PrefBlog

Commissioner Daniel M. Gallagher and Commissioner Troy A. Paredes of the SEC collaborated on an astonishingly ignorant Statement on the Regulation of Money Market Funds:

Our decision not to support the Chairman’s proposal, based on the data and analysis currently available to us, has also been informed by our concern that neither of the Chairman’s restructuring alternatives would in fact achieve the goal of stemming a run on money market funds, particularly during a period of widespread financial crisis such as the nation experienced in 2008. The Reserve Primary Fund did not “break the buck” in a vacuum, but rather in the midst of a financial crisis of historic proportions.

Since the Commission adopted Rule 2a-7, the principal rule that governs money market funds, the Commission on multiple occasions has reviewed the efficacy of the rule and has adopted amendments to make improvements. Most recently, in 2010, the Commission adopted changes to Rule 2a-7 that have improved the liquidity and transparency of money market funds and decreased the credit risk of their portfolios with the objective of making such funds more resilient.

Reserve Primary broke the buck because it held some paper that defaulted. Any commercial paper can default. The changes to Rule 2a-7 – that I mocked at the time for their substitution of box-ticking for capital – may well have decreased the credit risk of MMF portfolios, but it cannot have eliminated credit risk.

Second, the necessary analysis has not been conducted to demonstrate that a floating NAV or capital buffer coupled with a holdback restriction would be effective in a crisis. Indeed, both alternatives disregard the predominant incentive of investors in a crisis to flee risk and move to safety. Reason indicates that such behavior — the “flight to quality” — is likely to overwhelm the buffer proposed by the Chairman and swamp the effect of a holdback. As for the floating NAV proposal, even if there is no stable $1.00 NAV — i.e., even if, by definition, there is no “buck” to break — investors will still have an incentive to flee from risk during a crisis period such as 2008, because investors who redeem sooner rather than later during a period of financial distress will get out at a higher valuation. Thus, if neither the floating NAV proposal nor the capital-buffer-with-holdback proposal will solve the money market fund run problem, then neither proposal will foreclose the possibility that policymakers might once again face the prospect of supporting the commercial paper market in response to a widespread financial crisis.

The holdback provision means that investors who redeem their holdings – possibly with a threshold, so the holdback would apply only to accounts with more than $X invested – have a much reduced incentive to run, because the holdback will be at risk. Logic does not appear to be a strong point of Messrs. Gallagher & Paredes, both of whom have legal, rather than investing backgrounds.

Their profound ignorance of the simplest principles of portfolio management lead them to support gating as an alternative:

We have urged that the Chairman take a different way forward for strengthening the resiliency of money market funds. This approach would (i) empower money market fund boards to impose “gates” on redemptions; (ii) mandate enhanced disclosure about the risks of investing in money market funds; and (iii) conduct a searching inquiry into, and a critical analysis of, the issues raised by the questions we pose below.

In particular, it would be useful to receive comment on a proposal that would permit money market fund boards, as they deem appropriate and consistent with their fiduciary obligations to investors and without having to seek an exemptive order from the Commission, to “gate” redemptions to stave off a run and to allow the fund manager time to mitigate the concerns of investors who otherwise may be inclined to redeem. The Commission’s 2010 amendments allowed boards to unilaterally suspend redemptions if the fund is put into liquidation. At that time, the Commission received input recommending that the Commission allow boards to impose a gate when they deemed appropriate, consistent with the boards’ fiduciary duties to the fund’s shareholders.

Discretionary gating directly responds, we believe, to run risk, both as to an individual fund and across multiple funds, as well as to the potential disparate treatment between retail and institutional investors.

If your redemption can be blocked by the fund in toto, then you cannot rely on converting your holdings to cash on a moment’s notice, an idea which I am sure Assiduous Readers will agree is the whole point of MMFs. I consider the holdback option to be inferior to enforced holding of permanent capital, but even with the holdback at least you get almost all your money back when wanted and you put a cap on your losses to boot.

Sorry folks! The Project That Would Not Die staggered out from its crypt tonight and ate all my time. So the preferred share market action tables will be delayed a bit.

Update:

Good news! There’s a sign of success in the politicians’ and regulators’ war on finance!

Investment bankers in the U.K. favor working in Singapore over New York and London, where they face lower wage growth and higher taxes, according to recruitment firm Astbury Marsden.

Thirty-one percent of respondents chose Singapore as their most favored location, followed by New York (20 percent) and London (19 percent), the recruiter said in its annual “Preferred Location Survey.” Hong Kong and Dubai got 16 percent and 15 percent, respectively. The survey found 60 percent of bankers expect the Asia-Pacific region to the largest financial center in 10 years.

“A fast growing, low-tax and bank-friendly environment like Singapore stands as a perfect antidote to the comparatively high-tax and anti-banker sentiment of London and New York,” Mark Cameron, chief operating officer at Astbury Marsden, said in the statement. “Financial centers in the West have taken a real battering since the start of the financial crisis.”

The OSC approved settlements with Boaz Manor, John Ogg and Michael Labanowich.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 4bp, FixedResets flat and DeemedRetractibles up 5bp. Volatility was average. Volume picked up a little, but is still dead.

Let’s all reach for yield!

German insurers, which came through the subprime mortgage crisis largely unscathed, are seeking to boost investment returns by buying junk loans to corporate borrowers.

Senior secured loans, which are repaid first in a default, are originated by banks for borrowers considered high yield or high risk as they usually have a significant level of debt relative to equity. The loans are then are sold on to investors.
…
Leveraged loan prices plunged to 59.2 cents on the dollar in mid-December 2008 as investors dumped risky debt two months after the collapse of Lehman Brothers Holdings Inc. They averaged 95.12 cents on Aug. 22, which was the highest since June 2011, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has climbed from 90.75 at year-end.

The OSC is giving itself more money:

Canada’s largest securities commission says it is facing a financial shortfall this year and needs a major increase in the annual fees it charges to public companies and those registered to work in the securities industry.
…
The fee increase will total 15.5 per cent in each of the next three years for issuers – companies that have issued securities in Ontario. Compounded over three years, that means fees will be 54 per cent higher by 2015 than they are today.
…
Registrants – firms and individuals registered to work in the securities industry – would face increases of 7.9 per cent annually over the next three years, the OSC said. Compounded, that means an increase of about 25 per cent by 2015.

I am sure we will all sleep better at night now. But I’m considering visiting their offices on Monday:

A key figure in the multimillion-dollar Portus financial scandal, a complicated investment scheme that collapsed in 2005, has reached a tentative settlement with officials at the Ontario Securities Commission.

An agreement between Portus co-founder Boaz Manor and the OSC’s enforcement branch, announced Friday, will be put before a panel of commissioners at a hearing scheduled for Monday afternoon.
…
Earlier this week, the OSC reached settlements with two lesser figures in the Portus saga — Michael Labanowich and John Ogg. Hearings for those settlements are scheduled for Monday morning, before the hearing for the Manor settlement.

Ain’t it great what a little lobbying can do?

SEC Chairman Mary Schapiro this week abandoned a four-year effort to adopt tougher rules for money funds as three fellow commissioners said they wouldn’t support her proposal. The announcement marks a victory for the fund industry, which had lobbied against the plan.
…
Schapiro has argued the funds’ stable $1 share price encourages investors to flee at the first sign of trouble. That’s because those who react quickly can sell their shares at $1 each even if the net asset value has dropped below that level.

Schapiro’s staff this month produced a list for Congress of more than 300 instances over the past 40 years in which fund companies have sought permission from the SEC to support funds. The list was presented as evidence that funds weren’t as stable as the funds industry maintained.
…
Schapiro’s plan would have given fund managers a choice of switching to a floating share price that reflected the market value of holdings, or establishing a capital buffer to protect against credit losses and redemption restrictions to discourage investor flight.

I was gratified by a reference to a speech by Eric Rosengren, boss of the Boston Fed, titled Our Financial Structures – Are They Prepared for Financial Instability?:

As recent studies have highlighted, it is quite common for money market mutual funds that have impaired assets to obtain support from their sponsors.[12] Whether this is a cash infusion or a purchase at face value of an impaired asset,[13] this support can represent draws on capital[14] at times when the sponsoring organization is facing other capital pressures.
…
In the absence of such reforms for all money market mutual funds, an alternative for funds with depository institution or depository institution affiliated sponsors would be to include likely money market mutual fund support in the sponsor’s stress tests. Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario.

Again, this is an admittedly partial approach, in the absence of more comprehensive reforms that I hope will occur. But this approach would at least make more banking organizations more resilient (it would not be just money market mutual fund structures that would need capital – any financial structure that broke down during stress would need more capital) but it would also make clearer to money market mutual fund investors that banks had capital that could support funds during stressful periods. It would thus make clear that money market mutual funds with well capitalized sponsors are likely to be less risky than those that do not have well capitalized sponsors.

Similarly, other financial products that circumvent standard capital requirements – such as non 2a-7 “money market like” funds, stable value wrap products, and asset-backed commercial paper – could lead investors to expect that the sponsor holds capital for the support that these products could need in times of stress. While some firms are likely to argue they would not provide support for so-called capital efficient products, the high frequency of support of money market mutual funds and other off-balance-sheet items during the crisis makes such claims dubious.

I have long advocated consolidating banks’ balance sheets with their sponsored funds.

It was a mildly negative day for the Canadian preferred share market, with PerpetualPremiums down 5bp and FixedResets and DeemedRetractibles both off 1bp. Volatility was OK. Volume was virtually non-existent – I’m not reporting a single block today!

There good news on photovoltaics:

A technology that would enable low-cost, high efficiency solar cells to be made from virtually any semiconductor material has been developed by researchers with the U.S. Department of Energy (DOE)’s Lawrence Berkeley National Laboratory (Berkeley Lab) and the University of California (UC) Berkeley. This technology opens the door to the use of plentiful, relatively inexpensive semiconductors, such as the promising metal oxides, sulfides and phosphides, that have been considered unsuitable for solar cells because it is so difficult to tailor their properties by chemical means.
…
Photovoltaics are the ultimate source of clean, green and renewable energy but today’s technologies utilize relatively scarce and expensive semiconductors, such as large crystals of silicon, or thin films of cadmium telluride or copper indium gallium selenide, that are tricky or expensive to fabricate into devices.

“Solar technologies today face a cost-to-efficiency trade-off that has slowed widespread implementation,” Zettl says. “Our technology reduces the cost and complexity of fabricating solar cells and thereby provides what could be an important cost-effective and environmentally friendly alternative that would accelerate the usage of solar energy.”

Academic research in the States provides the skills, the patents and the profits. The research wasn’t done in Ontario because we blew the budget installing shoddy and expensive technology. Yay us.

Sorry folks – the tables will be delayed. On the bright side, I’ve just finished a major project, so things are looking up!

Update, 2012-08-24:

The SEC has passed some do-gooder rules. The first is bribe-prevention:

The Securities and Exchange Commission today adopted rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring resource extraction issuers to disclose certain payments made to the U.S. government or foreign governments.
…
The types of payments related to commercial development activities that need to be disclosed include:

• Taxes
• Royalties
• Fees (including license fees)
• Production Entitlements
• Bonuses
• Dividends
• Infrastructure Improvements

The new requirements clarify the types of taxes, fees, bonuses, and dividends that are required to be disclosed. These types of payments generally are consistent with the types of payments that the Extractive Industries Transparency Initiative suggests should be disclosed. Congress specifically referenced the EITI in defining “payment” in the law.

The second is about conflict minerals:

The Securities and Exchange Commission today adopted a rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act to require companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo (DRC) or an adjoining country.

The regulatory reform law directed the Commission to issue rules requiring certain companies to disclose their use of conflict minerals that include tantalum, tin, gold, or tungsten if those minerals are “necessary to the functionality or production of a product” manufactured by those companies. Companies are required to provide this disclosure on a new form to be filed with the SEC called Form SD.

Why the US is so eager to enforce laws for the benefit of other countries is quite beyond me. The Globe points out:

The SEC made a point of detailing the costs of the reforms before voting on both rules. The agency has seen prior rules successfully challenged in court based on allegations it did not adequately weigh costs and benefits.

An SEC official estimated the total industry-wide cost of implementing the new conflict minerals rule for companies would be around $3-billion to $4-billion. The annual cost could run between $206-million and $609-million.

On the resource extraction rule, the SEC pegged initial compliance costs at close to $1-billion, and said ongoing compliance costs could run between $200-million and $400-million.

But what the hell? Compliance is always good, right? and we’ve got lots of money.

But in a world in which it is considered rational to treat trading as a kiddie game, what do I know?

Knight Capital Group Inc. (KCG)’s $440 million loss from a computer malfunction this month highlights the dangers of limiting human input in decisions about canceling trades, according to two industry executives.

Regulators should have discretion to reverse transactions when the outcome puts a firm’s survival at risk, said Neal Wolkoff, former chairman and chief executive officer of the American Stock Exchange and ex-head of ELX Futures LP. They should allow “do-overs” in extreme cases, said R. Cromwell Coulson, CEO of OTC Markets Group Inc. (OTCM) in New York.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 7bp, FixedResets off 2bp and DeemedRetractibles up 17bp. Volatility was normal. Volume was low.

PerpetualDiscounts (that wonderful three-constituent index) now yield 4.97%, equivalent to 6.46% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.4%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 205bp – everything unchanged since August 15!

Time for another politically inspired shake-down of a bank? Oh, why not?

Public pension funds from Arkansas, Ohio, Oregon and Sweden will be lead plaintiffs in a group lawsuit against JPMorgan Chase & Co. (JPM) over trades made by Bruno Iksil, known as the “London Whale.”

U.S. District Judge George Daniels in Manhattan ruled today that lawsuits against the New York-based bank should be consolidated into a class action. The pension funds allege they lost as much as $52 million because of fraudulent activities by JPMorgan’s London chief investment office.

The lead plaintiffs named by Daniels are the Arkansas Teacher Retirement System, Ohio Public Employee Retirement System, School Employees Retirement System of Ohio, State Teachers Retirement System of Ohio, Oregon Public Employee Retirement Fund and the Swedish pension fund Sjunde AP-Fonden.

The best thing about public pension funds, you understand, is that they allow you to keep the wage increases out of the headline number. But the second best thing is that they give you another avenue for grandstanding shakedown attempts.

The Muddy Waters business model is gaining popularity:

A series of scathing reports by a small Toronto investment research house targeting some of India’s corporate heavyweights is riveting the country’s business community, and sparking intense scrutiny of the state of corporate governance in one of the world’s hottest economies.

Veritas Investment Research Corp. has alleged “manipulative accounting,” poor disclosure practices and other gaping flaws in transparency at major Indian real estate, communications, and infrastructure firms. In the process, the company has shone a rare light on the fragility of oversight in the Asian giant – and made some powerful enemies.
…
Arun Jain, an expert on corporate governance who teaches at the elite Indian Institute of Management in Lucknow, said the hard-hitting Veritas reports raise the question of why no Indian firm is doing similar work. “Sometime the gap between who is being analyzed and who is doing the analysis is not big,” he said.

India’s business world can be a cozy one. “You know that someone you write about this week could be a potential client next week, so if you don’t have something nice to say, you just don’t do a report,” said an analyst who has worked for the Indian branches of several international firms, and who did not want to be quoted by name.

Right? Wrong? I don’t know. Indian equities are not exactly my area of specialization. But I do like to see a little mudslinging in the analytical community (provided, of course, that it’s relevant and informed mudslinging) and it’s easier when it’s a foreigner carrying the bucket.

Which is why, of course, the abortive LSE / TMX merger would have been so much better for Canadians than the Maple / TMX deal. But not for every Canadian.

It was a mildly positive day for the Canadian preferred share index, with PerpetualPremiums and DeemedRetractibles both gaining 2bp and FixedResets winning 7bp. Volume continued its recent pattern of ‘Very low, with high spots’.

The Fed is pushing on a string:

The gap between U.S. bank deposits and loans is growing at the fastest pace in two years, providing lenders with more funds to buy bonds and temper the biggest sell-off in Treasuries since 2010.

As deposits increased 3.3 percent to $8.88 trillion in the two months ended July 31, business lending rose 0.7 percent to $7.11 trillion, Federal Reserve data show. The record gap of $1.77 trillion has expanded 15 percent since May, the biggest similar-period gain since July, 2010. Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.
…
“Every bank is looking for a way to increase their yield,” said Mike Pearce, president of Bank of The West in Grapevine, Texas, whose company has been purchasing government securities after deposits grew faster than loans in 2010 and 2011. Instead of earning the Federal Funds rate of zero to 0.25 percent on the deposits, its bond holdings are yielding about 3.25 percent, he said.

The danger here is that when the economy starts picking up and people actually start competing with the Treasury for loans, yields will skyrocket. Who remembers 1994?

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 9bp, FixedResets off 7bp and DeemedRetractibles gaining 3bp. Volatility was minimal. Volume continued its recent pattern, with pockets of institutional activity and total lack of interest from retail.