Month: July 2017

The SEC says cryptocurrencies are securities (link to full report added):

The Securities and Exchange Commission issued an investigative report today cautioning market participants that offers and sales of digital assets by “virtual” organizations are subject to the requirements of the federal securities laws. Such offers and sales, conducted by organizations using distributed ledger or blockchain technology, have been referred to, among other things, as “Initial Coin Offerings” or “Token Sales.” Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.

The SEC’s Report of Investigation found that tokens offered and sold by a “virtual” organization known as “The DAO” were securities and therefore subject to the federal securities laws. The Report confirms that issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies. Those participating in unregistered offerings also may be liable for violations of the securities laws. Additionally, securities exchanges providing for trading in these securities must register unless they are exempt. The purpose of the registration provisions of the federal securities laws is to ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors’ protection.
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The SEC’s Office of Investor Education and Advocacy today issued an investor bulletin educating investors about ICOs.

The Ontario government’s pension fund manager has opened for business:

Toronto-based Investment Management Corporation of Ontario (IMCO) begins managing the $60-billion on behalf of its first two clients, Workplace Safety and Insurance Board (WSIB) and the Ontario Pension Board (OPB), on Monday after a lengthy integration process. IMCO hopes to add other small public-sector plans over time by offering them access to a broader range of asset classes at lower fees.
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IMCO has roots in a 2012 report on what might be gained by pooling Ontario’s fragmented public-sector pension funds. It was penned by Bill Morneau, who was then president of Morneau Shepell and a pension investment adviser to Ontario’s Minister of Finance. His review suggested that size does matter in investing, that grouping these funds together would be a more efficient investment method and that plans might collectively save more than $75-million each year.
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When the initial build out of IMCO’s investment teams is completed more than a year from now, he will need to be able to make a compelling argument to potential future clients that the improved returns and lower costs will lead to better results than what they would be able to source on their own. Otherwise, there’s no incentive for a prospective client to join the voluntary IMCO group.

But the model already has a strong track record in Western Canada. Alberta Investment Management Corp., known as AIMCo, manages more than $90-billion of assets for 26 pension, endowment and government funds in its province. British Columbia Investment Management Corp., or BCIMC, is even larger, managing $135-billion for more than 30 institutional clients.

Like its Western cousins, IMCO will also look to manage more of its money in house, rather than buying investments in asset through other fund managers.

It will not have escaped the intelligent and assiduous reader that, in the context of a $60-billion portfolio, $75-million in projected fee savings is only slightly greater than the square root of fuck-all. I don’t want to issue any doom-filled forecasts here, but as I have pointed out in the past:

I don’t think there’s anything wrong with the Yale model, but there are definitely problems with the implementation – as I told one guy recently, just because I believe the “Warren Buffet style” of investment CAN work, doesn’t mean I think YOU can do it.

The field is filled with ignoramuses and charlatans and institutional boards aren’t any better at picking winners than any other retail investor who handles his investments as a part-time job. Hiring a small group of specialists to farm out the work to third party firms just makes matters worse, because then allocations are made on the basis of two salesmen talking to each other.

For an institution to outperform, I believe that you have to have most, if not all, of the investment expertise in-house. ‘You don’t need to sell anything, guys, you just have to outperform on a rolling four year basis or you’re fired.’ This is the Teachers/OMERS model – and it works.

So, I will direct readers’ attention to the assertion in today’s Globe article: he will need to be able to make a compelling argument to potential future clients that the improved returns and lower costs will lead to better results. That is to say, sales. It must be remembered that, in government as in business, the guys in charge of pension plans are not professional investors and don’t have any more expertise in investing than any other accountant with a $200,000 RRSP. So they’re susceptible to just as much stockbroker flim-flam as any other member of the gullible investing public.

So you get investment decisions being made on the basis of how well it can be explained to an uninformed client and that view becomes pervasive throughout the organization; with people’s bonuses being paid not for performance, but for Assets Under Management. In the worst case scenario, people start brown-nosing the government of the day instead of asking themselves how, exactly, do I put more actual money into my actual clients’ actual pockets:

It’s a black day for the professionalism of the Canadian investment management industry, such as it is. It looks like the OTPP’s foray into politics (sneered at on October 7) comes straight from the top:

Ontario’s proposal to create a voluntary disclosure rule to boost women on boards is unlikely to cause much improvement and will likely have to be turned into a quota, warns the head of Ontario Teachers’ Pension Plan.

Speaking at a public forum Wednesday hosted by the Ontario Securities Commission, Jim Leech said Canada has a smaller proportion of women on corporate boards than countries like Turkey and Poland. He said voluntary disclosure rules can be tried for three or four years, but will probably end up being rejected as inadequate.

“Let’s skip this intermediate step we don’t think is going to work,” Mr. Leech proposed.

Teachers has urged regulators to instead require all public company boards to have at least three women directors.

Maybe Leech is sucking political arse in hopes of a position with the proposed Ontario Pension Plan.

So, let’s hope. And particularly, let us hope that the new entity looks more like HOOPP, one of the best organizations I know of and not so much like Honest Jimmy’s Best Mutual Funds:

Never let it be said that I never say anything nice on this blog! For instance, on March 25, 2009 and again on April 17, 2012, I said nice things about the Hospitals of Ontario Pension Plan (HOOPP). And now there are more nice things to say:

The Healthcare of Ontario Pension Plan (HOOPP) has posted returns for 2012 of 17.1 per cent, which boosted the pension plan for Ontario healthcare workers to a record $47.4 billion in assets, compared to $40.3 billion at the end of 2011. This strong double-digit return increased HOOPP’s 10-year average rate of return to more than 10 per cent, one of the best long-term records among pension plans worldwide.

At the end of 2012, HOOPP was 104 per cent funded – this fully funded status means the Plan has sufficient assets to pay for every promised member’s pension benefit, with no shortfall.

“HOOPP had a very strong year in 2012 – with our best investment results in more than a decade,” says HOOPP President & CEO Jim Keohane. “This was a year when all of our investment strategies worked. We were firing on all cylinders, with positive returns from every type of investment,” he said. HOOPP’s liability driven investment (LDI) strategy continues to contribute to HOOPP’s success, Keohane added.

“Liability Driven Investment” is the cool way of saying “paying attention to your client’s needs”. HOOPP is in a good position to do this, because they have exactly one client and aren’t looking for new ones, despite idiotic initiatives from Premier Dad’s office that would encourage large plans to stock up on salesmen and get rid of those dreary nerds. That’s the real secret – a focus on return made possible by a complete absence of pressure for sales. Then you can fire the moron whose sole useful attribute is being buddies with a large client; then you can do all kinds of things. In an interview with the Star, though, president and CEO Jim Keohane emphasized scale, which is probably more diplomatic.

It was a tough day for global bonds:

Markets took a risk-on tone Tuesday as generally positive earnings and economic data bolstered confidence in the strength of the global economy. The data come as the Fed will weigh robust global growth against feeble inflation and mixed U.S. economic data. Expectations are for policy makers to keep rates on hold; clues to the fate of its balance sheet will be key.

• •The yield on 10-year Treasuries rose seven basis points to 2.33 percent, the most in a month.
• •Germany’s 10-year yield rose six basis points to 0.566 percent.
• •Britain’s 10-year yield rose seven basis points to 1.258 percent, the highest in more than a week.
• •France’s 10-year yield rose seven basis points to 0.812 percent, the first advance in more than a week.

In Canada the five-year yield popped up to 1.63% and the ten-year rose to 2.02%.

The Tembec Empty Voting controversy, discussed on July 20, now looks like a fizzle:

Shares in Tembec Inc. rose the most since May after Rayonier Advanced Materials Inc. won support from two key shareholders for its increased bid for the Canadian lumber and paper producer.
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Rayonier Advanced is now offering Tembec investors the choice of receiving C$4.75 a share in cash — valuing the company at about C$475 million ($379 million) — or 0.2542 Rayonier Advanced shares for each Tembec share.
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Paul Boynton, chief executive officer of Rayonier Advanced, said in an interview Sunday that the companies have entered into an irrevocable agreement with Tembec’s two biggest shareholders, Oaktree Capital Group LLC and Restructuring Capital Associates to support the deal. The pair collectively hold about 37 percent of the target’s shares.

Today’s inflation numbers provided some ammunition for the hawks:

Canada’s core consumer prices and retail sales came in faster than expected, signaling that overall inflation may turn around to clear the way for another rate increase this year.

The average of the central bank’s three core inflation measures rose to 1.4 percent in June, Statistics Canada said Friday from Ottawa, up from a May reading of 1.3 percent that was the lowest since 1999. Retail sales doubled economist forecasts for May with a 0.6 percent increase, bringing the year-over-year gain to 7.3 percent, more than double the average over the last decade.

Canada’s dollar strengthened a fourth day as the reports lined up with Bank of Canada Governor Stephen Poloz’s argument that inflation will shrug off some temporary weakness and move back toward his 2 percent target over the next year.

S&P downgraded Manitoba:

• •Although Manitoba is taking clear steps to improve its fiscal sustainability in the long term, it faces large projected budget deficits and further growth in its already-high debt burden over the next two years.
• •We are therefore lowering our long-term issuer credit and senior unsecured debt ratings on the Province of Manitoba to ‘A+’ from ‘AA-‘.
• •The stable outlook reflects our expectations that, in the next two years, the government will implement the medium-term measures to control costs that were introduced in its 2018 budget, putting it on a gradual path to fiscal sustainability.

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The downgrade reflects the large, expenditure-driven structural deficits currently facing Manitoba. The current government, in power for a little more than a year, has laid out a seven-year path back to operating balance mostly through restructuring its cost base. While these steps bode well for strengthening budget performances in the medium term, they will not prevent the government from posting large after-capital deficits over the next two years, in our view. We expect borrowing needs associated with these deficits to keep Manitoba’s debt burden well above that of its Canadian provincial peers.

Empty Voting has assumed some importance in the Tembec takeover:

This week Oaktree said it intends to solicit proxies from those opposed to the deal. Oaktree opposes the US$807 million “flawed” transaction for what it terms “a flawed and poorly timed process;” for the lack of explanation for the “material gap between Rayonier’s offer and Tembec’s intrinsic value,” and because of its view that a standalone Tembec would be a better alternative.

Oaktree also raises the issue of empty votes, illustrating that comment by referring to the activities of Fairfax Financial, Tembec’s largest shareholder, which had a 19.99 per cent stake when the transaction was announced on May 25. (At that time, Rayonier and Tembec said Fairfax was “supportive of the transaction.”)

Now, thanks to a series of stock sales, with the last being for 14.2 per cent of Tembec — a sale announced on June 19, which so happens to be the meeting’s record date — Fairfax “no longer beneficially owns, or has control or direction over any of the outstanding share,” according to a filing. Fairfax issued three press releases (June 9, June 15 and June 19) indicating sales of its Tembec shares.

Note that this does not necessarily fall under the heading of “empty voting”, assuming that the shares in question were transferred on or prior to the record date, since the purchaser would then be entitled to the votes. Fairfax would be casting “empty votes” if they actually held the shares on the record date and cast the votes they were therefore entitled to while contracted to sell them; the question would then be the ’empty support’, if I can call it that, whereby Fairfax is touted as being ‘supportive of the transaction’ but then does not actually cast its votes.

The Globe’s story states that the issue actually is Empty Voting, but details and legal documents are hard to come by!

Fairfax subsequently sold its position in Tembec in the days that followed. But because it was an investor as of the so-called record date – the cutoff used by companies to establish who their shareholders are – it might be entitled to vote the stake it held at that time despite the fact it has since cashed out.

Such a situation, known as empty voting, remains relatively rare in Canada but a few cases have come up that were contested in court. Oaktree says Tembec and Rayonier potentially misled investors into thinking Fairfax backed the merger for its long-term value. And it says Fairfax should not be allowed to vote on the proposal because it no longer has an economic interest in Tembec.

It will be recalled that such empty voting (or debt decoupling, or any one of many sobriquets) is important in the CDS market:

In the primer on CDS I referred to a paper by Hu & Black regarding debt decoupling:

We have also heard from bankruptcy judges that they sometimes see odd behavior in their courtrooms, which empty crediting might explain. For example, one judge described a case in which a junior creditor complained that the firm’s value was too high, even though a lower value would hurt the class of debt the creditor ostensibly held.

There has been lots written about this issue, notably with respect to Telus:

In my recent paper, Empty Voting Revisited: The Telus Saga, I analyze the various instances of this important legal battle and develop regulatory implications.
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The ensuing courtroom battle between Telus and Mason is legion. The complicated story line involved (inter alia) two major court decisions. First, the Court of Appeal for British Columbia ruled on the validity of Mason’s request for a shareholder meeting (TELUS Corporation v Mason Capital Management LLC, 2012 BCCA 403). In essence, the Court upheld the request. Crucially, the Court held that Mason’s risk exposure and its potential status as ‘empty voter’ did not allow the Court to disregard the valid calling of the meeting. Two months later, the Supreme Court of British Columbia, in a separate proceeding, approved a ‘plan of arrangement’ (a restructuring mechanism under Canadian law), as proposed by Telus. The Court held that the ‘empty voting’ situation was indeed one of the factors that had to be taken into account for assessing the fairness of the arrangement (In re TELUS Corporation, 2012 BCSC 1919). These two somehow contradictory decisions are important because they illustrate how courts are struggling with responding to the empty voting problem more generally. As I explain in the article, only where the law provides for discretionary, substantive court control, Courts will be able to take the risk exposure of shareholders into account.

Empty voting ultimately calls for regulatory responses globally. As I elaborate elsewhere, regulators should be guided by two main principles: first, transparency: disclosure of significant empty positions is paramount to any market reaction; and secondly, regulators should introduce a right to disenfranchise risk-decoupled shareholders under certain circumstances (as opposed to a voting restriction ipso iure).

Robert M. Yalden, Jeremy Fraiberg and Andrew MacDougall of Osler issued a call to arms in 2012:

Why hasn’t something been done before now?

Although empty voting has long been recognized as a concern, to date almost nothing has been done to address it. The Canadian Securities Administrators’ Notice and Request for Comment dated December 18, 2008 on proposed NI 55-104 Insider Reporting Requirements and Exemptions stated that the CSA was aware of and reviewing issues on empty voting. On July 14, 2010 the U.S. Securities and Exchange Commission issued a Concept Release on the U.S. Proxy System requesting comments on potential regulatory initiatives to improve proxy voting in the U.S., including initiatives to address empty voting. More recently, one of the key initiatives in the Ontario Securities Commission’s Statement of Priorities for 2012-13 is to improve the proxy voting system by conducting an empirical analysis to review concerns raised about its accountability, transparency and efficiency and facilitate discussions amongst market participants to improve the system.

One reason that nothing has been done to address empty voting is that some degree of empty voting is an unavoidable consequence of the need under our proxy voting system to set a record date for voting that precedes the meeting date. There are also practical difficulties in establishing enforceable rules to protect the integrity of the vote. Another reason is the desire to avoid regulations that might impede the benefits to market liquidity of share lending arrangements and derivative transactions. But a key reason is the lack of empirical evidence as to the extent of the problem.

And all this was foreshadowed by Latham & Watkins, a US law firm:

While somewhat of an over-simplification, our corporate statutes and
accompanying judicial decisions are premised on a paradigm of:

• • relatively low volatility in share ownership,
• • the purchase and sale of shares in face-to-face (or near face-to-face) transactions,
• • physical embodiment of shares in the form of share certificates,
• • transfer of shares through the manual assignment of negotiable share certificates and their reissuance to new owners through physical delivery to and by transfer agents and registrars,
• • a coincidence of record and beneficial ownership, or at most a relatively simple (one tier) system of “street name” holdings, and
• • perhaps most fundamentally, the ability to link beneficial ownership to specific share certificates.

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This question is not simple. After all, a believer in free markets and market efficiency would presumably view the residual equity position in a corporation as consisting of a bundle of rights, with the right to vote being merely one stick in that bundle. In the context of an efficient market analysis, if an investor chooses to sell or otherwise dispose of its right to vote (as it does when it lends the stock for a fee), why is that bad? Why is it different from selling some of the economic up-side or buying protection against the economic down-side through selling call options or buying put options? And if it is permissible for the owner of the vote to dispose of the voting right, how can it be wrong for another investor to buy the voting right? After all, the investor is acquiring voting rights in an open market and at a cost which in theory reflects the value of the rights. If there is no proxy vote or contest then pending or in sight, presumably the vote has little value. If the transaction is in the midst of a proxy contest or other controversial vote, presumably the vote has greater value and the acquirer will have to pay that much more.
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The long gap between record date and meeting date is anachronistic and a vestige a long gone era of physical stock certificates trotted around lower Manhattan for manual clearing, transfer and registration. With modern technology, there is no apparent need to retain an advance record date concept to manage shareholder voting. Rather, the record date could be as late as the close of business on the night preceding the meeting, with a voting period (i.e., the time for which the polls remain open) at or in conjunction with the meeting lasting several hours or perhaps a full working day. Assuming the various book entry systems supporting the equity markets could be made to “talk to each other” electronically, voting could likewise be electronic, and a “real time” voting system should be feasible.

Such a real time voting system would need accommodations from the SEC. Physical proxy statement delivery in advance of the meeting to all voters could no longer be mandated by the proxy rules.

Falk Bräuning and Kovid Puria publish some interesting research in a Boston Fed paper, Uncovering Covered Interest Parity: The Role of Bank Regulation and Monetary Policy Uncovering Covered Interest Parity: The Role of Bank Regulation and Monetary Policy:

Covered interest parity (CIP) is a concept holding that the interest rates paid on two similar assets that only differ in their denominated currencies should, after controlling for any foreign exchange rate risk, be the same. Fulfilling this condition depends on the idea that international capital mobility is largely frictionless. More specifically, the theory underpinning CIP predicts that converting the amount borrowed in a foreign currency using the foreign exchange (FX) spot market, while simultaneously hedging the resulting exchange rate risk using a foreign exchange forward contract, should result in a cross-currency basis equal to zero. (Such a simultaneous spot purchase and forward sale of foreign currency is called an FX swap, a contract in which investors essentially borrow in one currency and lend in another currency.) Because the U.S. dollar is the dominant global currency used in international trade and finance, trades against the dollar account for about 90 percent of the activity that occurs in the FX swap market. The ten largest global banking institutions account for two-thirds of the trades in the FX swap market, with nonfinancial corporations and other investors also using the FX swap market to hedge foreign currency risk or engage in arbitrage activity.

Historically, the CIP relationship was so stable across countries that it came to be regarded as one of the few binding laws in economics. Prior to the 2007–2008 financial crisis, the cross-currency basis was close to zero for all pairs, but after the crisis began, large violations of CIP were present, especially with respect to the U.S. dollar. When the European sovereign debt crisis arose in early 2010, the cross-currency basis also widened, but then flattened out by late 2012. While credit risk and liquidity risk have subsequently remained low, since mid-2014 large and persistent violations of CIP have been observed, resulting in substantial increases in the cost of borrowing U.S. dollars in the FX swap market. This paper analyzes the driving factors behind these most recent deviations in the CIP condition.
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• •More stringent post-crisis bank regulations increased the cost to banks of providing dollars to the FX swap market, and lowered their incentives to engage in CIP arbitrage. A key regulatory change for U.S. banks, effective on January 1, 2013, essentially acted as an adverse supply shift, particularly for banks with lower Tier 1 capital ratios. The authors estimate that banks with a 1 percentage point lower capitalization ratio reduced their FX swaps by 19 percent more than did banks with average capitalization ratios.
• •The key factor behind the recent widening of the cross-currency basis is the surge in demand for assets denominated in U.S. dollars, a situation that stems from international monetary policy differences and related interest rate differentials between the United States and other countries. This demand effect, coupled with U.S. banks reducing their participation in the FX swap market, means that the supply of dollars is no longer perfectly elastic. This situation has created a higher forward premium beyond what is predicted under the CIP condition.
• •The Federal Reserve’s provision of dollar swap lines with other central banks has allowed foreign central banks to supply dollars directly to their counterparties. The authors find that European banks obtain more dollar liquidity from the European Central Bank when the cost of borrowing dollars in the FX swap market is high, and that subsequently the cross-currency basis between the U.S. dollar and the euro decreases.

It is my belief that many of today’s economic problems are the result of disruption; we are experiencing change at a historically unprecedented pace. The Industrial Revolution and the Renaissance combined weren’t NUTHIN’ compared to what’s been happening since 1980. And usually the effects of disruption are difficult to foresee:

Japan thought it was on track to beat deflation. Then came the Amazon effect.

The country’s retailers have been cutting prices in response to the rise of online rivals like Amazon.com Inc., disrupting what had seemed like perfect conditions for Japan to get the stable dose of inflation it has long been looking for.

In part as a result, Japan’s central bank is likely to lower its price forecast for the current financial year at its policy meeting on Thursday, said people familiar with its thinking. That reflects continued resistance to price rises, despite Japan’s longest economic expansion in 11 years and its tightest labor market in decades. The Bank of Japan is also likely to raise its view on the economy while keeping its policy settings on hold, the people said.