Whatever happened to Europe’s sovereign-bank loop?

Whatever happened to Europe’s sovereign-bank loop?

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Back in 2010 I wrote an FT Alphaville post called “Europe’s grim sovereign-bank loop.”

It was, to my knowledge, the first use of the term and one that has since been employed by many analysts, regulators and policymakers’ to describe the intermingling of Europe’s banking system with Europe’s sovereign debt crisis. Alastair Ryan and John-Paul Crutchley, then bank analysts at UBS, were the first to identify the trend of banks of using cheap financing from the ECB to buy and/or repo government bonds. This carry trade ultimately gave birth to the so-called sovereign-bank loop, in which the deteriorating fortunes of eurozone periphery governments weakened eurozone periphery bank balance sheets and vice versa. Four years later and it’s worth asking what happened to the loop?

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Yieldcos and MLPs and Glencore, oh my!

Yieldcos and MLPs and Glencore, oh my!

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Here’s a thing that I wrote back in 2011, while parsing an Oliver Wyman report contending that the next hypothetical banking crisis would stem from over investment in commodities: “… as soon as investors start to doubt what constitutes ‘real’ demand for commodities and what’s pure speculation, they’ll head for the exits en masse, which will lead to a collapse in commodity prices, abandoned development projects and bank losses.” Though major losses haven’t occurred at the banks yet (just the famously non-bank Jefferies), we have seen the effects of the collapsing commodities super cycle elsewhere. Yieldcos, MLPs and commodities traders like Glencore and Trafigura — once the darlings of the financial world — are facing increasingly tough questions about their business models and, consequently their access to capital markets.

So here’s my latest post on an ongoing theme, this time about SunEdison and its yieldco, TerraForm Power:

The website of SunEdison, the renewable energy company, is a virtual smorgasbord of sunshine and light. “Solar perfected,” reads one slogan splashed across the page. “Welcome to the dawn of a new era in solar energy,” reads another banner over a pink-hued sunset.

While SunEdison’s marketing materials are firmly in the clouds, its share price has sunk to earth. The company is one of a batch of energy firms that have spun off their completed projects to public equity investors through vehicles known as “yieldcos,” only to see the share prices of those vehicles subsequently tank.

Now SunEdison and one of its two yieldcos, TerraForm Power, face additional questions about the health of their collective funding arrangements. Those concerns are emblematic of a wider problem for energy and commodities companies that have relied on eager capital markets to help finance their staggering growth in recent years.

Lured by the higher yields on offer from funding such projects, investors have stepped up to finance a host of energy-related products in recent years, contributing to a glut in supply that has spurred a dramatic collapse in commodities prices. That’s helping to fuel additional market scrutiny of commodities’ players—from giants such as Glencore to U.S. shale explorers and solar panel operators.

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The concern now is that funding structures built on that fragile dynamic are apt to collapse should investors come to believe that the financing of latent commodity demand has far outpaced actual growth.

Investors are asking tough questions about ‘yieldcos’

It’s volatile all the way down…

It’s volatile all the way down…

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shortgamma

The surge in volatility trading strategies and volatility-linked products is impacting volatility itself. I was tempted to break out the tail wagging the dog GIF again for this one, but I’ll keep it simple. Read the below, then read this, and this, and this, and so on.

Market volatility has changed immensely

On Aug. 24, as global markets fell precipitously, one thing was shooting up.

The Chicago Board Options Exchange’s Volatility Index, the VIX, briefly jumped to a level not seen since the depths of the financial crisis. Behind the scenes, however, its esoteric cousin, the VVIX, did one better.

For years, the VIX has been Wall Street’s go-to measure for expected stock market volatility. Derived from the price of options on the S&P 500-stock index, the volatility index has evolved into an asset class of its own and now acts as a benchmark for a host of futures, derivatives, and exchange-traded products to be enjoyed by both big, professional fund managers and mom and pop retail investors.

The dramatic events of last month underscore the degree to which the explosion in the popularity of volatility trading is now feeding on itself, creating booms and busts in implied volatility. Even as the VIX reached a post-crisis intraday high, the VVIX, which looks at the price of options on the VIX to gauge the implied volatility of the index itself, easily surpassed the levels it reached in 2008.

Analysts, investors, and traders point to two market developments that have arguably increased volatility in the world’s most famous volatility index, beginning with the rise of systematic strategies.

It’s a week after this was published and the Vix has since been collapsing after shooting up to that August 24 high.

Bank deposits, again

Bank deposits, again

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It’s time to start thinking about bank deposits again.

And it’s always time to think about the interplay between monetary policy and financial regulation.

A new research piece by Zoltan Pozsar attempts to estimate the amount of deposits that could flow out of U.S. banks thanks to an interest rate rise by the Federal Reserve and the mechanics of the central bank’s new overnight reverse repo (RRP) programme.  At the same time, new Basel banking rules have pushed banks to hold big buffers of high-quality liquid assets (HQLA) to cover potential outflows. As I put it in the piece: “Two grand experiments, one conducted in the technical backwaters of monetary policy and the other operating in the realm of new banking rules, are about to collide. It bears watching.”

Go ‘watch’ the full article over here.

bankdeposits

 

 

The Tarf Barf

The Tarf Barf

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Hi, Mr. Chief Financial Officer of Generic China Corp. This is John Doe from sales at Solidly Second-Tier Bank. How are you? Listen, I think I have something that might interest you. Ever heard of a Target Redemption Forward? No? Let me explain. It’s a structured product, kind of like a series of exotic options that pay a monthly income as long as the spot yuan exchange rate remains above the strike price. Now, I hate to mention this, but I want to be up front with you, because you know I value your business. The risk here is that if the yuan falls below a certain level—say, 6.2 against the dollar—the option gets knocked out and you have to pay out double the amount. I personally don’t see that happening any time soon. I mean, with USD/CNH trading in this kind of range, we’re talking practically no-risk money.

You’re in? Great!

You already know how this ends (in tears and delta hedging).

Read about the latest slaughter in structured product land over here.

The corner in corporate bond markets

The corner in corporate bond markets

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The backlash to the bond market liquidity theme in full-swing. That’s fine and expected though I do think some people are taking it a bit far. The problem with the liquidity story is not the story itself but simplistic bandwagon reporting that does not advance the narrative at all. I’ve said before on Twitter, it’s not enough to simply say that dealer holdings of fixed income have fallen X percent over the past X years, or that bond market liquidity is “a concern.” Many people, myself included, were talking about that theme and writing that story years ago and we need move on from that.

With that in mind, here’s a fresh angle to a stale story. In my opinion, it strikes at the heart of the issue – which is that the liquidity story is simply the flipside of what has been an intense scramble for corporate bonds in recent years.

What no one ever says about corporate bond market liquidity

Everyone’s worried about bond market liquidity. That much we know. Whether it’s high-yield corporate bonds sold by junk-rated companies or the ultra-safe Treasuriessold by the U.S. government, investors’ ability to buy and sell these securities without “overly” affecting prices has moved to front and center of the proverbial market concerns.

The causes, we hear, are myriad. Regulation that has curbed banks’ ability to hold vast sums of bonds on their balance sheets is often blamed. We are also told that years of low interest rates have herded investors to the same positions, spurring billions of dollars worth of inflows into global bond funds. The worry is that should those inflows reverse, bond prices could hit an air pocket and face a rapid descent.

There’s a long list of potential solutions to the problem. A shift toward electronic trading was once supposed to save a corporate bond market in which many trades are still done over the phone (although so-called electronification has apparently impeded liquidity in the U.S. Treasury market). Exchange-traded funds that give investors the ability to instantly dart in and out of positions are promoted as a quick fix for a longer-term problem. BlackRock, the world’s biggest asset manager, is pushing standardized bond issuance and wants to delay trade reporting for corporate debt.

All these solutions miss the point, however. None focus on the real reason behind deteriorating liquidity, which is that vast swaths of the corporate bond market have simply been cornered …

Read the rest over here.

Big bond news buried in a little report

Big bond news buried in a little report

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Buried in BlackRock’s recent report into bond market liquidity was a bombshell bit of news.

Here’s the story:

BlackRock Inc. is muscling into trading venues that had long been the exclusive territory of big banks as the world’s biggest asset manager seeks to make up for declining liquidity in the bond market.

BlackRock revealed last week that it’s now trading bonds directly with inter-dealer brokers, following years of warning that liquidity is waning. In September, BlackRock said the corporate bond market is “broken.”

Banks have long facilitated the business, but regulations passed after the 2008 crisis hobbled their ability to do so. By trading with inter-dealer brokers — an industry that includes ICAP Plc and Tullett Prebon Plc — BlackRock is circumventing a middleman.

Money managers are “looking to get liquidity anywhere they can get it, and the other side is the inter-dealer brokers — their business model has been totally turned upside down,” Kevin McPartland, head of research for market structure and technology at Greenwich Associates, said in a phone interview.
Tara McDonnell, a spokeswoman for New York-based BlackRock, declined to comment.

A large investor trading directly with inter-dealer brokers marks a sea change for Wall Street, where big bond trades traditionally are executed between asset managers and large banks like JPMorgan Chase & Co. and Goldman Sachs Group Inc. Trading venues run by ICAP and Tullett Prebon, meanwhile, have historically brokered trades between banks and stayed clear of interacting directly with buy-side investors such as BlackRock …

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What we didn’t learn about the events of Oct. 15

What we didn’t learn about the events of Oct. 15

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This week, the US.government released its report on the events of October 15.

I was disappointed.

The 72-page report has lots of points of interest but doesn’t come up with any definitive reason for the sharp movements in the 10-year U.S. Treasury. More disappointing than that (for me) was the report’s treatment of the events leading up to the day and specifically its very brief mention of volatility selling.

Here’s what the report said:

In addition, market participants reported that some large asset managers had maintained positions structured to profit from a continuation of the low-volatility environment that characterized much of 2014, though data to validate such claims are limited. Some market participants have speculated that a change in the distribution of certain options-specific risk factors among certain firms could have been a contributing factor. In particular, anecdotal commentary suggested that some dealers had absorbed a portion of the sizable “short volatility” position believed to have been previously maintained by large asset managers. As volatility spiked on October 15, those positions would have prompted some dealers to dynamically hedge this exposure, exacerbating the downward move in yields.

Long-time readers of this blog may remember that this is something I’ve written about before, specifically in a piece for the Financial Times entitled: “Caught on the wrong side of the ‘vol’ trade.” Unlike the Oct. 15 report, that article names a specific player who was said to have suddenly stopped selling vol.

“Pimco was a massive seller of volatility and when Gross left they started taking that position back,” says one hedge fund trader. “The Street was still thinking that short was out there. People expected the road to be there and the road wasn’t there.”

Given the debate over whether large asset managers are or are not systemically-important, it’s shame the Oct. 15 report did not dive into this particular theme a bit more.