The Financial Services Club's Blog

Stressed? Don't worry. The French and Germans will sort it out ...

I will not spend much more time on this, but was irritated by the CEBS stress tests last week and so one more quick note.

The reason CEBS, the European Commission and European Central Bank gave for not including the scenario of a sovereign default in the stress tests is that they just don’t think it’s going to happen.

“It is not possible”, they said.

“Why”, we asked.

“Because it is just incredibly unlikely and, even if anything did start to fragment in the fissures of finance in Greece or Spain, we have the European Financial Stability Fund (EFSF) to solve it”, they replied.

Now that’s an interesting statement ... because it is also a fuddle.

The EFSF is a €440 billion fund designed to cover any sovereign debt crisis in Europe in the future.

Therefore, the concept of a bank being exposed to huge losses from Greece and Spain is no longer an issue.

That is the logic.

And it’s quite good.

But it’s already been shot to pieces.

Ken Wattret, a market analyst with BNP Paribas, performed a really interesting analysis of the EFSF and issued a note in July that provides a clear Q&A overview. The analysis is available through their website (large pdf, see page 10) and a public version was summarised nicely by Financial News.

Here’s my summary of Ken’s research note:

The EFSF is a limited liability company based in Luxembourg announced in May as a measure to “preserve financial stability in Europe”. Its CEO is Klaus Regling, a former senior German Finance Ministry official who worked on the preparations for EMU and who has also worked at the IMF.

The purpose of the EFSF, according to its terms of reference, is “to collect funds and provide loans in conjunction with the IMF to cover the financing needs of Eurozone member states in difficulty, subject to strict conditionality”.

According to the Framework Agreement, the EFSF will finance the provision of loans via the issuance of “bonds, notes, commercial paper, debt securities or other financing arrangements” which will be backed by unconditional and irrevocable guarantees from those member states which participate.

Only the member states of the Eurozone participate in the scheme, providing guarantees up to a total of €440bn on a pro-rata basis.

If a Eurozone member state seeks assistance from the EFSF, they must initially agree a Memorandum of Understanding (MoU) with the European Commission, in liaison with the IMF and the ECB. This MoU will set out the budgetary and economic policy conditions which the Eurozone member state must comply with in order to receive financial assistance.

The detailed terms and conditions would then be set out in a Loan Facility Agreement which is subject to the agreement of all the guarantors (i.e. those countries in the EFSF).

The EFSF will enter into force when five or more member states, comprising at least two-thirds of the total guarantees, have confirmed that they have concluded the necessary procedures under their national legislation. It will last for almost three years, with the guarantees applying to loans made on or before 30 June 2013.

Now then, what Mr. Wattret did next is the most intriguing part. He produced this chart (double click to see larger image):

Column C3 is the one that interests me, for it shows that Germany and France contribute almost half of all of the ECB’s capital for this scheme, whilst the PIIGS – Portugal, Italy, Ireland, Greece and Spain – contribute almost 35% of the scheme, with Italy and Spain representing 30%.

Greece does not contribute anything to the scheme at this time for obvious reasons.

So what the ECB are saying is that the $1 trillion exposure of European banks to the sovereign debt of just Greece and Spain, as discussed yesterday, can be covered by the €440 billion available in an emergency through this scheme.

But let’s take this a step further.

Spain gets into distress and has to leave the scheme.

That removes a further 12% of the scheme’s funding.

In fact, if Ken had continued his percentages and logic across columns C6 and C7, then the new figures look like this:

In other words, should Spain have issues, the burden on France and Germany increases by a further 7% of the fund – or an additional €7.5 billion to bring their number to a total of €250 billion between them.

This is what prompted me to ask at the end of the CEBS press conference: “so what you’re really saying is that you didn’t use the scenario of a sovereign default because you believe French and German citizens will be happy to bailout Spain like they did with Greece?”

That didn’t go down well but it had to be asked and, no matter how unlikely it is for this to occur, it is the reality of the situation.

Why banks have no competition

I had a couple of really interesting dialogues with bankers yesterday.

The first was with a career banker who is now working with one of the New Banks on its launch. The second was with an Asian bank manager running his bank's UK operations.

As I talked with both, they expressed their frustrations with the UK regulatory system, the FSA, licensing and operations.

Here’s roughly how the commentary went.

The Government, Treasury, Bank of England and the FSA are all publicly stating that they want more competition in banking. They seek to actively encourage new entrants, according to their press, but then they do their darndest to ensure no-one can compete.

In particular, it’s the FSA’s stringent rules that create inordinate hurdles to getting approvals to open and operate in the UK.  These controls are needed, as loose control is what caused the crisis, but how much of a barrier such controls create to new entrants is a question we should also be asking.

For example, in order to get a banking licence you must first assemble a group of people of whom the FSA approve. Getting that approval can be hard.

First, you have to ask for approval for all key staff. That can be a lengthy process and is restricted to approval by the FSA for the individual to perform one or more strictly 'controlled functions' on behalf of an authorised firm.

These controlled functions relate “to the carrying on of a regulated activity by a firm”, which means that each time you change roles or add activities you need to be vetted again.

And that vetting is not just for one person, but for each member of the bank’s senior management from non-executive directors and executive directors, through Chief Executive and key functional heads of compliance, risk and audit.

For a new bank, that can be a phenomenally time consuming process but it is needed to ensure integrity and appropriateness (what happened when they vetted Andy Hornby, Adam Applegarth, Fred Goodwin ...).

Thing is, if you’re engaged in a controlled activity and not approved then the individual can be fined and possibly jailed, and their firm’s license rescinded.

This means that each time a person changes role or function, they need to be re-approved.

As you would expect, management of the bank’s processes, procedures and people to ensure compliance is a full time job and can be hard for an existing bank.

For a new bank or foreign bank, it can be near impossible.

For example, one of the individual’s selected for a senior role with one of the new bank entrants was a mighty talented chap ... from an Icelandic Bank. Once those banks found their assets thawing, the FSA immediately gave them the cold shoulder and the talented individual was shown the exit door before he’d even been hired.

In another case, the foreign bank operating in Britain tells me they have just appointed a new CEO. The CEO’s appointment was notified to the FSA in April but, due to the vetting process, he’s still not able to take up his key role and the bank is therefore headless ... they hope he can take his position in August.

Even with that, as a foreign bank they have to comply with FSA rules and with UK Home Office rules. These state that when a foreign bank employee changes their job title, they cannot have their business cards changed to reflect their new role until a work permit is issued reflecting the new title. That can also take months.

Phew.

This stuff is hard and it is getting harder, as the FSA are getting increasingly aggressive on enforcement and increasingly stringent on their criteria for approval.

But let’s say that you can be bothered gathering a group of competent and capable people who get FSA approval: is that it?

Nope.

You then need your banking licence.

That’s tough too.

Here’s how tough that is, as articulated by a compliance consulting firm:

“Applying for a UK banking license is a complex process. You will need to complete a comprehensive set of application forms and provide the regulator (the Financial Services Authority) with a full set of supporting documents such as your business plan, risk management policy statements, compliance manuals and procedures and other information.

“You will need to show the regulator that you have a clear and workable business plan. You will need to evaluate your capital requirements and to demonstrate that sufficient capital is in place.

“Applying for a banking license is officially known as a ‘Complex Application’, and is unlike the vast majority of Financial Services License applications.”

Jeez.

It’s so darned complex that you have to hire a consultancy to advise you how to do it.

For some banks, it's too much and they give up.  For others, it takes them about three years of administration and form filling to get to the start line.

Meanwhile, you may think you can short circuit all of this by buying an existing bank.

That's what I thought when I heard that JC Flowers is trying to acquire Kent Reliance or that Virgin buys Church House Trust.

Nope.

Y’see getting the people approved and gaining a licence has no relationship with your ability to conduct business.

That’s a separate matter.

By way of illustration, I thought that the likes of JC Flowers and Virgin were buying a banking licence so that they could take over the branches of RBS and Lloyds, and become a fully fledged bank with several hundred branches.

Nope.

The banking licence only provides you with a licence to take deposits and offer loans.

But the deposits and loan levels you can provide are restricted to the capital you have to cover the business from day one.

So if you have one branch supporting 10,000 customers, you must have the capital to cover the exepcted holdings of 10,000 customers; two branches, 20,000 customers; ten branches, 100,000 customers; and so on.  And you must have that capital coverage for all customer holdings before you open those branches.

This is illustrated in a recent speech by Thomas Huertas, Director for the Banking Sector with the FSA, who states that: “the only capital that really absorbs loss whilst the bank is a going concern (at least in the UK) is core Tier I capital or capital that is convertible into core Tier I capital whilst the bank remains a going concern.”

As a result, the FSA has increased the Tier 1 Capital levels a bank must reserve against its potential losses, with the rest covered by contingency capital (convertible equity).

This means a new bank must have enough capital to cover all of its projected exposures from day one ... a tough call, and one that means that even if you have a banking licence you cannot suddenly open hundreds of branches without loads of money in the bank.  And getting a return on that money will take years.

All of these challenges and issues are the reasons why we are not seeing massive new competition in banking in Britain, or anywhere else for that matter.

But then all of these rules and regulations are there to safeguard society aren't they?

So when you hear politicians saying that they want to see lots of competition in banking, it is a complete untruth.

In conclusion, and to quote Thomas Huertas again from a speech in June 2008 before the crisis:

“Regulations do not restrict competition. Entry into banking, especially in the UK, is free to anyone who can meet the threshold conditions for establishing a bank. The UK places no barriers to the ownership of banks on the basis of nationality, and under EU directives any EU-incorporated credit institution is, under the so-called passport granted to all banks under the single market, entitled to establish a branch or sell its services cross-border into the UK. This policy of free, but orderly, entry underlies not only London's position as one of the world's leading financial centres, but also contributes to competition in retail banking.”

What he actually meant was that banking is open to free competition, but only from other existing banks with banking licences from their country of operation, and with major capital assets to cover their exposures.

This is why there hasn’t been a new bank opening in Britain for over a century and the only new competition has been from existing foreign banks, such as Santander.

Revising MiFID and RegNMS for HFT

Gawd, I hate acronymns and look at that!  Three in one blog entry title!!!

Anyways, for the nerdy-nerd equities guys, this will grab their attention.

It's all to do with trading in European and American stocks and shares using High Frequency Trading (HFT) systems, and the regulations therein with EU MiFID rules applying over here and USA RegNMS rules applying over there.

These rules are going to be overhauled soon thanks to the Flash Crash, that dreaded thing that caused US stock markets to go haywire on May 6th.  There has been lots and lots written about the Flash Crash of May 6th, but there’s not been a great deal saying it was a good thing ... until you meet JPMorgan.

In this week’s Eye on the Market, they identify five things they like about the Flash Crash, namely:

[1] Stock-specific circuit breakers.

The U.S. has been slow to install circuit breakers on major exchanges, relying instead on “clearly erroneous trade rules” that cancel trades after the fact. In Asia and Europe, circuit-breakers have been around for a while. In Asia, trading is restricted outside of pre-specified daily bands of 5%, 10% and 15% (different by market). In Europe (e.g., Deutsche Bourse), trading is halted for 5 minutes after a 3%-10% move, and then reopened. In the wake of the Flash Crash, 10% circuit breakers are now applied to a few stocks as part of a pilot program (they have already been triggered on Citigroup, Anadarko and the Washington Post Company). If we are going to exist in a world with automated robots doing the lion’s share of daily trading, circuit breakers may be needed to prevent unintended and unmanageable meltdowns.

Another topic under discussion by the SEC: prevent HFTs from having “unfiltered, naked access” to the exchanges by requiring them to live by the same pre-trade risk management controls that clearing members do. Why? As noted by the Chicago Fed, “high-frequency trading has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment”.

[2] More balance to the HFT discussion.

HFT supporters claim they are providers of liquidity to the market, and that HFT makes U.S. markets more efficient than ever. Suggestions to the contrary have been deemed “utterly laughable” by firms defending them. However, the Flash Crash highlights the uncertainties around these assertions.

While volumes have tripled in the last few years, there’s a big difference between volume and liquidity (the ability to transact without moving the price). In an industry barometer survey1 conducted by the Tabb Group in May of this year, barely half the participants had a high degree of confidence in the US equity market structure; 73% did not believe the market structure is “orderly”.

One of the survey recommendations: HFTs should be required to register as broker-dealers.

To be sure, there were weaknesses in the old specialist system as well2. But specialists were required to maintain a fair and orderly market, and post quotes that were part of the National Best Bid and Offer system; their reputations mattered. HFTs have no such requirements (no minimum shares or minimum quote times); one proposal would require quotes to be valid for at least one second. The SEC has broadened the trader reporting system in order to analyze HFT activity more closely.

[3] Proposals requiring HFTs to act more like the floor specialists they’re replacing.

With the advent of HFTs, cancelled orders have soared. Today’s ratio of 30 cancelled orders for each one executed means that 97% are cancelled.

To curb abusive practices, some market participants recommend applying a fee to HFTs for an excessive number of cancelled orders. The increase in cancelled orders is one reason we do not agree that increased order depth on S&P 500 stocks at the NBBO is a clear indication of greater liquidity, as some market research alleges. Quotes pulled within a nano-second of being posted, and which are part of an algorithmic order detection exercise, don’t seem like liquidity in the traditional sense. Ameritrade’s representative on the recent SEC Roundtable referred to this as “opportunistic liquidity”.

[4] More discussion around HFT “co-location”.

Some HFTs co-locate computer servers inside stock exchanges3 to minimize the milliseconds (or nanoseconds) required to scan existing orders, and have algorithms act on this information. As trading execution and IPO listing fees declined, exchanges have tried to make up the difference by selling access to market data. Some exchanges have products which give clients a faster look at quotes, in exchange for a fee. As a result, some HFTs end up with access to information sooner than institutional or retail investors who rely on more standard venues (such as SIP Quotes).

The search for co-location benefits has existed forever (in polite company, “order anticipation strategies”). Broker-dealers in past decades argued that being closer to floor traders on the CBOT was an advantage to their clients. But historical parallels can lose their meaning when the instruments of battle change: one HFT computer can reportedly decode more than 5 million messages per second. The Flash Crash has increased the debate around whether co-location confers advantages to HFTs, and whether there should be obligations and responsibilities that accompany them.

[5] Asset managers learn that “cheapest <> best”.

After the NYSE moved to decimalization in 2001, bid-offer spreads fell almost in half on S&P 500 stocks (less so for the Russell 2000 stocks, where HFTs are less active). Schwab retail commissions fell from $35 in 2003 to less than $10 in 2009. This trend is confirmed by broader research from the American Association of Individual Investors. So if the prism of success is bid-offer costs and commissions on individual trades, the battle has been won.

But is that the right prism to define what makes an optimal marketplace? Part of the HFT industry tracks the order flow of larger investors who leave electronic footprints4. Using algorithms which include spraying the tape with thousands of quotes, the intentions of large investors is ferreted out. This can result in higher trading costs for such investors, and by extension, their clients, who include 401k investors, and pensioners participating in state and corporate plans. Quantitative Services Group computes analyses of HFT impacts on execution costs. They estimate that HFT tracking algorithms can drive execution costs up 1.5 to 3 times, even when institutional investors parcel trades into smaller orders to avoid detection.

There’s lots more of interest in their report, which you can read in full and download if you want:

JPMorgan's Eye on the Market

Meanwhile, you may note that a lot of it is about High Frequency Trading (HFT), which I’ve written quite a bit about recently:

• Who's afraid of HFT, HFT, HFT?
• High frequency trading in jeopardy thanks to flash crash
• More Banking Statistics: Algo and High Frequency Trading

as have many others.

This means that this area is going to get regulated, and it will mean significant restructuring.  For example, back in January, the SEC started a consultation through the Concept Release - a request for public comment on securities issues - on HFT and more.

Key areas under review include:

Market Quality Metrics

What are the best metrics for assessing market quality for long-term investors and have these metrics improved or worsened in recent years?

Fairness of Market Structure

Is the current highly automated, high-speed market structure fundamentally fair for investors?

High Frequency Trading

What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?

Is the overall use of any harmful strategies by proprietary firms sufficiently widespread that the Commission should consider a regulatory initiative in this area?

Co-Location

Do co-location services (which enable exchange customers to potentially route trades faster by placing their computer servers in close proximity to an exchange's computer system) give proprietary trading firms an unfair advantage?

If so, should the proprietary firms that use these services be subject to any specific trading obligations?

Dark Liquidity

Has the trading volume of undisplayed trading centres (such as dark pools) reached a sufficiently significant level that it has detracted from the quality of public price discovery?

If more individual investor orders were routed to public markets, would it promote quote competition in the public markets, lead to narrower spreads, and ultimately improve order execution quality for individual investors beyond current levels?

Are a significant number of individual investor orders executed in dark pools and, if so, what is the execution quality for these orders?

Lots of comments have been received on the Concept Release, and its conclusion cannot be far away.

Now we have a European response to this area with Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, producing a draft report last week. This report provides indication of much of what might be in the revised MiFID and very little is left untouched.

Jeremy Grant over at the Financial Times, has picked out some of the more interesting nuggets from Kay’s report:

• She suggests it may be necessary for “informal market makers” – read: HFTs – to be subject to mandatory liquidity provisions;
• Calls for an “ongoing regulatory review” of the algorithms used by HFTs;
• Seeks an examination of HFT to determine whether market flow generated automatically is providing “real liquidity” to the market and what the effect of this is on overall price discovery;
• Suggests that, “in the interests of equitable treatment”, rules need to be introduced so that MTFs (multilateral trading facilities”, like Chi-X Europe) are subject to the same level of supervision as exchanges, under certain circumstances;
• Calls for new provisions under Mifid for “broker crossing networks”, including requirements that they submit to authorities “orders matched in the system”, and “details on access to the system”; and
• Suggests a minimum order size for dark pools.

This is pretty dramatic stuff and Jeremy finishes his column by referencing David Doyle, a regular speaker at the FSClub, returning to the London meeting on 12th January 2011 for our annual EU regulatory update.

David presented on the key changes in MiFID at a conference at the London Stock Exchange last week, stressing that “the whole review of MiFID will have as its driving principle investor protection – that is, the interest of the retail investor, not the operators of exchanges, dark pools and HFTs.”

Too true David, too true.

If you’re interested in more of what David had to say, here are his slides:

Mi fid, david doyle, july2010

View more presentations from Chris Skinner.

EU's bank stress tests creating more bank stress

It turns out that 91 European banks are to be put through a ‘stress test’ to see how well or badly they will cope with a shock to the system. The stress test itself was a little unclear until late last week, when the Committee of European Banking Supervisors (CEBS) detailed what would happen. As a result, a lot of folks think it’s a fudge, and the intention of creating more confidence in the EU’s banking system may actually have achieved the opposite.

Here’s the lowdown.

CEBS stress tests were announced after their initial approach was viewed as being too little and too narrow. The intention was to stabilise confidence in the EU banking system following the crisis in the Eurozone, and the approach was meant to follow the example set by America in May last year.

Back then, everyone felt the American banking system could not deal with the exposures they had to OTC derivatives, so the Federal Reserve tested the banks to see if they could deal with not just those exposures, but any other severe shocks to the system.

The US tests used two economic scenarios: one mirroring the consensus of economic experts on the course of the downturn through 2010, and the second modelling a worse-than-expected course of economic activity.

This resulted in recognition of a $74.6 billion shortfall, which was far less than the figures being bandied around before the stress test results. For example, the IMF estimating that the U.S. banks needed another $275 billion to $500 billion whilst some analysts throwing figures around that the industry may need as much as $1 trillion.

The less than anticipated shortfall led to increased confidence in the American banks. That confidence led to some stability in the system thereafter, financial stocks jumped 36% in the seven months after the tests, which is why it was worth doing.

This is why the US example was followed by the lengthy discussion of living wills in the UK regulatory sector, and the idea of reverse stress testing as implemented by the FSA last December. In these tests, banks are meant to imagine that they have failed and then have to work backwards to determine which risks and vulnerabilities caused their hypothetical collapse.

The FSA’s approach to stress testing consists of three main elements: companies’ own internal stress testing, where they assess their ability to meet capital and liquidity demands in a sudden downturn; the regulator’s testing of specific companies; and simultaneous “system-wide” stress testing, based on a common crisis scenario.

In both the US and UK examples, the stress test methodologies were completely transparent and now we come to the European bank stress tests.

In the EU tests, CEBS will study 91 banks, mainly in Spain and Germany, but also several other key banks including Britain's "Big Four" – RBS, HSBC, Barclays and Lloyds. In the latter example, thanks to the FSA’s scrutiny, they have already been subject to tough tests at home and should pass with flying colours.

The list is actually considerably longer than the original announcements in June which selected just 25 banks for review, and includes the German Landesbanken for the first time.

The significance of that decision cannot be underscored more deeply as BaFIN, the German regulator, announced a year ago that €800 billion of toxic debt sat on the balance sheets of these banks, particularly some of the Landesbanken, and that was double the amount they had estimated just three months earlier.

With almost $1 trillion in deposits, 2,500 banks and 45,000 branches, Germany also has one of the densest banking networks in the world, and hence a weakness in the German system would be a weakness for all, particularly as Germany has been bailing out Greece and, soon, Spain, Italy, Portugal and more.

In Spain’s case, as recently blogged, there is a big problem with the mid-size banks where the savings banks, regional banks and mid-sized banks are all closing, merging and consolidating, with anything from a quarter to a third of all Spanish bank branches to close.

That’s not good.

But the stress tests can turn this situation around by showing that Europe can cope with even the worst case scenario.

That’s a tough call, as we are all asking: ‘Can it?’

After all, a stress test if it turns out to be negative will worsen the situation but, if it’s positive, it will improve everything.

So the stress tests are being reported to be as transparent as the US version, with a three scenario test, according to the German newspaper Handelsblatt.

The first will analyse how banks perform if economic growth is at the rate forecast by the European Commission; the second will test the effect of a 3% drop in gross domestic product; and the third will look at how banks would cope with a "shock" situation in government bond markets, a scenario similar to events in May this year when Greece was downgraded by Standard & Poor’s.

It is that downgrade which has caused all of these jitters anyway, and created the uncertainty and lack of confidence in the Eurozone. Without confidence in the European banking system, then even worse scenarios could be considered, such as the collapse of the Eurozone and a return to national boundaries and nationalistic tendencies therein.

But there is already an issue with the European stress tests as the approach, structure and details of the tests have been changing over time, and many think the results – to be announced on 23rd July – will be a fudge. This view was given even more fuel when there were rumours that France and Germany were trying to suppress the methodology to be used for the tests.

This is bad news, as the lack of confidence in European banks will be made worse when or if there is a lack of confidence in the European banks’ stress tests, and the stress tests will only increase market uncertainty, rather than decrease.

All in all, my view is that Europe is caught between the Devil and the Deep Blue Sea.

If they complete the stress tests and release the results with complete transparency, there is likely to be some fallout. Unless the results show that the fears for bank counterparty risks in Europe are unfounded, which in the case of the Landesbanken and Spanish caja banks is unlikely, then it will just confirm what many already suspect: Europe’s broke.

On the other hand, if they complete the stress tests and release the airbrushed results that show some manipulation or opaqueness, then everyone will believe that their fears for bank counterparty risks in Europe are proven.

Therefore, what seemed to be a great idea to bolster confidence in the Eurozone may actually prove to be a lose-lose situation.

So how can the Eurocrats create a win out of this?

Just be totally honest.

If there are real issues in the heartland of Europe’s banks, be brutally frank about them.

It is only with total honesty, transparency and clearly washing any dirty laundry in public at the end of the month that Europe has any hope of surviving this current battering.

Monthly MiFID MTF Monitor: May 2010

We are pleased to provide our fifth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR). 

Market Share based upon Euro Value

May 2010

April 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

May 2010

April 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

May 2010

April 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

What happens to SEPA, Chi-x etc if the euro fails?

There’s the classic old joke about the European dream being a place where the police are English, the chefs are Italian, the car mechanics are German, the lovers are French and the bankers are all Swiss. The nightmare is that it is a place where the police are German, the chefs are English, the car mechanics are French, the lovers are Swiss and the bankers are Italians.

It seems that the nightmare is coming true, although the basket case is Greece and the bankers are German.

Last week’s surprising comments from German Chancellor Angela Merkel that “the euro is in danger” and “if the euro fails, Europe fails” sent shudders across the world’s markets, and probably made Brussels shake with rage.

But the Germans are shaking with rage. After Nicolas Sarkozy was rumoured to threaten Merkel with France’s withdrawal from the euro if she didn’t step up to the plate and support a Greek bailout, Germany’s citizens have been demonstrating their rage by printing deutsche marks whilst the national newspaper, Bild, is stirring anger towards the EU and the Greeks in particular with headlines such as:

• "How much more do we have to pump into this country?" April 26th
• "Why are we paying the luxury pensions of the Greeks?" April 27th
• "Greeks ready to cut back? They would rather strike!" April 28th

As I talk to German colleagues, they refer to Greece as the Golden Fleece and that they aren’t paying bills in Greek restaurants because they’ve prepaid to 2020.

All of this puts a huge strain on the European Union, in its fragile 53rd year of unity, particularly as Spain, Italy and Portugal are considered to be on a par with Greece by many, forming a Southern European Union called the PIGS [Portugal, Italy, Greece and Spain].

It raises a key question in my mind, and I’m sure all of the bankers I deal with: if the euro fails, what happens to the monetary union of banks, the Financial Services Action Plan and all those bank and insurance directives like Solvency II, MiFID and the PSD?

What happens to Chi-X, SEPA, the EBA and the rest?

In order to answer this question, you have to look at two key areas. First, is the economic and monetary union (EMU) broken? Second, if it is, do we throw away the eighteen years of change introduced by the agreement to launch the euro when the Maastricht Treaty was signed in February 1992?

Let’s take the first question: is the EMU broken?

We asked this question in 2005, when the French and Dutch threw out the EU Treaty. Answer: it is political union that they were rejecting, not economic union. Note: even with their rejection, and the Irish no vote, the Treaty became the Lisbon Treaty in 2010 regardless of such resistance. In other words, in the interests of the long-term vision of Europe, Europe wins.

Equally, America has taken years to gain its United status, starting with a nation of disparate states that had far less history than those of Europe.  Their Union was easier in comparison, and that still took years, so Europe’s union will take time and will face many more tests.

But this is the greatest test so far.

The size of this test should not be underestimated as it is the first time that we are seeing an economic union, resulting in a cascading effect upon money and politics. Historically, the tests for Europe have been mainly about how much power is ceded to Brussels. This test is showing the inter-relationship between economies and Germany’s anguish is that if they are to keep the vision of Europe in harmony, then they have to pay for it.

Therefore, returning to the rejection of the European constitution, that was a political rejection and when a country has an economic crisis, the monetary union means that other nations pay and, as a result, that political will is tested when one nation's tax dollars are taken to pay for another nation's debts.

That is why this challenge is so much greater than any before, because it is testing the political will of citizens, not just their ability to trade and compete.

The core issue though, is that it is not just the Greek economy and Greece that would leave the Union if they were allowed to fail.  It is the Union.

Should the Greek economy fail to honour their government bonds due to being economically bankrupt, the ratings agencies and banks would downgrade Spain, Portugal and Italy, and there would be a spiral effect. This means the European Union breaks apart.

That is why the Greek failure option is unpalatable ... but is the alternative palatable?

Why do we need a European Union?

Answer: Europe needs to be a Union to maintain its drive to be a regional superpower, and competitive commercially and economically with China and America. There’s the rub. If Europe fails, then the UK, Germany and France fail, as parity to compete internationally and intraregion becomes far more difficult.

This is why Greece needs the bailout and why Germans are paying.

It does not help Angela Merkel maintain her status or power hold in Germany – her popularity is sinking faster than the Titanic – but if Greece fails, it is felt that Europe may fail too. And that is not an option seen to be agreeable today.

Also, nations have been bailed out already.

Two years ago, Spanish banks received over €50 billion worth of ‘aid’, in the form of mortgage-backed securities with the European Central Bank (ECB), when they faced a property meltdown.

Did the Germans wail out about that bail out?

No.

Why?

Because it wasn’t on the front page of the Bild.

That bail out was smaller and less obvious, so no-one really noticed.

The Greek bailout is a bit bigger – €110 billion – admittedly, but it is supported by the IMF and is necessary for Europe’s future. ‘nuff said, although if you want to know more, Robert J Samuelson in the Washington Post provides a particularly good overview of why Europe needs to support Greece.

My summation is that Europe will survive this crisis, the euro will stay and the currently ridiculous pricing of US$1.24 to the euro will reverse within the next month or so, as forecasted by most economists.

But let’s look at the worst case scenario: what do we do if the euro does fail? Does it mean we unravel all we’ve done to date?

This is the second and, in some ways, more important question: is there a backup plan?

OK, if the Eurozone breaks apart, then it matters ... but it will not throw away all that has been built to date.

The banks will still want to use cross-border instruments that work. They will just bring back a margin to represent those cross-border movements whilst maintaining the efficiency of the infrastructure that has been built.

As Werner Steinmuller, Head of Global Transaction Services of Deutsche Bank, stated when we researched the Payment Services Directive (PSD) and the Single Euro Payments Area (SEPA) last year:

Deutsche Bank is in a comfortable situation. We spent quite a sizable amount on SEPA infrastructure and have a brand new system that is extremely capable of doing this that is also highly scalable. Others have not made this investment so this gives us a price advantage. We have built some conversion solutions for handling old volumes and now can run both old instruments and the new SEPA instruments so, if SEPA is coming, we are extremely well positioned. If SEPA fails, I can write off the investments and still win.

In other words, the SEPA process has forced the banks to build new infrastructure, new systems and new efficiencies in transaction processing. That will stay.  It does not go away if the euro goes away, as the new infrastructure is designed to handle efficient transactions, not euro payments.

So if we look at SEPA Credit Transfers and Direct Debits, the Euro Banking Association (EBA) and STEP2 ... it will all stay. The EBA will be a private consortium to operate efficient systems, rather than a government initiative to create efficiency, and it will stay. There will be a charge for this, and a charge that could provide a substantial return to the banks that created this infrastructure, but it will not go away.

The same will be true for Chi-X, and the capabilities electronic trading platforms have introduced into the European equities markets. Sure, some countries may want to block and reverse policies in these areas – Spain? – but the process of regional investing is unstoppable now. Goldmans, Merrill, BarCap and co, won’t want to see this go away, so it will remain.

Bottom-line: the efficiency of European payments and investing is in the interest of banks, corporates and institutions today, not just governments and policymakers.

So, if the euro fails, my answer is that the all the investment made by the financial markets in efficient systems will stay.

It will just be at a profit rather than a regulation.

Challenges and Solutions for Banking UK

There were two interesting documents released yesterday, and worthy of mention here.

The first is an official House of Commons Library publication: Download Key Issues for the New Parliament 2010 (8 Mb pdf). 

Two pages of the 72 page document are dedicated to the future of financial services.  What does it say?  Here's the text:

“There can be few policy areas of comparable size with a bigger ‘in-tray’ than that of financial regulation and services. While the world hesitantly recovers from the global financial crisis, its legacy is a profound re-examination of the adequacy of existing legislation and institutions, together with a consideration of just what society wants and expects from its financial institutions.

“CONTRADICTORY OBJECTIVES

“This consideration will inevitably involve making a choice between potentially inconsistent or irreconcilable outcomes. For example,

“Banks should be forced to raise more equity capital to make them stronger.

“Banks should be subject to higher taxation and controls on profits.

“BUT new equity is hard to raise if banks’ profits are permanently lower in future.

“Or,

“Bank lending should be more tightly controlled by restrictions on ‘leverage’.

“BUT banks should lend more to industry and individuals.

“QUESTIONS TO BE ANSWERED

“The issues currently facing regulators and legislators include:

• Capital adequacy – how much and what quality of capital should banks and others be forced to hold?

• Liquidity – what level of liquid resources should banks retain? What should these consist of and how should they be measured?

• Size - should there be controls on the size of financial institutions? If so, should it be by way of splitting the banks by function, or by quantitative controls on the levels of business they can carry out? If not, might they be forced to pay a surcharge as an insurance policy against the consequences of future failure?

• Remuneration and ‘corporate governance’ – what structures need to be put in place to improve internal controls?

• Other agents and influences – what should be done regarding credit ratings agencies or short-selling hedge funds? Did the accounting profession and its standards contribute in some way to the problem? How ‘complex’ should complex financial instruments be allowed to be?

• Lastly, the regulatory system itself – is there a role for a more formal international supervisory system? If so, what powers and sanctions should it have over national authorities? What actually is macro-prudential supervision?

“How will the UK Parliament make its voice heard in international discussions of the future of banking?

“These issues will be decided upon at a variety of different policy levels. While some will be purely ‘domestic’ - for example, the future regulatory structure in the UK - others, such as broad principles on capital adequacy, will be agreed on by international regulators in Basle and subsequently form the core of new European Union directives for implementation in EU Member States. In the UK, implementation might be by national legislation or by rules made by the current independent regulator, the Financial Services Authority (FSA), outside of Parliamentary control or scrutiny. One challenge for the future Parliament is to be able to exercise its voice and express its opinion within this framework.

“The end of the cheque could disproportionately affect the most vulnerable firms and individuals

“DOMESTIC CONCERNS

“For Members for whom (saving) the world is not enough, an important domestic agenda awaits that they will find hard to ignore.

“By 2012 bank cheque guarantee cards will be withdrawn. By 2016, the Payments Council will have decided whether or not cheques should cease to be a recognised method of payment. The next five years therefore will see this argument unfold in public. The issues are likely to be the impact on groups that still use cheques – the elderly, small firms, traders etc and the adequacy of any technological replacement.

“‘High cost credit’, or the provision of sub-prime credit to individuals excluded from the mainstream banks, is currently being reviewed by the Office of Fair Trading. When it publishes its conclusions, anticipate a lively debate over the balance between control, regulation and credit accessibility. More generally, the terms and conditions under which credit is made available will change with the imminent transposition of the EU Consumer Credit Directive.

“Last, but by no means least, approximately 10,000 small independent financial advisers are likely to cease trading following the FSA’s Retail Distribution Review. The review was the response to the long-running complaint that a commission-driven sales model has contributed to past mis-selling scandals of financial products. Arguments stressing the commission system’s lack of transparency and its potential for conflict of interest between seller and customer will be set against fears that, when faced with up-front charges, individuals will be put off seeking much-needed financial advice.

From consideration of the global regulation of credit derivatives to the possible death of the cheque book, from bankers’ bonuses to credit for the poor, from ‘too big to fail’ to too small to survive, there is much for Members to consider and decide upon in the next five years. Watch that in-tray.”

Interesting stuff.

Responding to this straight away, the new coalition Conservacrats published their document: Download The Coalition programme for government (500 Kb, 36 page document).

The first priority, #1, number uno, is banking. Here’s what they’re going to do:

“In recent years, we have seen a massive financial meltdown due to over-lending, over-borrowing and poor regulation. The Government believes that the current system of financial regulation is fundamentally flawed and needs to be replaced with a framework that promotes responsible and sustainable banking, where regulators have greater powers to curb unsustainable lending practices and we take action to promote more competition in the banking sector. In addition, we recognise that much more needs to be done to protect taxpayers from financial malpractice and to help the public manage their own debts.

• We will reform the banking system to avoid a repeat of the financial crisis, to promote a competitive economy, to sustain the recovery and to protect and sustain jobs.

• We will introduce a banking levy and seek a detailed agreement on implementation.

• We will bring forward detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector; in developing these proposals, we will ensure they are effective in reducing risk.

• We want the banking system to serve business, not the other way round. We will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry.

• We will develop effective proposals to ensure the flow of credit to viable SMEs. This will include consideration of both a major loan guarantee scheme and the use of net lending targets for the nationalised banks.

• We will take steps to reduce systemic risk in the banking system and will establish an independent commission to investigate the complex issue of separating retail and investment banking in a sustainable way; while recognising that this will take time to get right, the commission will be given an initial time frame of one year to report.

• We will reform the regulatory system to avoid a repeat of the financial crisis. We will bring forward proposals to give the Bank of England control of macro-prudential regulation and oversight of micro-prudential regulation.

• We rule out joining or preparing to join the European Single Currency for the duration of this agreement.

• We will work with the Bank of England to investigate how the process of including housing costs in the CPI measure of inflation can be accelerated.

• We will create Britain’s first free national financial advice service, which will be funded in full from a new social responsibility levy on the financial services sector.

• We take white collar crime as seriously as other crime, so we will create a single agency to take on the work of tackling serious economic crime that is currently done by, among others, the Serious Fraud Office, Financial Services.”

Alright?  'Nuff said?

... watch this space.

 

The future of banking regulation

The City of London released an interesting document yesterday on the future of regulation of banking. They talk about liquidity, leverage, capital and risk liberally, and state that the future regulatory regime must not clamp down on capital reserves in banking so hard that the banks are unable to lubricate the global economy.

What I found interesting is that there are quite a few contradictions in the 77 page report although, to be honest, I only read the Executive Summary.

From this summary, it’s interesting that they plead that the macroprudential structures don’t squeeze capital ratios, but hardly talk at all about the leverage issues Lehman Brothers created.

If my memory serves me, Lehmans was operating at leverage ratios of up to 1:40, e.g. for every $1 of capital, $40 was being used to ‘gamble’ on the global markets. I also remember that their debts at bankruptcy were around $400 billion and BarCap estimated that for every $1 of debt, around $20 of Credit Default Swaps were being leveraged against Lehmans AAA rating. In other words, $8 trillion of leverage was in the system off the back of Lehman Brothers.

That was the issue, particularly when this leverage – and therefore liquidity – disappeared overnight.

Following on from this, they refer to the fact that the crisis was not caused by a lack of capital, but by a lack of liquidity. True, but I did not gather a clear view on liquidity risk or leverage ratios from the document. It may be in there, but it’s hard to find.

For example, in Section Five that addresses Leverage Ratios, the report states that “judgement and discretion are vital, including judgement and discretion concerning circumstances under which firms will be permitted temporarily to have capital that is inadequate. The notion of employing a leverage ratio as a last-resort backstop to limit the damage caused by regulatory get-arounds arises precisely because of the limited ability and appetite of regulatory authorities for exercising discretion. That core problem is the one to address.”

A bit of fudge if you ask me there.

The same is true on liquidity risk, with the report proposing a global liquidity standard and yet they then say that they are “unconvinced that there is a case yet made for pursuing significant further deepening of international coordination of banking regulation. Indeed, we believe it quite likely that greater exercise of national discretion is the appropriate path forwards.”

Now I understand the conundrum that you cannot have one nation regulate for example to stop bank bonuses as it will just mean bankers jump across to other nations. So you need a global agreement of some form. Equally, no global agreement will work, as there is always gold-plating and protectionism of national instruments, so you need a global framework with local interpretation.

That is kinda what they’ve proposed, but it’s rather unclear. For example, their closing comment on liquidity is:

“In our view, improving liquidity standards are amongst the most important and material changes to be introduced — though they are likely to have high costs that must be recognised. However, the scope for international standards to deliver adequate liquidity is limited without increased roles for national lenders of last resort and in particular an increased role for central banks in prudential supervision.”

In fact, the regular mantra in the document appears to be the frictions and tensions between global and local. For example, they state that there is a “risk that regulation will not apply evenly or that regulation will apply in the UK before the rest of the world”, and that this “is seen as a significant threat to London’s competitiveness. It is therefore widely urged that the Basel measures enact a common international timetable. International firms that operate in multiple markets are particularly keen to see common, consistent frameworks and standards applied.”

Yet, as mentioned, they don’t think regulation will or can be applied consistently across multiple markets.

All in all, more questions raised than answers in this document, but worth a read for those who are technically minded and interested.

Download available from the City of London's website.

 

The Return of the MiFIDs, 2010-2012+

We had a fun meeting of the financial services club this week, looking at the implications of MiFID, the Markets in Financial Instruments Directive, and the outlook for MiFID II, or MiFID2 if you prefer.

I’ve referenced the revision of MiFID before and included a great white paper by Philippe Guillot of CA Cheuvreux for reference.

Equally, we now see more developments taking place, including investigations by CESR – the Committee of European Securities Regulators – that will conclude at the end of May, and covers 107 questions across a broad spectrum of issues:

Investor protection and intermediaries

• Telephone recording
• Execution data quality
• Instrument complexity
• Personal recommendations
• Supervision of tied agents
• Options and discretions

Equity markets

• Pre-trade regime for RM/MTFs
• Definition of Sis
• Post trade transparency regime
• Extended scope of transparency
• Regulatory framework for consolidation and cost of market data
• RM and MTF alignment and crossing networks
• Eliminating options and discretions

Transaction reporting

• New trading capacity (riskless principal)
• Counterparty and client identifiers
• User guidelines (how to fill in the reports)

There are also bigger issues, such as the post-trade clearing environment and its challenges. For some time, there has been reference to a Clearing & Settlement Directive for example, and MiFID2 is meant to address this.

It is also meant to address the fragmentation of trade reporting and the price tape.

It may also pop a whack at ‘dark pools’ and high frequency trading.

For all we know, it could even re-regulate the new electronic trading platforms – most of which are yet to wipe their face with a profit – and make them completely unworkable by introducing reporting rules and overheads that are as onerous as the ones that traditional stock exchanges have to work with.

Now, to be clear, we don’t know what’s in MiFID2 right now – we won’t really know until 2012 or after when the new regulation is drafted – but there are some pretty good guesses and so, in order to find out what those guess would be, we gathered an expert panel on star wars day (May 4th):

• Andrew Allwright, Business Manager, MiFID Solutions, Thomson Reuters
• Andrew Bowley, Head of Electronic Trading Product Management, Nomura
• Hirander Misra, CEO of Algo Technologies Ltd and former COO, Chi-X
• Philippe Guillot, Global Head of Trading and Execution, CA Cheuvreux
• Willy Van Stappen, COO, Equiduct

to debate and discuss. Here is the outline of the evening:

MiFID Wave 2 Discussion, May 4th 2010 from Chris Skinner on Vimeo.

For full access to this knowledge, join the Financial Services Club.

Meanwhile, there are some rapid fire changes ahead with key dates this year including:

April

The FSA formed a MiFID working party and trade associations, such as FIX Protocol, ISITC, FISD and RDUG all have meetings looking at the implications of MiFID 2.

May

CESR hearings on key questions and issues around MiFID2 and closure of consultation at end of month.

June

The MiFID JWG, Joint Working Group, reforms on 9th June in a meeting at Thomson Reuters.

Wow!

The MiFID JWG reforms.

Can’t wait to be there ...

Meanwhile, for those who want something substantial to read about MiFID2, Philippe of CA Cheuvreux sent me their response to CESR's call for evidence. 

Download CESR 10-142 Micro-structural issues of the European equity markets [2MB PDF]

It's well worth a read at 57 pages.

If you're wondering what is in the document before downloading, here's the executive summary on the main answers to CESR's Call for Evidence:

I. HIGH FREQUENCY TRADING (HFT)

3. What are the key drivers of HFT, and (if any) limitations to the growth of HFT?

The key drivers of HFT are all linked to the reduction of frictional costs:

• Optimal latency reduces the implementation risk;
• Market and settlement fees (optimisation of a maker/taker model);
• Tick size.

Any change in the frictional costs of the order book has a direct impact on HFT.

4. In your view, what is the impact of high frequency trading on the market?

HFT increases the number of orders and trades being carried out on the market, decreasing the average trade size (ATS). HFT increases the trading cost for almost all players, from brokers to exchanges via the increase of complexity and memory needed to trade. HFT has no positive impact on volatility.

5. What are the key benefits of HFT? Do these benefits exist for all HFT strategies?

The benefits of HFT must be weighed against the value extracted from the markets and the extra collective costs it generates. Given that high frequency traders constantly extract value from the markets, and that activity on MTFs (mainly guided by HFT) decreases when volatility increases, it appears that when the market needs liquidity most, the HFT activity does not provide it, as it provides liquidity when it is least needed (during the market outages of November 2009, no price formation process occurred on MTFs when primary markets were closed, which means that HFT cannot be considered reliable liquidity providers). There is a disproportion between the costs supported by the markets and the supposed benefits of HFT.

6. Do you consider that HFT poses a risk to markets (e.g. from an operational or systemic perspective)? In your view, are these risks adequately mitigated?

The HFT activity raises the collective costs of trading by increasing the need for technology, anti gaming and surveillance investments. There is also no reward in terms of decreased volatility. Thus far, there is no evidence of the purported benefits of the decrease in the bid-ask spread, while the implementation costs linked to market impact have risen.

9. Do you consider that additional regulation may be desirable in relation to HF trading/ traders? If so, what kind of regulation would be suitable to address which risks?

Any increase in frictional costs is a smooth way to control the expansion of HFT. Any frictional cost components can be used to achieve this aim: increased tick sizes, minimum duration of orders, avoiding co-location, increasing market surveillance procedures that will at least increase the latency of orders.

IV. FEE STRUCTURE

Large liquidity-providing orders and small liquidity-consuming orders should pay lower fees than small liquidity providing ones (as the latter blur pre-trade information) and large consuming ones (as these create market impact and uncertainty, i.e. volatility).

1. Please describe the key developments in fee structures used by trading platforms in Europe.

Most European MTFs have adopted a maker/taker fee schedule to attract liquidity. Like other changes (tick size, co-location), fee schedules have naturally been designed to attract liquidity rather than to improve the efficiency of the Price Formation Process (PFP).

2. What are the benefits of any fee structures that you are aware of?

For investors, only the net sum of the fees is relevant. As the technological investments required to access the numerous venues available are larger than the resulting reduction in fees, no immediate benefit can be associated with the maker/taker fee schedule.

3. Are there any downsides to current fee structures and the maker/taker fee structure in particular? If yes, please describe them.

Current fee structures have a great impact on the rewards of any HF trading activity. But without regulatory constraints, their evolution is guided by the fact that they can be used to attract liquidity in one a pool vs. another one.

4. What are the impacts of current fee structures on trading platforms, participants, their trading strategies and the wider market and its efficiency?

The specificities of the maker/taker fee structure can also affect the net sum paid by investors who need to buy or sell at some point, because they have a view on the fair price of an asset (and they will have to act as liquidity consumers at some point), vs. HF traders that wait for an opportunity to arise. It is the regulator’s duty to ensure that a level playing field is maintained among the various members of an exchange or an MTF, by ensuring that proprietary orders not linked to binding market-maker activities do not receive more favourable treatment than agency orders.

V. TICK SIZE

7. What principles should determine optimal tick sizes?

At present, tick size is based only on the stock price, whereas other factors such as liquidity and volatility should also be considered. Thus far, there has been no satisfactory study of optimal tick size and the constraints that tick size should place on the order book and the PFP. We urge the regulator to take measures so that tick size cannot be used as a weapon in market share battles, and to utilise it as the main lever for adjusting the order book.

The other responses are over here on CESR's website, and it is worth reading a few of them. 

For example, Chi-X talk about High Frequency Trading (HFT) as "a means of execution that can be applied across a range of trading strategies referring to an automated trading process generated by mathematical algorithms rather than being a strategy in itself".

I suppose they would, as all their clients strategically use their automated trading process to generate arbitrage alpha through HFT.

Similarly, in response to the question: "Do you consider that additional regulation may be desirable in relation to HF trading/ traders? If so, what kind of regulation would be suitable to address which risks?" NYSE Euronext state that the company: "strongly feels that HFT provides value to the market by systematically capturing the short-term alpha".

Hmmmm ... nothing like short selling alpha is there?

They go on to say: "Harmonising at European level and upgrading regulators’ surveillance systems may require changes in how regulators are funded, with a more even distribution of the burden across all trading platforms, be they exchanges or MTFs."

In other words, harmonise the regulators structures and funding, but don't enforce stronger regulation.

Interesting.

Finally, a former speaker at the FSClub - Anthony Hilton, City Editor at the Evening Standard - wrote an excellent piece last week in said publication:

Why MiFID was the right idea but wrong result

Much is written about how the monopoly of the Stock Exchange has been broken since the implementation of the European directive MiFID, which encouraged the arrival of electronic trading platforms where customers can buy and sell shares more cheaply.  What is less commented upon is that the success of the new arrivals in grabbing market share does not mean they are making any money ...

 

 

Monthly MiFID MTF Monitor: April 2010

We are pleased to provide our fourth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR).  This month is particularly interesting with the demise of NASDAQ OMX Europe - rumours are that Equiduct are interested in buying their business - and a meeting at the FSClub tonight on MiFID Wave 2 (more on this later).

Market Share based upon Euro Value

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter 

 

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

We are pleased to provide our fourth month of monitoring the MTF performances in European Equities trading, in partnership with Thomson Reuters Equity Market Share Reporter (EMSR).  This month is particularly interesting with the demise of NASDAQ OMX Europe - rumours are that Equiduct are interested in buying their business - and a meeting at the FSClub tonight on MiFID Wave 2 (more on this later).

Market Share based upon Euro Value

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Volume of Trading

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

Market Share based upon Trade Count

April 2010

March 2010

Source: Thomson Reuters Equity Market Share Reporter

If you prefer numbers to charts, then here are the numbers:

Source: Thomson Reuters Equity Market Share Reporter 

 

Source: Thomson Reuters Equity Market Share Reporter

Source: Thomson Reuters Equity Market Share Reporter

 

Source: Thomson Reuters Equity Market Share Reporter

* these figures reflect auction and non-auction transparent order book and dark pool trades, but excludes real-time and post-trade on-exchange reported and off-exchange OTC trades in order to provide a true comparison between the MTFs impact and the traditional exchanges.

For last month's monitor, click here.

Want to know the latest on SEPA?

If you're wondering what's happening with SEPA (the Single Euro Payments Area) then this interview with Gilbert Lichter, Secretary General of the Euro Banking Association (EBA) and CEO of EBA Clearing, provides a good overview of the latest and greatest:

Gilbert Lichter from Chris Skinner on Vimeo.

The interview took place after our recent FSClub meeting with Gilbert.

Why the G20 will disagree with the IMF reforms

I don’t know if any of you read the IMF report recommending two new bank taxes:

• a bank levy based upon the risk banks represent, called a Financial Stability Contribution (FSC); and
• a straight tax on profits and bonuses called the Financial Activities Tax (FAT).

If you haven't, then I can recommend it's worth a skim.  For example, they reject the Tobin Tax / Robin Hood Tax idea, saying that this would just get passed on to customers by the banks. 

However, the fact that they support the idea of a levy and a tax – a double whammy – could have bankers worried ... except that bankers are pretty clever at tax avoidance and Canada and Japan have said they won’t implement these plans so it’s a G18 agreement right now, or less.

In my view, the document is also flawed.  Here's why.

The document itself is just for discussion for the G20 Ministers meeting this week, with the aim of agreeing something in June.  It was leaked by Robert Peston over at the BBC, and has created a fair bit of mileage for him with two blog entries: IMF wants two big new taxes on banks and How much would IMF bank taxes raise?

Robert's estimate for the latter is about £5 - £10 billion ($7.5 to $15 billion) per annum.

The leak has also sparked a whole range of other headlines, including:

Leaked IMF document urges two new taxes for banks - The Times
IMF recommends double tax whammy on the world's banks - The Independent
IMF urges double tax hit on banks to refund taxpayers - The Telegraph
IMF warns over sovereign debt - The Independent
Post-crisis banks must refinance $5 trillion - The Times

And here’s the document itself (Download IMF G20 Document, 57 page pdf).

All well and good.

Now the actual content is debatable and not set in stone.

As I said, it’s for discussion.

But it does contain some really interesting appendices which are noteworthy as useful research materials, covering diverse subjects from each country’s proposals for reform to their contributions to the bank crisis to date.

For example, here are the amounts announced or pledged for financial sector support so far, as a percentage of 2009’s GDP (doube-click chart to see a bigger version):

What this shows is that for the ‘advanced economies’ – think USA, UK, France, Germany, Japan et al – the cost has been 6.2% of GDP in direct support and a further 10.9% in guarantees.

The total of columns A to E represents 29.8% of advanced economies’ GDP in 2009.

That compares with 1.8% in the emerging economies – think the BRICs, Indonesia, et al. 

Mind you, they then go on to say that “for the advanced G-20 economies, the average amount utilized for capital injection was 2 percent of GDP, that is $639 billion, or just over half the pledged amounts. France, Germany, the USA and the UK accounted for over 90 percent of this. For the advanced G-20 economies, the utilized amount for asset purchases was around 1.4 percent of GDP, less than two-thirds of the pledged amount. Similarly, the uptake of guarantees has been markedly less than pledged.”

This is why the report reckons that the global financial crisis has cost about $533 billion less than originally estimated, and is now just a mere $2.28 trillion when all is said and done.

Now how much is $1 trillion again?

Thanks Mint.

So yes it’s still a lot, but it’s half a trillion dollars less than before.

Phew!

Now who’s the daddy when it comes to global bailouts and guarantees:

Wow, the UK wins!

We’re number one, we’re number one, we’re number wohohohohone.

Wait a minute.

That means we’re #1 in global bailouts of banks.

Hmmm ... not sure if we should be so thrilled with that accolade and maybe this is why Gordon Brown is so keen on the idea of a Tobin Tax or a Robin Hood Tax or a Financial Activities Tax or ... well, any tax really to help with our debt mountain to be honest ...

Source: the Daily Mail

... as the burden of national debt amongst the G7 nations is at a 60-year high, with the UK’s Treasury planning to increase national debt by over £560 billion between now and 2015. That’s about $800 billion or almost a trillion (how much is a trillion again?).

Meanwhile, the emerging economies paint a very different picture:

Apart from Russia, this crisis has cost the key future economies of the world urrmmmm ... nothing.

These charts make it clear that NINE of the G20 nations have had no crisis. Add to this the fact that Canada’s financial system has been the most stable in the world, and Japan do not intend to implement these tax and levy options, and you realise that under half of the G20 will be keen to support any radical changes to the financial markets.

It's not as clear cut as this, as the fact that the Advanced Economies bailouts allowed the Emerging Economies to survive this crisis without their economies also imploding is a key part of the dialogue.

Another useful chart shows why the IMF has reduced the bailout numbers by $533 billion where financial markets have used far less of the pledged amounts than those offered by their respective governments:

Finally, these charts are followed by a review of each country’s bank taxation policies implemented or proposed (Appendix 2, Page 32), a review of corrective taxation and prudential policies (Appendix 3) and the current taxation policies (Appendix 4).

This last section is also particularly intriguing as it demonstrates why banking has been so critical to Gordon Brown’s policies of the past decade. For example, here’s the percentage of a country’s total tax pool raised from financial firms by country.

G20 Corporate Taxes Paid by the Financial Sector (in percent)

This makes it clear that for every country, but particularly for Italy, Turkey, Canada and the UK, the role and influence of the financial sectors on their economies and government policies is fundamental to the country and its economic and public sector health.

Without bank taxes, countries fail.

But with bank failures, countries fail.

And that is their Catch-22 and the reason why this is so hard to change.

Between domestic interests and focus, aligned with the radically different ways in which this crisis has impacted each G20 nation, it is unlikely that we shall ever see a simple agreement of policy reform now, or at the G20 meeting in Toronto in June.

UPDATE: 23rd April 07:50

Looks like the head of the IMF agrees with me:

IMF Says Financial Revamps Could Thwart Global Deal

The International Monetary Fund's managing director said he worried that rivalries among countries could thwart a global overhaul of financial regulation, as governments split over the merits of an IMF proposal to levy a new tax on the world's banks.

"The risk…is that different parts of the world will have their proposals which make sense" to them, but "which may be somewhat inconsistent," Dominque Strauss-Kahn said at a press briefing ahead of this week's meetings of financial officials from around the world.

Goldman Sachs ... or Sack Goldmans?

There are so many articles and analysis into Goldman Sachs practices at the moment ...

... that I’m not going to write a lengthy analysis to add to all of these, but have picked a few of the best articles at the end of this blog entry.

What I would like to say is that the Goldman Sachs area of this blog shows that the SEC’s actions announced last Friday could be easily anticipated. From their near admittance of market manipulation in July 2009, followed in August 2009 of talk about the SEC looking at their flash trading practices; to the comments I made in January about the fine line “between making markets and moving markets that Goldman walk. It will be interesting to see how Goldman and company make markets in the future, between the Obama tax and the new regulatory regime.”

This was followed by the way they had to defend themselves recently, as evidenced by Chief Executive Lloyd Blankfiend’s letter to shareholders earlier this month.

Now the USA’s SEC has announced their formal investigation of Goldman Sachs, followed by the UK FSA's agreement to coordinate this investigation across borders.

There has to be a concern about their future.

Here’s my take on it.

The case for Goldman Sachs

• They are the world’s most successful investment bank
• They are the world’s best order execution broker
• They are able to create incredible profits from complex instruments
• They are the preferred choice of most clients for investment advice for these reasons, and this is why they maintain their success

The case against Goldman Sachs

• They are the world’s most successful investment bank ... and most of their brethren – Bear Stearns, Lehman Brothers, Merrill Lynch have imploded through this crisis
• They stitch clients up
• They are purely driven by greed and pay massive bonuses
• They manipulate markets in their own favour

Sure the list could be longer, and sure we can argue the toss over some of these points, but overall there could be a case of saying the investigations into the bank are all driven by schadenfreude and political motivations. For example, Barack Obama presents his financial reform bill to the Senate this week, so what better timing.

Nevertheless, for the SEC to have “Pit Bull” Richard (Rick) Simpson in there litigating against the bank, means that there has to something in this and that must be a worry for them. Equally with the share price dropping 13 percent on Friday and further again today, even with their stunning results of $3.6 billion profits and $5.5 billion in bonuses for the last quarter, the reputation of the bank is taking a battering.

The core of this debate is the question: does Goldman Sachs make stunning profits – over $100 million every day for 131 trading days last year – by betting against clients?

If the answer is yes, then it’s more a case of Sack Goldmans rather than Goldman Sachs.

Best of the media coverage from The Week, via the NY Times, Reuters, Naked Capitalism

Why the SEC is going after the Wall Street powerhouse, and what it means for the financial industry

The Securities and Exchange Commission took on Wall Street titan Goldman Sachs on Friday, filing a potentially explosive civil lawsuit accusing the investment bank and one of its mortgage traders, Fabrice Tourre, of fraud. (Watch a CBS report explaining the SEC's charges.) Here's a brief rundown of the charges, and what they could mean for Goldman, Wall Street, and financial reform legislation:

What is Goldman accused of? 

The SEC says that Goldman created and sold a package of mortgage-backed securities to investors in 2007 without telling them that the person who picked or approved the securities, hedge fund manager John Paulson of Paulson & Co., was betting heavily that they would fail. Goldman brought in independent fund manager ACA Management to help pick the portfolio, allegedly to make the deal seem more trustworthy. But the SEC says Goldman misled ACA, too, not disclosing that deal "sponsor" Paulson was betting against, not on, the investments. Paulson's role was withheld from investors, too.

What's Goldman's defense?

That the investors who bought the securities were given "extensive information" about the securities they were investing in, and were "sophisticated" enough to know that somebody was going to take the opposite side of their bet. Also, Goldman says that while it earned $15 million in fees, it lost $90 million in the deal, although it didn't explain how.

Who else lost, and made, money on the deal?

The investors collectively lost $1 billion, with the primary losers being ACA Capital and German bank IKB. Paulson & Co. earned almost $1 billion in profit.

Is Paulson being charged?

No. Legal scholar Alan Dershowitz thinks that was a somewhat arbitrary choice by the SEC, though, saying in The Daily Beast that Paulson "could easily have been charged with conspiracy to defraud."

How damaging is this for Goldman?

Analysts say the hit to Goldman's "seemingly invincible" reputation could be much worse than any punitive damages. Given how important trust is on Wall Street, "it's very bad for business" if your clients think "you are doing shady things," says NYU law professor Marcel Kahan. And while any SEC fine would be "really small potatoes" for the firm, Goldman's stock price tumbled 13 percent on the news Friday, erasing more than $10 billion in market capitalization. Also, Britain and Germany are mulling their own investigations, based on the SEC allegations.

Are other Wall Street banks facing similar SEC charges?

It's certainly possible. SEC enforcement chief Robert Khuzami says the agency is stepping up its anti-fraud actions, and specifically looking at "similar deals" involving other Wall Street firms. Until Friday, Goldman employees were able to "sleep soundly after collecting their huge bonuses," says The New York Times in an editorial. Since Goldman wasn't the only bank betting against its own mortgage products, "others on Wall Street may have a harder time sleeping" now, too.

What are the politics of this case?

The SEC is an independent agency, but political strategists and banking lobbyists say the Goldman fraud allegations could help the Democrats pass a financial reform bill. The House passed its version last year, and the Senate finance committee recently sent its version to the full Senate (on a party-line vote) for debate this week. Some Republicans and TV pundits suggest that the announcement was timed to help secure the bill's passage. Business Insider's Henry Blodget says the SEC also might have rushed out the lawsuit to divert attention from a damning internal review of the agency's enforcement over the past few years.

Other recommended articles include:

• Goldman Sachs profits top $3bn - BBC
• Goldman Sachs charged by the SEC – the Economist
• Did a Clever SEC Bait Goldman Sachs Into Compounding Its Legal Problems? – Seeking Alpha
• Goldman Sachs: the bank that thought it ruled the world - the Telegraph
• And more in today's "things worth reading"

Will regulators destroy the banking system?

On April 1st, the European Commission announced their key work plans for 2010.

The plans are wide-ranging and imply a fundamental restructuring of the European banking markets.

If you don’t think it’s going that far, then think again as a wide range of strategic initiatives were announced including a new European supervision architecture and proposals in areas covering everything from derivatives markets, short selling and credit default swaps, deposit guarantee schemes, market abuse, crisis management tools and bank capital requirements. On this last point, they are even mooting a bank levy to generate €50 billion in case of future bailouts.

Alongside all of this, you have the hoo-ha of Paul Volcker’s proposals on getting rid of bank prop trading, which has now been shot down, and Gordon Brown’s Tobin Tax which may go by-the-by as a result of the UK general election.

Whichever way you look at it though, we have governments and regulators everywhere saying that things must change, and trying to work out how to change things.

Then you have all of the Committees, such as the UK’s Treasury Select Committee and the US congressionally chartered Financial Crisis Inquiry Commission, who are bank bashing on regular occasion to try to work out what things to change.

In the case of the latter, they’ve had regular visitations from bank leaders and other besmirched economists and thinkers, to find out what caused the financial car crash of 2008.

Of note in this parade of failed financial acolytes was the appearance of Alan Greenspan, the highly esteemed and now generally blamed former head of the US Federal Reserve.

Mr. Greenspan makes regular appearances blaming the crisis on everything from the fall of the Berlin Wall and China’s emergence through globalisation, to the banks leveraging of subprime and complex trade-off and packaging of such debt through complex financial instruments.

As the man at the helm during the build-up to the crisis, he rarely takes the blame or admits fault. For example, in his latest appearance before the Committee, he states: “In 2002, I expressed concerns to the FOMC, noting that ‘…our extraordinary housing boom…financed by very large increases in mortgage debt – cannot continue indefinitely.’”

He may have said this but he omits to mention that, in 2005, he concluded a speech to the American Bankers Association with the closing lines: “In summary, it is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices.”

In fact, about the only accurate thing he said recently is that: “Regulators who are required to forecast have had a woeful record of chronic failure. History tells us they cannot identify the timing of a crisis, or anticipate exactly where it will be located or how large the losses and spillovers will be ... nor can they fully eliminate the possibility of future crises.”

Now I don’t want to make this a Greenspan bashing column, as that would be too easy, but I do want to pick up on that phrase: “a woeful record”, as it is very relevant to where we are today.

For example, as the European Commission considers its wide-ranging changes, I could pick up on many of their previous attempts to regulate the markets that have yet to succeed and would beg the question: why don’t you fix what you started whilst starting to work out what to fix?

After all, we have Basel III, UCITS IV, Solvency II and CRD IV all coming up.

Notice something about those? Yes, they are all updates of earlier regulations that did not work as expected.

We have the same with regulations that I write about regularly such as MiFID, the Markets in Financial Instruments Directive. In the 2010 workplan, the European Commission announced that they were going to be taking a review of MiFID to make legislative proposals that would include the “dark pools issue”. What this demonstrates is the law of unintended consequences, where MiFID has made everything electronified, fragmented and opaque. The opposite of some of its intentions, which were for transparency and a level playing field.

In summary, what worries me right now is: first, that the regulators and policymakers are scrabbling around not knowing what to do; second, that they have obviously got it wrong in the past; third, that they are woeful at working at the future; and finally, that their whole focus on shaking up the banking system will destroy it.

Not being too much of a scaremonger am I?

 

New UK Financial Services Act

Just noticed that the governors are dropping half of the new Financial Services Bill, in order to rush it through Parliament before the general election is called on May 6th. 

The Financial Services Act, formerly known as the Financial Services Bill, is about to be passed into Law and includes:

• New powers for consumers to collectively challenge banks in court in addition to a new consumer financial education body and a free nationwide money guidance service (dropped)

• A requirement for firms to develop ‘living wills’ to help them better understand the risks involved in their businesses and deal with periods of stress, and to ensure they can be wound down in future crises without excessive taxpayer support

• Tougher rules on pay and bonuses that will ensure remuneration policies do not contribute to excessive risk taking

• Strengthening of the regulatory framework, including the creation of the Council for Financial Stability and enhanced powers for the Financial Services Authority

Key features of the Act

Stronger financial regulation and corporate governance

A new Council for Financial Stability, chaired by the Chancellor and including the Chair of the Financial Services Authority (FSA) and the Governor of the Bank of England, to focus on managing systemic risk and protecting financial stability, both in the UK and internationally (dropped)

A new, explicit financial stability objective for the FSA, enabling it to place greater emphasis on monitoring, assessing and mitigating macroprudential risks in its supervisory and regulatory approach.

Enhanced powers for the FSA:

• Rule-making powers may be used by the FSA for any of its objectives (not just consumer protection as at present);
• Information-gathering powers extended to non-regulated firms (including hedge funds), where information is relevant to financial stability;
• Strengthened powers to take action where firms and individuals are guilty of misconduct;
• Ability to place restrictions on short selling and to require disclosure of short selling.

Legislative provisions on pay that follow Sir David Walker’s review of corporate governance (to be published 26 November 2009) and the G20 agreement on remuneration, including:

A duty for the FSA to make binding rules which implement the G20 pay agreement following further detail from the FSB in Spring next year;

FSA powers to void any individual contract that contravenes specified rules, and to make provision for the recovery of payments made under that contract contrary to those rules;

An end to multi-year guaranteed bonuses, or large bonuses paid out as a cash lump sum at year-end, and all bonuses subject to clawback;

A new FSA duty to require firms to produce Recovery and Resolution Plans (RRPs) or living wills. RRPs will ensure institutions have robust recovery plans to deal with periods of stress without recourse to support from taxpayers. By removing barriers to effective resolution of failed firms, RRPs will help protect against system-wide risks and reduce the need to draw on taxpayers’ funds to ensure financial stability in the future.

Greater protection and support for consumers

New measures to enable consumers to collectively seek redress and compensation where there has been widespread detriment, including:

• Allowing a representative to bring an action through the courts on behalf of a group of consumers;
• Streamlining the FSA’s powers to order a review of past business and to secure compensation if there have been legal or regulatory breaches. (dropped)

A ban on unsolicited credit card cheques, preventing financial institutions from encouraging customers to borrow more than they can afford.

A new independent consumer financial education body will be established by the FSA, to increase financial education and awareness among consumers. The new body will roll out a national Money Guidance service from 2010 (currently being joint-piloted by the FSA and the Treasury) that will deliver accessible, impartial financial guidance. (dropped)

New authority for the Financial Services Compensation Scheme (FSCS) to act as an agent to deliver compensation to UK customers of financial firms based overseas, improving depositor protection.

The Financial Services Act will enact proposals set out in the ‘Reforming Financial Markets’ paper published by the Government in July. The following documents have also been published today alongside the Act:

Public responses to the ‘Reforming Financial Markets’ consultation paper

HM Treasury response to the consultation

HM Treasury response to the Treasury Select Committee Report ‘Banking Crisis: Regulation and Supervision’

Impact Assessment for the Financial Services Act.

If you're interested in more, I just received this great assessment from Dechert LLP ( Download Dechert's "An Overview of the Financial Services Act 2010, 11 page pdf)

 

A new PSD-approved Payments Institution starts business

Nick Ogden, CEO and founder of Voice Commerce (he previously created WorldPay, the RBS payments unit, back in 1993 and sold it to them in 2002*), recently spoke at the FSClub about using voice biometrics as part of authentication in mobile financial transactions.

Who are Voice Commerce Group?  Best to read what they say about themselves:

“The Voice Commerce Group was founded upon a simple principle ‘whenever we speak we establish a position of trust’. Consumers use their voices to communicate decisions; perhaps to instruct, to agree or to buy something. This natural process already happens automatically billions of times every day and the Voice Commerce Group has taken this natural capability and automated the process through its innovation in voice signatures.

“Voice signatures allow consumers to use their own unique voice to sign and authorise transactions, and their patented technology now lies behind worldwide standards for mobile trust. Using voice signatures guarantees transactional security when making a payment and protects users against personal data compromise. Voice signatures are complex devices that combine the use of voice biometrics with transactional history, trends and patterns to create a highly secure, unique authorisation environment. The system can deliver two factor identity authentications virtually anywhere. Authorisation failures, suspected imposters or potential fraudsters can be controlled and managed and transactions re-qualified using automated outbound IVR. This not only improves customer service but reduces the risk of fraud and identity theft.”

Why am I giving them a plug here?

Because, during the evening at the FSClub, Nick mentioned that Voice Commerce were one of the first Payments Institutions (PI) to register with the FSA, after the PSD was transposed last November and were about to announce that they are also one of the first PIs to be accepted as a Principal Member of Visa Europe.

The announcement was released this morning, so now is the time to talk about it.

What does being a Principal Member of Visa Europe mean?

The membership means Voice Commerce can start providing its own payment services to businesses including acquiring payment transactions.

Following the launch of the PSD in November 2009, Visa Europe confirmed that Payment Service Providers such as Voice Commerce, as defined in the PSD, would be eligible to apply to become members of Visa Europe. Subject to stringent risk management requirements and being capable of complying with Visa Europe’s operating regulations, the Voice Commerce application was approved by Visa Europe at the Board of Directors Meeting in February 2010.

Nick comments that: “as a Payment Institution, Voice Commerce is regulated in exactly the same way as banks in relation to capital adequacy and regulatory responsibilities for payment services. Being granted Visa membership means we can further compete on an equal footing across Europe with our banking peers. Our next move will be to grow the business and bring fresh creativity to the industry using innovative payment services, including voice biometrics to authorise payments.”

Voice Commerce also describe themselves as being “authorised by (the) UK Financial services Authority under the European Commission Payment Service Directive, and regulated in the provision of e-money services”. This means that they have to “maintain appropriate financial capital adequacy”.

Interesting.

Very interesting.

Particularly interesting as the firm that Nick created, WorldPay, is now up for sale with a price tag of £3 billion ($4.5 billion).

Bidders include private equity firms Advent International Corp; TPG Inc.; Warburg Pincus LLC; Kohlberg, Kravis Roberts & Co; Permira; CVC Capital Partners, Blackstone Group LLP and The Carlyle Group LLP.   Tsys, Atos, ChasePaymentTech and First Data are rumoured to be in there .. and IT firm Voice Commerce Group, whose chairman and chief executive officer is Nick Ogden, the founder of Worldpay, is making a bid to get them back too!

From Lafferty Card News:

“A skilled management team has already been assembled as part of the acquisition offer that will include the existing team at Voice Commerce. The team has appointed Montrose Partners, specialist financial advisors, to assist in their bid ... the value of Ogden’s bid for RBS WorldPay has still to decided, but he said Voice Commerce has substantial support from a number of private equity firms. When asked when a deal might be completed, he said: The expectation from UBS, who are handling the deal, is hopefully by August 2010. The process of due diligence is now taking place while they attain the position and value of the company. Following this period, UBS are expected to produce a sales memorandum in January 2010. Voice Commerce then predicts an 18-month separation process of the business, at which point the full extent of the deal will become clear.”

Jamie Dimon's Regulatory Reform Recomendations (Part Three)

Jamie Dimon’s letter to JPMorgan Chase’s shareholders included a whole section on the crisis and his solutions.  Because Tim Geithner and Barack Obama listen to every word Jamie utters, I think it's worth reproducing the whole section here to see whether, in a year or so, his recommendations are implemented:

“Banks are not fighting regulation

“We at JPMorgan Chase and at other banks have consistently acknowledged the need for proper regulatory reform, and I also spoke about this topic in great detail in last year’s letter.

“Looking back, one of the surprising aspects about the recent crisis is that most of the specific problems associated with it (global trade imbalances, the housing bubble, excessive leverage, money market funds, etc.) were individually well-known and discussed. But no one, as far as I know, put together all of the factors and predicted the toxic combination it would become – and the crisis it would cause.

“So what can we do to help fix the situation going forward? We must focus on the problem: bad risk management. This not only caused financial institutions to fail, but it also revealed fundamental flaws in the system itself. These flaws existed at both a macro level, where the interplay of the numerous critical factors was missed, and a micro level: for example, the failure to prevent AIG from taking excessive, one-sided positions in trading derivatives and the failure to limit mortgages to families who could afford them and to keep loan-to-value ratios to a more reasonable 80%-90%.

“Over the last 50 years, we have allowed our regulatory system to become dangerously outdated. The structure is archaic and leaves huge gaps in the system. Today, in America, banks account for only one-third of the credit outstanding, with all kinds of non-banks taking and trading risks and providing credit to the system. So the idea that banking is confined to deposit-holding entities is inaccurate and deceptive. The failure of so many firms in a range of sizes and categories – from Bear Stearns and Lehman Brothers to IndyMac and WaMu to Fannie Mae, Freddie Mac and AIG, as well as local community banks – proves that regulation needs to be administered by product and economic substance, not by legal entity. We have a chance to simplify and strengthen our regulatory system, and, if we do it right, it will not only be able to handle the complex challenges we face today but will be able to do so in a way that will be flexible enough to continuously adapt to our changing world.

“We support a systemic regulator

“Going forward, we will need a systemic regulator charged with effectively monitoring the spread and level of risk across the financial system in its entirety. Think of it as a “super risk” regulator. Such a regulator would not eliminate all future problems, but it would be able to mitigate them. If we had eliminated just some of the problems, it might have stopped the crisis from getting this bad. Congress appears to be well on its way to creating just such a regulator, and we hope it succeeds.

“Some issues the systemic risk regulator should keep in mind are the following:

• Focusing the process on managing risk. This should not be a political process. It should function like a strong risk management committee.

• Eliminating gaps and overlaps in the system. For example, mortgages were regulated by multiple entities, some of which did a terrible job, causing a “race to the bottom” as even good companies started to do bad things to maintain market share.

• Analyzing areas like the mortgage market and other elements of the consumer-finance system to ensure that when new rules are written, they create a sound, safe, effective and consumer-friendly mortgage market.

• Carefully tracking new products, as they often are the source of many problems.

• Reviewing credit across the whole system – including “hidden” extensions of credit, such as enhanced money market funds and SIVs.

• Aggressively monitoring financial markets and potential excesses, or bubbles. It may be hard to detect bubbles, and it may be inadvisable, once detected, to exert a direct influence on them with macro economic policy. However, it is appropriate to try to minimize the collateral damage bubbles can cause. It also would be appropriate to try to manage bubbles, not by using monetary policy but by restricting credit on specific markets (i.e., it would have been appropriate to ask lenders to reduce loan-to-value ratios in mortgages or to minimize speculation in the financial markets by reducing the leverage used in the repo markets).

• Recognizing distortions as they develop in the broader economy (fiscal deficits, trade imbalances, structural state budget deficits) and forcing policy bodies to anticipate the problems that may result.

• Encouraging international coordination as much as possible – not only so companies compete on a level playing field but also because crises don’t stop at national borders.

“These are just some of the ways a systemic regulator could help fix the flaws in our regulatory framework and create a system that continually adapts and improves itself.

“We support an enhanced resolution authority — and the elimination of too big to fail

“Even if we achieve the primary goal of regulating financial firms to prevent them from failing, we still have to get government out of the business of rescuing poorly managed firms. All firms should be allowed to fail no matter how big or interconnected they are to other firms. That’s why we at JPMorgan Chase have argued for an enhanced resolution authority that would let regulators wind down failing firms in a controlled way that minimizes damage to the economy and will never cost the taxpayer anything. Fixing the “too big to fail” problem alone would go a long way toward solving many of the issues at the heart of the crisis. Just giving regulators this authority, in and of itself, would reduce the likelihood of failure as managements and boards would recognize there is no safety net. Think of this enhanced resolution as “specialized bankruptcy” for financial companies. The principles of such a system would be as follows:

• A failure should be based on a company’s inability to finance itself.

• The regulator (or specialized bankruptcy court) should be able to terminate managements and boards.

• Shareholders should be wiped out when a bank fails – just like in a bankruptcy.

• The regulator could operate the company both to minimize damage to the company and to protect the resolution fund.

• The regulator could liquidate assets or sell parts of the company as it sees fit.

• Unsecured creditors should recover money only after everyone else is paid – like in a bankruptcy. (In fact, the resolution authority should keep a significant amount of the recovery to pay for its efforts and to fund future resolutions.) • In essence, secured creditors should be treated like they are treated in a bankruptcy. • The resolution fund should be paid for by the financial industry (like the FDIC is today).

• All institutions under this regime should live with the exact same rules.

• Regulators should make sure that companies have enough equity and unsecured debt to prevent the resolution fund from ever running out of money. To give an example, while Lehman had $26 billion in equity, it also had $128 billion in unsecured debt. A resolution regulator, in my opinion, would clearly have been able to let Lehman meet its obligations, wind it down and/or sell it off and still have plenty of money left over to return some money to the unsecured creditors. Had this been done wisely, the economy would have been better off.

• If a firm fails, there should be enough clarity about the financial, legal and tax structures of that firm to allow regulators, cooperating across international boundaries, to wind it down in a controlled manner – what some refer to as living wills.

• While there is no argument about who should pay for the resolution (i.e., banks), there are some technical issues about how it should be funded. The resolution regulator does need to be able to fund these companies while they are being wound down, and there are plenty of appropriate ways to accomplish this.

“Once it is established that any firm can fail, firms of all sizes and shapes should be allowed to thrive. It is wrong to assume that big firms inherently are risky. Banks shouldn’t be big for the sake of being big, but scale can create value for shareholders and for consumers who are beneficiaries of better products that are delivered more quickly and less expensively. These benefits extend beyond individuals to include businesses that are bank clients, particularly those that are global in scale and reach, and the economy as a whole.

“Many banks’ capabilities, size and diversity enabled them to withstand the crisis and emerge from it as stronger firms. This strength, in turn, made it possible for many firms to acquire weaker firms at the government’s request and help to alleviate potential damage to the economy.

“Closing comments on regulation

“While we support the general principles behind enhanced regulation of derivatives, securitizations and enhanced consumer protections, we do not support each and every part of what is being recommended. The devil is in the details, and it is critical that the reforms actually provide the important safeguards without unnecessarily disrupting the health of the overall financial system.

“We also believe there are some serious ideas that need attention if the system is to be made more fail-safe:

• Repo markets could be better structured, monitored and controlled.

• Loan reserving could be made far less pro-cyclical.

• Securitization markets could be fixed so that both originators and distributors have skin in the game.

• A system could be put into place to prevent a “run” on money market funds.

• The ability to buy shareholder or creditor voting rights without owning and being exposed to the risks of owning the underlying securities should be extremely limited. Investors should not have the ability to vote the capital securities actually owned if the investors are voting for the failure of the company and stand to gain more on their short positions than on their long positions.

• Finally, we support strong controls on so-called naked short selling.

“During the past year’s discussion among regulators and legislators, many other ideas have been proposed or recommended – from the Volcker Rule to new bank taxes to changes in Basel capital. These ideas are all in varying stages of development and are too undefined to comment on here. What we would urge our regulators and legislators to do is proceed with clarity and purpose and avoid broadly penalizing all firms alike – regardless of whether they were reckless or prudent.”

Part One: An overview of JPMorgan Chase's Operations.
Part Two: Jamie's views on banker's bonuses and TARP.
Part Four: Industry observers’ views about Jamie.

 

More on CESR's Dark Pool Regs

I recently wrote a little piece about CESR, the EU Securities Regulator, and their update to Dark Pools regulations.  It got quite a reaction, including feedback from some of the dark pools regulators themselves, who 'corrected' the view that the Best Bid-Offer had been updated by making it clear that nothing had actually changed recently.

For example, the document has been updated only to reflect how reference prices are formed in a negotiated trade waiver (Page 11).  In fact, the clarification provided for me is that there are various price waivers allowed under MiFID:

(1) The Reference Price Waiver

This is allowed in various ways:

(a) all orders are submitted to the system for execution/crossing at the midpoint of the European Best Bid and Offer (EBBO); or
(b) all orders are submitted for execution/crossing at the midpoint of EBBO or the European Best Bid or the European Best Offer; or
(c) all orders are submitted for execution/crossing at the midpoint of the primary market BBO or the primary market's Best Bid or Best Offer; or
(d) all orders are matched and executed at the official closing price published by the primary market; or
(e) the trading platform offer continuous trading based on the volume weighted average price (VWAP) on the relevant primary market.

(2)The Negotiated Trade Waiver (this was the change made on March 9th)

In this case, the trading system formalises negotiated transactions at or within the volume weighted spread, so that trading participants individually agree on the price and volume of the trade before transmitting it to the trading platform. The system then ensures that all negotiated transactions are at or within the volume weighted spread on the public order book of the trading platform.

(3) The Order Management Facility Waiver

In this case the dark order system displays a part of the order (a peak) whilst the rest of the total volume of that order is not displayed, resting in the order management facility. After the displayed portion of the order has been executed, a new peak is sent to the order book with a new time stamp, and the non-displayed portion of the order is decreased accordingly.

(4) The Large-in-Scale Waiver

An order is 'large in scale' when compared with normal market size, if it is equal to or larger than the minimum size of order specified in Table 2 in Annex II of the Commission Regulation 1287/2006. 

That last bit is complex and CESR can't agree on it, by the way.

In fact, the whole darned lot is pretty complicated, but the point is that nothing much changed in recent days, apart from a new 'Negotiated Trade' Waiver.

What is clear is that this whole area will be under intense review when CESR draft MiFID II.  As a result, it would do FSClub and Finanser readers no harm to attend our meeting on 4th May.

What’s in MiFID Wave 2?

A panel discussion with:

• Andrew Allwright, Business Manager, MiFID Solutions, Thomson Reuters
• Andrew Bowley, Head of Electronic Trading Product Management, Nomura
• Hirander Misra, CEO of Algo Technologies Ltd and former COO, Chi-X
• Peter Randall, CEO, Equiduct 
• Philippe Guillot, Global Head of Trading and Execution, CA Cheuvreux

The European Commission plans to expand MiFID trading rules to tackle issues missed by the original document, as calls mount for a second version of the controversial directive. The European regulator had been set to undertake a small-scale “technical” review of the 2007 directive, which outlawed rules forcing firms to use stock exchanges. However, sources familiar with the situation said the study might now include “more wide-ranging elements”. Among changes that could be on the agenda are new rules on over-the-counter and structured products, a pulling together of trade-reporting requirements and tighter rules around the definition of “best execution”.

If you want to come, then register.

A few choice regulatory quotes

There was a great panel session at the IPS payments show this week on the future of regulation.  Here are a few choice quotes:

“This is the G20-isation of regulations.”
Philippe Mongars of the Banque de France

“By the end of 2010, there will be an agreement of a new macroprudential supervisory structure by the G20 ... the main focus areas will be in strengthening bank capital, strengthening risk management, introducing liquidity standards , mitigating cyclicality and ensuring improvements in governance.”
Shunsuke Shirakawa of the Japanese Financial Services Authority

“We have experienced a once in a century financial crisis twice in the last few years: one generated by domestic issues and one that is global in origin.”
Shunsuke Shirakawa, the Japanese Financial Services Authority

“The immediate crisis has gone and not a lot has happened in the regulatory structures yet ... but the level of cooperation (between supervisors) has been unprecedented. We will get a set of rules as a result, and then the question will be whether everyone applies those rules with the same rigour. This is why the European Union has created a supranational structure to check that the new regulations are followed consistently within the EU (this is CEBS, ESMA and CIOPS).”
Sir John Gieve, former Deputy Governor of the Bank of England

“Banks will require more capital and it must be real capital, as in equity capital.”
Sir John Gieve, former Deputy Governor of the Bank of England

“From a payments viewpoint, the main issue will be the loss of profits due to the loss of the leveraged model of trading. Most profitability in the past years has been as a result of bank leverage. That loss of profit stream will create a much greater focus upon costs, which will lead to outsourcing and other cost reducing programs, as banks need to find new ways to generate profitability.”
Sir John Gieve, former Deputy Governor of the Bank of England

“The book ‘Too Big To Fail’, which provides the inside track on the collapse of Lehman Brothers, has over 500 pages. Some call it ‘Too Big To Read’. The UK authorities first appear on about page 380 and then disappear on page 383, and yet we get the blame for the crisis!”
Sir John Gieve, former Deputy Governor of the Bank of England

Towards Currency Union

I've been studying developments in the Middle East lately, and particularly the countries of the Gulf Cooperation Council (GCC). The GCC has been running since 1981 and comprises six core states of the Persia Gulf Region: the UAE, Saudi Arabia, Kuwait, Bahrain, Oman and Qatar.

The GCC is a bit like the EU, which formally established in 1957, in that its aims are to:

• create similar regulations in areas such as the economy, finance, trade, customs, tourism, legislation, and administration;
• foster scientific and technical progress in key areas of industry, mining, agriculture, water and animal resources;
• establish scientific research centres;
• set up joint ventures;
• unify the military presence for the Peninsula Shield
• encourage cooperation of the private sector;
• strengthen ties between the peoples of the GCC; and
• create a common currency by 2010.

Ah, there’s the key one at the end there. A common currency.

I’ve been visiting the region regularly for about ten years now, and this currency has always been on the agenda. Now, after a decade, it’s still on the agenda, and that’s about it.

That’s surprising as the GCC is very closely harmonised already; unlike the EU where there has been a massively fragmented region of economies, cultures, languages and monetary policies.

So you would think it would be easy.

In particular, the GCC countries are all closely pegged to the US dollar and, apart from the UAE’s wild child Dubai, pretty stable economies.

So what’s holding it back?

Politics.

It is a political issue about harmonising currencies that is the gating factor to a GCC currency or an Arabic currency. On this later point, assuming the GCC succeed, there is a plan for a single currency for the 18 member countries of the Council of Arab Economic Unity. These include the six GCC states, plus Yemen, Egypt, Iraq, Lebanon, Libya, Sudan, Syria and a number of other countries.

What are the political issues?

Firstly, what to call the currency.

If you call it the riyal then it means that Saudi, Oman and Qatar wins, as the dirham is the currency of the UAE whilst the dinar is used in Kuwait and Bahrain.

This is why the region voted to call it the ‘khaleeji’, which means ‘of the Gulf’, although no-one refers to the khaleeji, they just talk about the ‘currency union’.

So there is no official currency name as yet.

I did discover some currency designs:

 

 

But these are fake as none of the bankers I met had seen these designs, and the fact its called dinar gets thrown out of court straight away ... as does the fact that half is in English rather than Arabic.

In fact, the only thing folks liked about these notes is the six flag logo, so that might stay.

Even if the region gets a currency name that all nations can agree upon, where will they headquarter the Gulf Central Bank?

As soon as it was chosen to be in Riyadh, the UAE walked out. Meanwhile, Oman had said it wouldn’t join the currency and Kuwait has issues due to being linked to a basket of currencies, rather than just the dollar.

Nevertheless, five nations have agreed to create a Gulf Monetary Council and move towards union by 2015 rather than 2010. GCC Secretary-General Abdulrahman Al-Attiyah has stated that the first meeting of the joint monetary council will take place at the end of this month, and that is considered to be an important milestone towards the monetary union.

Some say 2010 was just the start date towards union anyway.

All in all, like the EU efforts, the GCC has a long road ahead. At least they have the oil resources to motor along it.