PrefBlog

There’s always a lot of political complaining about corporate short-term thinking, with the equity markets forcing managers to focus on the next quarter’s profit rather than investing for the long term. I’m never too sure about how seriously to take this. First, there seems to be quite a lot of technological advance anyway and second, long-range planning by it’s nature can often go astray and blow up the companies just as well as anything else. One way or another, there’s an interesting insight into the role of indexers:

Most of the more than $4-trillion (U.S.) that BlackRock oversees on behalf of clients is in index funds that passively track market benchmarks. Because it can’t sell individual stocks in index funds, BlackRock is, by necessity, in it for the long haul.

So instead of threatening, [Blackrock Chairman and CEO] Mr. [Larry] Fink cajoles. He writes letters. Very, very well-read letters. His latest went to the heads of all the biggest companies in the United States and Europe, hundreds of them, urging CEOs to think long term.

“As the largest index player in the world, we have to own companies, even if we hate ‘em,” Mr. Fink said in an interview on a recent visit to Toronto. “The most powerful component of our ownership is our vote, and we have to vote for what we think is in the best interests for the long term. Whether we like you or not, we are going to be an investor for the long term. We want leadership to focus on long-term strategies.”

In many ways, BlackRock’s fortunes are tied to long-run economic growth. That’s what drives stock indexes higher. It’s a rising-tide-lifts-all-boats game.

The Lapdog’s learning that sucking political arse is a risky career choice … the demands keep increasing and the promises keep accumulating:

Less than a year into his new job, Mr. Carney is getting decidedly mixed reviews from a much tougher crowd of critics. He’s already had one big flub, after he was forced to revise his stated plan to hold interest rates down until the unemployment rate fell below 7 per cent.

The jobless target was achieved two years ahead of Mr. Carney’s forecast, with unemployment hitting a five-year low of 6.8 per cent in March, and the latest jobs reports have been among the strongest in years. Still, Mr. Carney insists he won’t raise interest rates any time soon, although financial types in the City no longer find his “forward guidance” of much use. They have taken to calling it “fuzzy guidance.”

Some even label Mr. Carney a monetary “dove” who’s tempting fate. For the first time on his watch, members of the central bank’s monetary policy committee disagree over the course of action to take. The governor’s insistence that there is still too much slack in the economy to raise rates is challenged from within. His soon-to-leave deputy recently took a jab: “There is a real danger of spurious precision and the pretense of knowledge in this area.”

What’s the peak of the next interest rate cycle? Place yer bets, gents, place yer bets:

From bond yields to futures and swaps, traders see little chance the economy will strengthen enough over the course of its expansion to compel the Fed to lift its overnight rate beyond about 3.3 percent. That’s less than the historical average of 4.25 percent that New York Fed President William Dudley said would be consistent with the central bank’s current target for inflation and compares with its long-term estimate of 4 percent.

The divergence reflects deepening concern among bond investors that tepid wage growth and a lack of inflation will persist for years to come, and hold back growth as the Fed moves to end its unprecedented monetary stimulus. Lower peak rates will also reduce the likelihood of any selloff in longer-term Treasuries, which have rewarded holders this year with the biggest returns in two decades.

It was a day of modest movement for the Canadian preferred share market, with PerpetualDiscounts and DeemedRetractibles both gaining 2bp, while FixedResets were off 5bp. Volatility was low. Volume was below average.

In a story picked up by the Globe, Renee Altom wrote a piece for the Richmond Fed titled Why was Canada exempt from the financial crisis?; she concludes that a

So to truly understand a country’s financial landscape, you have to go back — all the way back — to its beginning. Financial regulation in a new world typically starts with one question: Who has the authority to charter banks?

This seemingly small choice sets off a chain reaction, according to Michael Bordo and Angela Redish, Canadian economists at Rutgers University and the University of British Columbia, respectively, and Hugh Rockoff, a monetary expert also at Rutgers. They’ve studied the differences between Canada and the United States in several papers dating back to the 1990s.

They argue that the states here prohibited banks from branching, while Canada did not.
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Many economists have argued that this “unit banking” in the United States made banks more fragile. For one thing, banks were rather undiversified.
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According to the recent study by Calomiris and Haber, set out in their 2014 book Fragile By Design, united factions with an interest in keeping banks small succeeded in shooting down attempts at branching liberalization until the 1980s.
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The U.S. Constitution gave all functions not explicitly handed to the federal government, such as regulatory policy, to the states. Interests needed only to win legislative fights at the local level, which was a far easier task than in today’s relatively more federalized system, Calomiris and Haber contended. Thus, they argued that the origins of a country’s financial stability — or lack thereof — are mainly political. Small farmers opposed branching because it would allow banks to take credit elsewhere after a bad harvest. Small banks wanted protection from competition. And many others opposed any signs of growing power concentrated in any one institution — or bank.
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There have been many proposed explanations for why our financial system proved much less resilient than Canada’s in 2007 and 2008, from insufficient regulation, to lax mortgage lending, to our history of government rescues.

The longer lens of history shows, however, that any one explanation for financial instability — and therefore any one regulatory attempt to fix it — may be too simple. Even if unit banking is a relic of the past, it is still with us through its effects on the evolution of the U.S. financial system — just as reforms today will determine the shape and stability of the financial system of the future.

The slowdown in trading hasn’t hurt TD & RBC much:

Heading into the current bank earnings season, the worry was that Canadian investment banks would suffer from the same trading slowdown that hit so many global rivals. RBC was particularly in the spotlight, because it has the biggest trading operation of all the Canadian lenders.

Yet their results came in Thursday, and they were surprisingly good considering what the worst case scenarios looked like.
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For RBC, the strength stems from its capital markets operations beyond Canada’s borders. “The growth is really focused in the U.S., and our [fixed income] Europe business has performed well in the last quarter as well. And I think really it’s just more origination in Europe and also the markets are much improved in Europe,” Mr. McGregor added.

TD benefited from origination as well, albeit mostly in the domestic market. Asked about the bank’s strong trading numbers in the first half of fiscal 2014, capital markets head Bob Dorrance said they’re “driven significantly by the origination markets.”

Coincidentally, S&P came out with a report titled Delving Deeper Into Global Trading Banks’ Risks And Rewards: A Study Of Public Disclosures. RBC is one of the top 15 global banks for trading, with a 1.8% market share.

Tougher regulatory requirements, particularly as they pertain to capital, have caused some of the biggest global banks to scale back their trading businesses to ensure that profitability clears their cost of capital. Although this has enabled a few select banks with scalable trading operations to increase their market share, the overall trend has been a decline in sales and trading as a percentage of banks’ total revenues–a development that has reduced some of the market risks related to banks’ trading operations from their 2007-2008 peaks, in our view. That said, we believe trading risks remain significant, and could destabilize banks that don’t manage them properly.
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• We have carried out a study of public disclosures by the 15 rated banks with the largest global trading operations to assess changes in the risk of their trading activities.
• Trading as a percentage of overall revenue has declined for most of these banks over the past five years, and trading risks have subsided from their excessive precrisis levels, largely because of stricter regulation and lower market volumes. However, the risks are still significant, in our view, and could destabilize banks that don’t manage them well.
• We don’t expect to take any imminent rating actions on these banks based on developments in their trading activities, but changes in their risk profiles, over time, could lead to positive or negative rating actions.

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Assessing trading risk at banks can be a difficult endeavor because trading positions, especially derivatives and less-liquid securities, are very complex and opaque. Moreover, the value at risk (VaR) models and other internal models that aim to measure market risks can be inaccurate and inconsistent, particularly in relation to peers. And a significant market disruption may render fair values, which are the basis for many derivatives and securities, unreliable and difficult to measure.

Notably, two recent Bank for International Settlements (BIS) trading surveys that analyzed risk-weighted assets for market risk showed substantial discrepancies across banks in measuring VaR and also showed that regulatory capital requirements for market risk vary among global banks. An October 2013 BIS paper (“Fundamental Review of The Trading Book—Second Consultative Document”) outlines, among other things, certain proposals to improve the accuracy and consistency of bank trading risk-weighted assets, in order to make them more commensurate with risk. We believe this is a step toward further consistency across banks, but more clarity is necessary (see “Basel’s Proposed Overhaul Of Capital Requirement Calculations For Banks’ Trading Risk Is Only A Step Toward Greater Consistency,” published Jan. 31, 2014). Although VaR has certain limitations–and thus, in isolation, may provide an incomplete picture of a bank’s trading risk–we still believe it has value when considered with other factors in determining market risk. That said, we do not base our analysis on ratios alone, not least because some can be the result of a multitude of different influences, some positive and some negative, which we detail in Appendix 3.

The BIS document is titled Consultative Document: Fundamental review of the trading book: A revised market risk framework. To my astonishment, it does not mention ageing as a test for whether or not something is legitimately in the trading book, but:

Having reflected on feedback from the first consultative paper, the Committee has developed a revised boundary that retains the link between the regulatory trading book and the set of instruments that banks deem to hold for trading purposes, but seeks to address weaknesses in the boundary by reducing the possibility of arbitrage and by providing more supervisory tools. As such, this boundary is more likely to be aligned with banks’ own risk management practices relative to the valuation-based approach.
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The Committee remains concerned about the risk of arbitrage. To reduce the incentives for arbitrage, the Committee is seeking a less permeable boundary with stricter limits on switching between books and measures to prevent “capital benefit” in instances where switching is permitted. The Committee is also aiming to reduce the materiality of differences in capital requirements against similar types of risk on either side of the boundary. For example, the Committee has decided that the calibration of capital charges against default risk in the trading book will be closely aligned to the banking book treatment, especially for securitisations. The Committee is also investigating the development of Pillar 1 charges for interest rate and credit spread risk in the banking book.
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Main differences between the current and proposed definition of the boundary

Intent-based boundary (current)	Revised boundary
Requirement for reports to supervisors to make the boundary easier to supervise: N/A	Requirement for reports to supervisors to make the boundary easier to supervise: Banks must prepare, evaluate and have available specified reports used by banks in their boundary determination decision, including reports on inventory ageing, daily limits, intraday limits (banks with active intraday trading), market liquidity and any deviations from the presumption lists.

So there will be reports! Lots and lots of lovely reports, requiring the employment of an army of regulators to read and another army of ex-regulators to prepare. Super!

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 18bp, FixedResets down 5bp and DeemedRetractibles off 1bp. Volatility was average. Volume was below average.

Bank of America is closing its internal market-making unit:

Bank of America Corp. is dismantling an electronic market-making unit created last year to serve the lender’s Merrill Lynch wealth-management division, said two people with knowledge of the decision.

Increased regulatory scrutiny of U.S. equity markets and managers’ concerns for the potential perception of a conflict of interest killed the project, said the people. The desk advanced to a testing phase before being abandoned in recent weeks and two executives hired to run it, Jonathan Wang and Steven Sadoff, were told to seek new jobs within the firm, the people said, requesting anonymity because the matter is private.

Businesses such as the shuttered Bank of America unit usually execute equity orders internally, rather than sending them to the public stock market. Critics including Kor Group LLC’s Dave Lauer say the practice may cause harm by keeping some supply and demand private, distorting prices. Bank of America’s decision coincides with a renewed examination by regulators of whether trading in the $22 trillion U.S. stock market is fair.

For Bank of America, “this is either not a profitable business anymore or they don’t want to deal with the regulatory scrutiny that’s coming,” said Joe Saluzzi, co-head of equity trading at Themis Trading LLC in Chatham, New Jersey. “It definitely tells you they’re concerned and maybe they’re hearing things we haven’t.”

Kor Group LLC’s Dave Lauer’s argument is, essentially:

This structure is not dissimilar to something called Payment for Order Flow (PFOF), in which a wholesaler (such as Knight Getco or Citadel) will pay a retail broker for its order flow and then either internalize that flow or send it along to the broader market. In the case of PFOF, it is very profitable for the wholesalers to buy retail order flow and lucrative for brokers to sell this flow – so much so that it is generally referred to as “uninformed” or even “juicy” order flow. These terms describe the willingness of retail traders to pay the spread and the associated fees without a short-term view as to what will happen to the stock price over the next few milliseconds and seconds because of their long-term investment outlook or for swing/day-trading. For wholesalers, the profits from trading against this flow more than offset the fees that they pay to the retail brokers.

However, the PFOF model does a disservice to the market at large, as removing this order flow can theoretically inhibit price discovery, discouraging market makers from posting orders if they know that the only orders that make it to the exchange are the so-called “toxic” or “professional” flow. Internalizers and wholesalers are free-riding the public quote, and in essence “queue jumping” (a loaded term, to be sure) orders on lit exchanges that may have price-time priority from an absolute perspective.
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So why can’t we count on the market and competitive forces to fix these issues? Because maker-taker creates a fundamental conflict of interest and a puts exchanges between a rock and a hard place. It makes no difference to an exchange’s revenue what its rebates/fees are – as the exchange makes money on the difference between the two. However, exchanges are unable to lower their rebates and fees because doing so would chase away resting orders to those exchanges that do not lower their rebates.

This is why regulatory intervention is required, and the Notre Dame study quantitatively shows that. In order to move forward, this intervention should be in the form of a pilot study – as advocated by Royal Bank of Canada (RBC) and others – that eliminates rebates in a set of symbols, and requires the trade-at rule in those names, as Canada and Australia do. This rule simply states that in order to execute a trade of less than 5,000 shares off-exchange (in a dark pool or internalization system), there must be significant price improvement (at least a tick, or half a tick if the spread is a tick wide). High-frequency trading (HFT) proponents explain, quite reasonably, that maker rebates are necessary to compensate them for adverse selection (as explained earlier, only the “toxic” flow actually makes it to exchanges now). The trade-at rule will reduce adverse selection and improve price discovery on public venues, ultimately benefitting all investors and providing compensation to market makers.

He also used as evidence the study by Robert Battalio, Shane Corwin, and Robert Jennings, Can Brokers Have It All?, referred to here on April 21, 2014. Seems to me that if the spread’s too wide, there’s money to be made by improving it.

TRACE? SchmACE!

The world’s biggest bond dealers, including JPMorgan Chase & Co. (JPM) and Morgan Stanley, failed to properly report trades to the industry’s price-tracking system more than 11,000 times. JPMorgan’s penalty: About three minutes of its annual profit.

Fines levied in settlements disclosed last month by the Financial Industry Regulatory Authority amounted to a fraction of what the two New York-based firms generated from trading debt during the two-year reviews. JPMorgan’s $95,000 penalty was the biggest imposed by Finra as it cited at least three other dealers in the past five months for similar types of violations.

Regulators are seeking to uphold the integrity of the bond-price reporting system known as Trace, the biggest window into a market that’s grown about 78 percent since 2008 as investors poured money into debt securities. Holding back information on trades can give Wall Street dealers an advantage over customers seeking a fair price, undermining Finra’s stated goal of equal access for all participants to real-time data.
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JPMorgan racked up the most Trace-related violations disclosed this year, the result of five separate reviews, according to a settlement released in April. The bank, which ranks as the biggest bond trader and top underwriter of corporate debt, neglected to post trades or missed deadlines in at least 6,300 instances from March 2010 through May 2012, at times omitting a quarter of required reporting, Finra said.

In one review, Finra found the violations accounted for almost 20 percent of corporate debt transactions the bank was required to report over three months in 2011. In another, JPMorgan didn’t report 24 percent of new-issue offerings over five months, the regulator said.

Sometimes the bank didn’t report the correct volume, time or date of transactions, and the firm inadequately supervised compliance, according to the documents.

Moody’s sounded a warning on the provinces:

Both parties should take note of the latest from Moody’s, which puts [Ontario] net debt as a percentage of revenue at 237.7 in the 2014-15 fiscal year, the highest in the country.

Not only the highest, actually, but far and away above the next in line, Quebec, at 189.5.

The lowest is Alberta, at 31.9.

Alberta and British Columbia are alone among the provinces in holding a triple-A rating with Moody’s, the former deemed “stable” and the latter “negative.”

“Most Canadian provinces maintained their ratings and stable credit outlook through the financial crisis and subsequent slow recovery,” Moody’s said in its report.

“However, the continued accumulation of debt and difficulty in returning to balanced budgets is increasing negative credit pressure for some provinces.”

Revenue-to-debt, I can’t help with. But there’s a a good idea for improving debt-to-GDP!

Italy will include prostitution and illegal drug sales in the gross domestic product calculation this year, a boost for its chronically stagnant economy and Prime Minister Matteo Renzi’s effort to meet deficit targets.

Drugs, prostitution and smuggling will be part of GDP as of 2014 and prior-year figures will be adjusted to reflect the change in methodology, the Istat national statistics office said today. The revision was made to comply with European Union rules, it said.

Renzi, 39, is committed to narrowing Italy’s deficit to 2.6 percent of GDP this year, a task that’s easier if output is boosted by portions of the underground economy that previously went uncounted.

The administrators of the TMXMoney.com website got back to me this morning about the problem with the pricing data, as discussed on May 20 and May 21 …

Hello,

Thank you for your comment. We have forwarded your inquiry to marketdata@tmx.com. They will contact you shortly.

In the future, for any inquiries relating to market data, please reach out to marketdata@tmx.com directly or call (416) 947-4778.

If you have any suggestions for new functionality/features please feel free to use the “Suggest an Idea” box on TMXmoney.com.

Thank you,

This was followed shortly afterwards with:

Status update

An idea you voted for has been closed!

3 votes have been returned to you Go spend your votes on more ideas…

In other words … ‘Shee-it, man, if we had a clue we wouldn’t have to work for a bank!’ Well, it was worth a try! Thanks to all those who voted for the suggestion.

Assiduous Reader GA writes in and says:

AMBest withdrew their rating of CCS.PR.C and CCS.PR.D

IS this an indication that shares will be called for redemption by the end of the month? CCS.PR.D should certainly be redeemed and they have until the end of the month to announce it!

So, first of all, it’s true: A.M. Best Affirms Ratings of Co-operators General Insurance Company, Its Subsidiary and Co-operators Life Insurance Company:

A.M. Best has affirmed the financial strength rating (FSR) of A- (Excellent) and issuer credit ratings (ICR) of “a-” of Co-operators General Insurance Company (Co-operators General) and its subsidiary, The Sovereign General Insurance Company (Sovereign) (Alberta).

In addition, A.M. Best has affirmed the FSR of A (Excellent) and ICR of “a” of Co-operators Life Insurance Company (Co-operators Life) (Saskatchewan). The outlook for all ratings is stable.

Concurrently, A.M. Best has withdrawn the debt ratings of “bbb-” of the preferred shares of CAD 100 million 5% non-cumulative redeemable Class E preference shares, Series C [TSX: CCS.PR.C] and CAD 115 million 7.25% non-cumulative five-year reset Class E preference shares, Series D [TSX: CCS.PR.D] issued by Co-operators General.

But I think that it indicates only that Cooperators is tired of paying for ratings that don’t really make a lot of difference to their ability to sell preferred shares. Only ratings by DBRS and S&P are important; during the crisis it looked as if Moody’s was going to become a third player, but there doesn’t seem to be much of a rush for three ratings other than the initial handful of banks and insurers.

I continue to visit the Cooperators media page regularly to check whether they’ve finally pulled the trigger on the expected CCS.PR.D redemption (redeemable on 2014-6-30; Issue Reset Spread of 521bp) but it hasn’t happened yet.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 17bp, FixedResets gaining 4bp and DeemedRetractibles up 11bp. Volatility would have been low if it had not been for fine performance from the (generally very volatile) Floaters. Volume was very low, considering the boost that should have resulted from the two new issues settling today.