September 24, 2010

I speculated in the post Alpha Trading Systems to Offer Dark Pegged Orders:

I do not profess to be an expert on ATS marketting practices, but this appears to be an attempt by Alpha Group to forestall the creation of internal dark pools by its members (or pool the cost of such systems; Alpha is owned by the major dealers) by offering a sub-pennying mechanism in a manner that is smoothly integrated with extant trading systems.

The Alpha / TMX competition has now attracted some press notice and I am pleased to see that CIBC agrees:

We believe that, as described, the facility will operate more as a third party internalization engine rather than a proper dark pool, and do not have any concerns around this. We believe that the internalization activity enabled by this facility is common practice today, and that Alpha is simply commoditizing technology to offer dealers an alternative to building and operating their own costly internalization systems.

The TMX opposes sub-pennying:

To reiterate our position as outlined in TMX Group’s submission in response to CSA Consultation Paper 23-404, we believe that any dark trading, including internalizing features and practices, whether through a marketplace such as Alpha’s proposed facility, or through a dealer’s own systems, must provide meaningful price improvement over the displayed national best bid or offer (NBBO). It is critical that regulation encourages and supports the continued integrity and value of the visible market and price formation process by providing an incentive for the public display of liquidity. This requires internalized and non-displayed trading to provide meaningful price improvement over the displayed NBBO. Sub-penny price improvement is not adequate improvement to justify the yielding of priority of a previously posted visible quote. A minimum full cent price improvement is meaningful and should be required and enforced by regulators.

Other comments have been published.

Global hysteria over derivatives may engulf European property funds:

Europe’s commercial real estate owners, saddled with 1.9 trillion euros ($2.5 trillion) of debt, may be forced to make billions of euros in cash payments under planned laws that would treat them like hedge funds.

Property fund managers could face demands for cash collateral to cover bets on interest-rate movements, under European Commission proposals to regulate the derivatives industry. Interest-rate swaps were attached to about 130 billion pounds ($204 billion) of U.K. real estate debt at the end of 2009, according to a De Montfort University study. Most would be subject to such a payment.

Real-estate buyers use swaps to secure a fixed interest rate when taking out a floating-rate loan to buy a building. That helps ensure that the property’s rental income will be enough to service the loan, even if rates rise unexpectedly. Under the EU plan, a demand for payment, or margin call, could result if rates go the opposite way than the swap anticipates. Businesses unable to pay could be declared to be in default.

If the proposed regulations had been in place, U.K. borrowers would have needed to put up collateral of about 10 billion pounds to cover swaps that moved the wrong way, William Newsom, head of valuation at Savills Plc, estimated in June.

Now, all by itself, this isn’t a big deal. What will hapen is that the investment companies will take out a credit line at the same time as entering the swap; any demands for collateralization of the swap will be met by drawing down the credit facility. But it’s just another piece of regulatory garbage – lots of extra paperwork for zero net benefit.

There’s an amusing complication in the US adoption of Basel 3:

A 24-line section of the 848-page Dodd-Frank Act is delaying U.S. implementation of international rules for how much capital banks need to hold against securitized assets.

The financial-overhaul legislation, signed by President Barack Obama in July, requires regulators to remove all references to credit ratings of securities from their rules. Revised standards on how much capital banks need to hold against such assets in their trading books, approved by the Basel Committee on Banking Supervision in 2009, rely on such ratings.

Current Basel trading-book rules treat all top-rated bonds the same, allowing banks to hold as little capital against AAA rated mortgage-backed securities as they do against Treasuries. The trading book is a subset of the balance sheet where banks park assets they intend to trade in markets, as opposed to the banking book where assets are meant to be held until maturity or at least for a longer period.

The new rules require higher capital charges for securitized bonds than for corporate or sovereign debt, bringing the trading-book standards in line with the banking book. Ratings scales of outside firms are used to calculate how much capital is required for different securities. The change will increase banks’ capital charges by as much as 4 percentage points, according to a Basel study.

It’s kind of nuts to use credit ratings with no qualifications. It was CDOs that sank the investment banks; say, f’rinstance, you have 10 “normal” securitizations. Each one has a senior tranche of $80-million rated AAA, and junior tranche of $15-million rated BBB, and an equity tranche of $5-million, unrated. You put together a CDO comprised of all the junior tranches, $150-million, and divide that up into a senior tranche of $115-million, rated AAA, a junior tranche of $15-million, rated BBB, and an equity tranche, unrated.

Now, the senior tranche may well be legitimately AAA, in that it has a 0.1% chance of defaulting. But if economic conditions change, you’ve got exposure to the fastest defaulting mortgages in a $1-billion pool (of the original mortgages). The rating is much more volatile, and loss given default is much more severe. See Hull & White on AAA Tranches of Subprime for more discussion.

The moral of the story is: You cannot describe any security, particularly not highly structured securities, with a single number. Credit risk is a vector quantity, not a scalar, no matter how much easier assuming the latter makes life for banks and their regulators

Even credit unions are being consumed by the commercial real estate vortex:

Credit unions in the U.S. may absorb as much as $9.2 billion in losses over the next decade as the industry strives to recover from sour investments in real estate and consumer loans, U.S. regulators said today.

Part of the plan to resolve the credit unions’ financial problems includes the National Credit Union Administration packaging $50 billion in distressed securities for sale as $35 billion in bonds carrying government guarantees, the agency said today. The debt will be backed primarily by bonds tied to home loans, with the first sale scheduled for next month.

The NCUA already sold more liquid securities from two credit unions that failed last year: U.S. Central Federal Credit Union in Lenexa, Kansas and Western Corporate Federal Credit Union in San Dimas, California. The administration said today that it assumed control of Members United Corporate Federal Credit Union of Warrenville, Illinois; Southwest Corporate Federal Credit Union of Plano, Texas; and Constitution Corporate Federal Credit Union of Wallingford, Connecticut.

There was continued heavy volume in the Canadian preferred share market today as the two major classes took divergent paths: PerpetualDiscounts gained 9bp while FixedResets were down 8bp.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.3471 % 2,124.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.3471 % 3,218.7
Floater 2.87 % 3.28 % 78,722 19.03 3 0.3471 % 2,294.1
OpRet 4.88 % -0.89 % 78,587 0.18 9 -0.0765 % 2,375.4
SplitShare 5.90 % -37.74 % 65,161 0.09 2 0.3676 % 2,386.0
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0765 % 2,172.1
Perpetual-Premium 5.66 % 5.02 % 140,513 5.34 14 -0.0556 % 2,003.6
Perpetual-Discount 5.49 % 5.51 % 203,896 14.59 63 0.0901 % 1,987.7
FixedReset 5.22 % 2.93 % 301,805 3.29 47 -0.0785 % 2,279.8
Performance Highlights
Issue Index Change Notes
MFC.PR.E FixedReset -1.87 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 26.30
Bid-YTW : 4.23 %
CM.PR.D Perpetual-Premium -1.27 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-05-30
Maturity Price : 25.25
Evaluated at bid price : 25.35
Bid-YTW : 4.28 %
TRP.PR.C FixedReset 1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-24
Maturity Price : 23.49
Evaluated at bid price : 26.25
Bid-YTW : 3.53 %
CM.PR.J Perpetual-Discount 1.48 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-24
Maturity Price : 21.44
Evaluated at bid price : 21.76
Bid-YTW : 5.15 %
Volume Highlights
Issue Index Shares
RY.PR.I FixedReset 232,320 RBC crossed blocks of 185,000 and 40,000, both at 26.70.
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.65
Bid-YTW : 3.07 %
TD.PR.G FixedReset 131,135 Desjardins bought 12,900 from Canaccord at 28.19; TD crossed 100,000 at 28.22.
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 28.20
Bid-YTW : 2.87 %
TD.PR.I FixedReset 110,365 TD crossed 100,000 at 28.42.
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 28.35
Bid-YTW : 2.89 %
BAM.PR.M Perpetual-Discount 94,430 RBC crossed 63,300 at 20.00.
Maturity Type : Limit Maturity
Maturity Date : 2040-09-24
Maturity Price : 20.12
Evaluated at bid price : 20.12
Bid-YTW : 5.94 %
BMO.PR.L Perpetual-Premium 70,011 RBC crossed 35,000 at 26.54, then 15,000 at 26.50.
Maturity Type : Call
Maturity Date : 2017-06-24
Maturity Price : 25.00
Evaluated at bid price : 26.38
Bid-YTW : 4.95 %
BNS.PR.T FixedReset 62,675 National crossed 25,000 at 28.29.
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 28.27
Bid-YTW : 2.78 %
There were 56 other index-included issues trading in excess of 10,000 shares.

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