Jain Global Seeks Regulatory Capital Business

Bobby Jain is launching a new fund led by an ex DE Shaw portfolio manager to invest in bank capital relief trades or SRTs (significant risk transfers), allowing banks to transfer credit risk from their loan portfolios to external investors - it's also known as "RWA optimization". The benefit to the bank is that it reduces the capital it has to hold. Investors receive a premium for absorbing potential losses. "Basel III Endgame" is expected to increase demand for these services.

GRID Bill Passed to Expedite Dispatchable Generation

The American House of Representatives has passed a bill which could accelerate the progress of dispatchable power generation. The bill's sponsor, Rep. Troy Balderson, lamented "shovel-ready projects" were being delayed "while demand continues to climb". 

In the US, a bill must go through both both "chambers" (House and Senate, which together form the US Congress) and then be signed into law by the President who has the right to veto the bill as well.

The GRID Power Act gives FERC (Federal Energy Regulatory Commission) a total of 60 days to review proposals from RTOs and ISOs for projects to be pushed to the front of interconnection queues. 

The projects need to show how they would boost the reliability and resilience of the grid.

Interconnection queues are lists maintained by grid operators that track requests from power developers to connect new generation projects like wind turbines, solar farms, battery storage or dispatchable plants to the electricity grid. Projects in the interconnection queues may be withdrawn due to financing issues or delays in gaining regulatory approval.

For example, we may have a BESS project (Battery Energy Storage System) in Howard County Texas that wants to connect into the ERCOT system, with a capacity range of 200MW-300MW. Another example can be a small gas project that wants to connect into AESO (Alberta Electric System Operator) - Alberta is a province in Western Canada - supplying, say, 0-10 MW.

Monitoring the queues can give an indicator of future capacity. CAISO (California ISO, or California Independent System Operator, to give it its full title) queue reports can be found here. 

EPSA (the Electric Power Supply Association) has published an article explaining the GRID Act and how it contributes to reliability in a growing power system.

Swiss Capital Requirements Weigh Heavy on UBS

The Swiss government has proposed heavier capital requirements on UBS, as revealed by UBS Group CFO and Stern-school MBA grad Todd Tuckner (Todd joined UBS in 2004 and is thus a 21 year veteran, prior to which he was an international tax partner at KPMG). 

These capital requirements would up the bar on core capital (removing currently allowed items such as software and deferred tax assets from counting as capital). Software was counted as an intangible asset with some regulatory value, especially if it supported core banking operations. However, concerns that is less loss-absorbing and more volatile in valuation than current treatment requires have prompted its exclusion from core capital (CET1- Common Equity Tier 1 capital, basically the highest form of capital, acting as a high quality shock absorber in the event of losses).

UBS will need to decide what to do - either push back, and hope for the best, or relocate its HQ to be outside of Swiss regulation, or plan both in parallel.

The proposed rules are to avoid an incident such as the collapse of Credit Suisse in 2023 from happening again. UBS has criticised the proposal as being non-proportionate.

Republicans Push for Simplified Dodd-Frank, Democrats say "No Thanks"

The bill in question is the Financial CHOICE Act, a simplification of the post crisis Dodd Frank Act.

Repeal and Replace the Dodd Frank Act Message from Trump is a Boon for Banking Stocks (especially Goldmann Sachs)

"Dodd Frank is a disaster" said President Trump, on the law Obama signed into law in 2010, named partly after Connecticut native, and Democrat, Chris Dodd, and Barney Frank, a Harvard Law School alumnus and also a Democrat.

Swap Execution Facilities (or SEFs) came about as a direct result of the Dodd-Frank Act.

The market response has been positive.

Goldman stock rose 4.2% (NYSE:GS) and Bank of America 2.5% (NYSE:BAC). This is despite the stocks having very similar betas of 1.5 and 1.47 respectively.

Gary Cohn, formerly Chief Operating Officer of Goldman Sachs, former options dealer and now chief economic advisor to Donald Trump, waxed lyrical to the Wall Street Journal regarding the move.

What Kinds of Volumes are Being Done on Cleared Interest Rate Swaps?

Volumes Compared by Currency

The CME Group's clearing solution for interest rate swaps is doing considerable volume.

For trade date February 26, 2016, $21.6 billion of swaps were traded, with $12.5 trillion open interest.  Dollar and Euro are trading around parity (with the Euro being slightly more valuable), so that's a 20 bn EUR equivalent trading volume.

Euro swaps traded only 5.2 billion euros worth in comparison. So the volume of USD swaps is approximately four times as large.

Swaps on GBP actually exceed USD swaps in trading volume terms, for the same day, 24 billion pounds traded, which is around $34 bn (which is about 1.5x larger).

Cleared Swaps on Different "Flavours of LIBOR"

The CME clear swaps on USD Libor, Euribor and plain old "LIBOR" (which is GBP LIBOR of course) as well as host of other currencies.

Where Are Rates At - USD Libor

Friday's level for USD Libor Overnight was 37 basis points.  1 month is 43 basis points and 3 month USD Libor is 63 bps. A daily update on USD Libor levels can be found here. 1year USD Libor is 116 basis points.

"Regular" LIBOR

Overnight is 48bps, 1 month is 50 bps, and 3 months is 59 bps. 1 year LIBOR is close to 100 bps.

Who sets the LIBOR Rates

The former BBA Libor is now known as ICE Libor following the reform of the benchmark and management by ICE Benchmark Administration.  The Wheatley Review of LIBOR in 2012 made specific recommendations for the reform of LIBOR including a change of administration.  Under a tender process led by Baroness Hogg, the NYSE Euronext came up trumps (later renamed to ICE Benchmark Administration). Both administering and making submissions to LIBOR became regulated activities from 1 April 2013 - LIBOR being the first benchmark to be regulated.

As part of their activities, ICE has a dedicated surveillance team identifying breaches of submission standards and tolerances through "a combination of alerts and pattern matching".

Other Benchmark Rates administered by ICE

The ICE Swap Rate is the new replacement for ISDAFIX effective August 2014. ICE also now administer the LBMA Gold Price.

The Greatest Volume of Swaps

Interest Rate Swaps, followed by Overnight Indexed Swaps followed by basis swaps.

Solvency II Rules Set for 2015 Launch

Solvency II Rules due in 2015 will set strict rules for insurers; where they will be expected to lay out detailed risk and capital plans. "Inadequate or opaque models" would not get regulatory approval, warned BOE boss Mark Carney.

The technical rules for Solvency II are managed by EIOPA, the European regulator for insurance and occupational pensions.

How Should Commodities Be Regulated?

The recent takeover of JP Morgan's physical commodities business by Swiss trading house Mercuria (founded by two former Goldman Sachs traders, or more specifically Goldman Sachs J Aron unit, after spending time at Cargill) for $3.5 billion, is an ambitious move for the relatively new commodities trader, starting out as a ten-person team supplying oil to Polish refineries.  It now employs over a thousand people, with revenues topping over $100bn last year. Analysts remark that the remarkable fact about Mercuria is its aggressive efforts to scale the business. How would Mercuria be able to succeed where JP Morgan could not? One answer lies in regulation.

As Mercuria is not a bank in the sense that it does not take deposits from customers, regulation is different than for a deposit-taking institution. Further, it falls under Swiss regulation rather than North American legislation. JP Morgan's exit is prompted by capital constraints and increasing regulatory scrutiny, particularly on US banks that have been the subject of controversial bailouts. So uneven regulation is one source of competitive advantage that Mercuria has over JP Morgan.

It should be emphasised that the duo who built Mercuria, Marco Dunand and Daniel Jaeggi, came from a banking background, and it is remarkable that they have found a way to leverage that while succeeding in a way that banks have failed.