PrefBlog

Spend-Every-Penny is continuing his heroic efforts to pump up a Canadian housing bubble:

Ottawa has increased by $50-billion the amount of residential mortgages that it is willing to guarantee.

But this time the Canada Mortgage and Housing Corp., the biggest provider of mortgage default insurance, is not getting any. Instead, the additional backing is going only to private-sector players such as Genworth Canada, who will see their maximum raised to $300-billion from $250-billion.

Genworth Canada disclosed the news on Thursday, which helped drive its shares up more than 3% to $22.73.

The mortgate insurance market in this country is dominated by a handful of players including the CMHC, Genworth Canada and Canada Guarantee, with CMHC accounting for the lion’s share. In the interests of fair competition, all are given access to government guarantees.

Yes, here in Canada, lenders can freely compete to see who can suck arse in Ottawa enough to get mortgage guarantees. Auctioning off the guarantees would be uncivilized; especially since there are those who have a rather peculiar take on the necessity of government guarantees:

In the financial institutions legislation we have a requirement that all mortgages over 80% have mortgage insurance, so on the one hand, we have a requirement that a mortgage lender must receive mortgage insurance from either CMHC or a private mortgage insurer in order to take on the mortgage of a Canadian who wishes to purchase a house with a down payment of less than 20%. With that mandatory requirement in legislation, the government would be under an obligation to ensure that mortgage insurance is available.

The Toronto Exchange will be close the regular session at 1pm on December 24. That will allow us members of the highest paid profession on earth to go shopping and complain about how lazy the clerks are.

CMHC has released the Canadian Registered Covered Bond Programs Guide. DBRS notes:

Upon an initial review of the Guide, DBRS expects that the current Canadian covered bond issuers will either amend their existing respective programs or create new programs to comply with the Guide. Given the substantial requirements prescribed in the Guide, DBRS does not expect any new Canadian covered bond issuances over the next few months while the issuers are implementing the changes to existing programs or establishing new programs. DBRS will not assign any final ratings to any proposed new issuances until DBRS has received confirmation that the relevant issuer, the program and series have been registered in accordance with the Guide.

On November 26 I referred to Ontario lawyers’ claims that there were too many lawyers; I was interested to see some American numbers on the topic in a rather whiny Bloomberg article:

The same housing crash that hammered young architects and loan officers also slammed lawyers. Law schools are turning out about 45,000 degree holders a year for about 25,000 full-time positions available to them, according to the National Association for Law Placement Inc. in Washington. The class of 2011 had the lowest placement with law firms, 49.5 percent, in 36 years.

Whiny? Yes, whiny:

Only one-fifth of those who graduated college since 2006 expect greater success than their parents, a Rutgers survey found earlier this year.

Uh … yeah. You’re only six years out of school, chumps, and a rather significant recession got in the way. Call me back in twenty years and then we can discuss your success relative to your parents.

The Canadian preferred share market was hot today, with PerpetualPremiums up 6bp, FixedResets winning 22bp and DeemedRetractibles gaining 18bp. Volatility was good, all positive and heavily skewed towards FixedResets. Volume was average.

An article of mine has been published in the December Advisor’s Edge Report, titled OSFI’s Academic Foray, which discusses a paper published by OSFI titled Evidence for Mean Reversion in Equity Prices, which they explain as:

OSFI has had discussions with some life insurance industry representatives on equity return models that incorporate mean reversion assumptions. This was done as part of its work on the use of internal models to determine capital requirements for segregated fund guarantees.

OSFI has considered the question of whether such assumptions are prudent, and has decided that it will not review requests for approval to use internal models that incorporate mean reversion in equity returns.

The paper “Evidence for Mean Reversion in Equity Prices” accompanying this letter explains the rationale behind OSFI’s decision. It is being released so that industry participants and other stakeholders can better understand OSFI’s views on this subject.

Sadly, as I conclude:

The OSFI paper held great promise to explain to the investing public why it made a particular decision—a practice that allows us to become more familiar with OSFI’s priorities and the underlying philosophy that forms the framework for its decisions. This promise was not fulfilled.

If OSFI wishes to gain credibility as a knowledgeable and effective regulator of the Canadian financial system, it needs to produce analysis at a much higher standard. Both academia and the private sector offer considerable expertise on regulatory practice, and it should be harnessed.

I’ll post a PDF of the article as published and of my footnoted draft version after a decent interval.

ICE wants to buy the NYSE:

IntercontinentalExchange Inc., the 12-year-old energy and commodity futures bourse, agreed to acquire NYSE Euronext (NYX) for cash and stock worth $8.2 billion, moving to take control of the world’s biggest equities market.

IntercontinentalExchange, based in Atlanta, will pay $33.12 a share for the owner of the New York Stock Exchange, 38 percent above yesterday’s closing price, according to a statement today. Both boards approved the proposal and the companies expect to complete the transaction in the second half of 2013. Last year, the U.S. blocked a joint hostile bid by IntercontinentalExchange and Nasdaq OMX Group Inc. (NDAQ) for the New York-based company on concern the combination would dominate U.S. stock listings.

Merging NYSE Euronext, which owns the biggest exchanges by value of listings in the U.S., France and the Netherlands, with the second-largest futures market underscores both the growing importance of derivatives and the diminishing influence of the 220-year-old NYSE. The Big Board, once the benchmark for global free markets, has seen its share of trading in stocks listed on the exchange decline to 21 percent from 82 percent.

Boyd Erman in the Globe reports:

The trend of international consolidation of stock exchanges appears to be not just over, but unravelling.

As part of their planned combination, IntercontinentalExchange (ICE) and NYSE Euronext say they will look to sell their European equity markets, known as Euronext, in an initial public offering.
…
NYSE and Euronext combined. NYSE Euronext then tried another deal with Deutsche Boerse of Germany. TMX looked to merge with London Stock Exchange Plc. Singapore’s market looked for a tie-up with Australia’s.

For various reasons, most of those deals failed. The only big one that really got done was the creation of NYSE Euronext. And Thursday, management of NYSE declared the experiment over after synergies between the companies had been limited, and the value of Euronext, such as it is, lost within NYSE. ICE executives also pointed to a need to cut down on the number of businesses the companies would run, and regulatory changes that they said make it hard to run an international stock exchange business.

On a conference call to discuss NYSE Euronext’s planned acquisition by ICE, NYSE chief executive officer Duncan Niederauer conceded the Euronext transaction had been a bust.

“We’ve yet to deliver those returns and prove that hypotheses,” he said.

Pension chickens coming home to roost in the US:

A firefighter in Allentown, Pennsylvania, which plans to lease its water system to meet retirement costs, left last year with an annual pension of $99,289, more than double what state law says was due.
…
The unauthorized benefits, which some cities resort to partly because they prefer pension perks over raises, add to financial burdens lingering from the recession that ended in 2009. Localities in the sixth-most-populous state face $8.5 billion in unfunded pension liabilities, according to the retirement commission.
…
Audits of Pennsylvania cities that fall under pension restrictions show that 26 percent have given illegal benefits.

One such municipality was Allentown, a city of 119,000 whose plans are 64 percent funded, according to the retirement commission.

Here’s a good idea from Facebook:

Facebook said the test will start with a “small number of people” and will charge an unspecified fee to ensure a message gets sent to the main inbox — rather than a lower-priority queue — of another user, even a stranger. Facebook will test different fees, starting initially at about $1 per e-mail, according to a person with knowledge of the matter, who asked not to be identified because pricing is private.

“Several commentators and researchers have noted that imposing a financial cost on the sender may be the most effective way to discourage unwanted messages and facilitate delivery of messages that are relevant and useful,” the Menlo Park, California-based company said on its website.

For years, I’ve advocated a system for eMail whereby users pay $0.01 to send each eMail, and receive $0.01 for each email received; balance remitted or billed by the ISP monthly, balances of less than $10 either way are eliminated without payment.

Most individuals would receive payments, if any. Businesses would probably have to pay something, but $0.01 is a very cheap delivery charge for a legitimate business communication.

You want a spam-less eMail system? That’s how you get a spam-less eMail system. But all the damn hippies chant: ‘The Internet should be free!’ and I don’t think we’ll ever see that on a public system. Hippies destroyed the Internet!

It was a positive day for the Canadian preferred share market, with both PerpetualPremiums and FixedResets gaining 3bp, while DeemedRetractibles won 14bp. Volatility was low. Volume was very high.

There’s a smoking gun in the LIBOR fixing scandal:

According to transcripts released by the U.K. Financial Services Authority today, an employee identified as Trader A led efforts to influence Japanese Yen Libor submissions included paying brokers as much as 15,000 pounds ($24,400) a quarter and offering a payment to another for helping him keep that day’s rate low. Trader A worked at UBS in Tokyo from 2006 to 2009 and directly contacted employees at other banks to influence their submissions at least 80 times.

“I need you to keep it as low as possible,” Trader A wrote to the broker on Sept. 18, 2008, referring to six-month yen Libor. “If you do that … I’ll pay you, you know, $50,000, $100,000… whatever you want … I’m a man of my word,” according to the transcripts.
…
Between Sept. 19 and Aug. 25, 2008, Trader A and a colleague entered into nine so-called wash trades as a means of rewarding an unidentified broker with more than 170,000 pounds for helping rig the rate. Wash trades are where a trader puts through two or more risk-free trades through a broker which cancel each other out while leading to a payment of brokerage fees to the broker arranging the trade.

For how long will the Greeks tolerate this?

In the Greek mountain town of Kastoria, less than an hour from the Albanian border, Kostas Tsitskos, 88, can’t afford fuel to heat his home against the winter’s cold. So he and his son live in a single bedroom, warmed by a small electric heater.

“One room is enough,” said Tsitskos, who lives on a 734 euro-a-month ($971) pension and doesn’t have the 1,000 euros a month he needs to buy heating oil.

Greece is facing a heating-oil crisis. With an economy that has contracted for five years and an unemployment rate at a record 25 percent, residents in northern Greece can’t heat their homes. Kastoria hasn’t received funds from the central government to warm schools and the mayor said he will close all 53 of them rather than let children freeze, a step already taken in a nearby town. Truckloads of wood are arriving from Bulgaria as families search for alternative fuels.

Canadians shouldn’t get too cocky:

The Canadian economy is expected to pick up speed – a little – by the middle of next year, though external risks still “loom large,” a new forecast said Wednesday.

The country’s gross domestic product will grow 1.8 per cent next year and accelerate to 2.25 per cent in 2014, the International Monetary Fund said in its preliminary assessment of the Canadian economy. That’s down slightly from its October forecast of 2 per cent growth for next year.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums off 2bp, FixedResets gaining 7bp and DeemedRetractibles up 12bp. Volatility was average, but the highlights are all negative. Volume was quite high – presumably due to traders trying to get ready for year-end before the holiday lull.

PerpetualDiscounts now yield 4.88%, equivalent to 6.34% interest at the standard equivalency factor of 1.3x. Long corporates yield just under 4.3%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 205bp, a slight (and perhaps spurious) decline from the 210bp reported December 12.

As mentioned yesterday, I received a query from an Assiduous Reader asking me to clarify my remarks of December 13 regarding the recent CSA Discussion Paper and Request for Comments on Mutual Fund Fees.

Having reviewed my comments, I confess to some surprise that clarification should be required – they seem plain enough to me. But here goes:

i) The CSA is concerned that:

investors have no say in the extent to which their mutual fund assets are used to pay for advisor compensation.

I pointed out that this is like every other product sold to retail. When I buy a can of beans for $2.49 at the grocery story, I have no say in how that $2.49 is split between the producer, the middlemen and the store itself. Why should I? The deal’s right there: $2.49 for a can of beans, take it or leave it. What’s wrong with that? The price is disclosed and the nature of the product is disclosed: it makes no difference to me whether the Chilean farmer who planted and harvested the beans gets a nickel or quarter out of the deal.

Some people, of course, get all worked up about things like this and start “Fair Trade” organizations with the stated intent of increasing the proportion of the retail price paid to the producer, even if this increases the retail price. Well, more power to them! But most people don’t care because the question is totally irrelevant to them.

As far as mutual funds are concerned – the amount to be taken from the fund by the sponsor as management fees is stated in the prospectus and this figure is (as pointed out by Assiduous Reader mclachlan8) widely publicized. What happens to the fees afterwards is irrelevant to the investor.

ii) I found the following bland assertion rather breathtaking:

Using fund assets to pay for trailing commissions could encourage additional sales of the fund. This could increase the fund’s assets under management, which would increase the management fees payable. This creates an actual or a perceived conflict of interest between the mutual fund manufacturer and the fund’s investors. [footnote]

[Footnote reads:] G. Stromberg, supra note 81, at pages 16-17, comments on this conflict of interest as follows: “A result of this perspective is that independent investment fund organizations have increasingly become marketing companies, more focussed on gaining market share than on being investment management companies focussed on managing investment funds for the benefit of the investors in these funds. The major concern that arises from the focus on marketing considerations is whether marketing considerations are prevailing over investment management decisions and resulting in conflicts of interest between the fund manager and the fund investors.

One reason this is breathtaking is lack of a logical connection between the footnote and the text. Ms. Stromberg was concerned about investment management decisions, which do not have anything to do with the level of fees charged.

An example of an investment management decision that could be influenced by marketing considerations is the decision to invest in security XYZ because it was popular with retail; or because it enabled the marketing department to trumpet the holding as a bold example of incisive logic; or some such rationale. If this rationale conflicted with the portfolio manager’s honest opinion of security XYZ as an investment – yes, that’s a clear breach of duty, that’s bad, take them out and shoot them.

But it has nothing to do with the fee charged.

However, the most offensive portion of the chain of thought lies in the implication that fund assets are used to pay trailer fees. This is, generally speaking, false: fund assets are not used to pay trailer fees. Fund assets are used to pay the Management Expense Ratio; once this payment has been received by the fund sponsor, the funds become property of the sponsor and lose their identity as fund assets. And the fund sponsor is perfectly entitled to do whatever it wants with its property.

There are some rare cases in which fund assets are used to pay trailers: for instance, CPD.A differs from CPD in that the former pays a trailer to the advisors of the holder. This is fully disclosed in the prospectus and reported in the financial statements – I fail to see any problem with this. The payments are included in the reported Management Expense Ratio, and investors can take it or leave it, as they see fit. One of the CSA’s proposed changes [# (iii)] envisions all mutual funds having such a carve-out of trailers … but this is a proposed CHANGE, not a reflection of the current state of affairs.

iii) However, the CSA logic becomes even more convoluted – and even more offensive – in the latter part of the paragraph quoted:

This practice could put the mutual fund manufacturer at odds with its statutory duty to act in the best interest of the mutual fund [First Footnote] to the extent the mutual fund manufacturer, rather than the fund and its investors, is the primary beneficiary of the fund’s asset growth. The mutual fund manufacturer must be able to demonstrate that it is acting in the best interests of the mutual fund and its investors, and not itself, when engaging in this practice.[Second Footnote]

[First Footnote reads] See s. 2.1 of National Instrument 81-107 Independent Review Committee for Investment Funds, which requires the manager of the investment fund to (a) act honestly and in good faith, and in the best interests of the investment fund, and (b) exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. The Securities Acts of most of the CSA jurisdictions also contain a similar provision.

[Second Footnote reads] A mutual fund manufacturer could demonstrate this, for example, by reducing the management fees and expenses it charges to a mutual fund as its assets grow, thus yielding a benefit to the fund and its investors. Interestingly however, U.S. studies on trailing commissions, known in the U.S. as “12b-1 fees”, have concluded that trailing commissions don’t yield the expected benefit for investors. When 12b-1 fees were originally adopted in the U.S., mutual funds were experiencing net redemptions. The belief was that if fund flows could be attracted through the use of 12b-1 fees, existing investors would benefit through lower expense ratios as assets under management increased. Subsequent U.S. experience has shown this not to be the case with 12b-1 fees increasing expense ratios on a one-for-one basis even as assets under management increase. See S. Collins, The Effect of 12b-1 Plans on Mutual Fund Investors, Revisited (March 2004) ICI working paper, and L. Walsh, The Costs and Benefits to Fund Shareholders of 12b-1 Plans: An Examination of Fund Flows, Expenses and Returns (June 2004) SEC discussion paper available at: http://www.sec.gov/rules/proposed/s70904/lwalsh042604.pdf.

The logic of the part up to and including the first footnote is absurd. It continues the conflation of the roles of portfolio manager and sponsor discussed above. The Portfolio Manager certainly has a fiduciary duty to the fund to exert care and prudence in portfolio management – that much is basic. But this is an entirely separate topic from how much is charged for that Portfolio Manager’s care and prudence.

A criminal lawyer, for instance, owes fiduciary duty to his clients. But we don’t (often) see Clayton Ruby work for free, although I’m sure he does his share of pro bono work in the public interest. As a matter of general principle, most people will attempt to charge whatever the market will bear for their services, regardless of what those services might be. And why not? It’s certainly not unethical to ask your boss for a raise, or to find a better paying job.

The premise underlying the last sentence of the quoted CSA paragraph, leading up to the second footnote, is offensive to any conception of justice: “The mutual fund manufacturer must be able to demonstrate that it is acting in the best interests of the mutual fund and its investors, and not itself, when engaging in this practice.” Since when, in Canada, has it been necessary to prove innocence? I assert that it is the regulators, or aggrieved parties, who bear the onus of proving that the fiduciary duty of the portfolio manager has been breached.

iv) With respect to the part (ii) of the “possible changes”:

ii. A standard class for DIY investors with no or reduced trailing commission
Every mutual fund could have a low-cost ‘execution-only’ series or class of securities available for direct purchase by investors. The lower management fees of this series or class would reflect that no or nominal trailing commissions are paid to advisors, in light of the lack of advice sought by DIY investors who purchase and hold securities of this series or class. This low-cost series or class of securities could be made available to investors through a discount brokerage, or alternatively, be distributed directly by the mutual fund manufacturer, in which case the mutual fund manufacturer would need to be registered as a mutual fund dealer.

As I remarked, it’s not clear how the discount brokerages will bet paid for this service; it’s also not clear what the manufacturers’ responsibility to the clients will be for this additional service, or how (if?) they will get paid.

With respect to the discount brokerages, I mentioned yesterday the sabre-rattling that has commenced in the UK, with the discount brokerage Hargreaves mulling over how it should be paid for its services given the pending illegality of trailer fees in the UK. The UK has already passed the damn law, and the resolution of this question is not clear!

v) My last remark was with respect to:

v. Cap commissions
There could be a maximum limit set on the portion of mutual fund assets that could be used to pay trailing commissions to advisors as a way to mitigate the perceived conflicts of interests and the lack of alignment of advisor compensation and services described in Part V. …

I stated that the level of trailers is “just plain none of the regulators’ damn business.”, and stand by that remark. Disclosure? Sure – that’s regulatorary business. Level? No way.

A further problem with the regulatory proposals with respect to trailers has arisen in the comments to yesterday’s post with respect to fiduciary duty. If fees are charged directly by the advisor to the investor, then the advisor will have a fiduciary duty towards that client. This is basic, and is currently embedded in the securities laws in the case of secondary trading, where a commission is paid with respect to a trade and the advisor has a number of explicit duties with respect to that trade, e.g., to seek best execution and not to front-run the order.

Now, if one feels that stockbrokers should have a fiduciary duty to clients, that’s all well and good – but is best addressed under the heading “Fiduciary Duty” rather than “Trailer Fees”. Many of the CSA suggested changes have the effect of imposing fiduciary duty on advisors without being quite brave enough to say the word – which is already the subject of a completely different set of regulatory proposals anyway.

It was a mildly positive day for the Canadian preferred share market, with PerpetualPremiums up 8bp, FixedResets flat and DeemedRetractibles gaining 2bp. Volatility was low. Volume was average.

The patron saint of lapdogs is getting a little tarnish on his halo:

There has been quiet talk for some time that Bank of Canada Governor Mark Carney was seriously considering a run at the Liberal leadership but, until this weekend, it was only in the form of whispers.

A Globe report, however, has revealed that Mr. Carney had serious discussions with Liberal party insiders on his ability to defeat Justin Trudeau in a leadership campaign and even stayed at Liberal MP Scott Brison’s house for a period of time – a likely violation of the bank’s conflict of interest guidelines. If true, the allegations reveal a serious lack of judgment and threatens to taint one of the country’s most vital institutions.

I think Carney has done plenty to taint it already – in acting as a stalking horse for his political masters. But our hero can do no wrong:

The Bank of Canada says it’s assessed Mark Carney’s family stay over at the seaside home of the Liberal Party finance critic this past summer and decided he was not in a conflict of interest for accepting this hospitality.

The Official Opposition NDP pointed out, however, that its finance critic could only get a phone call from the Bank of Canada governor when she asked for a meeting.

I mentioned the regulatory proposals on trailer fees on December 13 and will have more to say – in response to a query from an Assiduous Reader – shortly. In the mean-time, there’s a dogfight brewing in the UK:

Peter Hargreaves made himself a billionaire by selling mutual funds through his discount broker, Hargreaves Lansdown Plc. (HL/) Now, as planned rules threaten his business model, he intends to raid fund managers’ profits.

Hargreaves built the firm into the U.K.’s biggest retail broker, the country’s equivalent of Charles Schwab Corp. (SCHW), by selling funds and charging money managers rather than clients. Starting in 2014, U.K. brokers will have to charge clients directly, a move analysts say jeopardizes the firm’s 64 percent profit margin. Hargreaves says funds must eat the cost.

“All the groups are sitting there, smug, thinking we’re getting 0.75 percent and we’re not going to give Hargreaves anything anymore,” Hargreaves, 66, said in an interview at his office in Bristol, western England, where he started the firm in his spare bedroom 30 years ago. “That’s not going to happen. They need to bear some of it.”

The Financial Services Authority, the U.K. regulator, plans to ban brokers from receiving cash from money managers and require investors to pay brokerage fees directly to bolster transparency in an industry where costs are more than double those in the U.S. Hargreaves Landsown has increased earnings sixfold since 2007, and the stock has climbed 65 percent this year in London trading, making it the second-best performer in the FTSE 100 Index. (UKX) Still, the shares have slipped 7 percent this month on concern the rule change will crimp earnings.
…
Hargreaves plans to introduce charges to replace the payments, called trail commission in the U.K., which would either be an annual fee based on the value of clients’ assets, a charge for each trade or a combination of the two. He declined to give more details on his pricing plans before the FSA approves the rules. The fees, which he called “competitive,” will probably apply to existing clients’ funds, he said.

A custodial fee charged by discount brokerages will be interesting, to say the least, regardless of how much sense it makes. Geez, I can hear the howls from the DIY guys already … ‘you mean I have to pay as much to hold my ETF (and my common stocks? and my GICs?) as others do to hold their 2.5% MER mutual funds? What?’

What else can we think of by way of unintended consequences? How about tied selling? “Sorry, buddy, but we will no longer allow you to buy ABC funds through your DEF account, because there’s nothing in it for us. We offer DEF funds only.” or how about “If you want to buy the ABC funds, you have to open a ‘Wonder-Gizmo ABC Account’. It’s quite expensive, I’m afraid, and charges have to be paid in person and in cash at our Tuktoyuktuq branch. Here, fill out these forms.”

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 5bp, FixedResets down 8bp and DeemedRetractibles up 13bp. Volatility was average, but entirely negative. Volume was high.