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.

There’s a bit of news regarding high-trigger CoCo issuance:

Nykredit Realkredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds, is planning to use its first sale of contingent convertible notes to bolster its rating after meeting capital requirements.

The Copenhagen-based lender, which is preparing a 500 million euro ($685 million) issue of Tier 2 CoCos that will be written down and canceled if a 7 percent capital adequacy requirement is breached, will use the securities “to get the best possible issuer rating relative to costs,” Chief Financial Officer Soeren Holmsaid in an interview.

What? Cancelled if 7% capital adequacy is breached? Yes, it’s true:

The notes are subordinated Tier 2 instruments without a coupon deferral feature and subject to a 7% capital adequacy trigger. On breach of the trigger, the notes will be automatically written down to zero and the notes cancelled, resulting in loss of principal and future interest for investors. The capital adequacy trigger is based on Nykredit Realkredit’s individual or consolidated common equity Tier 1 (CET1) ratio or Nykredit Holding’s consolidated CET1 ratio. The notes are rated three notches below Nykredit Realkredit’s ‘a’ Viability Rating (VR) in accordance with Fitch’s criteria for “Assessing and Rating Bank Subordinated and Hybrid Securities” dated 31 January 2014 at www.fitchratings.com. The notes are notched twice for loss severity to reflect the principal write-down feature, and once for non-performance risk, to reflect the moderate incremental risk due to the 7% CET1 ratio trigger, partly offset by the large capital buffer above this trigger point, compared with the risk reflected in the bank’s VR.

The interesting part is that they’re cheaper to issue than Innovative Tier 1 Capital (the cool guys are now calling this AT1):

Nykredit Realkredit A/S said it won’t follow its biggest Danish competitor in using additional Tier 1 instruments to refinance hybrid debt as contingent convertible bonds offer a cheaper path to supporting ratings.

“The rating impact outranks the need for regulatory capital for now,” Soeren Holm, chief financial officer at Copenhagen-based Nykredit, said in a phone interview on Friday. “We plan to use CoCo instruments for the refinancing. Standard & Poor’s includes all of them in full when setting our capital ratio.”

Well, Fitch can say what it likes, but I find the reliance on definitions of regulatory capital to be very alarming. There’s lots of room there for management discretion and regulatory discretion in times of trouble, and that means things can get pretty tricky when trying to analyze these things in a chaotic environment. We’ve seen regulatory discretion in Canada (albeit in the other direction) when OSFI solved MFCs problem by agreeing to pretend there wasn’t a problem during the recent credit crisis.

Aren’t you glad you don’t have these neighbors?

[1] The parties to this action live across the road from each other in Toronto’s tony Forest Hill neighbourhood. The video footage played at the hearing shows that both families live in stately houses on a well-manicured, picturesque street. They have numerous high end automobiles parked outside their homes.

[2] The Plaintiff, John Morland-Jones, is an oil company executive; the Defendant, Gary Taerk, is a psychiatrist. They do not seem to like each other, and neither do their respective spouses, the Plaintiff, Paris Morland-Jones and the Defendant, Audrey Taerk.

[3] In this motion, the Plaintiffs seek various forms of injunctive relief on an interlocutory basis. It all flows from the Plaintiffs’ allegation that the Defendants have been misbehaving and disturbing their peaceful life in this leafy corner of paradise.
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[23] In my view, the parties do not need a judge; what they need is a rather stern kindergarten teacher
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[27] There is no serious issue to be tried in this action. The Plaintiff’s motion is therefore dismissed.

It would appear that John Morland-Jones is an old UCC-boy who lives at the corner of Burton Road & Vesta. A nice neighborhood indeed! I see that Dr. Gary Taerk is with Toronto General Hospital which, given my experience with TGH personnel, sounds about right.

My suggestion to the TMX that they start reporting closing quotes (mentioned yesterday) has garnered twenty-five votes, so it looks like all eight of my Assiduous Readers have helped me out. Thanks! The Official Response is:

Hello,

This issue around Closing Prices on our 15-minute delayed website is currently under investigation. We hope to have it resolved as quickly as possible.

The problem is related to our use of Canadian Consolidated Quotes (“CCQ”) as a default when retrieving a quote. This view consolidates traded from all Canadian markets.

To correct this problem in the short-term, please check quotes on Toronto Stock Exchange or TSX Venture Exchange markets only instead of the CCQ. You can do this by adding TSX or TSXV suffix (:TSX or :TSV) in the “Get Quote” box when you enter a ticker.

Example: http://web.tmxmoney.com/quote.php?qm_symbol=RY:TSX
http://web.tmxmoney.com/quote.php?qm_symbol=PMI:TSV

Thanks again for your patience.

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

I posted a comment but it has been deleted – perhaps because it included links. So I’ve sent them an eMail:

Sirs,

As of December, 2010, quotes accessed after market hours could be affected by order cancellations on the Toronto Stock Exchange after 4pm. See the discussion of the GWO.PR.J on 2010-12-2 at https://prefblog.com/?p=13456 (more information at https://prefblog.com/?p=13796 ).

In addition, this problem has also affected the historical information available via tmxdatalinx.com

Has there been a change in procedures in the interim? If so, just precisely what is the source of closing quotations provided via tmxmoney.com and tmxdatalinx.com?

Sincerely,

More on the junk bond liquidity premium:

It’s getting harder to trade bonds. Hours, sometimes days can go by before investors can complete a transaction. That’s not dissuading them from piling into the most-illiquid debt out there.

Junk-bond investors are earning practically nothing extra to own older, smaller bond issues that don’t typically trade as often as bigger, newer debt offerings, according to Barclays Plc (BARC) data. The gap has collapsed to almost zero from a 1.05 percentage point premium for the less-liquid notes in the fourth quarter of 2011.

That means bondholders aren’t really being compensated for the risk that there might be no one who wants to buy their obscure securities if demand dries up and they’re forced to sell. They’re not worrying about that now, though, with volatility at historic lows and cash flowing into credit markets amid a sixth year of unprecedented Federal Reserve stimulus.
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Unlike stocks, junk bonds are traded over the phone away from exchanges. Wall Street’s biggest banks have traditionally facilitated corporate-debt trades using their own money. They’re reducing this role now in the face of regulations making them hold more capital against debt holdings.

In the past, dealers would purchase bigger clumps of bonds than they could immediately sell, allowing investors to get out of positions even if a broker didn’t have a client on the other side looking to buy. That’s changed, and junk-debt trading has fallen as a proportion of the total amount outstanding.

The amount of below investment-grade bonds in the market has swelled by 54 percent since 2009, yet trading volumes have only increased by 34 percent in that period, according to Bank of America (BAC) Merrill Lynch and Financial Industry Regulatory Authority data.

It was a day of small gains for the Canadian preferred share market, with PerpetualDiscounts up 4bp, FixedResets gaining 3bp and DeemedRetractibles winning 5bp. Average volatility was augmented by some good bouncing by Floaters. Volume was average.

So I was talking to a guy on the weekend who said he’d worked out that his house value had multiplied forty times since he bought it in 1967. Pretty good, eh? How does it compare to other things?

So the S&P 500 beat my buddy’s house over the period, but only by about 1.7% annually; property taxes, maintenance and insurance have been ignored, but so has rent … I suspect that once you throw everything into the mix the house has done a lot better.

Got some data? Let me know and I’ll add it to the table.

Coincidentally, Rob Carrick writes:

National price data from the Canadian Real Estate Association shows an average annual gain of 5.4 per cent nationally from 2004 through 2013 for resale homes. The comparable average return from stocks was just under 8 per cent. If we go back 20 years, we get an 8.3 per cent gain from Canadian stocks and an increase of 4.5 per cent in the average national house price. Over 30 years, stocks made 8.5 per cent and houses 5.5 per cent.

Stocks, or at least the benchmark for the Canadian market, win. Case closed. So why do houses enjoy such a great reputation as an investment? Some answers to this question were recently presented in a blog post by Adrian Spitters, a certified financial planner (CFP) with Assante Capital Management Ltd. in Abbotsford, B.C. For one thing, he thinks people take a much longer-term view of housing prices than they do with stocks. With stocks, they focus a lot on short-term price fluctuations and lose sight of long-term results.

The perception of stocks has also been hurt by two market crashes since 2000, even though long-term investors have still done fine. “Years ago, when people didn’t have access to information online, I don’t think they panicked as much about stocks,” Mr. Spitters said in an interview. “People tend to be more aware of the volatility.”

He also says people ignore the true cost of owning a home and thus come away with an overly optimistic view of how much money they’ve made. Property taxes, furnishings, maintenance, improvements, insurance and mortgage interest all have to be factored into calculations of how much money is being made on housing.

Property taxes, maintenance and insurance, I agree. Furnishings, mortgage interest, I disagree. But one thing is, of course, that houses can be levered up higher than equities.

Sunday School. Coming soon to a trading desk near you!

The video, shared widely on social media Friday, takes aim at the famously crass culture on trading floors – most recently highlighted in The Wolf of Wall Street movie – and is part of a broader campaign to change the corporate culture at scandal-plagued Deutsche Bank, which has faced major penalties in recent years for improper trading practices.

Mr. Fan warns in the video that all e-mails and conversations are open to scrutiny when regulators are investigating a case of suspected wrongdoing and said “communications that run even a small risk of being seen as unprofessional” must stop “right now.”

“Some of you are falling way short of our established standards,” Mr. Fan says in the video. “Let’s be clear: Our reputation is everything. Being boastful, indiscreet and vulgar is not okay. It will have serious consequences for your career, and I have lost patience on this issue.”

Assiduous Reader DW writes in and says:

I’ve read with some interest your recent posts on bond ladders. (I would have responded on your site, if I could figure out how to sign-in without re-registering. Although I’ve commented before, the system has no record of me; and instead of repeating the registration process again, I’ve decided to send you this note.)

I confess that many of the points raised by others and addressed by you are lost on me, in part because it’s easy to buy a bond ladder via an ETF and in part because I buy bond ladders as an act of duration defence, not offence; but also in part because I lack the financial sophistication to grasp some of the finer points – either that or they seem too minor for me to worry about.

But I have a specific question that ties into your point that some people hold short-term instruments to counter-balance longer-term fixed income, such as the preferred shares you recommend. I’m interested in your thoughts on whether it might make sense to use something like First Asset’s Laddered 1-5 Year Strip Bond ETF (BXF) for short-duration exposure. I like the strip aspect of the ETF because it eliminate the adverse tax effect of an ETF holding premium bonds; and I like the longer-term defensive characteristics of the ladder format. Your comments go me wondering whether it might make sense to construct something of a synthetic fixed income barbell by putting half of the fixed income allocation in something like BXF and half in a collection of the PrefLetter recommendations.

On this point, if it’s feasible, it would be nice to see some recommendations in your PrefLetter on this point: namely, how one might go about fitting your preferred share recommendations into an overall fixed income allocation, even if the guidance is only general and lists only a collection of bond ETFs you think are potentially sensible for this purpose. Regardless, the publication is excellent.

Some people lost their accounts during the horrific server migration in December. *sigh* They may re-register, or get me to do it.

Anyway, the first problem in looking at this is that the main page for the First Asset DEX 1-5 Year Laddered Government Strip Bond Index ETF states that:

The First Asset ETF has been designed to replicate, to the extent possible, the performance of a Canadian 1-5 year laddered government strip bond index, net of expenses. The current index is the DEX 1-5 Year Laddered Government Strip Bond Index … More information on the Index is available at the Index Provider’s website at www.canadianbondindices.com

… and the index is not mentioned on the TMX Debt Market Methodolgies page. It’s just the banks’ way of reminding us that they’re important bankers and we’re just ignorant customer scum. Ha-ha! Where else ya gonna go, suckers? Can you spell “monopoly”? However, somebody has inadvertently left a link to the methodology on the CANADIAN DEBT MARKET INDICES page, so we can look at that.

According to the DEX 1-5 year Laddered Government Strip Bond Index Methodology:

a Government only laddered index structure, in CDN$, selected from the constituents of the DEX Strip Bond Index (please refer to the DEX Strip Bond Index Methodology for qualification criteria)
– Laddered into 5 term buckets (1-1.99 yrs, 2-2.99 yrs, 3-3.99 yrs, 4-4.99 yrs, 5-5.99 yrs)
– Index constituents are rebalanced annually, each June 30 (or the last business day of June)
– Bonds will roll out to the next lower bucket on the rebalance date
– Bonds with < 1 year to maturity will roll out of the first bucket on the rebalance date at the mid market closing level on rebalance date – Index will re-invest the full market value of all roll out securities into the longest bucket at full units - Inception Date is June 29, 2012 – 5 bonds are selected for each term bucket (25 in total) in the following proportion: - 1 Government of Canada (or Government of Canada Agency) Bond - 4 Provincial Bond (including provincial guarantees) - Substitutions may be required where no Government of Canada or Agency Bond exists. – Minimum issue size 50MM – Select the most liquid in the bucket (as ranked by trailing 12 month average daily dollar volume traded)

They don’t say how they’re computing the “trailing 12 month average daily dollar volume traded”, but I assume it’s from data “provided by [the bank-owned] CDS (Canadian Depository for Securities) for the Canadian Strip marketplace.” as is the case with the Canadian Strip Bond Index. Compete with that, sucker! I feel certain that you, too, can buy such data from CDS at ever-so-reasonable prices.

With respect to distributions, according to the prospectus:

With respect to Strip Bonds, the First Asset ETF will generally be required to include annually in income notional interest deemed to have accrued on the Strip Bonds from the date of purchase, notwithstanding the fact that there is no entitlement to interest payable under the Strip Bonds.

OK, so all this is fair enough. How is it valued?

The value of any bond will be the price provided by FTSE TMX Global Debt Capital Markets Inc. (formerly “PC-Bond” a business unit of TSX Inc). FTSE TMX Global Debt Capital Markets Inc. will determine the price from quotes received from one or more dealers in the applicable bond, selected for this purpose by FTSE TMX Global Debt Capital Markets Inc.

So it looks like that the issues will be valued as strips. While this makes eminent sense, it should be noted that strips are expensive; pricing and yield information is difficult to get ahold of on their website (which is alarming in and of itself) but we can get some information from the December 31, 2013 Financial Statements.

They are, for instance, holding 195M PV of Canada Strips 2015-12-1, valued at $190,543. This means the price is 97.7144, with a term of 1.918 years. That’s an IRR of 1.213%, bond-equivalent-yield of 1.209%. A Two-Year Canada was yielding 1.13% about then.

Repeating all these calculations, very laboriously I might say, results in the calculation that (as of 2013-12-31) the portfolio was yielding 1.79% with a duration of just over three years. It was about 20% federal, 40% Ontario and 40% Quebec. Three year Canadas were about 1.21%. I don’t know about then, but now three year Ontario and Quebec bonds are both trading about 30bp over three year Canadas, So all in all, it looks like the pricing is fair, but you’re still paying strip prices for this stuff.

Strips are expensive and provincials are expensive (due to liquidity) and Canadas are very expensive (due to liquidity). I never recommend anybody ever buy Canadas, because the liquidity premium is grotesque.

Given that what you want is short-duration bonds to counterbalance the long duration of your preferred share portfolio, I would suggest buying short-term provincial bonds instead of strips (because strips are so expensive) and – if your portfolio is of sufficient size – buy short corporates in prudent size as they become available. Current coupon issues only, of course; and remember, in an RRSP it doesn’t matter so you can buy an ETF or fund in a registered plan without worrying about the coupon.

Here’s how business gets done:

A German water utility alleged a former UBS AG (UBSN) banker had an “inappropriate” relationship with consultants advising on disputed swap deals, the latest lawsuit to highlight how complex financial instruments backfired on municipal agencies during the 2008 financial crisis.

Kommunale Wasserwerke Leipzig GmbH said in court documents that Steven Bracy, the banker at the center of the allegations, booked strippers for consultants at Swiss firm Value Partners and went on an African safari with them. That happened even as he was supposed to be advising KWL on its derivative transactions with UBS.

KWL made the allegations in its response to a lawsuit filed by UBS, in which the bank is seeking $138 million under so-called credit protection agreements from 2006 and 2007. The utility argues in court documents that the close relationship between the bank and the consultants creates a conflict of interest that invalidates the deal. Bracy is scheduled to testify at the trial in London today.
…
Bracy, then a UBS employee, “appears” to have asked another man in 2006 to arrange for four strippers to be paid $5,600 each, KWL said in court documents. Later that year, Value Partners invited Bracy and another UBS employee to go on a “luxury safari” in South Africa to discuss a partnership.
…
A lawyer for UBS, Charles Falconer, told the court in April that written agreements show Value Partners was advising KWL on the transaction.

“There was never any doubt in anyone’s mind that Value Partners were acting for KWL,” he said. “Attempts by Value Partners during the course of the transactions to blur the line were rebuffed by UBS.”

Falconer said UBS didn’t force KWL to accept the deal and any blame was with the water supplier and its former managing director, Klaus Heininger. Heininger was convicted by a German court of accepting more than $3 million in bribes from Blatz and Senf beginning in 2005.
…
The strippers and safari weren’t the only gifts allegedly exchanged between UBS and Value Partners. The bank gave tickets to the World Cup soccer quarter-finals in Berlin in 2006 to Blatz and another person at Value Partners, and watches and suitcases to Blatz and Senf later that year, the bank said in court documents. The bank says the gifts were “normal” in the industry, unsolicited, too minor to breach fiduciary duties and not given surreptitiously.

The only thing I find surprising about this is that the strippers did so well. What did they have to do to earn $5,600 each?

Every now and then there’s a story decrying cybersecurity as a military boondoggle:

It’s a threat the government deems serious enough to hire more than 10,000 “cyber warriors” in the near future, according to the Cyber Security Challenge, a public-private contest created to hire the next generation of cybersecurity experts.

And it’s a focus that already consumes billions of dollars in taxpayer dollars each year.

In 2011, the federal government spent over $13 billion on cybersecurity, all but $3 billion of that from the Department of Defense, according to a recent report by the DOD’s Cyber Threat Task Force.

“There has been very little analysis as to the cost or expected benefits for any regulation pertaining to cybersecurity,” said James Gattuso, a senior research fellow at the Heritage Foundation, a nonprofit conservative think tank in Washington, D.C. “It’s admittedly a very difficult thing to measure.”

… and every now and then there’s a story about the lack of cybersecurity:

It shouldn’t be easy to shut down a European ministry for days, depriving bureaucrats of access to e-mail and the web. Someone, however, has managed to do just that to Belgium’s foreign ministry, which had to quarantine its entire computer system last Saturday and only managed to restore the work of the passport and visa processing systems on Thursday. Similar attacks seem to be taking place elsewhere in Europe, as Belgian Foreign Minister Didier Reynders told the Belga news agency after meeting with a senior French diplomat that “everyone (on the European level) notes at this moment a very powerful pickup in hacking activity probably coming from the east and in any case having to do with Ukraine.”
…
Given the attack target’s clout and resources, one would have expected the U.S. and its NATO allies to thoroughly study and block the malware. That didn’t happen. Defense conglomerate BAE Systems wrote in a recent report that “the operation behind the attacks has continued with little modification to the tools and techniques, in spite of the widespread attention a few years ago.”

… and every now and then there’s some actual sabre rattling:

The U.S. dramatically escalated its battle to curb China’s technology theft from American companies by accusing five Chinese military officials of stealing trade secrets, casting the hacker attacks as a direct economic threat.

The indictment effectively accuses China and its government of a vast effort to mine U.S. technology through cyber-espionage, stealing jobs as well as the innovation on which the success of major global companies like United States Steel Corp. (X) and Alcoa Corp. (AA) depends.
…
Those indicted were officers in Unit 61398 of the Third Department of the Chinese People’s Liberation Army. The Justice Department identified them as Wang Dong, Sun Kailiang, Wen Xinyu, Huang Zhenyu and Gu Chunhui.

In one of the cases, the Justice Department said Sun stole proprietary technical and design specifications for piping from Westinghouse, the nuclear reactor arm of Toshiba Corp. (6502), as the company was building four power plants in China and negotiating other business ventures with state-owned enterprises.

In another instance, Wang and Sun hacked into U.S. Steel computers as the company was participating in trade cases, according to the department’s statement.

… which results in more sabre rattling:

China is lashing out at the United States as a cybersecurity “hypocrite” after U.S. authorities indicted Chinese military officers with hacking into the systems of corporations.

China’s foreign ministry spokesman, Hong Lei, accused the U.S. on Tuesday of damaging already-fragile relations between Beijing and Washington. On Monday Beijing summoned the U.S. Ambassador to China to voice its complaints and pulled out of a joint cybersecurity working group, saying the U.S. must “correct its mistake and withdraw its indictment.”

A lot of long bonds are being issued globally:

Global borrowers from Shell in The Hague to Peoria, Illinois-based Caterpillar Inc. (CAT) raised a record $368 billion this year from bonds maturing in 10 years or more, according to data compiled by Bloomberg. The average yield companies pay to raise long-dated debt worldwide fell 61 basis points this year to 4.4 percent, approaching the low of 4.1 percent reached in 2013, Bank of America Merrill Lynch data show
…
The average maturity of global company notes has climbed to 8.5 years, compared with 8.1 years over the past decade, Bank of America Merrill Lynch data show.

OK, I want everybody to go to the TMX website. In the bottom left hand corner will be a little orange “Suggest an idea box”. Click that. Suggest something, or not. Your choice. But then go to the voting and feedback page (you might be able to do this directly. I’m not sure how their cookies work).

I have suggested the following:

Report Closing Quotes

You currently report Last quotations (as of 4:30pm) rather than Closing quotations (as of 4:00pm).

This is ridiculous. The extended session isn’t even an active market, as defined by the accounting profession.

I suspect that your use of Last quotations is a holdover from days prior to the extended session, and results solely from an oversight, since Last quotations have meaning only insofar as they reflect the Closing quotation.

You have ten votes and are allowed to place three of them with any one idea. I want three of your votes for this. For more information on this issue, see TMX DataLinx: “Last” != “Close” and More on the TMX Close != Last. This issue has been driving me nuts for over three years now.

Other ideas that got my support were:

provide real time quotes

It’s time for this – why not make a bold move a jump to the head of the line?

This doesn’t have a hope in hell, since selling real time quotes is extremely lucrative, but it’s a nice thought.

Provide alerts when a company changes their symbol and provide the new symbol is

This would be useful.

There was another about providing the net change rather than the gross price change on an ex-dividend day, but I can’t find it on the site now.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 19bp, FixedResets gaining 2bp and DeemedRetractibles off 5bp. Volatility was average. Volume was extremely light.