Posted by Sam Jones on Oct 23 14:46.
http://ftalphaville.ft.com/blog/2008/10/23/17365/the-cdo-unwind-waiting-to-happen/
Are the days of CDO carnage behind us?
Apparently not. Bloomberg reported on Wednesday:
Oct. 22 (Bloomberg) — Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.
The article is referring to synthetic CDOs: that is, CDOs which are not backed by tangible collateral (RMBS, CMBS, for example) but CDS contracts which reference some form of collateral.
In this case, CDS on corporations.
All of which may sound dreadfully esoteric. Until you ratchet up the numbers. On Friday last week, Barclays analyst Puneet Sharma put out a report on a possible synthetic CDO unwind, and what can be expected to happen to the market as we move through a recession in the coming months.
In graph form, here’s what would happen to the ratings on prime and high-grade tranches of the trillion dollar synthetic CDO market:
Huge, disastrous downgrades: exactly mirroring the structured finance downgrades from ABS CDOs which have brought the financial system to its knees already. Don’t forget, moreover, that these CDOs aren’t backed by dodgy subprime collateral, but are supposed to reference the investment grade corporate world. More proof that it’s not the collateral which is to blame, but the structuring. The medium is the message, and all that.
We guess the impact of this might make itself felt in three ways:
Firstly, there will likely be the mark-to-market losses on the CDO notes themselves. As the Bloomberg article noted, in some cases this is equivalent to a 90 per cent loss on capital. The question here then, is who is holding these notes? Hedge funds were certainly big buyers of synthetic CDOs. But guess what – banks are also holders too. And by and large, banks synthetic corporate CDO holdings haven’t been written down.
Secondly, trouble in the synthetic CDO market will – just as with ABS CDOs – have huge regulatory capital impacts for banks. Shama at Barclays produces another set of graphs to demonstrate:
Downgrades of synthetic CDOs, in other words, will have a devastating caustic effect on banks’ capital ratios – with the potential to completely offset government recapitalisation actions.
Thirdly – crisis for synthetic CDOs will suck money out of the banking system in other ways. Synthetics are “unfunded”. In a normal asset-backed CDO, the cash raised from selling bonds is used to buy assets, but in a synthetic CDO, the cash raised from selling bonds is not used up front: as a protection seller, the CDO collects premiums on CDS contracts which only cost it money in the event of a default (when the CDO must make good on its protection). Of course, depending on what is happening to the spread on the various CDS contracts a synthetic CDO might hold, the CDO might also need to make margin calls. Here is a quick diagram of the generic structure:
The point here is that the “collateral” account of synthetic CDOs usually takes one of two forms: a bank deposit, or a similar cash-equivalent holding: a money market deposit, for example. As spreads widen, and collateral posting (the red line in this diagram) comes into force, synthetic CDO SPVs will be drawing money out of banks and money market funds to meet their obligations. Given that there are quite a few synthetic CDOs out there, the effect shouldn’t be too insignificant.______
There’s one other point too: synthetic CDOs almost always have a super senior swap written on them. You can see it in the above diagram, technically sitting “outside” – above – the structure. The swap effectively offers the arranging bank protection against its position. The question is, who writes these swaps? LSS conduits, for one (another layer of SPV fun – backed by CP), insurers do (monolines and AIG, for example) and other banks do.
Complicated all the above might be. The long and the short of it is that the synthetic CDO market has used derivative technology to build a huge amount of leverage. With recession now biting, the whole house of cards is dangerously close to collapse.
The CDS markets should feel the impact when it does. One way synthetic CDO managers can offset losses- or rather, crystalise them at acceptable levels – would be to buy protection in the market to sterilise their portfolios.
2009年12月22日 星期二
S&P’s CDO rating methodology is unpatriotic, outrage du jour
Posted by Tracy Alloway on Oct 07 16:47.
Here’s a vitriolic demonstration of the current dilemma facing the ratings agencies.
Having been accused of ratings puffery — not being realistic or pessimistic enough when they first evaluated structured assets like collateralised debt obligations – the agencies are now being accused of being too bearish. To wit: the latest HCM Market Letter’s comments on Standard & Poor’s (H/T Sam Jones).
First, a bit of background:
On Sept. 17, S&P published a revised methodology for CDOs — the slice and dice securitisations backed by mortgages or other debt – after having flagged its revision proposal since at least March. The rating agency said the new methodology would affect nearly 5,000 deals, mostly based on corporate loans and worth about $578bn. Outstanding synthetic CDOs would likely get a downgrade of four notches, S&P said at the time. The upside was that CDOs which received triple-A ratings under the new criteria had to be able to withstand Depression era-esque default rates.
A fair trade-off? Not according to some commentators.
Here are the relevant excerpts from that HCM letter (emphasis ours):With this announcement, S&P accomplished several things. First, the revisions constitute an admission that its prior ratings were based on profoundly flawed intellectual assumptions and ratings models. Unfortunately, they have replaced their original mistakes with equally serious ones. Second — and most important from a systemic standpoint — the revisions effectively hammer the final nails into the coffin of the securitization of corporate debt. Third, with these revisions S&P unilaterally changed the rules governing hundreds of billions of dollars of Collateralized Loan Obligations that were issued over the past few years. It did so without giving investors in these transactions any right of appeal, or any recourse to recover their potential losses. Investments were made based on earlier ratings which arguably constituted an implied promise by the ratings agencies to maintain the original set of assumptions underlying their ratings. By unilaterally changing these assumptions to account for the first time for Black Swans, S&P has broken its compact with the entire financial world that came to rely on its ratings. This post hoc approach reflects extremely poorly on the intellectual abilities of the credit rating agency.
Err, ouch.
If that wasn’t enough, though, HCM are also accusing S&P of being ignorant of the current economic environment:Fifth, S&P is effectively raising the cost of capital for less than investment grade companies that are already suffering from a dearth of available capital sources. Moreover, it is doing so after credit conditions have improved. While the rating agency is a private sector entity, it has enjoyed the imprimatur of the Securities and Exchange Commission that requires so many areas of finance to rely on its ratings. Moves like this, which are dressed up in intellectual clothing but are little more than ex post facto attempts to correct its prior mistakes, have large systemic effects. The problem is that these systemic effects are being inflicted by an organization that has surrendered any claim to intellectual legitimacy by its prior errors. Moreover, it is compounding those errors by making changes to its ratings assumptions that fly in the face of current data that suggests that corporate credit conditions are improving, rendering its heightened default scenarios highly unlikely to occur and unsuitable for application to these structured credit products.
And what’s more, S&P’s actions pose wider problems for collateralised loan obligations — a type of CDO which securitises commercial loans:The tragedy is that S&P’s recent move suggests that they are being permitted to stick it to investors again. The rating agencies fail to understand that corporate loans are different from bonds or mortgages. Instead, they are applying the same standards they erroneously applied to Collateralized Mortgage Obligations and Collateralized Bond Obligations to Collateralized Loan Obligations. As a result, they are downgrading CLOs and limiting their ability to provide capital to less than investment grade companies in an already difficult financing environment. They are doing this without regard to the consequences of their actions, which is to render financing harder to come by for viable companies that need access to capital. Despite improved credit conditions, less-than-investment grade companies remain faced with the same situation that they have always faced, i.e., the rationing of credit. Banks long ago exited the lending business in favor of the originate-and-distribute model, and in the aftermath of the crisis have little desire to add assets to their balance sheets. As Chart 1 on the previous page illustrates so graphically, the banks are still in the process of exiting the lending business and nobody appears to be filling the gap. One of the last men standing to purchase less-than-investment grade securities in large volumes were CLOs, and an increasing number of these are being frozen out of the market by these downgrades just as market conditions are improving. This is directly contrary to the efforts the Obama Administration is making to encourage lending, and is another reason why credit agencies should be subject to far stricter regulation in view of the damage they have already done and continue to do.
Woah — downgrading CDOs/CLOs is now unpatriotic and against Obamanomics?
Evil ratings agencies. Perhaps we can have a McCarthy-style witch hunt to purge them of their new-found realism bearishness soon.
Or maybe just another ratings flip-flop.
Related links:Hedgie adventures in pop history; hyperbole. Redux – The Long RoomCDOs, a tendency to liquidate – FT Alphaville`Race to bottom’ at Moody’s, S&P secured subprime’s boom, bust – Bloomberg
Here’s a vitriolic demonstration of the current dilemma facing the ratings agencies.
Having been accused of ratings puffery — not being realistic or pessimistic enough when they first evaluated structured assets like collateralised debt obligations – the agencies are now being accused of being too bearish. To wit: the latest HCM Market Letter’s comments on Standard & Poor’s (H/T Sam Jones).
First, a bit of background:
On Sept. 17, S&P published a revised methodology for CDOs — the slice and dice securitisations backed by mortgages or other debt – after having flagged its revision proposal since at least March. The rating agency said the new methodology would affect nearly 5,000 deals, mostly based on corporate loans and worth about $578bn. Outstanding synthetic CDOs would likely get a downgrade of four notches, S&P said at the time. The upside was that CDOs which received triple-A ratings under the new criteria had to be able to withstand Depression era-esque default rates.
A fair trade-off? Not according to some commentators.
Here are the relevant excerpts from that HCM letter (emphasis ours):With this announcement, S&P accomplished several things. First, the revisions constitute an admission that its prior ratings were based on profoundly flawed intellectual assumptions and ratings models. Unfortunately, they have replaced their original mistakes with equally serious ones. Second — and most important from a systemic standpoint — the revisions effectively hammer the final nails into the coffin of the securitization of corporate debt. Third, with these revisions S&P unilaterally changed the rules governing hundreds of billions of dollars of Collateralized Loan Obligations that were issued over the past few years. It did so without giving investors in these transactions any right of appeal, or any recourse to recover their potential losses. Investments were made based on earlier ratings which arguably constituted an implied promise by the ratings agencies to maintain the original set of assumptions underlying their ratings. By unilaterally changing these assumptions to account for the first time for Black Swans, S&P has broken its compact with the entire financial world that came to rely on its ratings. This post hoc approach reflects extremely poorly on the intellectual abilities of the credit rating agency.
Err, ouch.
If that wasn’t enough, though, HCM are also accusing S&P of being ignorant of the current economic environment:Fifth, S&P is effectively raising the cost of capital for less than investment grade companies that are already suffering from a dearth of available capital sources. Moreover, it is doing so after credit conditions have improved. While the rating agency is a private sector entity, it has enjoyed the imprimatur of the Securities and Exchange Commission that requires so many areas of finance to rely on its ratings. Moves like this, which are dressed up in intellectual clothing but are little more than ex post facto attempts to correct its prior mistakes, have large systemic effects. The problem is that these systemic effects are being inflicted by an organization that has surrendered any claim to intellectual legitimacy by its prior errors. Moreover, it is compounding those errors by making changes to its ratings assumptions that fly in the face of current data that suggests that corporate credit conditions are improving, rendering its heightened default scenarios highly unlikely to occur and unsuitable for application to these structured credit products.
And what’s more, S&P’s actions pose wider problems for collateralised loan obligations — a type of CDO which securitises commercial loans:The tragedy is that S&P’s recent move suggests that they are being permitted to stick it to investors again. The rating agencies fail to understand that corporate loans are different from bonds or mortgages. Instead, they are applying the same standards they erroneously applied to Collateralized Mortgage Obligations and Collateralized Bond Obligations to Collateralized Loan Obligations. As a result, they are downgrading CLOs and limiting their ability to provide capital to less than investment grade companies in an already difficult financing environment. They are doing this without regard to the consequences of their actions, which is to render financing harder to come by for viable companies that need access to capital. Despite improved credit conditions, less-than-investment grade companies remain faced with the same situation that they have always faced, i.e., the rationing of credit. Banks long ago exited the lending business in favor of the originate-and-distribute model, and in the aftermath of the crisis have little desire to add assets to their balance sheets. As Chart 1 on the previous page illustrates so graphically, the banks are still in the process of exiting the lending business and nobody appears to be filling the gap. One of the last men standing to purchase less-than-investment grade securities in large volumes were CLOs, and an increasing number of these are being frozen out of the market by these downgrades just as market conditions are improving. This is directly contrary to the efforts the Obama Administration is making to encourage lending, and is another reason why credit agencies should be subject to far stricter regulation in view of the damage they have already done and continue to do.
Woah — downgrading CDOs/CLOs is now unpatriotic and against Obamanomics?
Evil ratings agencies. Perhaps we can have a McCarthy-style witch hunt to purge them of their new-found realism bearishness soon.
Or maybe just another ratings flip-flop.
Related links:Hedgie adventures in pop history; hyperbole. Redux – The Long RoomCDOs, a tendency to liquidate – FT Alphaville`Race to bottom’ at Moody’s, S&P secured subprime’s boom, bust – Bloomberg
‘More bad news’ on bank CDO exposures to come, BofAML says
Posted by Tracy Alloway on Dec 22 09:15.
FT Alphaville wrote in October 2008 that, by and large, banks’ holdings of synthetic corporate CDOs had yet to be written down. Fast forward to December 2009, and it looks like the same might still be true for the majority of those holdings.
Recall that synthetic CDOs are not backed by tangible collateral (RMBS, CMBS and the like) but by CDS contracts which reference such collateral. In this case, CDS on corporations.
According to Bank of America Merrill Lynch European banking analysts Stuart Graham and Alexander Tsirigotis, the issue is that lots of those corporations were rather lacklustre financial companies.
Here’s what they say:
We have been talking in our research about the risks for banks as holders of synthetic corporate CDOs since early September. This is a $1.6 trillion market, with very little clarity on which banks hold such instruments. Until recently, it has been a “dog which hasn’t barked”. However, the credit events at several US financials are now filtering through into rating agency downgrades of CDO tranches. The credit events at the Icelandic banks will also provide further downgrades. We think we will be hearing more bad news on exposures to synthetic corporate CDOs in the coming weeks.
We have long argued that a major risk for corporate synthetics was the over-exposure to the financials sector and certain names within that sector. In late September S&P downgraded 168 tranches of RM European Banks 20 October 2008 19 synthetic corporate CDOs and placed a further 600+ on rating watch negative. Chart 18 shows that these downgrades are very severe – nearly ¾ of all US tranches were downgraded by a full letter or more, while European tranches saw 60% of all affected tranches downgraded by a full letter or more. Moreover, the migration from investment grade to high yield was also significant with 30 US tranches (and 19 European) moving from investment grade ratings to speculative grade ones – or c. 30% of all downgraded tranches, in Europe and US. Recent events at KBC show how such downgrades can translate into large impairments.
And if you’re curious as to just what kind of financials those could be, the analysts have provided the below, rather interesting, table. Lehman Brothers and AIG, among others, make an appearance:
Related links:CDOs, a tendency to liquidate – FT Alphaville
S&P’s CDO rating methodology is unpatriotic – FT Alphaville
The CDO unwind waiting to happen – FT Alphaville
FT Alphaville wrote in October 2008 that, by and large, banks’ holdings of synthetic corporate CDOs had yet to be written down. Fast forward to December 2009, and it looks like the same might still be true for the majority of those holdings.
Recall that synthetic CDOs are not backed by tangible collateral (RMBS, CMBS and the like) but by CDS contracts which reference such collateral. In this case, CDS on corporations.
According to Bank of America Merrill Lynch European banking analysts Stuart Graham and Alexander Tsirigotis, the issue is that lots of those corporations were rather lacklustre financial companies.
Here’s what they say:
We have been talking in our research about the risks for banks as holders of synthetic corporate CDOs since early September. This is a $1.6 trillion market, with very little clarity on which banks hold such instruments. Until recently, it has been a “dog which hasn’t barked”. However, the credit events at several US financials are now filtering through into rating agency downgrades of CDO tranches. The credit events at the Icelandic banks will also provide further downgrades. We think we will be hearing more bad news on exposures to synthetic corporate CDOs in the coming weeks.
We have long argued that a major risk for corporate synthetics was the over-exposure to the financials sector and certain names within that sector. In late September S&P downgraded 168 tranches of RM European Banks 20 October 2008 19 synthetic corporate CDOs and placed a further 600+ on rating watch negative. Chart 18 shows that these downgrades are very severe – nearly ¾ of all US tranches were downgraded by a full letter or more, while European tranches saw 60% of all affected tranches downgraded by a full letter or more. Moreover, the migration from investment grade to high yield was also significant with 30 US tranches (and 19 European) moving from investment grade ratings to speculative grade ones – or c. 30% of all downgraded tranches, in Europe and US. Recent events at KBC show how such downgrades can translate into large impairments.
And if you’re curious as to just what kind of financials those could be, the analysts have provided the below, rather interesting, table. Lehman Brothers and AIG, among others, make an appearance:
Related links:CDOs, a tendency to liquidate – FT Alphaville
S&P’s CDO rating methodology is unpatriotic – FT Alphaville
The CDO unwind waiting to happen – FT Alphaville
2009年12月21日 星期一
The slumbering CLO awakes?
Earlier this month, FT Alphaville asked whether synthetic CLOs were gone for good, or merely hibernating?
This week it looks like the synthetic CLOs’ simpler cousin, your run-of-the-mill business loan-packed CLO, is beginning to awaken:
Dec. 16 (Bloomberg) — Banks may arrange as many as 100 collateralized debt obligations backed by high-yield, high-risk loans in 2010 following Wells Fargo & Co.’s “landmark” offering yesterday, according to Guggenheim Partners LLC.
Guggenheim was the main investor in the securities of Newstar Commercial Loan Trust 2009-1, a $250 million CLO arranged by Wells Fargo, said Scott Minerd, who helps supervise more than $100 billion as Guggenheim’s chief investment officer.
Wells Fargo is joined by JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. in approaching managers of leveraged loans to offer terms for new CLOs following a record rally this year in the debt. The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt.
. . . Leveraged loans have returned a record 49.8 percent this year after losing an unprecedented 28.2 percent in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. Leveraged loans are rated below BBB- by S&P and less than Baa3 at Moody’s Investors Service.
Ironically the stated reasoning behind this latest CLO is almost the polar opposite to the thing that fueled the early 2008 (mini) CLO boom-of-desperation.
This for instance, is from a February 2008 Wall Street Journal article:
In the past few days, low-rated corporate loans — the kind that fueled the buyout boom of recent years — have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices.
`Unloading’ eventually became synonymous with `creating CLOs’ — which helps banks shift high-risk loans off their balance sheets.
And the plummeting value of leveraged loans in 2008 saw a plethora of `landmark’ deals like Carlyle’s CLO funds, and err, Lehman’s Freedom CLO, which was packed with stuff like bank credit lines to CountryWide Financial — the mortgage house hit hard by the crisis and taken over by Bank of America.
The issue in 2008 was that the dropping value of leveraged loans essentially created margin calls — forcing sales of the CLOs’ assets in the event that counterparties couldn’t make the payments– which in turn led to further reductions in loan values. A sort of vicious CLO-circle, if you will.
Lots has of course changed since 2008 — but then again, lots hasn’t.
For instance, the pricing difference between the primary and secondary market for loans is still pretty wide, which makes some people doubt an imminent CLO comeback.
From Structured Finance News:
However, some still doubted the likelihood of an imminent comeback for the market. Several CLO market participants noted that the arbitrage between the senior financing and the yield on other assets, mainly those that are trading on the secondary, will continue to make it difficult for any new CLOs to launch. “You need two pieces — attractive equity rates and reasonable financings — to create that arbitrage,” a New York-based CLO manager told Leveraged Finance News.
For those interested, The AAA-rated tranche of the Newstar CLO will pay 375bps over Libor, for instance, while the AA-rated is priced at 750bps. The BB-rated bit and the unrated remainder reportedly weren’t offered to Guggenheim.
Related links:
Guggenheim Partners buys most of a new $275m CLO – WSJ
Leveraged loans are the new bonds – FT
Ratings agencies draw fire from CLOs – FT
2009年12月16日 星期三
Introducing collateralised currency securities
Posted by Izabella Kaminska on Nov 13 15:55.
Something like $3,200bn flows through the FX market every day. That’s enough to whet the appetite of any financial service provider in terms of prospective flow action.
The exchange-traded fund community happens to be no stranger to such temptation. In fact, ETF issuers in the United States have been tapping into the market’s apparent growing need for cheap and easy exposure to foreign exchange for a number of years now.
It’s what you might term a meeting of the unregulated OTC forex market with the increasingly opaque world of exchange-traded funds.
The latest offer of this nature springs from ETF Securities, an exchange-traded fund issuer, which on Thursday launched the “world’s largest exchange traded currency platform” and Europe’s first. Here’s the release (our emphasis):Europe’s first exchange traded currencies (Currency ETCs) have today commenced trading on the London Stock Exchange. ETF Securities has admitted 18 Currency ETCs to the Main Market, offering long and short passive exposure to G10 currencies versus the US Dollar.Pietro Poletto, Head of ETFs and ETCs for London Stock Exchange Group said: “As the number one ETC exchange in Europe, and given London’s reputation as the global centre for foreign exchange trading, we are proud to be the venue of choice for issuers looking to bring this new type of product into Europe.“We aim to offer investors access to a wide range of investment opportunities while retaining the benefits of simplicity, transparency and central counterparty security that are integral to trading on-exchange. As such we are delighted to continue leading the diversification of Europe’s exchange traded product offering by welcoming ETF Securities’ new products today.”
A good opportunity to play the carry-trade, right?
We’ve had a go at reading the 150-page prospectus to determine just what the products are about. In quick conclusion, the ETCs appear to be another fine example of how exchange-traded products are mutating from their transparent replication-based beginnings into ever more complex instruments.
First, it would be wrong to confuse these for exchange-traded funds anyway. They are investable units of exchange-traded ‘collateralised currency security’ notes — or in the words of fund issuers “complex, structured products” aimed at “sophisticated, professional and institutional investors” .
This means retail investors operating without the advice of independent financial advisors should really stay clear. UCITS-compliant funds can invest in them, but the ETCs themselves are not strictly UCITS products.
The type of financial whizz-kidery that brought us CDOs, meanwhile, appears to be thriving well in ETFs.
ETF Securities’ COO Nik Bienkowski confirms to us his ETCs are the first of their kind in terms of structure, anywhere in the world. As the prospectus notes:
Collateralised Currency Securities are being issued for the first time pursuant to this Prospectus and therefore have no trading record. There can be no assurance as to the depth of the secondary market (if any) in Collateralised Currency Securities, which will affect their liquidity and market price.
Which means, of course, there’s no precedent to look to.
So how do collateralised currency securities actually work? It’s complicated, so bear with us.
In the ETF Securities framework the whole thing depends — much like in the DB x -trackers model – on synthetic rather than physical replication of an index. This, the argument goes, achieves superior tracking for investors.
ETF Securities’ ETCs are based on Morgan Stanley’s MSFX Total-Return Currency Indices. The way they achieve that performance, however, is not by replicating the components of those indices, but by taking out a total return swap with a counterparty that assures the performance of that index.
In ETF Securities’ case that counterparty happens to be Morgan Stanley (and only Morgan Stanley for the time being).
The way the money flows is as follows:
Investors buy units of, for example, the long AUD Short USD ETC on the London Stock Exchange.
When enough units are purchased to raise the price of units relative to the NAV of the ETC — as implied on a constant basis by the relevant MSFX index (minus management, broker and transaction fees) — an authorised participant (AP) spots an arbitrage opportunity and offers to buy units at the NAV price direct from the issuer for cash, which he sells on for a risk-less profit to the market to ensure tracking.
Here though the AP does not deal with ETF Securities directly but via the ETCs’ chief counterparty, Morgan Stanley.
Morgan uses the proceeds it receives to hedge its total-return-swap exposure — but essentially can do whatever it pleases with the money.
To ensure that investors are protected in the event that Morgan Stanley fails to guarantee the performance of the index, Morgan Stanley pledges collateral to ETF Securities’ custodian — Bank of New York Mellon.
That collateral can be made up of any of the following: AA-rated G20 government bond, AAA-rated shares of government or treasury money market funds, AAA-rated supranational bonds, unsubordinated bonds issued by Ginnie Mae and any equity listed on “specified indices” anywhere in the world.
Bank of New York Mellon has the responsibility of monitoring the eligibility of the collateral, but to all extents and purposes, from what we can make out, Morgan Stanley determines the valuation on a daily mark-to-market basis.
Of course, if you were interested in what these actually consisted of, you’d be disappointed because there doesn’t appear to be any public record offered. All we know is that equities have to represent an over-collateralisation of between 105-110 per cent — i.e. be worth more than the underlying obligation by that percentage — and bonds between 100-102 per cent. If the collateral falls below those parameters Morgan Stanley is obliged to deliver the difference via a master repo agreement.
Meanwhile, we understand that Morgan Stanley’s position as chief counterparty does not make it ineligible for the role of authorised participant. In fact, from what Bienkowski tells us, the bank is currently listed among the ETCs’ APs.
What does all that mean?
A pretty cushy arrangement for Morgan Stanley, from what we can make out. Morgan can use the ETC to gain lucrative access to liquidity as and when it pleases, while sporting the ultimate money-making capability via its position as a Master authorised participant.
As for the investor — remembering the products were launched as a response to investor demand for “secure, transparent and liquid currency package”– it means a potential upside scenario of receiving all of the performance of a currency index, for relatively low management fees, but without any interest or dividend (no carry trade here then)…
…and downside scenarios that include credit-exposure to Morgan Stanley, covered by a claim on potentially illiquid securities, as valued by Morgan Stanley. Compulsory redemptions at inopportune moments due to a myriad of different triggers. And in the event of counterparty default, a position third-in-line for repayment:
(a) FIRST in payment of all amounts then due to the Security Trustee and the Trustee and unpaid (including to any attorneys, managers, agents, delegates or other person appointed by either of them) in respect of each class to which such Counterparty Collateral Pool is 105 relevant under the terms of the relevant Security Deed and the Trust Instrument (as determined by the Security Trustee in its absolute discretion), and to payment of any remuneration and expenses of any receiver and the costs of realisation of the security constituted by the relevant Security Deed then unpaid, (for the avoidance of doubt, excluding any Redemption Amounts owed to the Trustee under the Trust Instrument);(b) SECONDLY in or towards payment or discharge of all amounts then due and unpaid by the Issuer to the Currency Transaction Counterparty to which such Counterparty Collateral Pool relates under the Facility Agreement, ISDA Master Agreement or Global Master Repurchase Agreement with such Currency Transaction Counterparty;(c) THIRDLY in or towards payment of all amounts then due and unpaid in respect of the Collateralised Currency Securities to which such Counterparty Collateral Pool is relevant on a pro rata basis as provided in Condition 13.5; (d) FOURTHLY in or towards payment or performance of all amounts then due and unpaid by the Issuer under the Services Agreement to ETFSL (or any Affiliate with which the Issuer has entered into a Services Agreement);(e) FIFTHLY in payment of the balance (if any) to the Issuer (without prejudice to or liability in respect to, any question as to how such payment to the Issuer shall be dealt with as between the Issuer and any other person).
Dare we say it makes more sense to go to a reputable counterparty in the FX market direct? Especially if it’s the longer term view you’re going for.
Related links:
Have you been forexed? - FT Alphaville
Forex-marketing goes mainstream - FT Alphaville
Something like $3,200bn flows through the FX market every day. That’s enough to whet the appetite of any financial service provider in terms of prospective flow action.
The exchange-traded fund community happens to be no stranger to such temptation. In fact, ETF issuers in the United States have been tapping into the market’s apparent growing need for cheap and easy exposure to foreign exchange for a number of years now.
It’s what you might term a meeting of the unregulated OTC forex market with the increasingly opaque world of exchange-traded funds.
The latest offer of this nature springs from ETF Securities, an exchange-traded fund issuer, which on Thursday launched the “world’s largest exchange traded currency platform” and Europe’s first. Here’s the release (our emphasis):Europe’s first exchange traded currencies (Currency ETCs) have today commenced trading on the London Stock Exchange. ETF Securities has admitted 18 Currency ETCs to the Main Market, offering long and short passive exposure to G10 currencies versus the US Dollar.Pietro Poletto, Head of ETFs and ETCs for London Stock Exchange Group said: “As the number one ETC exchange in Europe, and given London’s reputation as the global centre for foreign exchange trading, we are proud to be the venue of choice for issuers looking to bring this new type of product into Europe.“We aim to offer investors access to a wide range of investment opportunities while retaining the benefits of simplicity, transparency and central counterparty security that are integral to trading on-exchange. As such we are delighted to continue leading the diversification of Europe’s exchange traded product offering by welcoming ETF Securities’ new products today.”
A good opportunity to play the carry-trade, right?
We’ve had a go at reading the 150-page prospectus to determine just what the products are about. In quick conclusion, the ETCs appear to be another fine example of how exchange-traded products are mutating from their transparent replication-based beginnings into ever more complex instruments.
First, it would be wrong to confuse these for exchange-traded funds anyway. They are investable units of exchange-traded ‘collateralised currency security’ notes — or in the words of fund issuers “complex, structured products” aimed at “sophisticated, professional and institutional investors” .
This means retail investors operating without the advice of independent financial advisors should really stay clear. UCITS-compliant funds can invest in them, but the ETCs themselves are not strictly UCITS products.
The type of financial whizz-kidery that brought us CDOs, meanwhile, appears to be thriving well in ETFs.
ETF Securities’ COO Nik Bienkowski confirms to us his ETCs are the first of their kind in terms of structure, anywhere in the world. As the prospectus notes:
Collateralised Currency Securities are being issued for the first time pursuant to this Prospectus and therefore have no trading record. There can be no assurance as to the depth of the secondary market (if any) in Collateralised Currency Securities, which will affect their liquidity and market price.
Which means, of course, there’s no precedent to look to.
So how do collateralised currency securities actually work? It’s complicated, so bear with us.
In the ETF Securities framework the whole thing depends — much like in the DB x -trackers model – on synthetic rather than physical replication of an index. This, the argument goes, achieves superior tracking for investors.
ETF Securities’ ETCs are based on Morgan Stanley’s MSFX Total-Return Currency Indices. The way they achieve that performance, however, is not by replicating the components of those indices, but by taking out a total return swap with a counterparty that assures the performance of that index.
In ETF Securities’ case that counterparty happens to be Morgan Stanley (and only Morgan Stanley for the time being).
The way the money flows is as follows:
Investors buy units of, for example, the long AUD Short USD ETC on the London Stock Exchange.
When enough units are purchased to raise the price of units relative to the NAV of the ETC — as implied on a constant basis by the relevant MSFX index (minus management, broker and transaction fees) — an authorised participant (AP) spots an arbitrage opportunity and offers to buy units at the NAV price direct from the issuer for cash, which he sells on for a risk-less profit to the market to ensure tracking.
Here though the AP does not deal with ETF Securities directly but via the ETCs’ chief counterparty, Morgan Stanley.
Morgan uses the proceeds it receives to hedge its total-return-swap exposure — but essentially can do whatever it pleases with the money.
To ensure that investors are protected in the event that Morgan Stanley fails to guarantee the performance of the index, Morgan Stanley pledges collateral to ETF Securities’ custodian — Bank of New York Mellon.
That collateral can be made up of any of the following: AA-rated G20 government bond, AAA-rated shares of government or treasury money market funds, AAA-rated supranational bonds, unsubordinated bonds issued by Ginnie Mae and any equity listed on “specified indices” anywhere in the world.
Bank of New York Mellon has the responsibility of monitoring the eligibility of the collateral, but to all extents and purposes, from what we can make out, Morgan Stanley determines the valuation on a daily mark-to-market basis.
Of course, if you were interested in what these actually consisted of, you’d be disappointed because there doesn’t appear to be any public record offered. All we know is that equities have to represent an over-collateralisation of between 105-110 per cent — i.e. be worth more than the underlying obligation by that percentage — and bonds between 100-102 per cent. If the collateral falls below those parameters Morgan Stanley is obliged to deliver the difference via a master repo agreement.
Meanwhile, we understand that Morgan Stanley’s position as chief counterparty does not make it ineligible for the role of authorised participant. In fact, from what Bienkowski tells us, the bank is currently listed among the ETCs’ APs.
What does all that mean?
A pretty cushy arrangement for Morgan Stanley, from what we can make out. Morgan can use the ETC to gain lucrative access to liquidity as and when it pleases, while sporting the ultimate money-making capability via its position as a Master authorised participant.
As for the investor — remembering the products were launched as a response to investor demand for “secure, transparent and liquid currency package”– it means a potential upside scenario of receiving all of the performance of a currency index, for relatively low management fees, but without any interest or dividend (no carry trade here then)…
…and downside scenarios that include credit-exposure to Morgan Stanley, covered by a claim on potentially illiquid securities, as valued by Morgan Stanley. Compulsory redemptions at inopportune moments due to a myriad of different triggers. And in the event of counterparty default, a position third-in-line for repayment:
(a) FIRST in payment of all amounts then due to the Security Trustee and the Trustee and unpaid (including to any attorneys, managers, agents, delegates or other person appointed by either of them) in respect of each class to which such Counterparty Collateral Pool is 105 relevant under the terms of the relevant Security Deed and the Trust Instrument (as determined by the Security Trustee in its absolute discretion), and to payment of any remuneration and expenses of any receiver and the costs of realisation of the security constituted by the relevant Security Deed then unpaid, (for the avoidance of doubt, excluding any Redemption Amounts owed to the Trustee under the Trust Instrument);(b) SECONDLY in or towards payment or discharge of all amounts then due and unpaid by the Issuer to the Currency Transaction Counterparty to which such Counterparty Collateral Pool relates under the Facility Agreement, ISDA Master Agreement or Global Master Repurchase Agreement with such Currency Transaction Counterparty;(c) THIRDLY in or towards payment of all amounts then due and unpaid in respect of the Collateralised Currency Securities to which such Counterparty Collateral Pool is relevant on a pro rata basis as provided in Condition 13.5; (d) FOURTHLY in or towards payment or performance of all amounts then due and unpaid by the Issuer under the Services Agreement to ETFSL (or any Affiliate with which the Issuer has entered into a Services Agreement);(e) FIFTHLY in payment of the balance (if any) to the Issuer (without prejudice to or liability in respect to, any question as to how such payment to the Issuer shall be dealt with as between the Issuer and any other person).
Dare we say it makes more sense to go to a reputable counterparty in the FX market direct? Especially if it’s the longer term view you’re going for.
Related links:
Have you been forexed? - FT Alphaville
Forex-marketing goes mainstream - FT Alphaville
2009年12月14日 星期一
Goldman’s collateral damage
Posted by Tracy Alloway on Dec 14 12:47.
Cast your mind back to that SigTarp report, published last month.
Readers will recall there’s been a persistent stink over whether the efforts of the Federal Reserve and the US Treasury to prop up AIG had the effect of bailing out Goldman Sachs — its largest trading partner. Goldman Sachs always denied that idea, saying its exposure to AIG was collateralised and hedged against the mega-insurers’ fall. Others, were not so sure.
Last week the Wall Street Journal continued that particular line of thought with an article titled “Goldman fueled AIG gambles“, which examined GS’s role in acting as a middleman between the insurer and other banks. In short, Goldman offered banks protection on some of their investments (for instance on CDOs of home loans), which it in turn hedged with AIG in the form of CDS.
The other issue with Goldman and CDOs was its position as originator.
From the article:
Goldman’s other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.
The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.
One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007.
A big investor in Davis Square’s top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed’s Nov. 2008 move to pay off banks in full on their AIG insurance contracts.
A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion.
Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.
A representative of Société Générale declined to comment.
The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed’s effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default.
The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance.
What the WSJ probably means is that Goldman would have had a difficult time collecting on the hedges it bought to protect itself against an AIG bankruptcy. That’s a fair point, given that the failure of AIG could easily have knocked out the counterparty to Goldman’s hedges, whoever it might have been.
And on the collateral issue — Janet Tavakoli notes in some recent commentary:
… if A.I.G. had gone bankrupt, a sensible liquidator would have clawed back collateral that A.I.G. had already given to Goldman due to the extraordinary circumstances. After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar.
And for a glimpse into the underlying collateral of those Goldman-underwritten CDOs, Ms Tavakoli has also provided us with this link. Click it and you can see the collateral breakdown of Abacus 2005-2, part of Goldman’s supposedly subprime-shorting CDO series, and Davis Square Funding IV — the one mentioned in the WSJ article.
They are full of goodies like Blackrock-managed Tourmaline CDO 2005-1, which won deal of the year in 2005, and then hit an event of default and went into acceleration in April 2008. There’s also tons of that Countrywide goodness mentioned in the WSJ article — the same Countrywide stuff that ended up as collateral of CDOs against which monoline insurers MBIA and Ambac sold protection.
Related links:Bond insurer death watch, FGIC edition – FT Alphaville
Weird waterfalls and the synthetic CDO stumper – FT Alphaville
The uncomfortable position of UBS – FT Alphaville
A swooning maiden and the Fed’s CRE exposure – FT Alphaville
Cast your mind back to that SigTarp report, published last month.
Readers will recall there’s been a persistent stink over whether the efforts of the Federal Reserve and the US Treasury to prop up AIG had the effect of bailing out Goldman Sachs — its largest trading partner. Goldman Sachs always denied that idea, saying its exposure to AIG was collateralised and hedged against the mega-insurers’ fall. Others, were not so sure.
Last week the Wall Street Journal continued that particular line of thought with an article titled “Goldman fueled AIG gambles“, which examined GS’s role in acting as a middleman between the insurer and other banks. In short, Goldman offered banks protection on some of their investments (for instance on CDOs of home loans), which it in turn hedged with AIG in the form of CDS.
The other issue with Goldman and CDOs was its position as originator.
From the article:
Goldman’s other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.
The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.
One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007.
A big investor in Davis Square’s top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed’s Nov. 2008 move to pay off banks in full on their AIG insurance contracts.
A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion.
Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.
A representative of Société Générale declined to comment.
The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed’s effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default.
The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance.
What the WSJ probably means is that Goldman would have had a difficult time collecting on the hedges it bought to protect itself against an AIG bankruptcy. That’s a fair point, given that the failure of AIG could easily have knocked out the counterparty to Goldman’s hedges, whoever it might have been.
And on the collateral issue — Janet Tavakoli notes in some recent commentary:
… if A.I.G. had gone bankrupt, a sensible liquidator would have clawed back collateral that A.I.G. had already given to Goldman due to the extraordinary circumstances. After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar.
And for a glimpse into the underlying collateral of those Goldman-underwritten CDOs, Ms Tavakoli has also provided us with this link. Click it and you can see the collateral breakdown of Abacus 2005-2, part of Goldman’s supposedly subprime-shorting CDO series, and Davis Square Funding IV — the one mentioned in the WSJ article.
They are full of goodies like Blackrock-managed Tourmaline CDO 2005-1, which won deal of the year in 2005, and then hit an event of default and went into acceleration in April 2008. There’s also tons of that Countrywide goodness mentioned in the WSJ article — the same Countrywide stuff that ended up as collateral of CDOs against which monoline insurers MBIA and Ambac sold protection.
Related links:Bond insurer death watch, FGIC edition – FT Alphaville
Weird waterfalls and the synthetic CDO stumper – FT Alphaville
The uncomfortable position of UBS – FT Alphaville
A swooning maiden and the Fed’s CRE exposure – FT Alphaville
2009年12月4日 星期五
‘The Dr Evil Scenario’ in securitisation
Posted by Tracy Alloway on Dec 03 15:46.
Goldman Sachs may not be pure evil, but it looks to have inspired a fear of the “evil” in the securitisation market.
We hear that potential securitisation investors are asking City law firms to be on the look out for any “Dr Evil Scenario” — a situation in which a party to the transaction could suddenly and unexpectedly (but within the written terms of the deal) alter the cashflow or some other aspect of a securitisation — something along the lines of Goldman’s recent decision to pay off junior-ranking tranches in a synthetic CDO, at the potential expense of senior bondholders.
Janet Tavakoli, president of Tavakoli Structured Finance, called that particular CDO an example of a “WTF deal.”
But it seems the possibility of such “WTF deals” and “Dr Evil Scenarios” are slowly seeping into the investor conscience.
Here, for instance, is an excerpt from international law firm Clifford Chance’s latest securitisation paper, appropriately titled “New Beginnings”:
Providing greater transparency on reference assets is not always as easy as it may sound due to the need to comply with data protection laws and duties of confidentiality. Restoring confidence in rating agency methodology will also not be easy. In addition, the more complex and esoteric structures create reputational and regulatory concerns for financial institutions that can cause participants to shy away from their use
To help restore confidence, in depth investor education and involvement in structuring new transactions from the outset, particularly in more complicated structures, is likely to be required. However, it is likely that many investors will not have the time or resources to develop the expertise required to assess properly the risks and rewards of investing in synthetic structures and may, once again, need to rely to a material extent on the ratings given to synthetic deals. This may cause some regulatory issues which could limit their ability to invest.
Which either means more work for the lawyers — or the rating agencies — or old-fashioned investor-driven due diligence.
Related links:
Weird waterfalls and the synthetic CDO stumper part deux - FT Alphaville
Synthetic CDO stumper - FT Alphaville
Goldman Sachs may not be pure evil, but it looks to have inspired a fear of the “evil” in the securitisation market.
We hear that potential securitisation investors are asking City law firms to be on the look out for any “Dr Evil Scenario” — a situation in which a party to the transaction could suddenly and unexpectedly (but within the written terms of the deal) alter the cashflow or some other aspect of a securitisation — something along the lines of Goldman’s recent decision to pay off junior-ranking tranches in a synthetic CDO, at the potential expense of senior bondholders.
Janet Tavakoli, president of Tavakoli Structured Finance, called that particular CDO an example of a “WTF deal.”
But it seems the possibility of such “WTF deals” and “Dr Evil Scenarios” are slowly seeping into the investor conscience.
Here, for instance, is an excerpt from international law firm Clifford Chance’s latest securitisation paper, appropriately titled “New Beginnings”:
Providing greater transparency on reference assets is not always as easy as it may sound due to the need to comply with data protection laws and duties of confidentiality. Restoring confidence in rating agency methodology will also not be easy. In addition, the more complex and esoteric structures create reputational and regulatory concerns for financial institutions that can cause participants to shy away from their use
To help restore confidence, in depth investor education and involvement in structuring new transactions from the outset, particularly in more complicated structures, is likely to be required. However, it is likely that many investors will not have the time or resources to develop the expertise required to assess properly the risks and rewards of investing in synthetic structures and may, once again, need to rely to a material extent on the ratings given to synthetic deals. This may cause some regulatory issues which could limit their ability to invest.
Which either means more work for the lawyers — or the rating agencies — or old-fashioned investor-driven due diligence.
Related links:
Weird waterfalls and the synthetic CDO stumper part deux - FT Alphaville
Synthetic CDO stumper - FT Alphaville
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