October 25, 2020

High & Low Finance: Wielding Derivatives as a Tool for Deceit

But they are often weapons of mass deception.

For some derivatives, a desire for deception is the only reason they exist. That deception can allow those who own derivatives to evade taxes or accounting rules. It can allow activity that might otherwise be illegal, were it not called a derivative, or that would face regulation if it were labeled what it truly is.

Sometimes, banks use derivatives they create to help their clients deceive the public. Other times, they enable the banks to deceive those clients.

The latest revelation of deception by derivative came in Italian government documents leaked this week to two European newspapers, La Repubblica and The Financial Times. The Financial Times said it appeared that Italy had used derivatives in the 1990s to allow it to make its budget deficit seem smaller, thus enabling it to qualify for admission to the euro zone. The report said it appeared those derivatives, now restructured, might be exposing Italy to a loss of 8 billion euros ($10.4 billion).

La Repubblica noted that the director general of the Italian Treasury Department at the time, Mario Draghi, is now running the European Central Bank.

Italy’s economy minister, Fabrizio Saccomanni, said it was “absolutely baseless” to say that the country used derivatives to lie its way into the euro zone. It was simply hedging against market risks. As for the current situation, he said, “There’s been no material damage to our public finances.” He drew a distinction between realized losses and those based on market values that could change.

What seems to have happened in Italy is similar to something that we already know Greece did. Rather than borrow money — which would increase the reported budget deficit — the country entered into a derivatives contract that called for the banks to make large upfront payments in return for larger payments later from the government.

And how did that differ from a loan? Functionally, not very much, in all probability. But if you call something a derivative you can often get away with keeping it off your balance sheet — or putting it on the balance sheet in a misleading way. If The Financial Times report is right, the deal made Italy’s reported budget deficit smaller just when the country needed that to join the euro zone.

There is some evidence that Europe knew what was going on and chose to ignore it. Joining the euro was seen as more of a political event than an economic one, a symbol of European unity.

The effect of the funny accounting was similar to that of a student cheating on college entrance exams. The student may get into a university where he or she cannot compete, just as Italy and Greece find themselves in a currency bloc where their economies are at a significant disadvantage.

But while uncompetitive students can drop out, or be expelled, the euro zone rules provide that no country can leave. That fact, perhaps more than anything else, accounts for the persistence of the euro zone crisis.

Such deception by derivative is hardly new. Enron was a pioneer. It used derivatives called “prepaid forward” contracts to hide debt in a way that made corporate cash flow appear better, something the company thought was necessary to impress the bond rating agencies.

Responding to claims that his bank and Citibank had made “disguised loans” to Enron, a JPMorgan Chase executive told a Senate hearing in 2002 that “the prepaid forwards were undoubtedly financing, as all contracts are that involve prepayment features, but every financing is not a loan.” He said the bank had properly accounted for them, but “the manner in which Enron accounted for them” was of no concern to the bank. It was, instead, “a matter for Enron and its management and auditors.”

Article source: http://www.nytimes.com/2013/06/28/business/deception-by-derivative.html?partner=rss&emc=rss

Britain to Fight Euro Zone Transaction Tax Plan in Court

Britain was concerned that the planned tax would affect transactions carried out beyond the borders of countries that sign up for it, Chancellor George Osborne said on Friday.

“We’re not against financial transaction taxes in principle … but we are concerned about the extra-territorial aspects of the (European) Commission’s proposal,” he said on the sidelines of meetings of finance leaders at the International Monetary Fund.

The British government filed the challenge at the European Court of Justice on Thursday, the deadline for challenging the Commission’s proposal, a Treasury official said.

U.S. Treasury Secretary Jack Lew has voiced opposition to the planned tax, which would affect banks on Wall Street and other financial centres around the world.

The 11 euro zone countries intend to introduce the tax on stock, bond and derivatives transactions next January, raising up to 35 billion euros a year.

There are provisions to ensure the levy is applied no matter where securities from the 11 states are traded, though it is unclear how and by whom the tax would be collected, especially in non-participating countries.

Brussels said it was confident the plan was on sound legal ground. “It was based on careful analysis to ensure that all the conditions for enhanced cooperation, set out in the (European) Treaties, were met,” said Algirdas Semeta, the European commissioner in charge of tax policy.

Under the EU’s rules, enhanced cooperation requires a minimum of nine countries to cooperate on legislation using a process, as long as a majority of the EU’s 27 countries give their permission.

Germany has argued that banks, hedge funds and high-frequency traders should pay for a financial crisis that began in mid-2007 and spread across the world, forcing euro zone countries to bail out peers such as Portugal and Greece.

The British Treasury official said the government hoped it could resolve its differences over the planned tax through negotiation.

He said Thursday’s challenge kept London’s legal options open while the transaction tax takes clearer shape in the year ahead.

A pan-EU proposal for the tax failed due to opposition from Britain, home to the City of London and Europe’s largest financial services industry, as well as other member states including Sweden.

Parliamentarians have criticized the government and the financial sector for not doing enough to stop the tax, saying Britain should go to court to halt the plans.

A trade group representing banks, brokerages and other market-related sectors slammed the planned change.

“This is a tax that will damage markets beyond the 11 states that are considering it, across Europe and also internationally,” said Simon Lewis, chief executive, the Association for Financial Markets in Europe.

“It will act as a brake on economic recovery by increasing costs to investors.”

(Reporting by William Schomberg; Editing by Andrea Ricci and Chizu Nomiyama)

Article source: http://www.nytimes.com/reuters/2013/04/19/business/19reuters-g20-eurozone-britain.html?partner=rss&emc=rss

Bucks: You’re Responsible for Your Own Behavior

Carl Richards

Carl Richards is a certified financial planner in Park City, Utah. His new book, “The Behavior Gap,” was published earlier this month. Here is an excerpt from his book. His sketches are archived here on the Bucks blog.

Bernie Madoff spent most of the last two decades running the largest Ponzi scheme in history, defrauding thousands of investors of billions of dollars. Many of those investors were intelligent, sophisticated people. Some were top managers at major Wall Street firms.

So what happened? Same old, same old. He promised the moon, and we wanted to believe he could deliver it.

There were warning signs. Many people on Wall Street had their suspicions of Madoff. A few were flat-out convinced that he was a fraud (and tried to tell the Securities and Exchange Commission and other regulators). Some Wall Street firms avoided doing business with the guy.

Others kept sending clients to him.

Patricia Wall/The New York Times

It would be nice to blame the whole thing on a few dirty rotten scoundrels. But that’s too easy. Part of the problem lies with our almost universal tendency to believe what we want to believe. It’s really, really hard to resist a deal that looks too good to be true — especially when other people are buying into it.

I understand why people invested with Madoff. The guy had great credentials, and his record was very strong. Most folks didn’t ask questions. They wanted those returns, and they trusted their advisers to protect them. Their advisers, in turn, trusted regulators. And regulators didn’t get the job done.

Whatever. The fact remains that some pretty sophisticated people didn’t nail down the facts before they put money (their own and/or their clients’) at risk.

It happens all the time. Few people asked many questions when supposedly conservative bankers started offering high-yielding but risky new products to mainstream investors, like derivatives and securities backed by subprime loans. Meanwhile, we kept borrowing more money even as we sensed that no-money-down mortgages made little financial sense. The banks offered us cheap access to money, so we didn’t ask questions. We took it, and hoped for the best.

You, me, and most everyone else struggle to work up the nerve to question things that appear too good to be true. But as usual, it turns out that our financial security is our own responsibility. And sometimes, that means we have to be skeptics.

Excerpted from “The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money,” published by Portfolio/Penguin. Copyright © Carl Richards, 2012. Reprinted with permission.

Article source: http://feeds.nytimes.com/click.phdo?i=82a45962bf8332a409c157e77a0cb2e5

DealBook: A German Regulator Seeks to Change NYSE-Deutsche Deal

LONDON — A German regulator has called for changes to the proposed $9 billion merger between Deutsche Börse and NYSE Euronext after raising concerns about how the deal would affect their operations in Frankfurt.

“We have communicated suggestions about how our concerns could be remedied,” said Wolfgang Harmz, a spokesman for the Hessian Ministry of Economy, the local German regulator for the Frankfurt exchange. He would not provide further detail on the proposed changes.

The local ministry has the power to revoke Deutsche Börse’s operating license and can forbid any changes to the ownership structure that result from the merger between Deutsche Börse and NYSE Euronext.

Mr. Harmz said any decision would come after the conclusion of the European Commission’s antitrust investigation, which is expected by the end of January 2012. Deutsche Börse was not immediately available for comment.

Local authorities are concerned about how the proposed deal would affect the companies’ continuing operations in Frankfurt, as well as whether management decisions would be made outside the German city, according to a person with knowledge of the matter.

In response to initial competition concerns by European regulators, the companies agreed in November to certain concessions. NYSE Euronext said it would sell its pan-European single-equity derivatives units, but not the options businesses in its home markets. Deutsche Börse said it would divest similar operations.

The companies added that they would give rivals access to Eurex Clearing, a clearinghouse for derivatives products, to offset regulatory concerns that the pending merger would lead to uncompetitive practices.

Both companies are adamant that any further concessions, particularly related to their fast-growing derivatives business, would put the merger in jeopardy.

“We want to pursue the transaction, but not at all costs,” Deutsche Börse’s chief financial officer, Gregor Pottmeyer, said in a statement last week. “Antitrust conditions should not be allowed to endanger the industry and economic logic of this transformational merger.”

Article source: http://feeds.nytimes.com/click.phdo?i=c164e9984b42caef64e07133e1981014

DealBook: Italian Bond Dispute Illustrates Obstacles to Triggering C.D.S.

Seat Pagine Gialle is the publisher of the Italian yellow pages directories.Chris Warde-Jones/Bloomberg NewsSeat Pagine Gialle is the publisher of the Italian yellow pages directories.

The publisher of the Italian yellow pages directories, Seat Pagine Gialle, has missed a payment on its bonds and announced a tentative agreement to cancel the bonds and issue shares in the company instead. But that agreement may collapse because of a disagreement over how much stock will be issued.

That sounds like a prime example of how bondholders could have protected themselves by buying credit-default swaps, which are supposed to assure that investors will not suffer if a creditor defaults.

But it may not be.

At a meeting Monday, a committee of the International Swaps and Derivatives Association, the trade group that administers the credit-default swap, was unable to decide whether a “credit event” had taken place. So the decision was delayed until a group of three independent experts could be appointed to consider the issue.

All this may soon be moot if the company does not manage to make the bond payment by Wednesday. In the meantime, however, it serves to emphasize how difficult it can be to determine whether a credit event has taken place. If it has, procedures go into place to determine how large the losses are and require those who issued the credit-default swaps to pay that amount to the purchasers.

Under the association’s rules, in some cases there is no event if investors “voluntarily” agree to exchanges that in reality cost them money, a fact that has made it seem likely that credit-default swaps on Greek debt will not be activated if a European plan to encourage banks to exchange their bonds for bonds worth half as much goes through. Since that exchange would not be mandatory, the swaps would not be activated if interest payments continue on the bonds that are not swapped.

Yellow page directories have lost business everywhere, and Seat has tried to expand its Internet business. But it reported a loss of 33.2 million euros for the first nine months of this year, and on Oct. 28 it said it would delay an interest payment of 52 million euros, or about $69 million, for a month.

Last week, it said it had reached a tentative agreement with a majority of creditors, but that disputes remained with its senior debtholders over how much equity would go to the holders of 1.3 billion euros in bonds. It said that if a final deal were reached and accepted by bondholders, it would make the interest payment by Wednesday.

The swaps association’s committee for Europe — the same one that would determine whether a Greek default occurs — met three times over the last two weeks and delayed a decision. On Monday, eight of the 15 members voted there was a credit event, but the other seven voted that there was not. Since support of 12 members is needed, the proposal failed.

Six of the 10 members that came from banks that make markets in swaps voted that there had been an event, but only two of the five members that come from institutions that invest in swaps agreed. The association said no one would discuss reasons for their votes.

If the tentative deal falls apart and the interest payment is missed, there would be no doubt that a credit event had taken place. But since Seat Pagine Gialle is trying to get a voluntary agreement for a swap of the bonds for stock, it may be possible that there would be no credit event at all, even though it will be clear that bondholders have suffered a major loss.

With a new doubt regarding whether the swaps would be activated, the price of credit-default swaps on the company dipped a bit on Monday, but remained high. Markit, a market information firm, said the cost of buying a swap on 10 million euros of bonds was 7.25 million euros on Monday, down from 7.95 million euros on Friday.

Article source: http://dealbook.nytimes.com/2011/11/28/italian-bond-dispute-illustrates-obstacles-to-triggering-c-d-s/?partner=rss&emc=rss

Common Sense: At UBS, It’s the Culture That’s Rogue

UBS moved swiftly to distance itself. Mr. Adoboli had engaged in “unauthorized” and “fictitious” trades that “violated UBS’s risk limits,” the bank claimed in a statement.

Mr. Adoboli remains in jail, his trading activities under investigation. UBS no doubt hopes they prove to be aberrational, an isolated instance of wrongdoing within the ranks of its approximately 65,000 employees worldwide. But the unauthorized trading is only the latest in a series of egregious ethical and legal lapses at UBS that have badly damaged the bank’s once-sterling reputation. In this broader context, how aberrational were Mr. Adoboli’s suspected lapses? Is the UBS culture at least partly to blame? And what if anything is UBS’s board going to do?

Mr. Adoboli, 31, a soft-spoken native of Ghana, worked his way up from a back-office accounting function to UBS’s vaunted Delta One derivatives trading desk. His circumstances bring to mind Société Générale’s Jérôme Kerviel in France. Mr. Kerviel is serving a three-year prison sentence for his unauthorized trading, which cost the bank about $7 billion in losses.

Mr. Adoboli’s lawyer told the court this week that he “is sorry beyond words for what has happened here. He went to UBS and told them what he had done and stands appalled at the scale of the consequences of his disastrous miscalculations.”

Like Mr. Kerviel, whose trading bears a strong resemblance to that of Mr. Adoboli, there’s no evidence that Mr. Adoboli stood to profit directly from his trading. Mr. Kerviel has steadfastly maintained he acted only for the benefit of the bank, pressured to distinguish himself by a rigid hierarchical culture in which he was the only trader from a working-class family who didn’t attend one of France’s prestigious grandes écoles. His superiors, he said, knew of and condoned his trading — as long as it was profitable.

Mr. Adoboli hasn’t offered any such justifications, but his immigrant status may have set him apart at UBS. (The bank is investigating whether others at the bank bear any responsibility.) His unauthorized trading also seems consistent with a culture at UBS that stressed individual advancement over team efforts, according to former investment bankers. “The problem isn’t the culture,” one of them told me. “The problem is that there wasn’t any culture. There are silos. Everyone is separate. People cut their own deals, and it’s every man for himself. A lot of people made a lot of money that way, and it fueled jealousies and efforts to get ever better deals. People thought of themselves first, and then maybe the bank, if they thought about it at all.”

Though UBS traces its roots to the mid-19th century, the modern bank is an amalgam of the former Union Bank of Switzerland; the Swiss Bank Corporation, (itself a combination of the Swiss bank and investment bank Warburg Dillon Read); the American investment bank PaineWebber; and a large team from the former Donaldson, Lufkin Jenrette, all acquired since 1998. Critics as well as some members of the bank’s current management say the firm never merged these disparate assets into one consistent culture, and that the headlong pursuit of growth at any cost trumped ethical and legal behavior, especially in the investment bank. (UBS didn’t respond to requests for comment.)

The financial crisis and its aftermath have proved daunting for most of the world’s banks, but in many ways UBS’s behavior stands out. In August 2008, UBS settled charges brought by Andrew Cuomo, then the New York attorney general, that it misled customers when it sold them what it described as nearly risk-free auction-rate securities even as its executives knew the market was collapsing. After the market froze and investors were unable to sell the securities, regulators sued, and UBS agreed to repay $19.4 billion and pay a $150 million fine.

Article source: http://feeds.nytimes.com/click.phdo?i=793c2638d04b9b38f9d61bbc64a869a8

DealBook: Derivatives Firms Face New Capital Rules

Financial regulators proposed new rules on Wednesday that would require large derivatives trading firms to bolster their capital cushions, the latest attempt to reduce risk in the $600 trillion swaps market.

The rules, proposed by the Commodity Futures Trading Commission, are largely aimed at swaps dealers — brokerage firms, big energy trading shops and Wall Street bank subsidiaries that arrange derivatives deals. The plan also would apply to so-called major swaps participants, companies that are either highly leveraged or have huge positions in swaps contracts.

The agency’s commissioners voted 4 to 1 in favor of advancing the proposal to a 60-day public comment period, after which they must vote on a final version of the rules. Scott D. O’Malia, one of the agency’s two Republican commissioners, voted against the proposal.

The proposed rules are a result of the Dodd-Frank Act, the financial regulatory law enacted last year. The law mandated an overhaul of swaps trading, an unregulated industry that was at the center of the financial crisis.

The commission has already proposed rules that would require many swaps — a type of derivative contract that can be tied to the value of commodities, interest rates or mortgage securities — to be traded on regulated exchanges.

But for months, the commission had declined to say which types of swaps would face the new rules. On Wednesday, after months of deliberation, the commission said its swaps definition would include foreign currency options and foreign exchange swaps and forwards.

The commissioners voted 4 to 1 to propose the definition, which would exempt insurance products and consumer transactions like contracts to purchase home heating oil.

The commission’s separate proposal to build capital cushions in the derivatives industry could help prevent a repeat of the 2008 financial collapse, regulators say.

In the lead-up to the financial crisis, investors bought billions of dollars worth of credit default swaps as insurance policies on risky mortgage-backed securities. When the underlying mortgages soured, American International Group and other companies that sold the swaps lacked the capital to honor their agreements.

Under the commission’s new plan, those firms would have to put aside enough cash to cover unforeseen calamities. Regulators, until recently, had little authority to set any rules for the swaps market.

“Capital rules help protect commercial end-users and other market participants by requiring that dealers have sufficient capital to stand behind their obligations,” Gary Gensler, the commission chairman, said in a statement.

Still, there is no guarantee that enhanced capital levels will avert future disasters. And there is no magic capital number that regulators see as a cure-all; different firms will face different requirements.

Swaps dealers and major trading firms that are already registered with the commission as futures brokers would have to hold at least $20 million of adjusted net capital, on top of existing requirements.

Other firms that are subsidiaries of big banks would have to meet the same capital standards as the parent company, while storing away at least $20 million of Tier 1 capital.

Yet another set of firms would have to keep tangible net equity equal to $20 million, in addition to putting aside funds to cover market and credit risk.

The commission’s proposal covers more than 200 firms expected to register as swaps dealers and major swaps participants.

The commission also voted to reopen or extend the public comment period 30 days on its earlier rule proposals. The agency plans to finalize most Dodd-Frank rules by the fall.

Article source: http://dealbook.nytimes.com/2011/04/27/derivatives-firms-face-new-capital-rules/?partner=rss&emc=rss

Preserving a Market Symbol

As the chief executive of the all-electronic Nasdaq exchange, Mr. Greifeld has questioned whether a physical place where human beings come together to buy and sell stocks is even necessary. He has dismissed the 219-year-old capitalist symbol of the New York exchange as “a stage prop” that ought to be taken apart “board by board.”

Now, though, with Nasdaq and the Intercontinental-Exchange in a fierce fight with the Deutsche Börse to buy the Big Board, and its parent company, NYSE Euronext, Mr. Greifeld insists that he will not only keep the floor open but reverse its long decline.

Although it might seem largely symbolic — only about 1,200 traders remain on the floor, down from more than 2,500 a decade and a half ago — both bidders are promising to keep it open, a rare point of agreement and a nod to the high-stakes public relations battle now under way.

Behind the scenes, however, starkly different strategic visions of the future of stock exchanges are being proposed. The tussle between the exchanges is a question about which model is going to compete most successfully in a global marketplace: one that straddles continents and product lines or one that stays local and focused.

“The question is, what is the exchange of the future?” said Richard Repetto, an analyst at Sandler O’Neill, an investment banking and brokerage firm. “Both want to compete globally but Nasdaq is saying, hey, we think the best way to compete globally is to stay as narrowly focused as possible. NYSE is saying, hey, you need to be diversified to compete and have global capabilities.”

The strategy of the Deutsche Börse calls for the combined company to trade stocks as well as higher-margin, faster-growing derivatives in both Europe and the United States.

“It is a bigger international play,” said Patrick J. Healy, chief executive of the Issuer Advisory Group.

Nasdaq’s vision is built on dominating stock trading in the United States. It would have some international equity trading, like its current OMX operations in the Nordic and Baltic countries, as well NYSE Euronext exchanges in European centers like Paris and Amsterdam.

But the merger would make the combined business the home of all the companies listed in the United States, responsible for 45 percent to 50 percent of domestic trading volume. Issuers, including overseas companies, might prefer a bigger, unified American capital market compared with the fragmented one now.

On Thursday the fate of the Big Board is likely to take center stage at the annual shareholder meeting of NYSE Euronext in Manhattan. But the final outcome may be decided only by a shareholder vote scheduled for July.

The deal with the Deutsche Börse — which went mainly electronic more than a decade ago and has only about 120 traders on its floor in Frankfurt — would give NYSE Euronext a much bigger share of the market for exchange-based derivatives trading in Europe, including interest rate derivatives as well as NYSE Euronext’s 27 percent share of cash stock market trading in the United States.

Under the Nasdaq-ICE bid, NYSE Euronext would be split into two. The NYSE Euronext’s stock-trading operations, including the NYSE floor, would go to Nasdaq, while ICE would pick up most of the derivatives businesses in the United States and Europe.

NYSE’s board has twice rebuffed the Nasdaq-ICE bid, even though Mr. Greifeld sweetened his offer last week with firmer bank financing and an offer to pay a $350 million break-up fee to NYSE Euronext if regulators veto the deal.

The NYSE Euronext board said it still prefers to merge with the Deutsche Börse, because that deal would keep the company intact, and emphasize the global cross-product strategy, while they argue an Nasdaq-ICE combination would run afoul of antitrust rules.

The Nasdaq-ICE bid is also a bet on the superiority of purely electronic trading. From its headquarters in Times Square, Nasdaq has done more than anyone else to draw business away and diminish the exchange, and in the shift to electronic trading the Big Board itself adopted ever more automation and set up its own electronic-only market, called Arca.

Article source: http://feeds.nytimes.com/click.phdo?i=0493bfa9d0059ebbc22f99294ab75015