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Financial system more vulnerable after Trump victory, says BoE

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Archive | November, 2016

Weak inflation figures put pressure on ECB

Posted on 31 August 2016 by

BERLIN, GERMANY - DECEMBER 17: People carry shopping bags as they leave a C&A department store on a busy shopping street in Steglitz district on December 17, 2012 in Berlin, Germany. Retailers are hoping for a strong Christmas season in Germany, one of the few countries whose economy has so far weathered the current Eurozone debt crisis relatively well. (Photo by Sean Gallup/Getty Images)©Getty

Stubbornly low inflation figures highlighted the fragility of the eurozone recovery on Wednesday, reigniting debate over whether the European Central Bank should take more unconventional actions to boost growth.

Consumer prices rose 0.2 per cent in August in comparison with a year earlier, according to a preliminary estimate from the EU’s statistics office. That was the same rate as in July, but less than the 0.3 per cent expected by economists and well short of the ECB’s target of below, but close to, 2 per cent.

    Core inflation — which strips out energy, alcohol, tobacco and food — slipped for the first time in three months from 0.9 per cent in July to 0.8 per cent in August.

    In a further indication of the weakness of the eurozone’s economy eight years after the advent of the financial crisis, the EU’s statistics arm added that the unemployment rate in the 19-member bloc was 10.1 per cent in July, the same level as in June.

    The ECB’s measures to inject more life into the regional economy — notably negative interest rates and large-scale asset purchases — have stoked much controversy, with German bankers warning that monetary policy was dangerously counterproductive, even as some economists said the latest lacklustre data could push the central bank to go further.

    Julien Lafargue, from JPMorgan Private Bank, said that Wednesday’s inflation data could “reignite the debate on whether more is needed for the central bank to bring inflation back towards its 2 per cent target”.

    Mr Lafargue said he did not expect a rate cut or larger debt purchases to be announced at the ECB’s next monetary policy meeting on September 8, but did expect the ECB to “give a strong indication that the current bond purchasing programme will be extended, probably by at least another six months”.

    In depth

    Eurozone economy

    An employee shows fifty-euro notes in a bank in Sarajevo in this March 19, 2012 file photo. The European Central Bank took the ultimate policy leap on on January 22, 2015 launching a government bond-buying programme which will pump hundreds of billions of new money into a sagging euro zone economy. The Europen Central Bank (ECB) said it would buy government bonds from this March until the end of September 2016 despite opposition from Germany's Bundesbank and concerns in Berlin that it could allow spendthrift countries to slacken economic reforms. Together with existing schemes to buy private debt and funnel hundreds of billions of euros in cheap loans to banks, the new quantitative easing programme will pump 60 billion euros a month into the economy, ECB President Mario Draghi said. Picture taken March 19, 2012. REUTERS/Dado Ruvic (BOSNIA AND HERZEGOVINA - Tags: BUSINESS)

    News and analysis of the single currency bloc’s fragile recovery as it attempts to regain competitiveness in the wake of the sovereign debt crisis and its struggles with austerity

    At present, the bank’s €80bn-a-month asset purchase scheme, aimed at driving down government borrowing costs, is planned to run until at least March 2017. The ECB has also cut its deposit rate to minus 0.4 per cent, effectively charging central banks a fee for parking excess deposits with central banks.

    While such policies have bought some breathing space for battered economies and financial systems in southern Europe, they are widely resented in Germany
    , where banks have seen already-thin margins crushed by low interest rates.

    John Cryan, chief executive of Deutsche Bank, told a conference in Frankfurt on Wednesday that “monetary policy is already working against the goal of creating a more secure and stable European banking system”.

    Georg Fahrenschon, head of the German Savings Banks Association, said the next financial crisis would have its roots in “incorrect regulation and fatal monetary policy. Of that I am deeply convinced”.

    Despite such criticism, Benoît Cœuré, a member of the ECB’s executive board, said last week that “if other actors do not take the necessary measures in their policy domains, we may need to dive deeper into our operational framework and strategy to do so”.

    But economists at Allianz, the German insurance group, said that the ECB should take a “relaxed” view of the latest figures. “Very soon inflation rates in the eurozone will move decisively away from zero and inflation expectations will also rise again,” they wrote.

    Coco bonds stage summer revival

    Posted on 31 August 2016 by

    The Canary Wharf business, financial and shopping district, top, stands beyond the River Thames seen from the Leadenhall Building, also known as the Cheesegrater, in the financial district of London, U.K., on Wednesday, Sept. 3, 2014. Rents for skyscrapers with nicknames like the Walkie Talkie and Cheesegrater rose faster than the rest of the financial district in the last three years, rewarding developers who started construction at a time when the economy was shrinking. Photographer: Simon Dawson/Bloomberg©Bloomberg

    It started as an unpleasant year for coco bonds. The price of the riskiest bank debt plunged in February as fears over Europe’s banking industry intensified. Some even questioned the future of an asset class that offers bondholders juicy yields but leaves them on the hook if lenders run into trouble.

    Yet when three UK banks sold coco bonds in August, the reaction was very different. Just over $6bn of bonds issued by Standard Chartered, Royal Bank of Scotland and Barclays attracted more than $50bn in demand from investors.

      That strong appetite for contingent convertible bonds — a class of bank debt which is exposed to losses when the issuers face financial stress — follows a recovery in the secondary market.

      A Markit index for the asset class, which in February was down 15 per cent, is now up for the year despite swooning again after Britain voted for Brexit. This week, it touched its highest level in 2016. So why are investors now piling in?

      Cocos are designed to transfer the risk of a bank failing from governments to bondholders, avoiding a repeat of the bailouts that scarred taxpayers during the financial crisis. For this reason, they offer high levels of return to compensate buyers.

      And that’s helped stir their recent recovery. Unlike sovereign and corporate debt, the European Central Bank isn’t buying unsecured bank bonds as part of its stimulus programme. While yields in many other portions of the bond universe have been compressed by the ECB hoovering up debt, yields on coco bonds stand out.

      RBS’s latest bond of this type, with a rating of single B from S&P, pays a coupon of 8.625 per cent.

      “There are few if any opportunities in the fixed income world where you can earn that kind of return,” says Tim Michael, head of European FIG syndicate at Citi. “The high yield index is materially lower than that,” he adds. The yield on Barclay’s pan-European High Yield bond index is just over 4 per cent.

      Another current tailwind for cocos, most of which are also referred to as additional tier one capital (AT1), are the dynamics in foreign-exchange markets. All three of the UK bonds were issued in dollars, and UBS sold a $1bn coco bond early last month also denominated in the US currency.

      “The reason why these transactions happened now is a lot of good things came together. One is it’s favourable to issue into dollars and swap into European currencies,” says Henrik Johnsson, head of Emea Debt Syndicate at Deutsche Bank.

      These (cocos) are just nowhere near as liquid as other fixed income instruments out there, particularly during periods of market stress

      – Hani Redha, portfolio manager at PineBridge Investments

      Selling dollar-denominated cocos also allows issuers to tap global demand. While half of Barclays’ latest bond was sold to UK investors, a quarter was snapped up in Asia.

      And then there’s the regulatory backdrop. The steep sell-off in the first quarter was, in part, precipitated by confusion over when exactly diminishing levels of capital would require a lender to halt coupon payments on the bonds.

      Over recent months, regulators have sought to reduce that uncertainty.

      In August, it emerged that the European Union is considering ways of protecting coupons on the bonds by prioritising them ahead of dividend payments and bonuses.

      “There’s a sense among investors that AT1s would have a better place in the capital structure relative to other liabilities,” says Mr Johnsson.

      DBS sells $750m in cocos at record-low yield

      People make transactions at DBS bank ATM machines in Singapore on March 17, 2014. Singapore's DBS Bank said on March 17 it had agreed to buy the Asian private banking business of French lender Societe Generale in a deal worth 220 million USD, boosting its access to the region's super rich. AFP PHOTO / ROSLAN RAHMAN (Photo credit should read ROSLAN RAHMAN/AFP/Getty Images)

      Singapore bank’s cost is half that of European rivals as investors scramble for yield

      Sam Theodore, head of bank ratings at Scope Ratings, suggested that such measures “should lessen the angst” around coupon payments.

      “More coupon reassurance for AT1 investors means that the market for this type of capital securities would be more likely to grow and remain open for higher volumes.”

      However, coco issuance this year still lags behind 2015, with the window for issuance frequently shut since the peak of the sell-off in February. Almost €15bn of European coco bonds have been issued so far in 2016, compared with €25.9bn by this stage last year. Over the whole of 2015, €32.4bn of bonds were sold, according to data from Deutsche Bank.

      Other headaches remain. “These (cocos) are just nowhere near as liquid as other fixed income instruments out there, particularly during periods of market stress,” says Hani Redha, a portfolio manager at PineBridge Investments.

      That said, no major default has befallen the market. Bank capital levels continue to rise — effectively increasing the distance to any potential losses on cocos.

      While these bonds are still a niche security, traded by specialist investors, they have come under greatest scrutiny when investors have fled banks’ shares as they did in the first quarter. So beyond the underlying creditworthiness of the particular lender, the biggest risk facing coco buyers is how other investors might behave during periods of broader distress in financial markets.

      “How strong are the hands that hold this stuff?” says Mr Redha. “We saw how they behaved earlier this year.”

      FSB report highlights slow pace of change

      Posted on 31 August 2016 by

      Governor of the Bank of England Mark Carney, speaks during the Bank of England Financial Stability Report press conference, at the central bank in central London on July 5, 2016. The Bank of England on Tuesday relaxed commercial banks' capital requirements to boost lending to businesses and households, and warned that financial stability risks 'have begun to crystallise' after Brexit. BoE governor Mark Carney pledged it would do whatever is needed to aid monetary and fiscal stability in the wake of the June 23 referendum that saw Britain vote to exit the EU. / AFP / POOL / DYLAN MARTINEZ (Photo credit should read DYLAN MARTINEZ/AFP/Getty Images)©AFP

      Mark Carney, governor of the Bank of England

      Global banking regulators have presented G20 leaders with a wishlist almost unchanged from the one they filed a year ago, underscoring the slow pace of change in some of the outstanding issues.

      In their second report on the implementation of regulatory reforms, the Financial Stability Board is calling on the world’s most powerful leaders to put in place legal powers to share information across borders and remove reporting restrictions on some derivatives.

        The FSB also wants the G20’s support to ensure that “legal data and capacity constraints” do not hamper implementation of an ambitious package of global financial reports.

        All three requests also featured in the FSB’s inaugural implementation report last November, though at that stage they also wanted the G20 leaders to ensure national authorities were “adequately resourced” to implement reforms.

        The areas that “merit ongoing attention” are almost unchanged from a year earlier, and include market liquidity, the effects of reforms on emerging and developing economies and maintaining an “open and integrated” global financial system.

        Despite highlighting so many persistent issues, the FSB stressed that progress was being made, with internationally active banks “considerably more resilient” than pre-crisis and on track to meet incoming capital and liquidity rules, known as Basel III.

        Mark Carney, the Bank of England governor who chairs the FSB, said the report “highlights the achievements to date in strengthening the resilience of the global financial system”.

        “This significant progress must not lead to complacency. Our priorities must be to implement our past agreements in a full, timely and consistent manner; to address new risks and vulnerabilities; and to continue to build an open global financial system that benefits all.”

        Last November, the FSB unveiled its proposals for Total Loss-Absorbing Capacity (TLAC), which is designed to end “too big to fail” by transferring the risk of bank failure to bondholders. Systemically important banks in certain jurisdictions have begun to sell debt which complies with the new measures.

        The FSB stated that “substantial work remains in achieving effective resolution regimes”, pointing to ongoing reforms in several FSB jurisdictions. The report identified weaknesses which include funding needs in resolution and continuity of access in resolution to financial market infrastructures.

        The report also highlighted the growth of non-bank credit intermediation in the post-crisis era, particularly in Europe. It added that regulatory reforms may have contributed to this growth by increasing the relative cost of bank-based finance.

        Deutsche Bank chief denies merger with rival

        Posted on 31 August 2016 by


        John Cryan, Deutsche Bank chief executive

        Deutsche Bank chief John Cryan said that Germany’s banking sector needed consolidation but dismissed a report that his bank had considered a merger with local rival Commerzbank.

        Germany’s Manager Magazin reported on Wednesday morning that Deutsche had held tentative internal discussions about whether a combination with Germany’s second-biggest lender “could possibly make sense”.

          “The considerations were theoretical and therefore in a very early stage. Whether they will be picked up again, is unclear. At the moment the idea is only given a very small chance of being realised,” the magazine wrote.

          Asked about the report at a banking conference in Frankfurt on Wednesday, Mr Cryan said that Deutsche was committed to carrying out the five-year strategy that he spelt out last autumn “on our own”, and that Deutsche was not looking for partners in Germany.

          Deutsche’s share price has lost half of its value over the past year, as investors fret about the prospects of Germany’s biggest bank in the face of rock-bottom interest rates, tightening regulation, and a number of unresolved legal cases. The bank made a €6.8bn loss last year.

          In an attempt to improve Deutsche’s profits and capital, Mr Cryan in October set out a plan that involved selling off Postbank, the post office that it bought in stages from 2008, cutting assets in its investment banking arm and exiting 10 countries, and Mr Cryan stressed that regulators wanted banks to shrink, not grow.

          However, in his speech at the conference, arranged by the German newspaper Handelsblatt, Mr Cryan said that the German banking sector did need consolidation.

          “There are simply too many banks in Germany. Unlike in Spain, France or northern Europe, there has never been a major move towards mergers. The result: fewer economies of scale, more competition, higher price pressures,” he said.

          Mr Cryan added that mergers were needed at a national level and across national borders. His counterpart at Commerzbank, Martin Zielke, took a similar line, agreeing there were too many banks in Germany. However, Georg Fahrenschon, head of the German Savings Banks Association, said that calls for a “fundamental wave of consolidation among banks” were “not appropriate”.


          share of the German banking market held by its 5 biggest banks in 2014, according to the ECB

          Germany has the least consolidated banking sector in the eurozone. According to the European Central Bank, the five biggest banks in Germany had a market share of just 32 per cent in 2014.

          The result is brutal competition for taking in deposits and giving out loans, which has put huge pressure on the margins of German lenders. In the first three months of the year, the sector’s return on equity was just 2.6 per cent, according to the European Banking Authority.

          Shares in Deutsche were up 2.3 per cent at €13.18 in morning trading in Frankfurt. Shares in Commerzbank were up 3.4 per cent at €6.31.

          Drop in yen gives Japan shares a fillip

          Posted on 31 August 2016 by

          A man looks at an electric quotation board displaying the Nikkei key index of the Tokyo Stock Exchange in Tokyo on August 26, 2016. Tokyo stocks ended the week in the red August 26 as dealers awaited a speech by Federal Reserve chief Janet Yellen and after data showed Japan is still struggling in its battle to kickstart inflation. / AFP PHOTO / KAZUHIRO NOGI©AFP

          Wednesday 05:10 BST. A drop in the yen as the US dollar rallied on expectations the Federal Reserve could soon lift interest rates lifted Japanese shares while energy and resources names dragged the Australian market lower.

          The Japanese currency was 0.1 per cent weaker at ¥103.03, having fallen 1 per cent in the previous session to break through the ¥103 barrier for the first time this month. The yen is on track for a sixth straight day of decline, the longest downtick since March.

          As exporter shares gained, the broad Topix rose 1.3 per cent and the Nikkei 225 added 1.1 per cent.

          After rising 0.5 per cent the previous session, the dollar index — a measure of the US currency against a basket of peers — was down 0.1 per cent at 95.967 in Asia.

          The euro was 0.1 per cent higher at $1.1155 while the British pound was up 0.2 per cent at $1.3106.

            All major currencies weakened against the US dollar on Tuesday after Fed vice-chair Stanley Fischer said a rate rise in September could still be on the cards — and possibly another one in December.

            “If the market believes that a strong US dollar would prevent the Fed from hiking rates, it had better think again,” analysts at DBS said. “Assuming that this Friday’s US non-farm payrolls come in above the Fed’s 85,000-120,000 range for normal job growth, a hike at the FOMC meeting on [September 21] is likely.”

            The market expects the US economy to have added 180,000 jobs in August, slowing from July’s 255,000 pace.

            Mr Fischer has led the charge recently in talking up the prospects of a September rate rise. On the sidelines of last weekend’s gathering of central bankers in Jackson Hole, he said the payrolls data would weigh heavily on the central bank’s decision of whether to lift interest rates next month.

            Market pricing puts the probability of a 25 basis point increase in the Federal Funds rate in September at 34 per cent, up from 28 per cent a week ago, while the chances of a December rise have increased to 59 per cent from 53.9 per cent.

            The price of gold, which is sensitive to interest rate expectations, was up 0.3 per cent at $1,314.93 an ounce after declining almost 1 per cent on Tuesday.

            Elsewhere in Asia, Hong Kong’s Hang Seng was flat, while China’s Shanghai Composite was up 0.3 per cent and the Shenzhen Composite advanced 0.2 per cent.

            The Hang Seng is on track for a 5.2 per cent gain in August, the best performance among Asian peers. The Shanghai Composite is heading for a 2.8 per cent gain this month, its best showing since March and a third straight month of gains.

            Australia’s S&P/ASX 200 was down 1 per cent thanks to heavy declines in the materials and energy sector as iron ore prices pulled back and with oil falling for a third straight day.

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            The sport price of the key steel-making ingredient with 62 per cent iron content was down for a fifth consecutive day at $58 a tonne.

            Crude oil prices fell more than 1 per cent overnight despite Iraq’s prime minister supporting plans for major oil producers to freeze output at an informal Opec meeting next month. Prices stayed under some pressure in In Asian trading, with Brent crude, the international benchmark, flat at $48.37 a barrel and West Texas Intermediate 0.1 per cent lower at $46.31.

            Analysts were poring over data showing Japanese industrial production was unchanged in July month-on-month, but shrank 3.8 per cent year-on-year in July, worsening from the previous month and below expectations.

            Capital Economics said that “while industrial production was unchanged in July, firms’ forecasts for the following months suggest that the economy started expanding again in the third quarter”.

            Analysts at Barclays said they still expect production to increase on a quarterly basis in the third quarter and are retaining their forecast for real GDP growth, but added they “see more downside risk than previously”.

            For market updates and comment follow us on Twitter @FTMarkets

            DBS undercuts rates with $750m cocos sale

            Posted on 31 August 2016 by

            People make transactions at DBS bank ATM machines in Singapore on March 17, 2014. Singapore's DBS Bank said on March 17 it had agreed to buy the Asian private banking business of French lender Societe Generale in a deal worth 220 million USD, boosting its access to the region's super rich. AFP PHOTO / ROSLAN RAHMAN (Photo credit should read ROSLAN RAHMAN/AFP/Getty Images)©AFP

            Singapore’s DBS has raised equity-linked capital at the lowest-ever cost for a US dollar-denominated issue, sharply undercutting rates paid by the likes of RBS and Standard Chartered earlier this month as investors’ search for yield intensifies.

            The bank sold US$750m of so-called contingent convertible, or coco, debt with a coupon of 3.6 per cent, well below initial guidance of about 4 per cent.

              Cocos, known in regulatory terms as additional tier one capital, rank just above common equity but below all other forms of capital. The bonds force losses on bondholders if equity capital falls below certain levels or — as in this case — at the regulator’s discretion.

              The global market for cocos, a key plank of post-crisis financial regulation, has suffered this year amid fears that lossmaking banks could be forced to suspend interest payments on the debt —— in turn prompting wider concerns the bonds were more volatile and thus riskier than first envisioned.

              So far this year, banks have sold US$46bn worth of the debt, according to Dealogic, compared with a record US$86bn in 2015.

              DBS’s deal is a sharp contrast to the rates paid by peers. Earlier in August, RBS sold US$2.7bn of cocos with a coupon of 8.63 per cent and Standard Chartered sold US$2bn at 7.5 per cent.

              “There is a level of conviction [in Asia] that while there’s loss absorption, no one believes the regulators will let it get to that point. Whereas if you’re, say, RBS you’ve already been nationalised once,” said one banker involved in the DBS transaction.


              Amount of cocos sold by banks this year

              Bankers said a scarcity of Singapore-related paper also helped reduce DBS’s borrowing costs.

              However, the deal comes as Singapore’s banks are facing pressure. DBS doubled its provisions for bad debts to S$336m (US$246m) in the second quarter, due to its exposure to the collapse of Singapore oil and gas services company Swiber.

              DBS is rated AA-minus by Fitch and one notch higher, at, AA2 by Moody’s Investors Service — which nevertheless in June gave Singapore’s banking system a negative outlook because of weakening growth and the stresses from its high exposure to energy-related companies.

              Contingent capital: coco a gogo

              A man walks past a branch of The Royal Bank of Scotland (RBS) in central London, Britain August 27, 2014. REUTERS/Toby Melville/File Photo

              Coco bonds look better than bank shares

              Orders for the DBS deal — its first dollar-denominated coco — reached US$6.5bn. Asian investors took 80 per cent of the deal with Europe and the Middle East accounting for the rest. By type, fund managers accounted for almost two-thirds while private banks — a perennial source of interest in higher-yielding assets — took 19 per cent.

              Hong Nam Yeoh, head of wholesale funding at DBS, said that while the bank’s capital adequacy ratios are already high, DBS had decided to take advantage of strong market conditions.

              “The differences between Additional Tier 1 instruments in Europe and Asia appear to be crystallising through dramatically different prices. We are essentially talking about two separate sub-asset classes now,” he said.

              DBS’s common equity Tier 1 ratio stood at 14 per cent as of June this year.

              DBS, Citigroup, Deutsche Bank, HSBC and Société Générale led the deal.

              Disrupting Treasury market proves a struggle

              Posted on 31 August 2016 by

              Market Reaction To The U.K. General Election At Panmure Gordon...A trader monitors financial information on computer screens on the trading floor at Panmure Gordon & Co., as results continue to be announced in the 2015 general election in London, U.K., on Friday, May 8, 2015. David Cameron is on course to remain prime minister at the head of a minority government after the U.K. general election, an exit poll and early results indicated. The pound jumped. Photographer: Chris Ratcliffe/Bloomberg©Bloomberg

              Anyone who believes trading in the $13tn US government bond market is ripe for change has had a sobering few days.

              Direct Match, one of the most prominent of a handful of companies confident that trading could be radically shaken up, last week admitted it will “not be able to execute on our vision anytime soon.”

                Founded by Jim Greco, a former employee at Getco, and by backed venture capital firms including Canaan Partners, Direct Match has been working on a platform in which high-speed trading firms, banks and investors can trade directly with one another in the world’s most important financial market.

                Treasuries are the cornerstone of the global bond universe, and the market has evolved in recent years as it becomes more electronic and high-speed trading firms jostle with banks that have historically dominated. However, the the basic architecture has remained in place, with the market split into two parts: the dealer-to-client market, where banks interact with insurers and asset managers; and the dealer-to-dealer market, where banks trade with each other.

                Banks blame more onerous regulations for forcing them to retreat from their bond trading businesses, which investors say has made it harder to buy and sell Treasuries. Despite trading volumes remaining steady over the past decade at around $500m per day, the size of the Treasury market has ballooned to around $13.4tn.

                It’s a backdrop that looked fertile, leading to the founding of firms like Direct Match with ambitions to create so-called “all-to-all” trading pools where everyone – whether banks, pension funds, asset managers and high-frequency traders – can take part, increase liquidity and invigorate trading.

                “Building liquidity from scratch is very, very hard,” says Kevin McPartland, head of market structure at Greenwich Associates. “You need a strong network to make it work and creating that is difficult.”

                Direct Match, which was dealt a heavy blow after losing State Street as a partner, which would have helped it settle trades. For the large centralised trading pools on which the company was modeled, it is crucial to have a firm track and tally trades to help ensure their settlement.

                But start-ups already face a daunting landscape. Plenty of trading still happens by phone, and most dealer-to-client electronic trading is concentrated at two incumbents: Bloomberg and Tradeweb. Meanwhile, ICAP’s BrokerTec and Nasdaq eSpeed are dominant in the “interdealer” market, where banks and HFT firms interact.

                Some established interdealer venues — most notably, Nasdaq and BrokerTec — have also launched platforms to push into the dealer-to-client portion of the market. BGC, which sold eSpeed to Nasdaq in 2013, is also said to be working on a platform, according to people familiar with the matter.

                “Although I still believe this is a solution that will and needs to happen, there are powerful entrenched players in the Treasuries market that like the status quo and will do everything possible to prevent any changes to it,” says Daniel Ciporin at Canaan Partners.

                There are two other start-up platforms which are attempting a more modest model than Direct Match by maintaining some of the relationship-based structure that exists today.

                The most established new entrant is LiquidityEdge, which offers an electronic stream of prices from known counterparties. The platform went live in September 2015 but declines to provide detailed trading volumes. Meanwhile, OpenDoor is focused on less frequently traded parts of the US government bond market — such as inflation-linked debt — and has raised $10m to develop a platform that hasn’t yet launched.

                Chart: Electronic trading in Treasury bonds

                “The US Treasury market is very bifurcated at the moment,” says Brian Meehan, a managing partner at OpenDoor. “What this industry needs is an all-to-all structure that allows the buyside to access more liquidity, while maintaining strong relationships with the dealers.”

                However, established platforms are already widely used, and altering the entrenched habits of investors is tricky. Getting investors onboard and engaged is the key to success, as banks and trading firms are likely to follow where their clients wish to trade.

                Bloomberg has already opened its doors to Citadel, a large electronic market-maker. Tradeweb is also looking to bring HFTs on to its platform, according to people familiar with the plans. Even the traditional interdealer platforms are looking at new ways to involve HFT.

                Another obstacle is that the largest asset managers and hedge funds are important clients for banks. Banks say they are sometimes willing to trade Treasuries at a loss in order to maintain the relationship, so the attraction of the new platforms will be greater for smaller players left adrift as banks have pulled back.

                “If you are a top-five or top-ten client for a bank then you get great pricing all day long,” says Nichola Hunter, chief operating officer at LiquidityEdge. “Why would you want to be in this new world? But if you are a mid-tier player then there is more of a sweet spot for alternative venues to be attractive.”

                Industry insiders accept that the Treasury market is in a period of flux, but banks and established venues maintain a strong hand in deciding its future direction.

                Joseph Noviello of Nasdaq eSpeed argues the Treasury market is “faced with an attack of disruption.”

                Maybe. But for now, Direct Match says it’s left exploring its “strategic options.”

                BoJ is the big whale in Japanese stocks

                Posted on 31 August 2016 by

                A Japanese national flag is hoisted at Bank of Japan headquarters in Tokyo...A Japanese national flag is hoisted at Bank of Japan headquarters in Tokyo February 25, 2013. Japan's prime minister is likely to nominate an advocate of aggressive monetary easing - Asian Development Bank President Haruhiko Kuroda - as the next central bank governor to step up his fight to finally rid the country of deflation. REUTERS/Yuya Shino (JAPAN - Tags: BUSINESS POLITICS) pworld©Reuters

                From July 29, when the Bank of Japan said it would nearly double its annual purchases of exchange traded funds from ¥3.3tn ($32bn) to ¥6tn, brokers in Tokyo have been selling stocks with a simple, unsettling message.

                In an equity market where the central bank is the biggest whale, and where the government in various forms has become the biggest shareholder in a quarter of First Section Tokyo stocks, it’s time to buy the fund flows, not the fundamentals.

                By way of apogee of the new abnormal, CLSA’s strategist Nicholas Smith removed Toyota from his model portfolio and replaced it with Fast Retailing — a stock disproportionately favoured by its trading history and the opaque way in which the Nikkei 225 Average is constructed. More broadly, he said, the BoJ will skew performance towards a particular basket of small and medium names.

                The fund flow trade, in different variations according to the brokerage, plays on the warping effects that the central bank’s ETF buying programme are having on equity, bond, currency and Reit markets.

                  For day traders, there is the short-term phenomenon of guessing when the BoJ will come into the market, and buying moments before that happens. But for the longer term players, still absorbing the distortions created by the negative interest rate policy announced in January, investors are finding themselves overwhelmed with unintended consequences of central bank moves.

                  The BoJ’s ETF programme, which strikes many investors as a signal of the deepening desperation of governor Haruhiko Kuroda and the broader breakdown of Abenomics momentum, is designed to boost stocks, stimulate growth and encourage individuals to invest in their own market.

                  The BoJ’s ¥6tn buying programme, which was limited to just ¥450bn per year when it began in 2010, makes the central bank larger than any other investor bloc on the Japanese market. Only once in the last decade has any group purchased more than ¥6tn in a year: foreigners in 2013 when they piled into the Abenomics story and what they believed was the prospect of widespread structural reform. But now it no longer makes sense, said the head of one Tokyo trading desk, to peddle any greater narrative than the fact that the BoJ, according to its current schedule, must buy an average of ¥70bn worth of ETFs every three trading days throughout the year.

                  Distortions already created by this massive programme, says JPMorgan’s FX strategist Tohru Sasaki, include a breakdown of certain long-held assumptions. Where in the past, a rising yen might batter Japanese shares, the fact that the BoJ will now buy regardless is suspending that pattern.

                  “With this helicopter money-like policy prevailing over the Japanese stock market,” said Mr Sasaki, “correlation between the Nikkei index and the dollar-yen rate has started to weaken. Even if stock prices decline in the morning, the decline tends to be limited because it is basically known that the BoJ will purchase $70.7bn of ETFs in the afternoon.”

                  Similarly Nomura’s Real Estate Investment Trust (Reit) analyst Tomohiro Araki said that, while the TSE Reit index had outperformed the Topix index by 21 per cent since the start of 2016, the BoJ now created the “possibility of equities outperforming Reits for reasons separate to underlying merits”.

                  But it remains in the equity markets that the biggest issues are likely to arise. According to its disclosed methodology, the central bank will buy ETFs in proportion to the market weights of the indices they track. Based on current capitalisations, analysts estimate that more than half of the funds would flow to the Nikkei 225 and two-fifths into the Topix. The balance is destined for the smaller JPX400, made up of companies chosen based on corporate governance criteria.

                  CLSA points out that this overemphasises the Nikkei 225, with a distorting flow towards certain Nikkei constituents. Unlike the Topix, for which members are weighted according to size and free float, Nikkei weights are calculated proportional to share prices.

                  As a consequence, companies with high share prices and thus high Nikkei 225 weightings are receiving more inflow than might be justified by their size. Fast Retailing, for instance, is weighted at more than 8 per cent of the Nikkei based on its having the second highest share price in Japan.

                  Based on its market capitalisation ¥3,870bn ($37.9bn) and free float (25 per cent), its weighting in the Topix is just 30 basis points. Toyota Motor, by contrast, has a lower weighting in the Nikkei than in the Topix, and will be the subject of less buying than justified by its size.

                  Goldman Sachs estimates that the doubling in BoJ buying coupled with the skew towards Nikkei weightings means that the central bank will own at least one-tenth of the equity in 32 companies by this time next year, up from five currently.

                  With this helicopter money-like policy prevailing over the Japanese stock market, correlation between the Nikkei index and the dollar-yen rate has started to weaken

                  – Tohru Sasaki, JPMorgan FX strategist

                  Over the coming 12 months, the government will buy an additional 5 per cent or more of the outstanding equity in small- and medium-sized companies including Taiyo Yuden, Comsys HD, Nissan Chemical and Konami.

                  But arguably one of the defining distortions of the BoJ’s programme is political.

                  Pushing against the BoJ’s policy to buy up listed companies stands the Tokyo Stock Exchange’s mandate on corporate governance — a key strut of the Abenomics programme and one of its more visible successes.

                  As part of a push to lift returns, the TSE introduced a corporate governance code last year — compliance with the code lies behind the selection criteria for one of the BoJ’s target indices, the JPX400.

                  One aspect of compliance relates to the Japanese tradition of corporate cross-holdings. The TSE wants companies to reduce their interests in other operating companies.

                  Companies have been slow to release all that pent-up stock on to the market: now that they are finally feeling the pressure to do so, they may find that they are simply selling it into the BoJ’s mega-purchasing programme.

                  Italy real estate funds are hot property

                  Posted on 30 August 2016 by

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                  What do Italian retirees own that international hedge funds want but just can’t have? The answer is shares in one of the more obscure European value investment trades of this year — closed-end Italian real estate funds.

                  These small listed funds were sold to retail savers and retirees before the financial crisis hit and for many years have sat unloved and obscure in the recesses of the Italian stock market.

                    In part because of poor liquidity, a lack of English language financial statements and non-existent analyst coverage, many of the 20 or so of these funds are currently trading at large discounts to their net asset value.

                    Recently, some private equity and hedge fund managers, including Capstone Equities, Fortress and Elliott, have launched tender offers to buy out the Italian savers, reasoning that they were trading significantly below the value of their underlying assets.

                    With Italian non-performing loans hitting a record high this year, these new investors must judge whether the discounts on offer provide a decent enough margin of safety in case the Italian economy gets worse.

                    The hedgies are also facing some reluctance from the original retail owners to sell out of their holdings at a large loss to par value. Their lack of enthusiasm is understandable.

                    Some of these real estate funds have no debt, generate positive cash flows and even own property outside of Italy in less troubled markets.

                    More importantly, many of the funds are in the process of liquidating their property holdings, providing a meaningful catalyst for closing the yawning gap between their net asset values and share prices through cash distributions.

                    One such fund, UniCredito Immobiliare Uno, currently trades at a more than 30 per cent discount to the €284m appraised value of its assets.

                    Yet earlier this year it sold one of its most valuable properties at only a slight discount to its book valuation. Another fund, Amundi Europa, trades at a more than 50 per cent discount to NAV and holds commercial real estate in Paris, Berlin and London, meaning it is significantly less exposed to Italy than it may first appear.

                    Anyone who can convince an Italian saver to sell them some shares at current prices looks to be getting a bargain.


                    ABF climbs on optimism over Primark

                    Posted on 30 August 2016 by

                    A customer browses clothing inside a newly opened Primark fashion store in Milan, Italy©Bloomberg

                    A customer browses clothing inside a newly opened Primark fashion store in Milan, Italy

                    Primark owner Associated British Foods was Tuesday’s biggest gainer after an RBC
                    survey showed the clothing retailer had improved perceptions this year for style while retaining its lead on price.

                    The findings supported Primark’s continued expansion in the UK and Europe, where openings cannibalising its flagship stores were becoming less of a problem, RBC said.

                      With more than half of ABF’s group sales coming from outside the UK, the group should be shielded from cost and currency pressures, RBC added. ABF rose 3.4 per cent to £30.51, also helped by Kantar Worldpanel industry data showing Primark’s strongest 12-week gain in market share since early 2015.

                      As part of the same research, RBC moved to “sector perform” from “outperform” on Debenhams, down 4.4 per cent to 60.1p. Midmarket peers such as Marks and Spencer are becoming more competitive on price, its survey found.

                      “We think Debenhams has managed its business well recently in tough trading conditions. However, as a department store chain with a low operating margin and relatively high fixed cost base and lease exposure, it is leveraged to a deterioration in household purchasing power,” it said.

                      Dollar strength meant miners were the wider market’s weakest sector, which dragged the FTSE 100 lower by 0.3 per cent, or 17.26 points, to 6,820.79. Fresnillo lost 5.6 per cent to £16.90 and Rio Tinto faded 4.7 per cent to £23.51.

                      Citigroup advised taking profit into the sector’s rally, saying it was unlikely to be supported by further gains for metals prices.

                      It said: “The one valuation metric where the mining companies look cheap is on spot free cash flow yield, but this is not being translated into dividend yields and therefore requires investors to make a leap of faith and hope that management will give them cash back. We think this risk is not worth taking and we think value is circa 20 per cent down from here.”

                      Vectura lost 3.9 per cent to 132.1p on news that its Flutiform asthma inhaler had failed a late-stage trial for treating chronic obstructive pulmonary disease (COPD).

                      JPMorgan called it “a minor negative”, adding: “As we already believe that Flutiform is used off label for COPD, we believe that this setback is likely to lead to a less impressive growth rate.”

                      Restaurant Group fell 6.2 per cent to 396p after its chairman Debbie Hewitt bought shares, which damped persistent speculation it might have been approached by potential bidders.

                      Housebuilder Berkeley lost 2.4 per cent to £25.95 ahead of likely relegation from the FTSE 100 in Wednesday’s index rejig.

                      Gold miner Polymetal (up 0.1 per cent to £11.15) was in line for automatic promotion to the blue-chips, while Micro Focus (ahead 2 per cent to £20.35) was leading the pack to replace Arm Holdings when the latter was deleted on September 2.