PrefBlog

The SEC has a new policy: Prove you’re not a crook!:

U.S. securities regulators have taken the unprecedented step of asking high-frequency trading firms to hand over the details of their trading strategies, and in some cases, their secret computer codes.

The requests for proprietary code and algorithm parameters by the Financial Industry Regulatory Authority (FINRA), a Wall Street brokerage regulator, are part of investigations into suspicious market activity, said Tom Gira, executive vice president of FINRA’s market regulation unit.

“It’s not a fishing expedition or educational exercise. It’s because there’s something that’s troubling us in the marketplace,” he said in an interview.
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It has alarmed some traders who are afraid their “secret sauce” — intellectual property sometimes developed over years and at great cost — could get into the wrong hands, especially when SEC and FINRA examiners leave for the private sector.

Having the code and insider knowledge of what works and what doesn’t will help the employment prospects of regulatory personnel, which is of course the whole purpose of regulation.

Now that the IMF and the ECB hold a lot of Greek bonds, there’s unprecedented concern about bondholder rights:

The International Monetary Fund opposes European plans to force Greece to put up collateral in its second rescue, said four people with direct knowledge of the matter.

The use of collateral, a concession to win Finland’s backing for 109 billion euros ($155 billion) of loans pledged by euro leaders in July, would deny the IMF priority creditor status and violate Greek bondholders’ rights, said the people, who declined to be named because the talks are in progress.

IMF objections threaten to snag Europe’s crisis-management effort after aid of 256 billion euros for Greece, Ireland and Portugal failed to restore order.
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Greece’s predicament deepened today with the forecast of a worsening economic contraction and a two-week suspension of a European-IMF economic review mission to give the government time to plot a pro-growth course. Two-year Greek yields rose today above 47 percent, a euro-era record.

Banking in the US is more interesting than in Canada:

Mortgage rates near historic lows have sparked a refinancing boom that has U.S. lenders struggling to handle the surge.
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The lending logjam extends to the nation’s biggest banks, which fired thousands of mortgage workers after interest rates rose in November through February, chilling refinancing demand. Now, the time needed to close a loan has as much as doubled to 60 days, according to Wilson and other bankers, and lenders are holding some mortgage rates higher than they could be to slow the torrent of customers, data show.

Refinancing applications are up 83 percent from this year’s low in February, according to an index compiled by the Mortgage Bankers Association, a Washington-based trade group. After topping 5 percent that month, the average rate on 30-year fixed loans fell two weeks ago to 4.15 percent, the lowest in surveys dating back to 1971 by Freddie Mac, the second-largest U.S. mortgage-finance company.

How about a double dip?

The Labor Department said U.S. payrolls were unchanged last month, the weakest reading since September 2010 and worse than the median economist forecast that called for growth of 65,000. Stocks sank and Treasuries surged in August as investors bet that the odds of a recession had increased. Markets reversed course toward the end of the month amid speculation the Federal Reserve would act to spur growth.

There’s more!

Bearish bets against the S&P 500 rose to a nine-month high as short sellers increased speculation stocks may decline. The proportion of S&P 500 shares outstanding sold short on Aug. 29 rose to 3.03 percent, the most since the end of November and up from 2.37 percent at the beginning of August, according to New York-based Data Explorers, which provides research on short sales and stock lending. Short selling of the gauge reached a three-year high of 5.52 percent in August 2008, before the index sank to a 12-year low in March 2009.

The yield curve, or the difference between two- and 30-year Treasury debt, narrowed to 312 basis points, the least in a year, as the jobless data bolstered the view that Fed Chairman Ben S. Bernanke will be inclined to take addition steps beyond the two previous rounds of debt buying, known as quantitative easing, or QE.

and even more!

Treasuries rose, pushing 10-year note yields below 2 percent, as the government’s payrolls report showed no jobs were added in August, stoking speculation that the Federal Reserve will increase its purchases of longer- maturity debt.

U.S. 30-year yields fell to the lowest in since January 2009 as U.S. employment data were the weakest reading since September 2010.
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The 10-year note yield fell 14 basis points, or 0.14 percentage point, to 1.99 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The price of the 2.125 percent security maturing in August 2021 rose 1 9/32, or $12.81 per $1,000 face amount, to 101 8/32. The yield touched 1.9806 percent.

Thirty-year bond yields fell 20 basis points to 3.30 percent and two-year note yields rose two basis points to 0.20 percent.

20bp on thirty-year paper? That’s like about maybe three bucks on price!

I think that at some point the regulators are going to have to do something about the more patronizing manipulation rules, by which I mean “repeal”. Tony Ianno got in trouble for high-closing:

In agreeing to the settlement, he now faces a range of sanctions from the regulator, including a five-year cease trading order that only allows him to conduct limited trading through his Registered Retirement Savings Plan.

He also faces a five-year ban on serving as a director or officer of a publicly-traded company and is also prohibited from serving as a company promoter during that time.

Additionally, Mr. Ianno has agreed to pay $50,000 toward the costs of the OSC investigation in addition to another voluntary payment of $50,000, OSC Senior Litigation Counsel Alexandra Clark Alexandra Clark told the hearing

I’m glad the extra $50,000 was voluntary, and not extorted from him or anything like that.

In March 2010, the OSC alleged the one-time parliamentarian broke securities laws by artificially inflating the share price of Covalon Technologies Ltd., a junior biotechnology firm. Mr. Ianno had purchased roughly 4 million of Covalon’s common shares in transactions worth $7.6-million at various times in 2007 and 2008.
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The OSC has said the lion’s share of Mr. Ianno’s share purchases were made on margin, meaning they were purchased using credit provided by various brokerage firms. Those loans were then secured against the value of the shares.

According to the OSC’s original statement of allegations, Mr. Ianno purportedly engaged in inappropriate trading of Covalon shares as he faced some 27 margin calls from eight different brokerages.

Specifically, he was accused of making frequent end-of-day purchases through multiple brokerage accounts that often resulted in increases in Covalon’s stock price.

Well, the “multiple brokerage accounts” part is something of a red flag, but high-closing was always hard to police and nowadays it’s getting worse. You can expect professionals to know the rules, but now there are hundreds of thousands of retail guys with market access that’s only very lightly filtered.

High closing has no effect on the valuation of the stock and no effect on the long-term price of the stock. By taking it so seriously, the regulators are pandering to momentum players when in fact their efforts should be directed towards protecting value investors. If you want to do something about high closing, then (a) stop using closing prices for margin and valuation purposes and use the closing quote and (b) give retail access to algorithms so that if somebody puts in a high bid at 3:59:55, there’s a good chance it will be executed at 3:59:55.015

There were no new fillings on the YLO MTN buyback today, but the usual basket of preferred shares was reported by the TMX as insider purchases. There has been no response from the company to my inquiry regarding their apparent exceeding of the maximum annual limit on their NCIB.

The Canadian preferred share market was fairly quiet in advance of the long weekend, with PerpetualDiscounts up 2bp, FixedResets down 1bp and DeemedRetractibles winning 8bp. Volatility was low. Volume was almost non-existent.

The goose that laid the golden eggs is looking a little green around the gills:

Banks in Europe are exploring ways to cut costs by routing more of their trades and other business through overseas subsidiaries, a plan that may shift tax revenue away from London and loosen European regulators’ influence over the lenders.
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Banks could record as much as 30 percent of the value of their trades through Hong Kong, Singapore and other jurisdictions instead of hubs such as London and New York without running into trouble with regulators, Matten said. Such a move would hurt traditional hubs such as London because assets are treated for tax and regulatory purposes in the country where they are booked. It would also allow banks to sidestep the U.K. bank levy, introduced last year to raise 2.5 billion pounds ($4.1 billion) from lenders operating in Britain, as well as any financial transaction tax imposed by the European Union.

Haresh Sapra, professor of accounting at the University of Chicago Booth School of Business, writes an interesting piece on Bloomberg titled More Transparency May Hurt Markets:

Standard setters have argued that fair-value accounting would alleviate information asymmetry between insiders and outsiders. Yet insiders of many financial institutions have complained that rather than enhancing market discipline, fair- value accounting would introduce volatility into their reported numbers, thereby inducing suboptimal decisions.
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The recent financial crisis is a case in point. When liquidity started drying up, some banks began to sell their illiquid loans, putting downward pressure on prices. Anticipating the fall in prices, other banks started selling their loans and prices declined further, leading more banks to sell their loans. The effects were so severe that prices no longer reflected fundamentals but rather the amount of cash or liquidity available to buyers in the market.

If information asymmetry were the only friction between insiders and outsiders, the feedback effect would be weak or even nonexistent and prices would play their proper role of providing market discipline. But in strategic environments with multiple imperfections, market participants who try to extract the informational content of current prices distort this very content by adding an extra, nonfundamental component to price fluctuations.

As a result, the choice of an appropriate measurement regime amounts to a dilemma between ignoring price signals — as one would in a historical-cost regime — and relying on their degraded versions, as would be done in a fair-value regime.

Fabulous Fab, the man being persecuted by the SEC for acting as a broker, is in the news again:

Goldman Sachs Group Inc. (GS) trader Fabrice Tourre, accused of misleading investors in a collateralized debt obligation, said in a court filing that IKB Deutsche Industriebank AG (IKB)’s alleged $150 million investment was actually made by two Jersey-based companies.

Tourre wants to take testimony of witnesses at Loreley Financing (Jersey) No. 29 Ltd. and Loreley Financing (Jersey) No. 30 Ltd., according to the filing yesterday in federal court in Manhattan. The U.S. Securities and Exchange Commission has said Duesseldorf, Germany-based IKB made the investment in the CDO, Abacus 2007-AC1.

“Discovery in this matter thus far has shown, however, that IKB’s alleged $150 million investment was, in fact, made by” the Jersey-based companies, Tourre’s lawyers wrote in the filing.
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“I think what they’re trying to establish here is they have sophistication piled on top of sophistication to show that this was a well-reasoned investment by, yet again, a sophisticated institution,” Jacob S. Frenkel, a former Securities and Exchange Commission lawyer now in private practice in Potomac, Maryland, said in a phone interview today.

The Canadian preferred share market started the month on a happy note, with PerpetualDiscounts winning 25bp, FixedResets up 21bp and DeemedRetractibles gaining 6bp. Volatility was a little bit better than usual, skewed towards positive returns. Volume was low.

Yesterday I reported on the optimistic accounting at BNP Paribas. The Danes are cracking down on optimism:

The Financial Supervisory Authority will restrict the flexibility it gives banks to calculate writedowns under international financial reporting standards, FSA Director General Ulrik Noedgaard said in an interview in Copenhagen. The regulator wants to curb “an optimistic approach” to writedowns displayed by some banks, he said.

Amagerbanken A/S and Fjordbank Mors A/S collapsed this year after the FSA told the two regional lenders to write down 1.9 billion kroner ($371 million) more in property and farming loans than stated in their accounts. The insolvencies triggered the European Union’s first senior creditor losses within a resolution framework, and prompted Moody’s Investors Service in May to downgrade six Danish banks, including Danske Bank A/S, the country’s biggest. Proper accounting could have helped deal with the losses in a less disruptive way, Noedgaard said.

This one will drive the slogan-chanters nuts:

Standard & Poor’s is giving a higher rating to securities backed by subprime home loans, the same type of investments that led to the worst financial crisis since the Great Depression, than it assigns the U.S. government.

S&P is poised to provide AAA grades to 59 percent of Springleaf Mortgage Loan Trust 2011-1, a set of bonds tied to $497 million lent to homeowners with below-average credit scores and almost no equity in their properties. New York-based S&P stripped the U.S. of its top rank on Aug. 5, saying Washington politics were making the country less creditworthy.
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S&P has awarded AAAs to more than $36 billion of securities in the U.S. this year that were created by bankers who continue to gather thousands of loans, bundle them into bonds of varying risk and pay ratings firms a fee to assign credit rankings.

The ambulance-chasers are after Sino-Forest … and anybody else they can blame for their investment:

Sino-Forest Corp. (TRE-T4.81—-%), the TSX-listed Chinese forestry company whose shares have collapsed following fraud allegations, repeatedly misrepresented its financial statements, backdated stock options and engaged in unusual and undisclosed related-party transactions, according to fresh allegations levelled in a proposed class-action lawsuit seeking more than $7-billion in damages.

The notice of action, filed on behalf of a group of Sino-Forest shareholders who purchased shares in various offerings between 2007 and 2011, is seeking more than $6.5-billion in damages from Sino-Forest, its top management, directors, and auditors Ernst & Young LLP, as well as the Beijing office of Pöyry Consulting Co. Ltd., which published reports about the size and value of the company’s forestry assets.

A host of investment banks … that underwrote Sino-Forest’s equity offerings were also named as proposed defendants in the action, which seeks an additional $824-million related to the stock sales.

Say what you like about US Republicans, they’re rugged individualists who scorn government hand-outs:

When Texas billionaire Harold Simmons wanted to build a radioactive waste dump, one data point that would loom large in the permitting process wasn’t required on the application: He is a major donor to Governor Rick Perry.
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Perry has a public record of rewarding his political donors with jobs and state contracts. He has appointed about 4,000 people — including many donors — to commissions, boards and other posts, according to Texans for Public Justice, an Austin- based, nonpartisan group that tracks state political donations.

The campaign to eliminate humour in the western world scored another victory:

The department store said in its statement: “We agree that the ‘Too pretty’ T-shirt does not deliver an appropriate message, and we have immediately discontinued its sale. Our merchandise is intended to appeal to a broad customer base, not to offend them.”

YLO did not file any Insider MTN purchases on SEDI today, but the Normal Course Issuer Bid for the preferreds continued – in fact, it appears that the company bought a block, as some insider (presumably the company) bought a block of 57,100 YLO.PR.B at 9.15, total value $522,465. The common traded somewhere north of 179-million shares on the month – about a third of the entire float, although a lot of that will be double-counted, what with day-traders and all.

The Canadian preferred share market closed the month on a mixed note, with PerpetualDiscounts losing 16bp, FixedResets up 2bp and DeemedRetractibles winning 18bp. Volatility was average. Volume was average.

PerpetualDiscounts now yield 5.39%, equivalent to 7.01% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 5.00%, so the pre-tax interest-equivalent spread (also called the seniority spread) is now 201bp, a tightening from the 210bp reported August 24 as yields converged slightly.

I sincerely hope that the banks have shot themselves in the foot:

The Bay Street firms that weren’t invited into the Maple Group plan to buy TMX Group Inc. (X-T39.94-0.42-1.04%) are lining up their options to ensure that competition and low-priced trading services remain should the deal to create a market-dominating company goes through.
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The Maple plan would combine the two biggest players in the country in trading, and create a for-profit system to replace the current not-for-profit clearing system for shuttling cash between buyers and sellers of stocks after trades take place.
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That’s why sources said some brokerages are already mulling the idea of starting a new trading system to compete in the business of matching stock buy-and-sell orders, and pushing regulators to adopt a strict cost control system for the clearing business based on the utility industry.

Eric Reguly of the Globe speculates that the LSE might come back with a new offer.

European debt problems are causing a little bit of what some might call hanky panky:

It appears that some companies are not following IAS 39 when determining whether the Greek government bonds that they classify as AFS are impaired. They are using the assessed impact on the present value of future cash flows arising from the proposed restructure of those bonds, rather than using the amount reflected by current market prices as required in IAS 39.

In addition, some companies holding Greek government bonds classified as AFS have stated that they are relying on internal valuation methodologies, rather than on market prices, to measure the fair value of the assets as at 30 June 2011. The reason generally given for using models rather than market prices is that the market for Greek government bonds is currently inactive (and therefore, in their view, does not provide reliable pricing information).

One bank pulling a fast one is BNP Paribas:

However, you wouldn’t normally discover government bonds in Level 3.

BNP Paribas’ argument seems to be that the market for Greek debt is now so illiquid that this accounting shift is justified. The bank explains its determination of fair value and what it counts as an ‘active’ market from page 23 of the full Q2 consolidated financial statements onwards.

Greek debt is hugely illiquid, but the price also reflects a market bet on a massive haircut at some point, and it has done for a while. The influence of Level 3 is in a way appropriate more than you’d think however, as it seems that mathematical modelling has been used during the construction of the Greece bond swap itself. Option 4′s valuation seems to depend on stochastic modelling in some way, for instance.

But for now we’ll just wonder if BNP’s Level 3 will be a guide to other banks taking their Greek impairments medicine…

On a brighter note, sovereign debt is sometimes upgraded:

Peru had its foreign debt rating raised one level by Standard & Poor’s, which said it expects recently elected President Ollanta Humala to continue policies that support the country’s economic expansion.

S&P raised Peru to BBB, the second-lowest investment grade, from BBB-. The outlook is stable. S&P also lifted Paraguay’s rating to BB-, three steps below investment grade, from B+, because an agreement with Brazil to boost its revenue share from a hydroelectric power plant has improved the country’s “fiscal flexibility.”

No new YLO MTN buy-backs but the Normal Course Issuer Bid for the preferreds is still being pursued vigorously, with the fund spending its usual $80,000+ today.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 7bp, FixedResets winning 17bp and DeemedRetractibles gaining 9bp. Volatility was OK, with several BAM issues doing well. Volume was a little on the light side of average.

Banks are pushing back against proposed capital rules:

The Clearing House Association and the Institute of International Bankers, whose members include JPMorgan Chase & Co (JPM), Bank of America Corp. (BAC), Wells Fargo & Co. (WFC), Citigroup Inc. (C), Deutsche Bank AG (DBK) and ING Groep NV (INGA), said in a letter that capital surcharges agreed to by the Federal Reserve and international regulators are “deeply flawed” and “reflexively based on the notion that size alone creates prudential concerns.”
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Bloomberg News obtained an Aug. 25 draft of the letter, which will be filed as a comment on proposed capital surcharges for big banks agreed on by the Basel Committee on Banking Supervision in June. The Fed, which is part of the Basel Committee, is also preparing to release its own proposals under the Dodd-Frank Act for stricter standards for the largest U.S. banks sometime in the next five weeks.

Tighter international and U.S. standards on capital, liquidity and risk management are likely to alter competition in the U.S., the banking groups said in their letter. The Basel capital surcharge will “lead to unjustified competitive inequities between large banks” subject to the charge and others that aren’t, they said.

A bit more detail regarding TRE. Sino-Forest announced the resignation of its chairman:

Sino-Forest Corporation (“Sino-Forest” or the “Company”)
(TSX:TRE) announced that Allen Chan has voluntarily resigned as Chairman, Chief Executive Officer and Director, pending completion of the review by the Independent Committee of the allegations made by Muddy Waters.
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Mr. Chan will become Founding Chairman Emeritus of the Company and will be fully available to assist Mr. Martin with operational matters and with the Independent Committee review as requested.

The Globe reported on the sequence of events :

Mr. Chan’s resignation follows a tumultuous week of allegations and confrontations. Shortly after the company alerted the OSC about its discovery of what sources described as irregular deals involving Mr. Chan, the OSC caught the company off guard on Friday by slapping a cease trade order on its stock and ordering the resignation of Mr. Chan and the four executives.

I have not yet seen any updated commentary from Richard Kelertas of Dundee Securities, whose changing views on the topic were discussed here on June 20.

S&P withdrew ratings after a downgrade to CCC-:

• We expect China-based commercial forest operator Sino-Forest’s business
  to rapidly deteriorate following additional fraud allegations and senior management resignations.

• We are lowering the corporate credit rating on Sino-Forest and the issue rating on its senior unsecured notes and convertible bonds to ‘CCC-‘ from ‘B’. We removed all the ratings from CreditWatch.
• We are also withdrawing the ratings due to heightened information risks.
• The negative outlook prior to the rating withdrawal reflected our view that the company’s operations were likely to deteriorate further in the
  next 12 months, at least.

Moody’s also downgrade, but did not withdraw the rating:

Moody’s Investors Service has downgraded to Caa1 from B1 the corporate family and senior unsecured debt ratings of Sino-Forest Corporation (“Sino-Forest”).

At the same time, Moody’s continues its review for further downgrade.

What a surprise! The Maple-TMX deal may well fail!

TMX Group Inc., which has gained the most of any exchange involved in the industry’s biggest wave of acquisitions, is now in danger of being left without a buyer.

Since reaching a three-year high in June as the London Stock Exchange Group Plc and a group of Canadian banks waged a bidding contest, the owner of the Toronto bourse has now fallen more than 10% with the LSE scrapping its agreement. TMX is trading almost $10 below the $50-a-share unsolicited bid from Maple Group Acquisition Corp., close to the widest gap since it was announced in May and indicating that traders are growing increasingly concerned the takeover will also fail.

While more than US$30-billion in acquisitions for exchanges have been announced in the past year, only one deal — Deutsche Boerse AG’s takeover of NYSE Euronext — has been approved by shareholders. Macquarie Group Ltd. says Maple’s attempt to buy TMX may not overcome antitrust scrutiny because it would combine Canada’s largest bourse with its biggest rival, Alpha Group, and create an entity controlling 85 percent of the nation’s trading. That may make TMX, one of the least valuable market venues versus earnings, fall further, said WallachBeth Capital LLC.

Of course, that all depends on what you mean by the word “fail”. If you define success as “scuttling an international acquisition that would create an entity with enough size to talk back to the banks”, then it’s already a success!

The Globe & Mail blog had a good post titled Ms. Lagarde’s recapitalization plan makes sense:

Freed of her government shackles, the former French finance minister pulled no punches Saturday in her first major speech to the august audience. Ms. Lagarde declared flatly that European banks “need urgent recapitalization. They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis.”

Her proposal: “Mandatory substantial recapitalization — seeking private resources first, but using public funds if necessary.”
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The response, predictably, has been howls of indignation in European political and banking circles. A Reuters headline summed up the attitude: “Europe snubs IMF call to force-feed bank capital.”
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But there is a saying that a nation’s banking system is only as sound as its government. And that is particularly true in Europe, where banks hold an inordinate amount of government debt on their books. The reason is simple: Loans to your friendly local government count as a risk-free asset under Basel rules. Too bad the markets don’t agree.

Golly – substitute “AAA subprime paper” for “loans to your friendly local government” and that last paragraph could have been written in 2008!

Her published remarks also include an exhortation for the US:

So the United States needs to move on two specific fronts.
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Second—halting the downward spiral of foreclosures, falling house prices and deteriorating household spending. This could involve more aggressive principal reduction programs for homeowners, stronger intervention by the government housing finance agencies, or steps to help homeowners take advantage of the low interest rate environment.

See the post titled Redefault on Modified Mortgages for more on that idea.

There’s more commentary at BusinessInsider.com

The Italians aren’t hurting enough yet:

The Italian government backtracked on parts of its widely criticized austerity package on Monday, scrapping a tax on high earners and scaling back cuts to local authority funding.

In a statement after seven hours of talks at Prime Minister Silvio Berlusconi’s home outside Milan, the government said it would also exclude years spent at university and military service from retirement age calculations, delaying retirement for some people.

The statement contained little detail on the funding impact of the changes or how the government would make up for revenue lost from the €45.5-billion ($66-billion U.S.) austerity package now making its way through parliament which is aimed at balancing the budget by 2013.

There was also no mention of any increase in value-added tax, a measure which had been widely mooted in the media before the meeting.

It was a good day overall for the Canadian preferred share market, with PerpetualDiscounts gaining 21bp, FixedResets down 3bp and DeemedRetractibles up 10bp. Volatility was reasonable. Volume was a little on the soft side of average.