DERIVATIVES - mapage.noos.frmapage.noos.fr/capitalaction/index/DERIVATIVES-CJN-final.pdf · 2010 H2...
Transcript of DERIVATIVES - mapage.noos.frmapage.noos.fr/capitalaction/index/DERIVATIVES-CJN-final.pdf · 2010 H2...
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DERIVATIVES Which banks are the potential Fukushimas?
11 December 2013
Christophe Nijdam Bank Equity Analyst
As bank equity analysts, we are concerned with the two channels by which bank systemic risk spread the most, i.e. liquidity and derivatives, destroying an enormous amount of shareholder value in the process, not to forget other stakeholders (the real economy, taxpayers, depositors, bank employees, society as a whole, etc.) Christophe Nijdam’s headstart exposure in derivatives: 1983 : co-founded the derivative group at CCF (now HSBC France) 1985 : co-invented the so-called CIRCuS (cross interest rate and currency swaption) Supervised the unwinding/running-off of an off balance sheet OTC interest rate derivative portfolio that had reached 6 times the size of the cash balance sheet at Crédit du Nord USA (then a Paribas subsidiary) in 1989-1990
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DERIVATIVES
Why this research memo?
3
Value-at-Risk (VaR) starts being disseminated around trading rooms
$80trn (3x 1998 GDP)
$630trn (10x 2012 GDP)
LTCM meltdown September 1998
Gramm-Leach-Bliley Act repeals the Glass-Steagall Act November 1999
Lehman failure September 2008
Bank of America, Derivatives 1995-2012
Source : FDIC
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($)
The notional amount is the face value of the derivative contract: it is used as a reference to calculate payments
e.g. IRS fixed rate (4%) against Libor (0.5%) on €100M swap agreement (€100M x 4%) – (€100M x 0.5%) = €3.5M net interest payment
e.g. CDS 75% loss/25% recovery €100M x 75% = €75M credit insurance net payment
The notional amount does NOT reflect the risk associated with such contract (see above IRS/CDS example)
However, the notional amount indicates the volume of activities of a bank in derivatives:
e.g., it’s the volume of credit insurance policies sold and/or bought (CDS),
the volume of interest rate insurance policies sold and/or bought (IRS),
etc.
The industry prefers to speak about « gross market values », ie the cost of replacing the contract at current market prices, as it downplays and understates the size of the actual risk (see CDS example) in a systemic crisis
If another indication of the relevance of the notional amount vs gross market value was needed, initial margin requirements for CCP (see further) are computed on notionals…
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DERIVATIVES
What is a NOTIONAL derivative amount?
($)
0,00%
1,00%
2,00%
3,00%
4,00%
5,00%
6,00%
7,00%
H1 2006
H2 2006
H1 2007
H2 2007
H1 2008
H2 2008
H1 2009
H2 2009
H1 2010
H2 2010
H1 2011
H2 2011
H1 2012
H2 2012
H1 2013
Gross Market Values/Notional Amounts Source: B.I.S., AlphaValue
See further about « how much a loss in notional is needed to wipe out equity »
GMV multiplied by c.3x from 2.16% in H1 07 to 5.89% in H2 08…
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DERIVATIVES
Gross Market Values vs Notional Amounts (%)
($)
It’s an off-balance sheet information which is disclosed in the footnotes attached to financial statements
Most banks do not split notional amounts between assets and liabilities, giving rise to double-count
The « counterparty risk » remains on full notional amounts (unless there is a valid netting agreement between, e.g., two banks, or a bank and a corporate)
What we find « on » balance sheets are fair (market, or worse, model) values of such derivatives, also roughly equivalent to « gross market values of contracts » (ie the theoretical cost of replacing the contracts at current market prices – see previous slide)
There are accounting differences in « on » balance sheets between US GAAP (partial netting of derivatives) and IFRS (no netting allowed); hence, IFRS balance sheets are larger vs US GAAP
But there is no accounting difference in NOTIONAL amounts between US GAAP and IFRS
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DERIVATIVES
Where do we find NOTIONAL derivative amounts?
($) On balance sheet
Off balance sheet
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DERIVATIVES
Notional derivative amounts (e.g. Goldman Sachs vs BNP Paribas)
($)
On balance sheet
Off balance sheet
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DERIVATIVES
Notional derivative amounts (e.g. Goldman Sachs vs BNP Paribas)
($)
-
100 000
200 000
300 000
400 000
500 000
600 000
700 000
800 000
H1 2006 H2 2006 H1 2007 H2 2007 H1 2008 H2 2008 H1 2009 H2 2009 H1 2010 H2 2010 H1 2011 H2 2011 H1 2012 H1 2012 H1 2013
Total notional derivatives o/w Interest rate o/w Forex o/w CDS
$692,908bn = 100% $706,884bn
$73,121bn = 11%
$561,299bn = 81%
$24,349bn = 4%
$683,814bn
$58,242bn = 10%
Source: B.I.S.
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DERIVATIVES
Global OTC derivative notional amounts (in US$ Billion, no double-count)
($)
$bn
Asian banks
other European banks
Swiss banks
French banks
British banks
American banks
In addition, please note that Liborgate / Euriborgate is driven by derivatives « within » Universal banks (only deposit-taking banks can participate in the rate-fixing panels; pure investment banks can’t)
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DERIVATIVES
Following the repeal of the Glass-Steagall Act, derivatives growth went haywire
Total notional derivatives by country of banks 1998-2013 (source: Berruyer, B.I.S. and bank annual reports)
H1 98 H1 00 H1 02 H1 04 H1 06 H1 08 H1 10 H1 12
($)
A naked CDS is buying a credit insurance policy without owning the underlying credit risk (bonds, loans, etc.), i.e. without an « insurable event »
In the insurance industry, you must own the underlying risk to have an « insurable event » and be allowed to insure that risk with an insurer
In essence, a naked CDS is like bying a fire insurance policy on your neighbour’s house
On top of that, with naked CDSs, there are no limits on the numbers of fire insurance policies you can buy on your neighbour’s house
Guess what happens next?
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DERIVATIVES
What is a NAKED Credit Default Swap (CDS)?
($)
• Report dated 20 September 2013 (extracts)
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DERIVATIVES
What does the ESMA say in its latest report on « Trends, risks, vulnerabilities »?
($)
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DERIVATIVES
What does the ESMA say in its latest report on « Trends, risks, vulnerabilities »?
($)
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DERIVATIVES
What does the ESMA say in its latest report on « Trends, risks, vulnerabilities »?
($)
* Core Tier 1 ratio of…20.7% (sic!) on 30 September 2013
Dexia failed twice on liquidity despite sufficient solvency ratios* both in September 2008 and September 2011
Dexia is still a systemic institution despite its shrinking balance sheet (« only » €238bn on 30 September 2013, down from €651bn on FYE 2008), hence the €85bn government refinancing guarantees (running until… 2076)
Dexia has latent losses of €29bn on €450bn in notional interest rate derivatives (6.4%... Who said that IRS were riskless?) – source: testimony of Dexia’s management in front of the French parliament on 22 May 2013
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DERIVATIVES
Dexia remains systemic through the liquidity and derivatives contagion channels
($)
« Propagator » of the value at risk (VaR) through its listed subsidiary RiskMetrics from the mid-nineties onwards – VaR is equivalent to managing risk by looking in the rear window mirror while not watching the blockroad ahead. Additionnally, danger comes from the blind spot (« angle mort ») in the mirror (« 99% confidence level does not tell you how much you will lose in the 1% occurrence/fat tail « Black Swan » syndrome)
VaR is responsible for the bloating of trading activities and the outgrowth of derivatives
Stumbled with the London Whale in the Spring 2012: $6.2bn loss on a $100bn CDS derivative portfolio (supposedly a « hedging » gone wrong) = a 6.2% loss in a few weeks
AIG London/Banque AIG France (efficient French « home supervision » from the ACP!), SwissRe, CDPCs, etc. all needed « bailouts » on CDSs
Tantamount difference in risk between an IRS and a CDS, but IRS is not riskless (see Dexia)
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DERIVATIVES
JPMorgan, the « best of class » in risk management, tripped over the London Whale
Usual suspects… the Global Trading and Universal Banks
(G-TUBS)
The Bank for International Settlements (BIS) identified 20 « universal banks » as part of the 28 « Global Systematically Important Financial Institutions » (G-SIFIS)
(April 2013)
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DERIVATIVES
« Universal banks » overweighted in the list of world systemic banks
Fitch has coined a specific category: the G-TUBS (« Global Trading and Universal Banks »), a select group of 12 banks (7 European – o/w 2 French, 5 American)
(10 October 2013)
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DERIVATIVES
Usual suspects… the Global Trading and Universal Banks (G-TUBS)
($)
-
10 000 000
20 000 000
30 000 000
40 000 000
50 000 000
60 000 000
2006 2012
e.g. €55,605bn for Deutsche Bank
No data for BBVA, Caixabank, Sabadell; no data in 2006 for Credit Suissse
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DERIVATIVES
Notional derivative amounts – 38 European banks – AV universe (€bn)
($)
-
500 000
1 000 000
1 500 000
2 000 000
2 500 000
3 000 000
3 500 000
2006 2012
No data for Caixabank, Sabadell; no data in 2006 for Credit Suisse and BNP Paribas
e.g. €2,622bn for Deutsche Bank
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DERIVATIVES
Notional CDS amounts – 38 European banks – AV universe (€bn)
($)
0,00
10,00
20,00
30,00
40,00
50,00
60,00
70,00
80,00
90,00
100,00
Cred
it Su
isse
UBS
Barc
lays
Roya
l Ban
k O
f Sco
tland
BNP
Parib
as
Dans
ke B
ank
Deut
sche
Ban
k
Nor
dea
Hsbc
Soci
été
Géné
rale
Créd
it Ag
ricol
e
Skan
dina
visk
a En
skild
a Ba
nk
JP M
ORG
AN
Sant
ande
r
BOA
MER
RILL
LYN
CH
Lloy
ds B
anki
ng G
roup
Nat
ixis
CITI
GRO
UP
Swed
bank
MO
RGAN
STA
NLE
Y
Com
mer
zban
k
GOLD
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SAC
HS
KBC
Groe
p
Dexi
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Uni
cred
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Sven
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Hand
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Inte
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Bank
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Banc
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Med
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EFG
Inte
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l
Notional amount / domestic GDP (2012)
No data for BBVA, Caixabank, Sabadell
e.g. 86 times Swiss GDP for Credit Suisse (relevant to determine domestic SIFIs)
Nb of times (x) #1 bank market cap
in the world, Warren Buffett is a large shareholder
Swiss, British, Danish and Swedish « finishes »
No French or German « finish »....
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DERIVATIVES
Notional derivative amounts relative to domestic GDP (2012) – 45 banks
($)
0,00
0,50
1,00
1,50
2,00
2,50
3,00
3,50
4,00
4,50
5,00
Notional amount / EU GDP (2012)
No data for BBVA, Caixabank, Sabadell
e.g. 4.5 times European GDP for Deutsche Bank
Nb of times (x)
Listed benchmark
Unlisted « marker »
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DERIVATIVES
Notional derivative amounts relative to European GDP (2012) – 45 banks
($)
0,00%
2,00%
4,00%
6,00%
8,00%
10,00%
12,00%
14,00%
16,00%
Total notional equity wipe out
38 European banks – AV universe. No data for BBVA, Caixabank, Sabadell
Weighted average: 29bp
Higher risk
Lower risk
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DERIVATIVES
How much a loss in notional derivatives is needed to wipe out equity (2012)?
0,00%
0,10%
0,20%
0,30%
0,40%
0,50%
0,60%
0,70% Total notional equity wipe out
Focus on the top 15 out of 38 European banks
38 European banks – AV universe. No data for BBVA, Caixabank, Sabadell
Read: a 16bp loss on BNP Paribas’ €48,300bn notional amounts would wipe out its €78.6bn
group share equity
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DERIVATIVES
How much a loss in notional derivatives is needed to wipe out equity (2012)?
($)
0,00%
50,00%
100,00%
150,00%
200,00%
250,00%
Wipe out CDS only
Weighted average: 765bp
38 European banks – AV universe. No data for BBVA, Caixabank, Sabadell
Higher risk
Lower risk
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DERIVATIVES
How much a loss in notional CDS is needed to wipe out equity (2012)?
($)
0,00%
5,00%
10,00%
15,00%
20,00%
25,00%
Wipe out CDS only
Focus on the top 13 out of 38 European banks
38 European banks – AV universe. No data for BBVA, Caixabank, Sabadell
Read: a 374bp loss on BNP Paribas’ €2,100bn notional CDS would wipe out its €78.6bn
group share equity
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DERIVATIVES
How much a loss in notional CDS is needed to wipe out equity (2012)?
($)
0,00
10,00
20,00
30,00
40,00
50,00
60,00
38 European banks – AV universe. No data for BBVA, Caixabank, Sabadell
Notional amounts x times balance sheet size (2012 total assets)
Possible leverage problems
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DERIVATIVES
Notional amounts will be part of the denominator in the future leverage ratio
Basel 3/CRD4, EMIR
($)
National « finishes » (= regulatory ratios higher than Basel 3/CRD4):
• Swiss (Ti1) – we understand why when looking at the derivative sizes at CS and UBS! • US (leverage, LCR) • British (CT1, leverage) – ditto Barclays and RBS • Danish (CT1, LCR) • Swedish (CT1, LCR) • Norwegian (CT1) • Brazil (total capital of 11% vs 8%) • China (total capital of 9% vs 8%) • India (T1 of 7% vs 6%, leverage of 4.5%)
Ringfencing • (See US Volcker, US Tarullo rule, UK Vickers, CS in Switzerland, but Liikanen is burried in Europe) • but US bank « push-out » of derivatives (into specific subsidiary outside of government deposit guarantee) has been overturned by the lobby on 30 October 2013
No « finish » at all or « ringfencing » in Germany and France (Deutsche Bank, BNP Paribas)
EMIR
• Required H2 14: Central Counterparty Clearing Houses (CCPs) for standard derivatives, but counterparty definition loopholes (SPVs, local authorities, etc.) • Required 12/02/14: 6 trade repositories with Legal Entity Identifier (LEI) approved by ESMA in Europe (DTCC in the US) – who/what/where • Required 01/12/15-01/12/18: Initial margins for non-CCP OTC (see next slide), Master Netting Agreements
Dodd Frank in the US • Swap Execution Facilities (SEF) since October 2013 = 18 electronic trading platforms increasing competition and transparency • Problematic of the US CFTC extra-territoriality rules when one US counterpart
In Europe • Projects for Organised Trading Facilities (OTF)
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DERIVATIVES
Risk mitigations: regulations (Basel 3/CRD4, EMIR), if not enucleated by lobby
ASSET CLASS Initial margin requirement (% of notional exposure)
Credit : 0-2 year duration 2
Credit : 2-5 year duration 5
Credit : 5+ year duration 10
Commodity 15
Equity 15
Foreign exchange 6
Interest rate : 0-2 year duration 1
Interest rate : 2-5 year duration 2
Interest rate : 5+ year duration 4
Other 15
($)
Source: « Margin requirements for non-centrally cleared derivatives », BIS & OICV-IOSCO, September 2013
Assuming a 3% p.a. funding cost for the margin requirement/collateral, a 1% initial margin on a 2-year IRS would cost 3bp p.a. (1% x 3%) while a 15% margin on an equity derivative would cost 45bp p.a. (15% x 3%), the price of safety against the systemic impact of the speculative portion of derivatives disguised as « market making »
An IMF report in 2010 estimated that ¼ of IRS, 1/3 of CDS and 2/3 of other OTC derivatives are not « standard » enough to be operated through CCPs. Based upon H1 13 notionals, it’s c.$220trn, or 1/3 of the total derivative market, which can’t be processed through the CCPs. Hence, margin requirements are crucial to help contain systemic risks on non-CCP OTC derivatives
With a cumulative 34% market share in equity derivatives in 2011 (source: JPMorgan research), the 4 listed French banks are reportedly currently lobbying the hardest against the 15% initial margins in equity derivatives and the 0.01% TTF on such equity derivatives
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DERIVATIVES
The initial margin requirements on non-CCP OTC that lobbyists want to kill
($)
Number of daily changes +/- 2% per year in the S&P 500
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DERIVATIVES
The case for initial margins in equity derivatives
Implicit volatility VIX Index
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DERIVATIVES
We live in a volatile world with Blackswans becoming the norm
The real challenge behind the European TTF
Deflating the derivative bubble
($)
10bp TTF on cash products (equities, bonds, money market funds) is plain stupid
1bp TTF on derivative notional amounts is smart as it reduces substantially the economics behind the market making/disguised prop trading bubble in derivatives
as a reminder, daily trade volume in F/X reached $5,300bn (BIS, April 2013), up from $4,000bn in 2010 and $3,300bn in 2007:
world trade ($18,300bn in merchandise and $4,300bn in services in 2012, WTO) is « covered » in 4 days
and world capital markets/global financial assets ($225,000bn, McKinsey, March 2013) are « hedged » in 42 days
or in 9 business weeks altogether (17% of a calendar year)
we wonder what F/X trader do at their desk the rest of the year? Counting beans or trifles?
by some estimates (BIS), only 7-8% of derivatives would be with end-users and 92-93% with « financial institutions » (the Merry-Go-Round of the G-TUBs with implicit state guarantees pertaining to their 2B2F status)
by some estimates, the TTF would induce a 75% reduction in European F/X volume and a contraction between 70% to 90% in other European derivative trading volumes (EC, 2013b) - (Great! What are we waiting for?) (100% - 75% = 25% - 7% end-users = 18% left for « real » market making)
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DERIVATIVES
The real challenge behind the European TTF: deflating the derivative bubble
($)
Which banks would lose the most from CCPs, initial margins [and European TTF on derivatives]
0,00%
0,05%
0,10%
0,15%
0,20%
0,25%
0,30%
0,35%
38 European (AV universe) + 6 American banks. No data for BBVA, Caixabank, Sabadell. Dexia excluded (in runoff)
Market cap on 30 November 2013 over 2012 notional derivative amounts
Highest market value sensitivity to derivatives
Banks in countries without domestic « finish » above Basel 3 requirements are underlined in pink
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DERIVATIVES
Which banks are the potential Fukushimas of the derivative time bomb?
Major shareholder of Wells Fargo, the world largest bank market cap
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DERIVATIVES
Remember what the smart money said