Author: Martin North

Martin North is the Principal of Digital Finance Analytics

Capital Markets 201 – Part 1

Welcome to the first in a new series of videos and posts in which we discuss the capital markets. It’s important to understand how these markets work because they are such a large element in the financial system, with bonds and other funding instruments, and the mix of derivatives together dominating the markets – and by the way, the risks in the system too. As you will know from our earlier posts, the total value of derivatives in the system globally dwarfs the value of the real economy.

You might like to know that I spent a number of years working in a major bank where I taught capital markets to their senior executives, because they had been subject to a major financial crash during which it became clear that the senior executives in the company had NO idea about how the markets really worked, and the inherent risks which they were taking. Some would say little has changed.

In this introduction I will discuss what we are going to explore in the series, over the weeks ahead.  I am not assuming any prior knowledge of the topic in these shows, so we will start out quite simply, but by the end of the series we will be touching on some really complex, yet interesting concepts.  So do come along for the ride. And I should explain that I called the series “Capital Markets 201” because this is going to be more, much more than a simple 101 overview.

So today, to start, I am going to outline the structure of the series and offer a definition of “Capital Markets”.

The capital markets are simply a market place where buyers and sellers engage in the trade of financial securities like bonds, stocks, and other instruments. This buying/selling may be undertaken by participants as diverse as banks, other financial institutions, companies, government entities and even individuals. The market may exist within a country, and internationally, with the bulk of the transactions relating to Australia for example, being off-shore.

These markets help to channel surplus funds from savers to institutions which then invest them, and many of these trades are in longer-term securities, though as we will see later sort-term funding and also a complex set of derivatives are also important in the sector.

Finally, capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of stocks and bonds, and other securities, whereas secondary markets deals with the exchange of existing or previously-issued securities. Another important division in the capital market is made on the basis of the nature of security traded, i.e. stock market and bond market.

Finally, as well as trading in the underlying securities there are many flavours of derivative. A derivative is a contract between two parties which derives its value/price from an underlying asset. The most common types of derivatives are futures, options, forwards and swaps. Generally stocks, bonds, currency, commodities and interest rates form the underlying asset.

So to the structure of our series of programmes.

We are going to start in the next video with the concept of the time value of money. It’s essential to understand that capital markets are essentially all about manipulating cash flows. So we need to know about how to assess cash flows, and develop some basic language to describe them. We will also touch on concepts such as compound interest, current and future value, and internal rates of return.

Next we will look at the treasury operations in banks and other large corporations, and discuss the concept of disintermediation, where companies behave like banks in their own right. We will also meet archetypical “Belgium Dentists” and where they put their money.

After that, we will start looking at the individual instruments which make up the Capital Markets armoury. So we will look at bonds and other funding instruments, and how they work, and the different flavours which are out there. These instruments are the bedrock of the capital markets, so we will look at who might buy and sell such instruments.

Once we understand how bonds work, we can then start to explore the more complex derivatives areas of the capital markets.

We will look at futures and options contracts and how they work. This is a big area and we will look at both contracts relating to physical commodities like corn and pork bellies as well as financial contracts.

We will take a deep dive into interest rate and currency swaps and options, an area which I find really interesting.  And there are a number of other variants which we will also touch on.

Then towards the end of the series we will start looking at financial engineering, where these various products are put to work. I will look for example at securitisation (I was involved in some of the early transactions in the 1990’s).

And as we bring the series to a close we will look at the risks in the system, the way the markets are regulated, or not, and some of the gaps in reporting and disclosure.

So buckle up, and enjoy the ride.  And by the way, I will run a couple of live Q&A events as we progress through the series, and I will also try and answer questions as we go though, so do post any you may have.

Watch out for the next episode – The Time Value of Money – coming soon.

And by the way, if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content. Here is the link, and it’s in the comments below.

ASIC commences civil penalty proceedings against ANZ

ASIC has commenced civil penalty proceedings in the Federal Court of Australia against Australia and New Zealand Banking Group Limited (ANZ) for an alleged continuous disclosure breach in relation to a $2.5 billion institutional share placement undertaken by the ANZ in 2015.

On 6 August 2015, ANZ issued a release to the Australian Securities Exchange (the ASX) entitled “ANZ announces Institutional Placement (fully underwritten) and share Purchase Plan to raise a total of $3 billion”.

On 7 August 2015, ANZ issued a release to the ASX in respect of the placement stating among other things, “ANZ today announced that it had raised $2.5 billion in new equity capital through the placement of approximately 80.8 million ANZ ordinary shares at the price of $30.95 per share”.

ASIC alleges that that ANZ contravened s.674(2) of the Corporations Act by failing to notify the Australian Securities Exchange (ASX) that approximately $791 million of the $2.5 billion of ANZ shares offered in the Placement was to be acquired by its underwriters rather than placed with investors.

ASIC is seeking a declaration that ANZ breached its continuous disclosure obligations and a pecuniary penalty order.

The proceedings are to be listed for a case management hearing in the Federal Court in Melbourne on a date to be fixed.

ASIC will be making no further comment at this time.

The Unlevel Playing Field – APRA’s Committed Liquidity Facility $243 Billion For 2019

APRA today published a letter relating to the Committed Liquidity Facility which is available to just 15 of the banks in Australia (The LCR banks). These have the back-stop option of calling on funds from the RBA to buttress their liquidity in case of need – so they can meet their obligations under the Basel III regime.

For a fee, if used, these banks essentially have a safety net in times of distress. Now APRA has outlined the arrangements for next year. Of course the other lenders have to operate without these supports.

More evidence of a lack of a level playing field in the system, and how the regulators are supporting the big end of town. No surprise then that big players are regarded by the markets as too big to fail.

But as Australian Government debt is hurtling beyond $500 billion, I have to say their so called justification – lack of liquidity in the local securities (mainly Australian Government Securities and securities issued by the borrowing authorities of the states and territories) is wearing a bit thin.

Why is this facility needed at all?

This is what APRA said today:

The Australian Prudential Regulation Authority (APRA) is today releasing aggregate results on the Committed Liquidity Facility (CLF) established between the Reserve Bank of Australia (RBA) and certain locally incorporated ADIs that are subject to the Liquidity Coverage Ratio (LCR).

APRA implemented the LCR on 1 January 2015. The LCR is a minimum requirement that aims to ensure that ADIs maintain sufficient unencumbered high-quality liquid assets (HQLA) to survive a severe liquidity stress scenario lasting for 30 calendar days. The LCR is part of the Basel III package of measures to strengthen the global banking system.

In December 2010, APRA and the RBA announced that ADIs subject to the LCR will be able to establish a CLF with the RBA. The CLF is intended to be sufficient in size to compensate for the lack of sufficient HQLA (mainly Australian Government Securities and securities issued by the borrowing authorities of the states and territories) in Australia for ADIs to meet their LCR requirements. ADIs are required to make every reasonable effort to manage their liquidity risk through their own balance sheet management before applying for a CLF for LCR purposes.

Committed Liquidity Facility for 2019

All locally incorporated LCR ADIs were invited to apply for a CLF amount to take effect on 1 January 2019. All fifteen ADIs chose to apply. Following APRA’s assessment of applications, the aggregate Australian dollar net cash outflow (NCO) of the fifteen ADIs was estimated at approximately $381 billion. The total CLF amount allocated for 2019 (including an allowance for buffers over the minimum 100 per cent requirement) is approximately $243 billion.

($ billion) 2015 2016 2017 2018 2019
Total forecast NCO 410 402 400 387 381
Available AGS and semis 175 195 220 226 225
Total CLF made available 275 245 223 248 243

When this arrangement was announced in 2011 the RBA said:

The Committed Liquidity Facility

The CLF will enable participating ADIs to access a pre-specified amount of liquidity by entering into repurchase agreements of eligible securities outside the Reserve Bank’s normal market operations. To secure the Reserve Bank’s commitment, ADIs will be required to pay ongoing fees. The Reserve Bank’s commitment is contingent on the ADI having positive net worth in the opinion of the Bank, having consulted with APRA.

The facility will be at the discretion of the Reserve Bank. To be eligible for the facility, an ADI must first have received approval from APRA to meet part of its liquidity requirements through this facility. The facility can only be used to meet that part of the liquidity requirement agreed with APRA. APRA may also ask ADIs to confirm as much as 12 months in advance the extent to which they will be relying on a commitment from the Bank to meet their LCR requirement.

The Fee

In return for providing commitments under the CLF, the Bank will charge a fee of 15 basis points per annum, based on the size of the commitment. The fee will apply to both drawn and undrawn commitments and must be paid monthly in advance. The fee may be varied by the Bank at its sole discretion, provided it gives three months notice of any change.

Eligible Securities

Securities that ADIs can use under the CLF will include all securities eligible for the Reserve Bank’s normal market operations. In addition, for the purposes of the CLF, the Reserve Bank will allow ADIs to present certain related-party assets issued by bankruptcy remote vehicles, such as self-securitised residential mortgage-backed securities (RMBS). This reflects a desire from a systemic risk perspective to avoid promoting excessive cross-holdings of bank-issued instruments. Should the ADI lack a sufficient quantity of residential mortgages, other ‘self-securitised’ assets may be considered, with eligibility assessed on a case-by-case basis.

The Reserve Bank has discretion to broaden the eligibility criteria and conditions for the various asset classes at any time. The Bank will provide one years notice of any decision to narrow the criteria for the facility.

Interest Rate

For the CLF, the Bank will purchase securities under repo at an interest rate set 25 basis points above the Board’s target for the cash rate, in line with the current arrangements for the overnight repo facility.

Margining

The initial margins that the Reserve Bank will apply to eligible collateral will be the same as those used in the Bank’s normal market operations. Consistent with current practice, each day the Bank will re-value all securities held under repurchase agreements at prevailing market prices.

Termination

Subject to the ADI having positive net worth, the Reserve Bank will give at least 12 months notice of any intention to terminate the CLF. The Bank’s commitment to any individual ADI will lapse if the fee is not paid.

 

 

ASIC gave CBA 96% penalty discount for misleading consumers

The Hayne royal commission has learned that the corporate watchdog allowed CBA to pay a substantially reduced fine despite misleading customers in its advertising, via InvestorDaily.

The royal commission has heard that ASIC not only gave CBA a severe discount for the misleading conduct but also let Australia’s biggest bank draft the media release regarding the action.

Senior counsel assisting Rowena Orr, QC opened Thursday’s hearing by questioning Helen Troup, the executive general manager of CBA’s insurance business CommInsure.

Ms Troup was taken through four pieces of advertising for CommInsure’s life and trauma insurance policy to determine how they discussed coverage for a heart attack.

Ms Troup accepted that in every case someone reading the adverts would believe the trauma policy covered all heart attacks.

The royal commission heard that CommInsure made a $300,000 voluntary community benefit payment as part of its agreement with ASIC to resolve the issue of misleading advertising.

Ms Orr pointed out to the commission that the maximum penalty for misleading conduct was 10,000 penalty units or almost $2 million per contravention.

In this instance, as Ms Troup had agreed to four adverts being misleading, it could have led to a fine of $8 million. But CommInsure only had to pay $300,000 as part of its agreement with ASIC to resolve the issue.

ASIC in fact seemed to have asked CBA if they thought the $300,000 was appropriate as Ms Orr read out to the commission a letter from the senior executive of ASIC, Tim Mullaly, addressed to CBA:

Could you please consider and let us know whether this is sufficient for CommInsure to resolve the matter, including by way of payment of the community benefit payment, in absence of infringement notices.

This provoked commissioner Hayne to ask if it was a case of the bank stipulating the terms of the punishment.

“The regulator asking the regulated whether the proposal was sufficient in the eyes of the party alleged to have broken the law, is that right?” he asked.

“We could have taken the approach of continuing to defend our position, so this was the alternative,” Ms Troup said.

Commissioner Hayne continued and asked Ms Troup if CommInsure viewed the community payment as a form of punishment.

“The $300,000 community benefit payment was a form of punishment,” she said.

Up until today’s hearing, CBA had not acknowledged the misleading adverts and had even advised ASIC on what language to use in their press release, said Ms Orr.

Ms Orr concluded by summarising that ASIC had given CommInsure notice of its findings, took no enforceable action and gave CommInsure the opportunity to make changes to the media release.

Employment Booms (A Little)

The trend unemployment rate decreased from 5.4 per cent to 5.3 per cent in the month of August 2018, according to the latest figures released by the Australian Bureau of Statistics (ABS) today.


ABS Chief Economist Bruce Hockman said that “since last August, the trend unemployment and underemployment rates have both fallen. As a result, underutilisation in Australia was at its lowest level since late 2013, at 13.6 per cent.”

Employment and hours

Trend employment increased by around 29,000 persons in August 2018 with full-time employment increasing by around 21,000 persons.

The trend participation rate remained steady at 65.6 per cent in August 2018, after the July figure was revised up.

“For those people aged 15 to 64 years, trend participation was the highest on record. Female participation in this age group, at 73.2 per cent, was also a record high,” Mr Hockman said.

Over the past year, trend employment increased by around 300,000 persons or 2.5 per cent, which was above the average year-on-year growth over the past 20 years (2.0 per cent).

The trend monthly hours worked increased by 0.1 per cent in August 2018 and by 1.8 per cent over the past year.

States and territories

For most states and territories, year-on-year growth in trend employment was at or above their 20 year average, except for Western Australia, Tasmania and the Australian Capital Territory. Over the past year, the states and territories with the strongest annual growth in trend employment were New South Wales (3.6 per cent), the Northern Territory (3.0 per cent) and Victoria (2.5 per cent).

Seasonally adjusted data

The seasonally adjusted number of persons employed increased by around 44,000 persons in August 2018. The seasonally adjusted unemployment rate remained steady at 5.3 per cent, the underemployment rate decreased to 8.1 per cent and the underutilisation rate decreased to 13.4 per cent. The labour force participation rate increased to 65.7 per cent.

The net movement of employed in both trend and seasonally adjusted terms was underpinned by well over 300,000 people entering employment, and more than 300,000 leaving employment in the month.

Chinese real estate investment in Australia drops by nearly 30%

While Asia and Europe enjoyed the highest Chinese investment growth in 2017, Australia and New Zealand experienced significant drops, according to Juwai.com’s Chinese Global Property Investment Report. The report provides an estimate of actual Chinese investments in Australian residential and commercial property; via MPA.

According to the report, total Chinese property investment in the two countries fell by 23.2%, from $23.9bn to $18.4bn. Although Australia recorded the largest share of the decline, Chinese investment in the country still remains substantial. Chinese purchases of residential and commercial properties in Australia dropped by 26.8%, from $24bn to $17.4bn.

In a statement, Juwai.com CEO and director Carrie Law said their estimate of Chinese investment in Australian property is based on industry data that helped them calculate the roughly $100bn-worth of new dwelling sales in the country last year.

“About one-quarter of those went to foreign buyers, and that Chinese buyers accounted for about three-quarters of foreign buyer spending. That yields about $19.4bn (US$14.1 billion) in estimated Chinese residential investment,” Law said.

Law attributes last year’s reduced Chinese investment to capital controls, restrictions on bank financing to offshore buyers, and to new foreign buyer taxes and restrictions. She expects moderate growth this year, “which is in line with Beijing’s goal of managed, rational overseas investment”.

Chinese buyers still consider Australia to have long-term value despite the higher stamp duties, Law added. The majority of Juwai’s residential buyers are purchasing properties in the country because they have kids studying or working there, or because it’s a place they plan to visit regularly or retire in.

“Australia offers a stable environment, safety, quality educational institutions, and high quality of life. Both Sydney and Melbourne rank in the top five most liveable cities in the world,” Law said

The report also showed that other than the U.S., Hong Kong, and Japan, Australia was China’s top destination for commercial property investment. Overall, Chinese international property investment rose to $65.9bn, with Australia, U.S., Hong Kong, and Malaysia receiving the most investment.

“Sources like KPMG suggest that Chinese commercial real estate investment accounts for one-third of all Chinese corporate direct investment in the country. Political tensions between the two countries have a greater impact in creating uncertainty with corporate commercial real estate investors than they do with individual investors buying residential property for their own use,” Law said.

More From The Property Front Line

I discuss in more detail the latest developments in the property market with Chris Bates, Financial Adviser and Mortgage Broker, drawing from his direct experience in the market.

Chris can be found at at www.wealthful.com.au and at www.theelephantintheroom.com.au plus via LinkedIn.

Please consider supporting our work via Patreon. 

Please share this post to help to spread the word about the state of things….

 

CBA ignored ASIC to deny claims payout

CBA’s life insurance business CommInsure has admitted to not following recommendations from the corporate regulator to update its medical definition of a heart attack so it could deny the payout of a trauma claim to one of its customers, via InvestorDaily.

On Wednesday, the royal commission heard that ASIC had sent a letter to CommInsure flagging its concerns that its reliance on outdated medical definitions in assessing claims – while not in breach of the duty of utmost good faith in Section 13 of the Insurance Contracts Act – fell significantly short of consumer expectations.

The counsel assisting Rowena Orr cited a letter from 22 March 2017 from the ASIC deputy chair at the time, Peter Kell, who noted that in, 2012, the European Society of Cardiology, the American College of Cardiology, the American Heart Association and the World Health Federation published an expert consensus document about the definition of heart attacks.

Sitting in the witness box, CommInsure managing director Helen Troup was questioned by Ms Orr on whether she was aware that this had been reached at the time.“Yes,” Ms Troup said.

“And that report endorsed the use of troponin as a means of detecting heart attacks?” Ms Orr continued.

“Yes,” Ms Troup responded.

“And the report said that laboratories should use a cut-off value of the 99th percentile of a normal reference population to determine whether there had been a heart attack?” Ms Orr said.

Ms Troup replied in the affirmative.

Ms Orr then noted Mr Kell’s comments in the letter that CommInsure’s decision to select the 11 May 2014 as the effective date of the change had no robust rationale, given the joint report was published in 2012.

She then noted the letter said CommInsure’s conduct was unreasonably slow in responding to the changes in medical practice, that it was on notice that the standard was to be updated and had not done that even three years after the joint report was published, and that seven other insurers had updated their definition by 11 May 2014.

“While this is not contrary to the law, it is ASIC’s view that this has unfairly impacted on some consumers and better practice would be to select an earlier date,” Ms Orr said.

What Have The Big Beasts In The Mortgage Industry To Fear?

Hot on the heels of Slater & Gordon launch of the ‘Get Your Super Back’ campaign, today I discussed the current state of the mortgage industry with Roger Brown a prime mover in the class action being planned against both major lenders and banking regulators. Looks like November will be an important check point.