PrefBlog

I mentioned the proxy battle over Trinorth Capital on June 11 … Management won. No concession or acknowledgement from the self-proclaimed Concerned Shareholders yet … I’m not holding my breath. However, management can now get back to doing what it does best: suspending dividends on their funds.

Speculation regarding Bernanke’s reappointment is mounting, with Larry Summers mentioned as a possible candidate. I can’t find great fault with Bernanke’s macro-economic handling of the crisis; it turned out that letting Lehman go was a mistake, but I, for one, didn’t forsee just how horribly things would turn out after that. Of greater concern is interference in private companies (the BAC/MER merger), but I think that one can be hung on Paulson.

Tara Perkins of the Globe passes on some speculation regarding the MFC/OSC Disclosure Kerfuffle:

The Ontario Securities Commission (OSC) appears to be examining whether Manulife properly disclosed, prior to last fall, how much risk it would face if markets tanked, noted Genuity Capital Markets analyst Mario Mendonca. Before then, Manulife only disclosed what would happen to it if stock markets fell by 10 per cent. Markets dropped more than 20 per cent in the fourth quarter.

It’s possible, although it would be most unfair if MFC was singled out for this practice when the effects of a 10% drop is all that’s disclosed by any insurer. I’m not saying, mind you, that I am against such improved disclosure; the effect of equity market declines on guarantees can be decidedly non-linear.

Who says that Dealbreaker is all fun ‘n’ games? Today there’s a very informative, yet entertaining, essay on Credit Default Swaps in Kazakhstan:

Emerging Markets and derivatives are like alcohol and barbiturates: each on its own has attractions but create a recipe for choking on one’s own vomit when combined.
…
There’s always some crazy eventuality that an emerging market can generate that defies the most thoughtfully drafted contract.

Mark Carney showed Canadian regulators’ traditional contempt for investors with some selective disclosure in Washington:

Bank of Canada Governor Mark Carney said his country’s recession is now as deep as in the U.S., according to a person who heard his remarks today in Washington.

Carney, 44, spoke at the Woodrow Wilson International Center for Scholars. No cameras or recording devices were allowed at the event, according to organizers.

Debt-Decoupling, a moral hazard feature of Credit Default Swaps is complicating restructuring efforts:

In the cover story for the The Deal magazine published Monday, Richard Morgan tells about the dire situation Gannett Co. (NYSE:GCI) finds itself in after nearly three-quarters of bondholders, hedged with credit default swaps, declined an exchange offer that expired May 5. Thanks to the CDSs, they stand to get a better payoff if Gannett defaults.

Morgan followed that story up with a report on McClatchy Co. (NYSE:MNI) in The Deal Pipeline on Monday (subscription required). It too tried to do an exchange offer on some troubled bonds, but reported last week that only a small minority of holders went for the offer, valued at around 33 cents on the dollar. Thanks to their CDS hedges, the bondholders can expect 100 cents if McClatchy defaults.

It’s an incentive some call perverse, and also one that couldn’t have existed before the CDS market sprang up. As Morgan writes, CDSs began the decade as a $900 billion market but ended last year with a notional value of $42 trillion. That’s a lot bigger than the $25 trillion market for outstanding corporate bonds, municipal bonds and structured investment vehicles that CDSs were designed to reference.

Dealbreaker remarks:

One of the primary complaints about the CDS market was the use of CDS by market participants as purely speculative tools. In this case, the players that hold the debt are hedging their exposure through CDS and capitalizing on a negative basis play. If hedging debt exposure through CDS becomes the next true villain in the attack on derivatives, there is really no hope for this market.

The “negative basis” refers to the fact that a long-bond plus protection-buy position will yield more than available elsewhere in the market with equivalent risk – this is due to funding pressures, since it’s hard (risky, anyway) nowadays to lever up a physical bond position 10:1; you can only do that by selling CDSs, driving down the spread. The newspapers’ woes are similar to problems highlighted by the Lyondell bankruptcy:

The potential for dispute and complexity in workouts and bankruptcies by reason of the existence of CDS was illustrated recently in the U.S. bankruptcy proceeding of the U.S. subsidiary of LyondellBasell, the world’s third-largest petrochemicals group. The U.S. company, LyondellBasell Chemical Company, filed for bankruptcy in New York in January 2009 after attempts to restructure its $26 billion debt were unsuccessful.70 The bankruptcy triggered a “default” under LyondellBasell Chemical Company’s CDS (i.e. CDS naming this company as the reference entity), but because its European parent and affiliates were not in bankruptcy, CDS covering bonds of those companies were not triggered.

Creditors sought to sue LyondellBasell’s parent company in Europe on guarantees and other obligations. These creditors included bondholders, and the U.S. company believed that the bondholders were seeking to enforce claims with the goal of triggering protection payments under their credit default swap contracts, which could have led to other parts of the corporate group being pushed into insolvency in Europe. Ultimately, U.S.-based LyondellBasell Chemical Company was able to persuade the U.S. bankruptcy court that such actions in Europe could undermine the chances of completing a successful bankruptcy in the U.S. The bankruptcy court issued a 60-day injunction prohibiting enforcement actions in Europe.

“The threat of CDS holders trying to force companies into an insolvency in order to trigger their recovery rights against their CDS counterparty will almost certainly be an issue in the wave of debt restructurings this year,” predicted LyondellBasell’s attorneys.

Note that legal manoeuverings regarding LyondellBasell have been phrenetic:

LyondellBasell Industries announced that LyondellBasell Industries AF S.C.A. has been voluntarily added to Lyondell Chemical Company’s reorganization filing under Chapter 11 of the U.S. Bankruptcy Code to protect the European holding company against claims by certain financial and U.S. trade creditors.

LyondellBasell Industries AF S.C.A. is a holding company incorporated in Luxembourg. It does not manufacture or sell products, and has no employees.

LyondellBasell is exercising an option available under U.S. law to prevent creditors from enforcing guarantees by LyondellBasell AF S.C.A. for pre-petition obligations of LyondellBasell’s U.S. businesses. It also prevents bondholders of Senior Notes due in 2015 from potentially pursuing remedies against LyondellBasell AF S.C.A. after an interest payment due on the notes in February was not paid. The company obtained a 60-day restraining order from the U.S. bankruptcy court in February to allow time for LyondellBasell to protect its European assets from these claims.

Extending Chapter 11 protection to LyondellBasell Industries AF S.C.A. is not an insolvency proceeding under any European law. No LyondellBasell manufacturing operation located outside of the United States has applied for or become involved in insolvency or bankruptcy proceedings in its respective home country.

… but they bought themselves enough time to get something done …

The European Commission Monday cleared U.S.-based industrial holding group Access Industries and German investor Andreas Heeschen’s ProChemie Holding to create a joint venture to take over troubled chemical company LyondellBasell Industries.

Both parties will have a 50% stake in LyondellBasell, parts of which are currently under bankruptcy protection, through a new holding company called ProChemie GmbH.

LyondellBasell was previously wholly owned by Access industries.

… the moral of the story being “Holding company guarantees are not necessarily worth much.”

The market drifted down just a tad today, with volume continuing high.

In recognition of the fact that investors get so much regulatory paper from their brokers that they don’t read it, the Canadian Securities Administrators are requiring the delivery of more paper. I’ll bet a nickel that every year the “Fund Facts” gets enlarged ‘because Granny didn’t know she could lose money if so-and-so went bankrupt’, until about twenty years from now, when new “Fund Briefer Facts” becomes mandated and then lucky buyers get even more mail to throw away without reading. Still, it keeps the regulators busy and Proactively Working In The Best Interest Of Investors, and that’s what counts, right?

Julia Dickson gave a speech in Vancouver lauding financial oligopolies:

One lesson everyone is relearning is the importance of proper consolidated oversight and supervision of financial groups, especially systemically important financial groups. This lesson has arisen in the context of AIG, where the parent holding company was regulated, but not to the extent required of a systemically important group of its size.

Canada is relatively well placed in this regard as there is already considerable consolidated oversight and supervision of the Canadian financial sector. The large securities firms are owned by the big banks, which OSFI oversees, meaning that securities firms must meet the same prudential standards as their parent bank. As well, the general structural model for large financial services groups is that they are headed by a regulated financial institution, which is overseen by OSFI, versus the holding company structure commonly seen in other jurisdictions.

Having a regulated Canadian financial institution at the top of such organizations enhances our ability to understand the risks facing the conglomerate. Further, given OSFI’s regulatory authority at the top level, we can intervene and require action to be taken, no matter where in the group we may have identified potential problems.

As a regulator, you need to have knowledge of the financial status and risk profile of all affiliates within a financial group. Indeed, as demonstrated by the AIG case, small parts of big companies can be hugely problematic.

She did not go so far as to say she wished to see an elimination of the holding company structure for insurers, but she is clearly headed in that direction. It is very disappointing to see such regulatory hostility to the concept of a layered financial system: banks – securities dealers – hedge funds, that can work quite well provided there are clear lines between the layers.

Plain vanilla for everyone! That’s the Canadian way!

C-EBS has published a consultation paper on implementation of hybrid capital guidelines.

Christopher Whalen, head of International Risk Analytics, had some home-truths for the Senate today:

Trading in credit-default swaps should be banned, Christopher Whalen, managing director of Institutional Risk Analytics in Hawthorne, California, said in prepared testimony for today’s Senate hearing. Regulators are too cozy with the banks in the market to be counted on to make changes, he said.

“The views of the existing financial regulatory agencies, and particularly the Federal Reserve Board and Treasury, should get no consideration from the committee since the view of these agencies are largely duplicative of the views of JPMorgan Chase & Co. and the large OTC dealers,” he said in the remarks.

I can’t find the full text of his testimony, but they will probably be posted soon.

Equities got hit today after the World Bank warned of lower future growth. The only way out of this mess is to hire more regulators:

Global Development Finance 2009: Charting a Global Recovery, warns that the world is entering an era of slower growth that will require tighter and more effective oversight of the financial system.

Perhaps in sympathy, PerpetualDiscounts were off somewhat today; while FixedResets were also down the loss of the latter was negligible. Volume continued high.