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Cost of US credit default swaps soars – Industry roundup: 11 May

US default swaps more expensive than emerging markets

The cost of insuring the US Treasury against default has overtaken that of some emerging markets as the government nears running out of money.

Bloomberg reports that US credit-default swaps are more expensive than contracts on the bonds of Greece, Mexico and Brazil, which have defaulted multiple times and whose credit ratings are several times below US’s AAA.

Some investors doubt that the US will be able to make good on its debt, according to the report. But even a technical default – which only delays interest and principal payments – would shake the US$24 trillion Treasury market, the bedrock of the global financial system. For holders of credit-default swaps (CDSs), such a scenario would yield attractive returns.

“There is some gambling going on in the US CDS,” said John Canavan, principal analyst at Oxford Economics. “It is not a pure play that the treasury will default and will default. In that sense it is different from countries like Greece or Mexico, where the worry would be that the government defaults and never pays you back or you get a haircut. pays back.”

House of Representatives Speaker Kevin McCarthy, who met with President Biden on Tuesday reportedly said he opposed a short-term debt-limit extension that would allow the Treasury to borrow until the end of the fiscal year on September 30. The meeting made little concrete progress toward averting a default but promised spending talks that would open the door to a possible compromise.

Treasury Secretary Janet Yellen reiterated her warning that the Treasury risks running out of room to stay under the debt limit until June 1 – the date when the government exhausts its options to fund itself.

This confusion has fuelled an increase in demand for euro-denominated US CDSs, which are the most actively traded. These contracts were trading up 166 basis points on Wednesday against default for next year, near record highs and surpassing levels of previous debt-limit standoffs in 2011 and 2013.

Bloomberg reports that volatility in the derivatives market has resulted in trading off, which will allow holders to receive handsome returns in the event of a default. Their payment will be equal to the difference between the underlying asset’s market price and par value, an attractive proposition when longer-dated Treasury bonds are trading especially cheap. The potential payout could exceed 2,400% according to Bloomberg calculations.

“I placed some CDX investment-grade security in my fund last week and am looking to add to that position over the next few weeks,” said Luke Hickmore, investment director at Aberdeen. It is also reviewing its exposure to US Treasuries by moving towards longer duration securities.

Hong Kong overnight funding costs at 16-year high

THE cost to borrow overnight in Hong Kong has jumped to a 16-year high as liquidity continued to tighten in the city after repeated currency intervention from the authorities.

The overnight Hong Kong interbank offered rate (Hibor) climbed 37 basis points (bps) to 4.81%, the highest since 2007, on Thursday. The Hong Kong Monetary Authority (HKMA) has been draining liquidity from the banking system to boost the local dollar, and reduce a gauge of interbank liquidity to its lowest since the 2008 financial crisis.

The currency had come under pressure when the gap between Hibor and its US counterpart widened to attractive levels for hedge funds to borrow the city’s dollar cheaply and buy the higher-yielding greenback. The HKMA has spent US$6.5 billion since February to defend the local dollar’s 7.75-7.85 peg with its US counterpart.

Rising demand for the local currency as some firms prepare for dividend payouts during summer is also playing a role in boosting Hibor.

The move “may be a hurdle for USD/HKD to rise back to 7.85 for now”, said Stephen Chiu, chief Asia FX & rates strategist at Bloomberg Intelligence in Hong Kong. “That said, USD/HKD buyers could return if the Federal Reserve refrains from cutting rates and Hibors fail to rise beyond their US counterparts.”


Crypto exchange Bittrex files for bankruptcy

Cryptocurrency exchange Bittrex and several affiliates filed for Chapter 11 bankruptcy on May 8, after its US operations shut down at the end of April in response to a regulatory crackdown.

Bittrex becomes the second largest platform for buying and selling coins to fail after FTX, although the company said that the bankruptcy does not affect its operations outside of the US. The Chapter 11 filing covers the US affiliate, based in Seattle, Washington and Bittrex Global, which serves customers outside the US, will continue to operate as normal, it added.

The filing comes three weeks after theUS Securities and Exchange Commission (SEC) accused the crypto platform of having flouted securities rules for years.

Bittrex announced its intention to wind down in the US on March 31, citing an uncertain regulatory and economic environment. On April 17, the SEC said the company had failed to register as an exchange, broker or clearing agency, an allegation which Bittrex executives said they will challenge. The SEC also sued Bill Shihara, the former CEO of Bittrex and Bittrex Global.

The federal regulator alleges that tokens OmiseGo (OMG), Algorand (ALGO), Dash (DASH), TokenCard (TKN), i-House Token (IHT) and Naga (NGC) are securities. Bittrex should therefore have registered with the SEC and applied specific transparency rules before offering these cryptocurrencies.

SEC Enforcement Director Gurbir Grewal said last month that the lawsuit against Bittrex “should send a message to other non-compliant crypto market intermediaries.

“As laid out in our complaint, Bittrex’s business model was based on three things: circumventing the registration requirements of the federal securities laws; counselling issuers of crypto asset securities to do the same by altering their offering materials; and combining multiple market intermediary functions under one roof to maximize profits,” stated Grewal.

The exchange believes it has more than 100,000 creditors, with estimated assets ranging between US$500 million to US$1 billion, according to a court filing.

Bittrex Global CEO Oliver Linch said that the company will fight the charges in court.

“For over five years, and despite multiple, specific requests to do so, the SEC would not provide notice of the specific conduct that it thought violated the federal securities laws," Bittrex said last month in a statement. "Specifically, on multiple occasions, we asked them to tell us what digital assets on our platform they viewed as securities, so that we could review and potentially delist them. They refused to do so.”

Last month Bittrex told its US customers to withdraw their funds by April 30, when the company shut down its operations, according to its website. For customers who missed the deadline Bittrex said on April 8 that their funds “remain safe and secure” and that its top priority is to ensure that they are made whole.

Banks divided on whether ESG spells risk or opportunity, study finds

Banks’ opinions are divided on whether various environmental, social and governance (ESG) factors should be viewed primarily as risks or opportunities, according to a study issued by global management consultancy Bain & Company.

The group found that many banks plan to launch a range of green products and services over the next few years, although most have yet to integrate climate risks into credit underwriting practices.

Bain and the International Association of Credit Portfolio Managers (IACPM) surveyed 55 banks and interviewed respondents, IACPM’s advisory council, as well as senior risk, finance and sustainability executives.

On both environmental transition and social issues, the survey finds that banks are roughly split between taking “offensive “and “defensive” postures, with a slight leaning in both cases towards offensive. While respondents assess their current ESG positioning as in line to slightly ahead of their peers, a large majority regard their stated ambition of future ESG position as significantly ahead of their competitors.

Banks’ views of risks and opportunities varies significantly by region. European banks appear more bullish on environmental transition factors, with approximately 60% viewing these issues primarily as a source of opportunity or even an “opportunity to create strategic value,” while fewer than one in three respondents in the Americas or Asia Pacific share this view. Conversely, more than half of Americas respondents view social issues primarily as an opportunity, while most Europeans consider social issues to be more of a risk or a balance of risk and opportunity.

Among the key initiatives taken by most banks to capitalise on ESG opportunities is the development of new financial products and services. More than four in five banks already offer green bonds and sustainability bonds; 86% and 84% respectively. The survey suggests that many more green products are on their way, such as green commercial building loans, with 73% of banks expecting to offer these by 2026, compared to 54% today, green car loans, expected by 65% vs 49% today, and green deposits at 57% expected vs 32% today. Other areas slated for significant growth include carbon commodities, green savings accounts, and green credit cards.

The survey finds that banks are at various stages of incorporating ESG risk, such as climate, into their activities. For example, 65% of banks have yet to integrate climate data and metrics into credit underwriting processes, although around one in four intend to do so within a year. European banks are farthest along in this metric, while only around one in five banks in the Americas have integrated these risks.

The report also examines issues that may be hindering banks from incorporating ESG risks or addressing opportunities, with key factors including a lack of frameworks methodologies and tools. For example, while over 80% of respondents report identifying physical and transition risks, only half have actually quantified this exposure or the need to assign roles for ESG accountability.

A key issue affecting the banks’ approach to ESG is a lack of clarity on accountability and decision authority, according to the report. The survey found that nearly two in three of the banks have not yet defined who has primary accountability for identifying and addressing climate risk, and only about half of banks that have already made net zero commitments have integrated climate metrics into performance reviews.

Michael Kochan, partner in Bain & Company’s Financial Services practice, said: “Incorporating ESG strategies into banking operations requires a delicate balance of managing risk and seizing opportunities. The gap between ESG aspirations and results has widened for many financial services institutions, despite increased pressure from stakeholders. Winners will focus strategy to create tangible value from climate-related products, services, and consulting.”


Visa in CBDC project to help Brazilian farmers

Visa has built a prototype of a programmable finance platform for Brazil’s farmers using a central bank digital currency (CBDC), in response to a challenge from the country’s central bank.

The US global payments group was one of nine firms picked by Banco Central do Brasil in March 2022 to participate in the LIFT Challenge Real Digital projects investigating various aspects of a CBDC.

Visa teamed up with Microsoft, agricultural commodities tokenisation specialist Agrotoken and software developer Sinqia to develop its submission; a programmable finance platform for small to medium sized enterprises (SMEs), particularly farmers, designed to enable greater access to global capital markets, facilitate interoperability between currencies, improve operational processes, and uncover new growth opportunities.

Visa says that the prototype is designed to provide local farmers with more timely and greater access to a global pool of investors for financing, allowing them to get the best price for their goods.

Catherine Gu, global head, CBDC, Visa, says: “By contributing our expertise, scale, network, and cutting-edge technologies in this market, we are able to help advance real-world applications of digital currencies — in this case making it possible for a soybean farmer to create and globally auction a tokenised contract on a permissioned version of the Ethereum blockchain, while utilising different forms of money and interoperating between them.”

The programmable aspects of digital currencies, enabling delivery and payment of assets and currencies to be automatically settled only when certain conditions are met, paves the way for more efficient capital usage and reduced counterparty risks, while leveraging the security, stability, and safety of a central bank liability via CBDC as a reliable settlement currency, says Visa.

The prototype platform brings existing financial processes and assets on-chain, allowing farmers to tokenise traditional financing contracts. To achieve this, Agrotoken brought its agriculture-based tokenisation expertise from existing solutions in Brazil and Latin America and Visa delivered a tokenisation process for turning existing Brazilian legal documents into an on-chain tradeable non-fungible token (NFT).

Visa also implemented a new onchain sealed-bid auction mechanism through smart contracts to enable a global pool of investors on the blockchain to participate in the financing process, achieving competitive price discovery. The platform uses Visa’s Universal Payments Channel which can interconnect between the Real Digital and other CBDCs, stablecoins or tokenised deposits, to ensure interoperability between digital currencies across different markets and networks.

Bank of England hikes UK rates to 4.5%

The Bank of England (BoE) has confirmed a 0.25% increase from 4.25% to 4.50% in UK interest rates, its 12th consecutive rise. As many anticipated, the nine-member monetary policy committee (MPC) voted 7-2 for a quarter point hike, matching recent increases by the US Federal Reserve and the European Central Bank (ECB).

The UK’s annual headline inflation rate remains stubbornly high and since peaking at 11.1% last October has stuck above 10%, driven by persistently high food and energy bills, while core inflation also remained unchanged, highlighting the risk of entrenchment. The BoE expects it to fall rapidly from the middle of 2023 to reach around 4% by the end of the year, however.

There is better news on the UK economy which, despite regular forecasts of impending recession, has held up better than expected although GDP was flat in February as widespread strikes and the cost-of-living squeeze hampered activity, while the labour market continues to look resilient.

Commenting on latest rise, Douglas Grant, Group CEO at Manx Financial Group said; “SMEs must take this as yet another reminder to review their existing lending structures and ensure they are prepared for further challenges.

“Many SMEs prepared for these hikes by listening to lenders and locking in their debt into fixed rate structures, but other businesses that were not as forward-thinking face significant uncertainty. According to our research, more than 20% of SMEs in the UK that sought external financing in the past two years were unable to obtain it. Furthermore, over 25% of SMEs had to halt or postpone certain aspects of their operations due to a lack of funding. The unavailability of finance is exacting a toll on SMEs and the UK economy, impeding growth precisely when it is most needed. The magnitude of the hindered growth is substantial and calls for novel solutions to bridge this funding gap.

“Despite the introduction and extension of loan schemes such as the Recovery Loan Scheme (RLS) Phase 3 last year, there is a need for more proactive measures. Since the economic upheaval caused by the pandemic, we have been advocating for a government-backed loan scheme that focuses on specific sectors, bringing together both traditional and alternative lenders to secure the future of SMEs. As the government looks for ways to revitalise the economy in 2023, the significance of implementing a permanent scheme cannot be underestimated. It could be the crucial factor that determines the survival or failure of many companies and, consequently, the overall economy.”

Although there was widespread agreement on today’s rate decision, projections for the rest of the year diverge although many believe UK rates have yet to peak and will reach 5% before they start to come down. The US Federal Reserve implemented a further 25bps hike to 5%-5.25% last week but dropped what the markets interpreted as a tentative hint that its cycle of monetary policy tightening is drawing to a close.

The European Central Bank (ECB) followed the Fed’s lead and increased its benchmark interest rate by 0.25% to 3.25%. The seventh successive rise takes eurozone rates to levels last seen in November 2008.


Japan’s SoftBank posts US$32 billion loss for Vision Fund arm

Japanese multinational investment holding company SoftBank Group said that its venture capital arm Vision Fund, established in 2017, reported a record loss of 4.3 trillion yen (JPY) – around US$32 billion – for the year to March 31 against a JPY2.55 billion loss a year earlier. It added that a recent rally in tech stocks had done little to alleviate another difficult year for its flagship investment unit.

Overall, SoftBank posted a net loss of JPY970.14 billion yen for the fiscal year, narrower than the JPY1.7 trillion loss in the same period a year before. Despite gains from exiting investments in high-profile companies such ride-hailing firm Uber, SoftBank said that it logged losses in areas including the share prices of Chinese artificial intelligence firm SenseTime and Indonesian ride-hailing and e-commerce company GoTo.

A year ago, SoftBank announced that it would go into “defence” mode in response to market volatility and be more disciplined in its investments. It has since announced several exits from some of the most high-profile investments to raise cash and narrowed its overall losses through sales of shares in T-Mobile and China’s Alibaba.

It continues to offload some of its shares in the latter company via a derivative called a forward contract, after CEO Masayoshi Son made his fortune with an early investment in Alibaba more than two decades ago. Last August, SoftBank announced the sale its remaining stake in Uber.

The results announcement comes as the company is reportedly close to a deal to sell US investment manager Fortress Investment Group to Abu Dhabi-based sovereign-wealth fund Mubadala Investment for more than $2 billion, according to insiders.

The deal has yet to be finalised, but if completed would mark another disappointing investment for SoftBank. The decline in value for Fortress, which manages US$46 billion, indicates that it has fallen behind its rivals under SoftBank’s ownership.

A Wall Street Journal report comments: “SoftBank, which has struggled from its investment in hundreds of tech startups through its US$100 billion Vision Fund and a successor fund, purchased Fortress in 2017 for US$3.3 billion. The original deal was part of a surprising effort by the Japanese technology giant to transform itself into one of the world’s largest investment firms.”


Tokenisation “set to transform asset management”

Tokenisation is not only being widely discussed across the asset management industry but is a fast-emerging reality, reports global funds network Calastone. An Autumn 2022 survey of institutional investors by BNY Mellon revealed 97% of respondents agreed that tokenisation ‘will revolutionise asset management’.

Calastone has released a whitepaper on the practical application of tokenisation in asset management. It includes an analysis of the current state of play, the different approaches to tokenisation, the regulatory landscape and considerations for the long-term application of the technology.

The white paper notes that while several industry players have dipped their toes into tokenisation, there are clear limitations to current approaches which seek to simply tokenise units of funds, for example. Tokenising units only serves to add a tokenised layer to an otherwise traditional fund, continuing to perpetuate its core inefficiencies. This approach fails to consider the long-term benefits of tokenisation and its potential to transform the asset management industry as we know it today.

Currently, the asset management industry is plagued by unwieldly manual processes and high costs which prevent asset managers from meeting customers’ evolving expectations and needs. To truly transform the process of investing, the industry needs to think about tokenisation not as a new technology, but as a transformative tool to create a frictionless digital marketplace for asset management; this can only be achieved by tokenising the underlying assets of funds, not just the units.

Changing the fundamental structure of a fund by tokenising at the asset level brings the entire value chain onto a common and digital Distributed Ledger Technology (DLT) platform, thereby increasing efficiency by facilitating real-time flow of data and enabling new levels of collaboration between liquidity partners, custodians, investment managers and distributors.

“The current efforts of industry players are a good start and show recognition that tokenisation is beneficial in asset management,” commented Adam Belding, Chief Technology Officer at Calastone. “Ultimately, however, approaches which do not utilise tokenisation at the asset level will not affect real change long-term as they fail to address fundamental issues with the underlying structure.”


South African rand drops to three-year low on power outage fears

The South African rand has fallen to three-year lows this week while international and domestic government bonds have also fallen, as fears grow of scheduled power blackouts known as loadshedding worsening during winter.

South Africa's struggling state utility Eskom told parliament on Tuesday that there would be a 45-day delay in returning a generating unit online, according to local media.The delay is likely to add further pressure on the grid during winter, when loadshedding across most parts of the country is already more than 10 hours a day.

“SA bonds and the ZAR (rand) are underperforming their emerging market (EM) counterparts,” Kieran Siney of ETM Analytics said in emailed comments.

“Until there is a concrete plan to resolve SA’s energy crisis that the market buys into, the underperformance will persist, notwithstanding the attractive yields on offer and deep undervaluation in the ZAR.”

The government’s local bonds have also dropped, with yields on the benchmark 2030 bond rising 17 basis points to 10.5%, the highest level since December.

ETM Analytics said in a separate note yesterday that misleading headlines on Tuesday had sparked a market rout by giving “the impression that it was losing control of the grid”.

“SA is in trouble, the grid is under pressure, Eskom does face multiple threats, but none of this is anything new,” it said.

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