PrefBlog

There was a NASDAQ whoopsy today:

Computer breakdowns shook American equity markets again today as malfunctioning software that feeds data between exchanges prompted Nasdaq Stock Market to halt trading in thousands of stocks and options.

Trading will resume in some stocks at about 2:45 p.m. with the remainder returning by 3:10 p.m. New York time, the company said in a statement on its website.
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The action froze stocks both on Nasdaq’s platforms and dozens of other markets around the country that trade securities it lists. Companies from Bats Global Markets Inc. in Lenexa, Kansas, to Jersey City, New Jersey-based Direct Edge Holdings published notices saying they were adopting Nasdaq’s halt.

I have no idea why trading in these securities at other exchanges was halted – the BATS notice doesn’t provide any information, nor does the Direct Edge website. What’s the point of a network if a single-point failure can bring down the system?

I haven’t seen anything to indicate that this problem is affecting the lunatic decision to move towards centralized counterparties for derivatives and repos, either.

The SEC is determined to enhance the safeguards necessary for justifying increased regulation:

The continuous and orderly functioning of the securities markets is critically important to the health of our financial system and the confidence of investors. Today’s interruption in trading, while resolved before the end of the day, was nonetheless serious and should reinforce our collective commitment to addressing technological vulnerabilities of exchanges and other market participants. The Commission is determined to enhance the safeguards necessary for strong market systems. As one step, I will work to advance rules that the Commission proposed earlier this year regarding new standards for the trading and other systems that are central to the integrity of our markets. I also will shortly convene a meeting of the leaders of the exchanges and other major market participants to accelerate ongoing efforts to further strengthen our markets.

The SEC is making some cosmetic changes to ethics guidelines:

Hundreds of U.S. Securities and Exchange Commission lawyers and examiners face new obstacles to cashing in on their agency experience under an expanded ethics rule to take effect in January.

The change targets the practice of regulators moving to jobs at law firms and investment banks where they capitalize on their SEC relationships. The ethics rule, which previously affected only the most senior officers, will now be applied to everyone who earns more than $155,440 a year, according to a copy of an agency announcement.

The employees will be banned from contacting old colleagues for one year after leaving the SEC when the policy becomes effective in January. Commissioners and division directors have long faced such limits.

The Canadian preferred share market was on fire today, with PerpetualDiscounts winning 78bp, FixedResets up 72bp and DeemedRetractibles gaining 26bp. The Performance Highlights table is suitably enormous, with Enbridge FixedResets notable amongst the many winners. Volume was extremely high.

Goldman Sachs had an options whoopsy yesterday:

For all the efforts to shore up electronic markets in the aftermath of one of America’s biggest trading catastrophes, yesterday’s options malfunction by Goldman Sachs (GS) Group Inc. shows the dangers haven’t gone away.

A programming error caused the firm to send unintentional stock options orders in the first minutes of trading, pushing prices on dozens of contracts to a dollar each, according to a person briefed on the matter yesterday and data compiled by Bloomberg. Any losses for Goldman Sachs, the fifth-largest U.S. bank by assets, won’t be known until exchanges determine which contracts should be canceled, said the person, who requested anonymity because the information is private.
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An internal system that Goldman Sachs uses to help prepare to meet market demand for equity options inadvertently produced orders with inaccurate price limits and sent them to exchanges yesterday, according to the person familiar with the situation. Some of the transactions have already been voided, data compiled by Bloomberg show.

A “large number” of trades from the session’s first 17 minutes for tickers beginning with the letters H through L are being examined and most of the transactions may be canceled, according to a statement yesterday from NYSE Euronext (NYX)’s U.S. options business. NYSE and Nasdaq OMX Group Inc. said today that they have completed the trade reviews, according to e-mailed statements from the exchanges.

Cancelling trades is a good policy: it gives the regulators more power and therefore larger paycheques, while the big firms find it more important to hire ex-regulators to lobby their buddies. After all, the purpose of capital markets is to provide good jobs for regulators, right?

Here’s one good way to reflate the economy:

Chancellor of the Exchequer George Osborne’s plan to boost the U.K. housing market is winning his Conservative Party votes at the risk of creating a property bubble, economists say.

Help to Buy is designed to let cash-strapped buyers purchase a home with a deposit of as little as 5 percent of the value of the property. The first phase — interest-free loans for buyers of newly built homes — began in April and has already stoked the strongest housing market since the financial crisis. Guarantees meant to spur 130 billion pounds ($204 billion) of mortgage lending will be available for all homes starting in January.
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A home-value gauge compiled by the Royal Institution of Chartered Surveyors rose to the highest in almost seven years in July. Halifax, the mortgage unit of Lloyds Banking Group Plc, estimates values rose for a sixth month to an average 169,624 pounds. Mortgage lending rose 29 percent from a year earlier to the highest level since the collapse of Lehman Brothers Holdings Inc. in 2008, the Council of Mortgage Lenders said yesterday.

Since Help to Buy began, 10,000 reservations for new homes have been made, according to figures published on the Department for Communities and Local Government website this month.

Rob Wood, an economist at Berenberg Bank and a former Bank of England official, forecasts house prices will rise 15 percent by the end of 2014.
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The program, announced in the March budget, is designed to help people who lack enough cash for a deposit, with the government lending 20 percent of the value of a newly built home up to 600,000 pounds, interest-free for five years. The lender provides 75 percent, meaning the purchaser has to raise a down payment of 5 percent compared with about 20 percent previously.

The second phase, set to run for three years, will provide 12 billion pounds of government guarantee to encourage lenders to offer mortgages with loan-to-value ratios of up to 95 percent. The program applies to new and existing homes and excludes buyers of second properties.

The initiative, which follows the Funding for Lending Scheme run by the Bank of England, has drawn a warning from the International Monetary Fund for its potential to stoke home prices and been described as “moronic” by Societe Generale SA analyst Albert Edwards for encouraging Britons to add to already high debt levels. U.K. households owed about 1.3 trillion pounds on their mortgages in June, according to the Bank of England.

There are more liquidity problems in US Corporates:

The lowest volumes for U.S. corporate-bond trading since 2008 are underscoring the potential for market disruptions as regulations prompt dealers to retreat.

August trading volumes have plummeted to a daily average of $14.1 billion, down 9 percent from the corresponding period last year, even as the amount of company debt outstanding has soared by 12 percent. Bonds have lost 5 percent since the end of April on the Bank of America Merrill Lynch U.S. Corporate Index, the worst stretch since the credit crisis as the Federal Reserve considers curtailing its record stimulus.

Exiting from fixed-income securities is getting tougher as the world’s biggest bond dealers respond to new capital standards, reducing inventories of the debt by 76 percent since the peak in 2007. Even as lenders from Goldman Sachs Group Inc. to UBS AG create electronic-trading platforms, investors are failing to find relief from waning liquidity, according to a July report by the Treasury Borrowing Advisory Committee.

“You’ve got to be very wary of getting into a crowded position,” Stephen Antczak, the head of U.S. credit strategy at Citigroup Inc. in New York, said in a telephone interview. “If everybody has the same mandate, who’s going to take the other side of the trade? If far more guys are mark-to-market sensitive than they used to be and you overlay the lack of liquidity, that kind of exacerbates the problem.”
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The unprecedented growth of funds that publish market prices of their assets daily has changed the dynamic of credit markets, with investors more inclined to redeem funds as sentiment deteriorates, Antczak said. The funds now account for more than 40 percent of the debt’s owners from about 25 percent in 2007, Citigroup data show.

So you’ve got TRACE, you’ve got capital constraints … electronic trading platforms aren’t going to help any, they’re going to hurt: it’s well known that transparency creates smaller spreads, but a thinner, more brittle market … at some point, regulators are going to have to sit down and ask themselves what bond markets are for. Are they to allow borrowers to access lenders? Or are they to be ‘fair’, whatever that means? Because right now, the public corporate bond market is being destroyed.

Yield increases are spreading through the economy:

Mortgage rates are again on the rise in Canada, increasing the likelihood of a slowdown in the national housing market.

On Wednesday, Royal Bank of Canada hiked its five-year, fixed-rate mortgage by 20 basis points to 3.89 per cent, one day after the Bank of Montreal raised its benchmark rate to 3.79 per cent.

It was a very good day for the Canadian preferred share market, with PerpetualDiscounts winning 43bp, FixedResets gaining 26bp and DeemedRetractibles up 31bp. The Performance Highlights table is suitably lengthy, with FixedResets being notable at both ends of the spectrum. Volume was high.

So, everybody’s wondering – is this a dead cat bounce or the start of a major rally? I’m preparing a three month forecast … readers will understand that due to the complexity of the problem, I won’t have it ready for about 90 days.

PerpetualDiscounts now yield 5.91%, equivalent to 7.68% interest at the standard conversion factor of 1.3x. Long corporates now yield about 4.9%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 280bp, another significant increase from the 270bp reported August 14.

The story so far:

The yield on the benchmark 10-year Treasury note rose to 2.88 percent late yesterday, reaching two-year highs for a third consecutive day, as investors become increasingly convinced the Fed next month will reduce how much stimulus it pumps into the economy. The yield had been as low as 1.63 percent on May 2.

Yields on U.S. corporate bonds from the riskiest to most-creditworthy borrowers have climbed to 4.23 percent from a record-low 3.35 percent on May 2, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index. They reached a one-year high of 4.3 percent on June 25.

So far this year, rising yields have been accompanied by improving confidence. The Bloomberg Consumer Comfort Index early this month reached the highest reading since January 2008. The New York-based Conference Board’s confidence gauge in June and July also had the strongest two months in more than five years. The Thomson Reuters/University of Michigan’s measure in July reached a six-year high, before falling this month.

Some spreads have narrowed:

About $50 billion of collateralized loan obligations may be refinanced in the next two years, rewarding holders of the most speculative portions of the funds at the expense of AAA investors, according to Royal Bank of Scotland Group Plc. (RBS)

BlackRock Inc. (BLK), Ares Management LLC and other firms have refinanced more than $2 billion of CLOs this year, and an additional $8 billion sold in 2011 will be able to cut interest payments by the end of 2013, according to RBS. Restrictions preventing more than $40 billion of 2012 investments from doing the same will be lifted in 2014, according to the bank.

Yield premiums on new-issue CLOs shrank to the lowest levels in at least three years as more investors piled into the debt seeking better returns than similarly-rated asset classes. Rising demand helped push CLO issuance to $60.6 billion globally this year, the most since 2007, according to JPMorgan Chase & Co.

The BoC has published a very dense paper by Selma Chaker titled Volatility and Liquidity Costs:

Observed high-frequency prices are contaminated with liquidity costs or market microstructure noise. Using such data, we derive a new asset return variance estimator inspired by the market microstructure literature to explicitly model the noise and remove it from observed returns before estimating their variance. The returns adjusted for the estimated liquidity costs are either totally or partially free from noise. If the liquidity costs are fully removed, the sum of squared high-frequency returns – which would be inconsistent for return variance when based on observed returns – becomes a consistent variance estimator when based on adjusted returns. This novel estimator achieves the maximum possible rate of convergence. However, if the liquidity costs are only partially removed, the residual noise is smaller and closer to an exogenous white noise than the original noise. Therefore, any volatility estimator that is robust to noise relies on weaker noise assumptions if it is based on adjusted returns than if it is based on observed returns.
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There are many possible extensions to this work. For instance, it would be interesting to allow for endogenous and non i.i.d. residual noise. Potentially, a nonlinear or an index model of liquidity costs would capture more noise than a linear one. Indeed, nonlinearities are well documented in market microstructure theory. Another extension would be to add jumps in the frictionless-price dynamics. There is evidence of jumps in the data, so accounting for discontinuities should be explored.

In addition to the estimation of volatility-type objects, this paper’s approach to decontaminate high-frequency prices from liquidity costs could be used to study whether the current stylized fact of the reversal of weekly returns (see Gutierrez Jr. and Kelley 2008) is still present for returns that are adjusted for liquidity costs.

There are interesting snippets of news about BAM:

Brookfield Asset Management Inc. has another $1-billion (U.S.) under management, after wrapping up fundraising for a timber fund that met hotter-than-expected demand.

Brookfield set out to raise $750-million to invest in timberland and said commitments exceeded the target. Toronto-based Brookfield also put in $250-million of its own money.
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The fund comes not long after another Brookfield manager, Brookfield Infrastructure, got out of the timber business, which it called a “lower yielding” asset, to focus on other areas.

… and the Loblaws / Shoppers deal:

Loblaw Cos. Ltd., which is offering $61.54 a share to buy Shoppers Drug Mart Corp., initially bid much less – $45 a share – for the drugstore chain in early 2011.

Loblaw increased the bid to $48 a share a few months later, but talks fell apart in June of that year partly because of the grocer’s concerns about the effects of generic drug reforms, which have eaten into drugstores’ profits and forced them to cut costs and shift strategies.

Wonder of wonders, it was a modestly positive day for the Canadian preferred share market, with PerpetualDiscounts gaining 5bp, FixedResets up 6bp and DeemedRetractibles winning 12bp. A choppy market, with a very long (considering the overall moves) Performance Highlights table, featuring FixedResets and BAM amongst both winners and losers. Volume was extremely high.

There are worries about more unintended consequences of tighter regulation:

Regulations aimed at reducing the risk of another financial crisis are starting to upend a key part of the bond market that expedites trading in everything from Treasuries to junk bonds.

The U.S. repurchase, or repo, market where banks and investors borrow and lend Treasuries and other fixed-income securities shrunk to $4.6 trillion daily outstanding last month, down 35 percent from a peak of $7.02 trillion in the first quarter of 2008, based on Federal Reserve data compiled from its 21 primary dealers.

From fewer repos to lower inventories of bonds, financial institutions are responding to more stringent capital standards imposed by regulators around the world. Already, the group of dealers and investors that advise the U.S. Treasury say that they see declines in liquidity in times of market stress, including wider gaps between bid and offer prices and the speed of completing trades. The potential consequences are higher borrowing costs for governments, companies and consumers.
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Even though Fed data show primary dealers trade almost $600 billion of Treasuries each day on average, making the market the deepest, most liquid in the world, prices suggest constraints on bank balance sheets are having an impact on trading.

The difference between the prices at which dealers buy and sell Treasury futures contracts is about 2/32, or 63 cents per $1,000 face amount, or double what it was in the five years before the bankruptcy of Lehman Brothers, according to data compiled by Bloomberg.
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The difference in yields between the newest Treasuries auctioned by the government and older bonds show investors are increasingly concerned about getting stuck with less liquid bonds, forgoing some yield in the process.
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In Europe, heightened regulations are also affecting the ability of financial institutions to facilitate bond trades. The region’s biggest banks must cut 661 billion euros ($883 billion) of assets and generate 47 billion euros of capital to comply with new regulatory capital requirements, according to an analysis by Royal Bank of Scotland Group Plc.

“Before the crisis, we were able to execute clips of 20 million euros worth of corporate or covered bonds in just one or two minutes,” Stefan Kreuzkamp, the co-head of fixed income for Europe at Frankfurt-based Deutsche Asset & Wealth Management said in an Aug. 15 telephone interview. “These days, it could take a couple of hours,” said Kreuzkamp, whose firm has about 1 trillion euros in assets.

At the same time, 11 European Union states have agreed to a financial transaction tax, known as the FTT, that the European Commission estimates may raise as much as 35 billion euros a year. Stock and bond trades would be taxed at a rate of 0.1 percent and derivatives at 0.01 percent. The levy on bond transactions would include overnight transactions.

If the FTT is imposed in the current form, it will end the repo market in Europe, said Richard Comotto, a senior visiting fellow at the University of Reading’s International Capital Market Association Center in southern England who has published reports on the implications of new bank regulations. The ICMA estimates that to cover the tax, a repo market maker would have to charge a spread on an overnight repurchase agreement of 72.05 percentage points.

“While a lot of regulation is worthwhile and long overdue, it is coming too far and too much in a short space of time,” Comotto said in an interview. “Most of them are not well thought out.”

Amen to that, Mr. Comotto. Amen to that.

KER-RUNCH! The Canadian preferred share market got pasted today, with PerpetualDiscounts losing 130bp, FixedResets off 73bp and DeemedRetractibles down 97bp. There doesn’t seem to be much point looking for a pattern in the enormous Performance Highlights table, although it is interesting that FixedResets are prominent among the big losers. Volume was very high.

The Great White Short?:

Foreign investors went on an unprecedented selling spree of Canadian bonds in June, offering further evidence of Canada’s fading international appeal.

A record $19-billion decline in foreign-held bonds, more than double the previous high set a decade ago, slashed what has become a reliable source of investment driven by Canada’s stellar reputation for financial outperformance.
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Recent years saw a consistent net inflow of foreign funds into Canadian securities in excess of $100-billion annually. But of late, the global investing community has grown leery of Canadian real estate, slowing growth and vulnerability to softening commodity prices. Hedge funds lined up to bet against Canada – the trade dubbed the Great White Short.

Over the first half of this year, net spending on Canadian bonds by non-residents amount to $16-billion, “a fraction of the net inflow chalked up during the first half of each of the prior five years,” Warren Lovely, an economist at CIBC World Markets, said in a research note.
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The Canadian dollar would certainly feel the effect of any sustained deterioration in the demand for Canadian bonds. That relationship could also help explain some of the dramatic currency volatility seen from mid-June to early July, when the Canadian dollar dropped by four cents against its U.S. counterpart, [chief currency strategist at Bank of Nova Scotia] Ms. [Camilla] Sutton said.

Just in time for Christmas:

Samsung Electronics Co. (005930) will introduce a wristwatch-like device named the Galaxy Gear next month that can make phone calls, surf the Web and handle e-mails, according to two people familiar with the matter.

The Galaxy Gear will be powered by Google Inc.’s Android operating system and go on sale this year to beat a potentially competing product from Apple Inc. (AAPL), the people said.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 3bp, FixedResets gaining 5bp and DeemedRetractibles down 22bp. The performance highlights table is as lengthy as we have come to expect recently: insurers are notable on the losers’ end, but somebody has decided they really, really like BAM! Volume was well above average.

The sale of Aviva’s US unit to Apollo has been approved with substantially the same conditions as the Sun Life – Guggenheim deal:

The key heightened policyholder protections to which Apollo agreed include:

Heightened Capital Standards. Apollo has agreed that Athene will maintain Aviva New York’s Risk-Based Capital Levels (RBC Levels) at an amount not less than 450 percent. (Capital serves as a buffer that insurers use to absorb unexpected losses and financial shocks – better protecting policyholders.)

Backstop Trust Account. Apollo has agreed that Athene will establish a separate backstop trust account totaling approximately $35 million to provide additional protections to policyholders above and beyond the heightened capital levels. If Aviva New York’s RBC levels fall below 450 percent, the funds in the backstop trust account will be used to replenish (“top up”) Aviva New York’s RBC levels to at least 450 percent. The $35 million in the trust account will be held separately from other Aviva New York’s funds for seven years and dedicated to the sole purpose of protecting policyholders.

Enhanced Regulatory Scrutiny of Operations, Dividends, Investments, Reinsurance. Apollo has agreed that any material changes to Athene’s plans of operations of Aviva New York, including investments, dividends, or reinsurance transactions will require the prior written approval of DFS.

Stronger Disclosure and Transparency Requirements. Aviva New York will file quarterly RBC level reports to DFS – rather than just the annual reports required under New York Insurance Law. Additionally, the insurer will disclose to DFS necessary information concerning corporate structures, control persons, and other information regarding the operations of the company.

The Bank of Canada has released the Bank of Canada Review – Summer 2013 with articles:

• CSI: A Model for Tracking Short-Term Growth in Canadian Real GDP
• The Accuracy of Short-Term Forecast Combinations
• Monitoring Short-Term Economic Developments in Foreign Economies
• Big Data Analysis: The Next Frontier

Nothing very interesting, I’m afraid – I didn’t read any of them.

Bonds got hit today:

Yields (USGG10YR) on 10-year notes, a benchmark for corporate and consumer borrowing rates, climbed above 2.8 percent for the first time in two years as reports showed U.S. initial jobless claims declined last week to the lowest level in almost six years and confidence among U.S. homebuilders rose in August to the highest level since 2005. Treasury data showed private investors abroad sold a record amount of notes and bonds in June, when Fed policy makers indicated they are considering a slowing of their quantitative-easing policy.

Yields on Canadian 5s, 10s and 30s were all up 4bp.

And, logically enough (which is not always the case) the Canadian preferred share market got thumped today, with PerpetualDiscounts losing 85bp, FixedResets off 16bp and DeemedRetractibles down 50bp. The performance highlights table is suitably enormous. Volume was extremely high.