a credit-based reference rate. For instance, floating rate notes (FRNs) issued by governments, non-financial corporations and securitisation trusts, which are currently priced at a spread to BBSW, could instead tie their coupon payments to the cash rate.

However, for other products, it makes sense to continue referencing a credit-based benchmark that measures banks’ short-term wholesale funding costs. This is particularly the case for products issued by banks, such as FRNs and corporate loans. The counterparties to these products would still need derivatives that reference BBSW so that they can hedge their interest rate exposures.

It is also prudent for users of any benchmark to have planned for a scenario where the benchmark no longer exists. The general approach that is being taken internationally to address the risk of benchmarks such as LIBOR being discontinued, is to develop risk-free benchmark rates. A number of jurisdictions including the UK and the US have recently announced their preferred risk-free rates.

One issue yet to be resolved is that most of these rates are overnight rates. A term market for these products is yet to be developed, although one could expect that to occur through time. Another complication is that the risk-free rates are not equivalent across jurisdictions. Some reference an unsecured rate (including Australia and the UK) while others reference a secured rate like the repo rate in the US.

As the RBA’s operational target for monetary policy and the reference rate for OIS (overnight index swap) and other financial contracts, the cash rate is the risk-free interest rate benchmark for the Australian dollar. The RBA measures the cash rate directly from transactions in the interbank overnight cash market, and we have ensured that our methodology is in line with the IOSCO benchmark principles. However, the cash rate is not a perfect substitute for BBSW, as it is an overnight rate rather than a term rate, and doesn’t incorporate a significant bank credit risk premium.

Federal Reserve Board Proposes to Produce Three New Reference Rates

Given questions about the transparency of the U.S. dollar LIBOR rate benchmark, and the quest for a more robust alternative, the US Federal Reserve Board has requested public comment on a proposal for the Federal Reserve Bank of New York, in cooperation with the Office of Financial Research, to produce three new reference rates based on overnight repurchase agreement (repo) transactions secured by Treasuries.

The most comprehensive of the rates, to be called the Secured Overnight Financing Rate (SOFR), would be a broad measure of overnight Treasury financing transactions and was selected by the Alternative Reference Rates Committee as its recommended alternative to U.S. dollar LIBOR. SOFR would include tri-party repo data from Bank of New York Mellon (BNYM) and cleared bilateral and GCF Repo data from the Depository Trust & Clearing Corporation (DTCC).

“SOFR will be derived from the deepest, most resilient funding market in the United States. As such, it represents a robust rate that will support U.S. financial stability,” said Federal Reserve Board Governor Jerome H. Powell.

Another proposed rate, to be called the Tri-party General Collateral Rate (TGCR) would be based solely on triparty repo data from BNYM. The final rate, to be called the Broad General Collateral Rate (BGCR) would be based on the triparty repo data from BNYM and cleared GCF Repo data from DTCC.

The three interest rates will be constructed to reflect the cost of short-term secured borrowing in highly liquid and robust markets. Because these rates are based on transactions secured by U.S. Treasury securities, they are essentially risk-free, providing a valuable benchmark for market participants to use in financial transactions.

Comments on the proposal to produce the three rates are requested within 60 days of publication in the Federal Register, which is expected shortly.

The Australian stocks most at risk from a rise in global bond yields

From Business Insider.

Global bond yields are poised to rise again and that will leave key sectors of the Australian share market exposed, according to Credit Suisse.

In a research note called “The Bondcano is back”, equity analysts Hasan Tevfik and Peter Liu have looked into which Aussie stocks are most vulnerable to the effects of higher bond yields.

Here’s the list:

It’s mostly comprised of stocks in stable industries which provide a consistent stream of dividend income to investors. In other words, stocks that act as a proxy for bonds.

It follows that such stocks are more attractive in the current environment, as they provide a safe return on investment that’s still higher than the return provided by low-yielding bonds.

Tevfik and Liu’s list also includes stocks that are currently trading on high price-to-earnings ratios, and stocks with high leverage which have benefited from cheap debt in the low bond yield environment.

Global bond yields have fallen this year as bond markets began to doubt the pace of inflation growth in developed markets.

However, Credit Suisse expects the yield on the benchmark US 10-year treasuries to push higher in the second half of the year.

“Our rate strategists expect US Treasury yields to reach 2.8% by the end of the year driven by a combination of stronger inflation, better economic activity vs expectations and further signs that central banks will continue their process of normalisation,” Tevfik and Liu said.

The two analysts said that the Aussie stock sectors most at risk from a rise in bond yields currently make up 22% of the market capitalisation of the ASX200.

They say the valuation of those sectors is currently trading on a price-to-earnings ratio of 21 times projected earnings over the next 12 months, which is 25% higher than the market average:

Tevfik and Liu also considered the influence of passive investment funds in their analysis.

Stocks which are most vulnerable to a rise in bond yields also make up a large position in the holdings of passive funds, due to their safer and less volatile nature.

Given the huge rise of passive investment vehicles in recent years, the analysts said there would be no major falls in their list of at-risk stocks unless passive funds changed their holdings.

Looking at the market more broadly, Tevfik and Liu said that share prices generally benefit when interest rates are low, and equity investors should be wary of the “Bondcano”.

“We think the Bondcano will continue to erupt, so what has been a tailwind for large parts of the equity market will become a headwind,” they said.

However, the threat to some companies from rising bond yields will be an opportunity for others. The two analysts added a table of stocks which stand to benefit if bond yields rise:

Tightening Is Toxic

From Moody’s.

The FOMC is expected to announce a 25 bp hike in the federal funds rate’s midpoint to 1.125% on Wednesday, June 14. Despite March 14’s 25 bp hiking of fed funds to a 0.875% midpoint, the 10-year Treasury yield fell from March 13’s 2.62% to a recent 2.20%. If the 10-year Treasury yield does not climb higher following June 14’s likely rate hike, the scope for future rate hikes should narrow.

At each of its end-of-quarter meetings, the FOMC updates its median projections for economic activity, inflation, and the federal funds rate. At the March 2017 meeting, the FOMC’s median projections for the year-end federal funds rate were 1.375% for 2017, 2.125% for 2018, and 3.0% for 2019 and beyond. However, the recent 10-year Treasury yield of 2.20% implicitly reflects doubts concerning whether the fed funds rate’s long-run equilibrium will be as high as 3.0%.

Perhaps, the FOMC will supply a lower long-run projection for fed funds. Nevertheless, in order to ward off speculative excess in the equity and corporate credit markets, the FOMC may wisely decide to overestimate the likely path of fed funds. The last thing the FOMC wants to do is help further inflate an already overvalued equity market.

Moreover, equity market overvaluation has pumped up systemic liquidity by enough to narrow high-yield bond spreads to widths that now under-compensate creditors for default risk. According to a multi-variable regression model that explains the high-yield bond spread in terms of (1) the VIX index, (2) the average EDF (expected default frequency) metric of non-investment grade companies, (3) the Chicago Fed’s national activity index, and (4) the three-month trend of nonfarm payrolls, the high-yield spread’s recent projected midpoint of 410 bp exceeds the actual spread of 380 bp. Moreover, after excluding the VIX index from the model, the predicted midpoint widens to 500 bp. The 90 bp jump by the predicted spread after excluding the VIX index is the biggest such difference for a sample that commences in 1996. The considerable downward bias imparted to the predicted high-yield spread by the recent ultra-low VIX of 10.2 points highlights the degree to which a richly priced and highly confident equity market has narrowed the high-yield bond spread. (Figure 1.)

High-yield spreads can narrow amid Fed rate hikes

There is absolutely nothing unusual about financial market conditions easing amid Fed rate hikes. When the fed funds’ midpoint was hiked from 0.125% to 0.375% in December 2015, the high-yield bond spread quickly swelled from a November 2015 average of 697 bp to February 2016’s 839 bp. However, though the midpoint is likely to reach 1.125% at the FOMC’s upcoming meeting of June 14, the high-yield spread has since narrowed to a recent 380 bp. (Figure 2.)

Early on, Fed rate hikes often were followed by thinner corporate bond yield spreads. For example at the start of the first tightening cycle of 1991-2000’s economic upturn, fed funds was hiked from year-end 1993’s 3.0% to 5.5% by year-end 1994. Despite that 2.5 percentage point hiking of fed funds, the high-yield bond spread managed to narrow from Q4-1993’s 439 bp to Q4-1994’s 350 bp. Not until the 10-year Treasury yield dipped under August 1998’s 5.5% fed funds rate did the high-yield spread widen beyond 600 bp.

It’s also worth recalling how the market value of US common stock soared higher by 19.4% annualized, on average, from January 1994 through March 2000 despite a hiking of fed funds from 3.00% to 5.75%. However, once fed funds reached 6.00% in March 2000, a grossly overvalued equity market finally crested and began a descent that would slash the market value of US common stock by a cumulative -43% from March 2000’s top to October 2002’s bottom. (Figure 3.)

The series of Fed rate hikes that occurred during 2002-2007’s recovery told a similar story. Notwithstanding a steep and rapid ascent by fed funds from the 1% of June 2004 to 5.25% by June 2006, the high-yield bond spread averaged an extraordinarily thin 340 bp from July 2004 through July 2007. At the same time, the VIX index averaged a very low 13.2 points despite the span’s 425 bp hiking of fed funds. Moreover, from June 2004 through October 2007, the market value of US common stock advanced by nearly 11% annualized, on average.

 

Speed Limits for Financial Markets? Not So Fast

From The IMFBlog.

On the afternoon of May 6, 2010, a financial tsunami hit Wall Street. Stunned traders watched as graphs on their computer screens traced the vertiginous 998-point plunge in the Dow Jones Industrial Average, which erased $1 trillion in market value in 36 minutes.

There was little in the way of fundamental news to drive such a dramatic decline, and stocks bounced back later that day. The event, quickly dubbed the “flash crash,” focused attention on the role of high-frequency trading and algorithms in amplifying market volatility.

Thick vs. thin

So far, though, there’s been remarkably little in the way of hard evidence on whether advances in information and communication technology help magnify market turbulence. Now, economists Barry Eichengreen, Arnaud Mehl, and the IMF’s Romain Lafarguette are trying to fill that gap. Their findings, surprisingly, are that faster transmission of market-moving news reduces volatility rather than increasing it.

The three economists present their research in a new IMF working paper titled “Thick vs. Thin-Skinned: Technology, News and Financial Market Reaction.”

The title refers to two popular hypotheses. The “thin-skinned” hypothesis holds that advances in information technology cause prices to react more violently to news by enabling strategies associated with volatility, such as algorithmic trading and stop-loss orders. High-frequency traders popularized by Michael Lewis’s 2014 book, Flash Boys, also have been blamed.

The “thick-skinned’’ hypothesis holds the opposite: advances in technology suppress volatility, because information that spreads more quickly reduces the information disadvantages of uninformed investors. Such investors “follow and amplify market trends by relying excessively on past or present returns to anticipate future returns,” the authors write. In other words, they engage in herd behavior, selling when prices fall and buying when prices rise. Better informed investors are less likely to follow the herd.

Ingenious test

Eichengreen and his co-authors have come up with an ingenious way of testing these hypotheses, by measuring reactions to news transmitted across superfast submarine fiber-optic cables.

“This result is consistent with the view that technology levels the informational playing field by easing access to information and that it thereby reduces trend following behavior,” they write.

Their laboratory is the world’s biggest financial market, the one for currencies, where average daily volumes exceed $4 trillion (more than the combined GDP of Italy and Brazil). They measured the reactions of currencies to major US economic news such as changes in gross domestic product, consumer prices and monetary policy.

London calling

To see how the speed of transmission affects the magnitude of the market reaction, they divided the markets into two groups: One receives news faster because it has direct fiber-optic connections with the major financial centers—Tokyo, London, and New York. The second set receives news more slowly, because it lacks direct fiber optic connections.

The amount of data they amassed is impressive: 240,430 observations for 56 bilateral exchange rates against the dollar between January 1, 1997, and November 30, 2015. Their conclusion: currencies traded in places which get their news faster via direct fiber-optic connections react less than currencies in places that receive their news more slowly. In fact, the reaction in markets with direct connections is 50 percent to 80 percent smaller.

Authors Eichengreen, Lafarguette, and Mehl decline to pass judgment on proposals to damp asset-price volatility by slowing the velocity of data flows with measures such as electronic “speed bumps.” But their study does suggest that transmitting information more broadly may reduce volatility.

 

 

That Other Bubble

From Bloomberg Technology

The financial world has been obsessed lately with debating whether we’re in a different sort of tech bubble, this time among public companies. One stock market strategist recently warned of “tech mania.”

The talk about tech stock froth is based on three interrelated facts: The performance of the U.S. stock market is more dependent on technology companies than any time in more than 15 years. Investors are willing to pay more to own these shares. And they’re crowded mostly into the same handful of big tech companies such as Amazon and Google parent company Alphabet.

Putting those data points together, some market watchers are worried that what has gone up in tech must inevitably come down — and take the whole ebullient stock market down with it.

It’s easy to understand why the finance world can’t stop talking about technology stocks. In the S&P 500 index, the sector accounts for about one quarter of the total market value of the equity benchmark. That is the largest share since 2001, according to Bloomberg data. (It’s worth noting that the S&P 500 doesn’t classify Amazon as a tech company, which is nuts. If the e-commerce giant took its rightful place, even more of the index would be tied to technology.)

Plus, money is pouring into the sector at a rate not seen in 15 years, according to research from Bank of America Merrill Lynch. And while investors aren’t paying stratospheric prices, as they did in the late 90s dot-com bubble, values of a broad collection of tech companies relative to their profits are higher than they have been since early 2004, Pavilion Global Markets calculated last week.

When you start mentioning things that haven’t happened to tech stocks since the early 2000s, you know we are living in odd times.

Every time there is tech froth, people will argue why this is or isn’t different than 1999. This isn’t 1999. But that doesn’t necessarily mean the exploding value of companies such as Apple, Netflix, Nvidia and Amazon is sustainable. I won’t try to predict the future, but the debate surely shows the outsized power of tech firms to drive global growth and equity markets.

Bubble talk isn’t likely to go away. Apple in May became the first U.S. company to top $800 billion in the total value of its stock. Now there’s a race to become the first company to sustain $1 trillion or more in market capitalization. Will it be Apple, or maybe Alphabet or Amazon? No non-technology companies, apart from Saudi Arabia’s mega government oil company, have a shot at the moment.

Stock-picker Altair’s shock sell-off could trigger the crash

From The NewDaily.

A veteran stock-picker’s shock decision to sell out of the share market entirely and return millions in cash to investors could trigger the very “calamity” he fears, according to experts.

Philip Parker, head of Altair Asset Management, announced in an open letter on Monday that he has given up on picking the market for the next six to 12 months because share and property prices will soon collapse.

It has triggered widespread speculation in the industry. Is it a publicity stunt or a prescient warning?

Many have pointed to the latest CoreLogic figures for May, which showed a drop in Melbourne and Sydney dwelling prices, to say the fund manager is onto something.

Preliminary figures from the property researcher showed dwelling values in Sydney fell 1.3 per cent and 1.8 per cent in Melbourne in the first 29 days of May.

Prices in Perth fell 0.6 per cent, while Brisbane was up 0.8 per cent and Adelaide prices increased by 0.5 per cent.

CoreLogic acknowledged that prices normally fall or moderate in April and May, but it attributed this result to banking regulator APRA’s crackdown on investor lending.

Last month, Sydney’s red-hot market showed early signs of cooling, with dwelling values inching down 0.04 per cent, while Melbourne values rose but at a slower pace than one month earlier.

Mr Parker, who markets Altair as a “high conviction” fund, wrote that he could not in good conscience keep charging fees “when there are so many early warning lead indicators of clear and present danger”.

“To me there are specific identifiers that are extremely recognisable that remind me of the late eighties and early nineties housing calamity,” he said.

“Giving up management and performance fees and handing back cash from investments managed by us is a seminal decision however preserving client’s assets is what all fund managers should always put before their own interests.”

Martin North, a property market analyst, said the only upside for the Australian economy at the moment is “sentiment and enthusiasm”, and that a shock move like Altair’s could be all it takes to tip the scales.

“Sentiment is crucial, which is why everyone wants to be buoyant and talk positive. There’s no doubt that with the international connectivity of the international markets, sentiment can be amplified and become self-fulfilling,” Mr North told The New Daily.

“If you call it right at the right point, you can make a lot of money. But what’s the collateral damage?”

Despite these concerns, Mr North gave credence to the potential triggers identified by Altair, namely: a property bubble burst in Melbourne and Sydney; a stock market bubble burst Australia-wide; a debt bubble burst in China; and political uncertainty in the US.

However, another property market expert, Dr Nigel Stapledon at the University of New South Wales, said Altair is “entitled to their view, but I don’t share it”.

He agreed that property prices are too high, but he said even if prices in Melbourne and Sydney fall by 10 per cent, Australians will barely notice so long as they are not forced to sell their homes.

If population growth persists, prices will recover, Dr Stapledon told The New Daily.

“Almost every year you have someone predicting Armageddon in the property market. Clearly prices are overpriced. You could easily have a 10 per cent price fall, but I don’t call that Armageddon.”

If the Chinese economy collapses, the Australian economy could enter a recession, and then immigrants might stop flocking here. Then we’d be in real trouble, he said.

“Those are risks. But there are always risks. It’s not clear to me those risks are going to emerge.”

Financials Are Under Pressure

The latest data on the S&P/ASX 200 Financials shows the 25 plus stocks in the index have collectively moved lower – and at a faster pace than the market. Though a little bounce today.

A range of factors are in play, including the bank tax, rising concerns about the banks exposure to property, and the risks of higher defaults in a low growth higher risk environment.

The bank credit default swap rate is higher, indicating higher funding costs and risks, and the yield curve is not helping.

Underlying this are the recent result rounds which showed that whilst volume may be up, net interest rates are not, and the pressure to slow loan growth, and lift margins will impact the competitive landscape and future volume growth.

Sell in May, and go away, possibly is good advice!

Macquarie Bank to address inadequacies within their wholesale FX businesses

ASIC has today accepted an enforceable undertaking (EU) from Macquarie Bank Limited in relation to the bank’s wholesale foreign exchange (FX) businesses, following an ASIC investigation.

ASIC is concerned that the bank failed to ensure that its systems and controls were adequate to address risks relating to instances of inappropriate conduct identified by ASIC.

ASIC Commissioner Cathie Armour said, ‘The wholesale spot foreign exchange market is one the world’s largest financial markets and the proper functioning of this market is of vital importance to the Australian economy.’

‘ASIC has now accepted undertakings from some of Australia’s largest market participants to put in place forward looking processes and controls to ensure that their foreign exchange businesses provide financial services honestly, efficiently and fairly.’

‘ASIC will continue to ensure that there can be ongoing confidence in how our financial institutions conduct themselves now and into the future,’ Ms Armour said.

ASIC identified the following conduct by employees of Macquarie in its spot FX business between 1 January 2008 and 30 June 2013:

  • On a number of occasions, Macquarie employees disclosed to external third parties confidential details of pending client orders including identification of a client;
  • On a number of occasions, Macquarie employees inappropriately disclosed to external third parties confidential and potentially material information about Macquarie’s trading activity associated with large pending AUD orders; and
  • On a number of occasions, when the market approached the trigger price of a stop loss order, Macquarie spot FX traders responsible for managing the order traded in a manner that may have been intended to cause the trigger price to trade when it might not have traded at that time.

ASIC is concerned that Macquarie did not ensure that its systems, controls and framework for supervision and monitoring were adequate to prevent, detect and respond to such conduct, which had the potential to undermine confidence in the proper functioning and integrity of the market.

Macquarie will develop a program of changes to its existing systems, controls, training, guidance and framework for monitoring and supervision of employees in its spot FX and non-deliverable forwards businesses to prevent, detect and respond to:

  1. inappropriate disclosure of confidential information to external market participants; and
  2. inappropriate order management and trading in respect of stop loss orders.

ASIC will appoint an independent consultant to assess the program and its implementation. The program will incorporate changes already made by Macquarie as part of ongoing reviews of its businesses.

Upon implementation of that program, for a period of three years, Macquarie will conduct an annual internal review of the program, which will be independently assessed, and provide an annual attestation from its senior executives to ASIC.

Macquarie will also make a community benefit payment of $2 million to The Smith Family to support The Smith Family’s financial services program aimed at improving young people’s understanding of money management.

ASIC encourages market participants to adhere to high standards of market practice, including those set out in the Global Code of Conduct for the Foreign Exchange Market, published by the Bank of International Settlements (BIS Global FX Code). The BIS Global FX Code provides a global set of practice guidelines to promote the integrity and effective functioning of the wholesale FX market. Phase 1 of the Code was published in May 2016, and Phase 2 is due for publication in May 2017.

ASIC is grateful for the assistance of international regulatory counterparts in progressing the investigation.

Background

Prior to accepting these EU from Macquarie, ASIC’s FX investigation has seen ASIC accept enforceable undertakings from each of the Westpac Banking Corporation, Australia and New Zealand Banking Group Limited, National Australia Bank Limited and the Commonwealth Bank of Australia (refer: 17-065MR and 16-455MR). The institutions also made voluntary contributions totalling $11 million to fund independent financial literacy projects in Australia.

The wholesale spot FX market is an important financial market for Australia. It facilitates the exchange of one currency for another and thus allows market participants to buy and sell foreign currencies. As part of its spot FX business, Macquarie entered into different types of spot FX agreements with its clients, including Australian clients.

Spot FX refers to FX contracts involving the exchange of two currencies at a price (exchange rate) agreed on a date (the trade date), and which are usually settled two business days from the trade date.

Non-deliverable forwards refer to FX forward contracts which, at maturity, are settled by calculating the difference between the agreed forward rate and a settlement rate (which is usually determined by reference to a benchmark published exchange rate). A FX forward contract is an agreement between two counterparties to exchange currencies at a future date at a rate agreed upon in advance.