TheChek News Flow

- Says: "Authorities in charge for monetary policy should give an adequate answer to this (problem) in order to prevent inflation expectations from falling... This would be a disaster for the euro zone and for high-debt countries in particular... The real tragedy for Italy is falling productivity."

Stories from the sewers reveal the mundanity of London’s excess

This is not about the supercharged pace of life, but something existential, says Gautam Malkani

After last week’s European elections, the results of the continent’s collective urine test.

Mercifully, the EU drugs agency has been taking samples straight from our sewers, not fumbling about with half a billion warm plastic pots. But the researchers could have spared themselves even that bother. London already knew it was the cocaine capital of Europe, and its citizens would not be proper cokeheads if they did not brag about it (no matter that Antwerp actually scored higher). Earlier this month, the capital boasted that a separate study found traces of the drug in the UK’s drinking water. What is more, Londoners like snorting on school nights: the city’s consumption appears to peak on Tuesdays.

As if to underscore the new normality of all this, two days after the EU reported its findings from city sewers, the Office for National Statistics announced it would be adding proceeds from illegal drug deals to the UK’s national accounts.

London’s work-hard, play-hard ethos has always put the city in overdrive – and nostrils have long been a favourite fuel inlet. But this week’s developments have brought home the increasing mundanity of the capital’s excesses.

Cocaine used to be the champagne of illegal narcotics. Now, even champagne no longer feels like champagne when you can order a glass of Dom Pérignon in the middle of a Westfield shopping mall. Ubiquity and wider social acceptance have put the devil’s dandruff on a shoulder-shrugging par with supermarket sushi. Even scoring the stuff no longer holds the same illicit thrill when you can just find a dealer in your local pub.

This is not substance-abuse snobbery. It is just the numbing that happens when a global city needs bigger and bigger hits just to provide the same fix for residents, visitors and inward investors. When West End theatres have to cast Hollywood A-listers just to get productions off the ground and when their neighbouring cinemas replace popcorn with “grilled polenta, tomato fondue, wild mushrooms and parmesan sauce” – duly served by waiters who will top up your wine glass in the middle of the car chase.

Just as the capital sustains that excess by segmenting between the cheap seats and deluxe sofas, so coke dealers have maintained London’s relatively low street price by splitting the product into two tiers – typically cutting the cheaper variety with benzocaine. Like high-end fashion designers producing ranges for high-street chains, London’s coke has managed to be both affordable and aspirational at the same time.

Even champagne no longer feels like champagne when you can order a glass of Dom Pérignon in the middle of a shopping mall

As our Cocaine Tuesdays suggest, the city’s charlie habit is not about living it up so much as trying to keep up. It is no longer only stockbrokers who list the drug in the same workaday toolkit as a can of Red Bull, caffeine pills and isotonic sports supplements. This is not just about the supercharged pace of life, but something more existential. Digital living and social media networks allow us to appear more confident, gregarious and sharper than we actually are. Perhaps cocaine helps our offline selves catch up with the idealised personas we present online. I have heard many a twenty-something male admit they only do coke so that they do not need to rely on LinkedIn profiles, cue-cards and other digital crutches when trying to impress women.

Being a cocaine capital of Europe therefore does not necessarily mean London is the continent’s party capital. More a swirling pit of angst.

When asked about the apparent spike on Tuesdays, addiction specialists suggest it may be linked to the comedown more commonly known as “suicide Tuesday” – the cokehead’s time-lagged equivalent of the hungover Monday blues. Just as some drinkers will ill-advisedly substitute Alka Seltzer with another round of alcohol, so cocaine users rack up another line. Indeed, some swear by the drug as a morning-after cure following a weekend bingeing on booze. Either way, we are getting even further from the dust-fuelled hedonist blowout and closer to the banal.

More prosaically, the high weekday use suggested by our sewers probably also reflects the fact that central London swells with commuters, who presumably spend their weekends decanting suspect chemical compounds into less polluted suburban drains.

The thinking behind analysing wastewater is that, unlike surveys, sewers do not lie. London’s effluence contained 711mg of benzoylecgonine – the metabolised form of cocaine – per 1,000 people, compared with 393mg in Amsterdam and 538mg in Barcelona. But here is the catch: the survey, carried out last year, has an uncertainty realm of about 40 per cent. Still nascent, the approach may one day yield lots of other useful data for a city more accustomed to taking its pulse by measuring a property market coked up to the penthouse windows.

In the meantime, as London’s restaurants, bars and clubs continue streamlining their washbasins and hiding their toilet cisterns, the capital’s populace will doubtless carry on snorting off the seats. Because unlike other legal and illegal substances, cocaine does not have that natural break-off point where you just have to stop and either pass out, vomit, gulp a gallon of mineral water or munch bumper bags of cheese puffs in the aisle of an all-night Tesco. You might, however, die of a heart attack. London, you have been warned.

Fears of a crash in the Chinese property market are widespread in the financial markets. That is nothing new. The domestic real estate sector has been growing at breakneck speed ever since private property ownership was first permitted in 1998, and on several occasions, most recently in 2012, there have been dire warnings from western investors that housing supply was far outstripping demand.

An easing in monetary policy headed off a hard landing two years ago, but this may only have delayed the inevitable. The renewed correction in the market in mid 2013, which now seems to be gathering momentum, is certainly the main downside risk in the global economy in 2014.

Following the devastating global impact of the US property crash of 2005-08, it is little wonder that investors are paranoid that China might be treading the same path. But there are many differences between the US then and China now. The US housing crash was transformed into something far more serious by excesses in the financial sector, and by adverse wealth effects on consumer spending.

Even though China has also built up severe credit excesses in its shadow banking sector, it is hard to make the macro arithmetic add up to a shock comparable in size to the 2008 US/global meltdown.

(Apologies for greater length than usual in this blog – skip to “GDP effects” for the bottom line.)

Overbuilding

The problem in the Chinese real estate sector can be summarised in one word: overbuilding. Until 2011, construction struggled to keep pace with the demand for new housing caused by China’s rapid urbanisation. House prices rose rapidly, providing households with the best performing asset available to them. This encouraged speculative purchases, increasingly financed by the shadow banking sector. China’s infamous ghost cities were the result. Goldman Sachs estimates that there is now significant over-supply of housing in 30 of the largest 200 cities in China.

All the available measures of housing supply indicate that it continues vastly to outstrip demand, especially in the stressed end of Tier 2 cities, and to a lesser extent in Tiers 3 and 4. In many of these cities, the already-completed floor space available for sale is equivalent to 3 years of sales at the current rate. Add in floor space now under construction, and current supply across the whole nation is equal to more than four years of normal sales.

Housing starts have fallen by 24.5 per cent in the last 12 months as construction firms have responded to excess supply, and to the tightening of credit conditions that was deliberately imposed by the new administration in 2013. This drop in construction explains all of the recent slowdown in real GDP growth, from 7.9 per cent in 2012 Q4 to 7.4 per cent now. Furthermore, the latest housing figures suggest that the supply/demand imbalance continues to build, with current construction of new floor space still in excess of new sales, and unsold inventory therefore rising further.

House prices have slowed sharply in response to excess supply, but there is clearly much further to go before equilibrium is restored. J.P. Morgan says that house prices will decline by 2 per cent next year, the first time they have moved into negative territory in modern China. There is clearly a risk that speculative home owners will panic, dumping more empty property onto the market. If so, a severe crash in house prices could ensue, leading to negative wealth effects and a major setback to consumer confidence.

While this is certainly conceivable, it still does not seem to be the most likely scenario. Several factors should protect China from the worst case outcome.

Mitigating Factors

Although there have certainly been speculative purchases in recent years, the demand for housing is fundamentally driven by a combination of urbanisation and real income growth in the employed labour force. The shift of the population into the cities has been running at about 1.5 percentage points of the population per annum for two decades, and there has been no slackening yet in this pace of demographic change. Furthermore, household incomes in the cities continue to rise at close to 10 per cent per annum. The demand for new housing units as households upgrade the standard of their accommodation is huge, at around 5-6 million units a year, which is half of all demand for new houses.

In a more static labour market, such as that in the US in 2005, a period of speculative overbuilding can take many years to eradicate, even if new building declines by half, which is what actually happened in America. The much more dynamic Chinese labour market should result in housing demand that eradicates over supply more rapidly, and with a smaller decline in the pace of new building.

There is scope for policy makers to soften the landing by easing controls over property demand, and that is already happening. Premier Li Keqiang said last week that policy would be fine-tuned if necessary, and this was followed by a cut in reserve requirement ratios for some banks on Friday. There is plenty of room for further cuts in reserve requirements, and for other fiscal and regulatory measures to boost construction. Although this would slow down the necessary rebalancing of the economy, the authorities would certainly prefer this scenario to a hard landing, given the unpalatable economic and social consequences that would bring.

GDP Effects

Housebuilding, real estate and related sectors accounted for 16 per cent of GDP in 2013. Mainstream economic forecasters seem to be expecting a drop in construction of several percentage points, replicating the experience of earlier slowdowns. A drop of this scale would directly reduce the level of real GDP by only about 0.5 -1.0 per cent. Some economists (eg Qu Hongbin at HSBC) talk of a downside scenario in which GDP might fall by about 2 per cent, but they generally add that this could be substantially offset by policy easing.

While these may be sensible central forecasts, there is clearly a rising probability of a harder landing, given the current imbalance in the market. The lesson from the US crash is that in a downside case the impact of a property crash can be much greater than predicted in advance by mainstream forecasters.

How bad might this be? No-one can be sure, but if we assume for illustration that construction/real estate output in China falls by 25 per cent compared to previous trends over three years, which is roughly half of the decline experienced by overall construction in the US collapse, the total hit to Chinese GDP would be 4 per cent, thus reducing the annual growth rate by 1.3 per cent for three years.

This does not allow for any knock on effects on consumer spending, nor for any collapse in the financial sector. Neither of these effects are likely to be very large. Unlike in the US case, equity withdrawal from the housing market is not permitted in China, so the boost to consumer spending has been much smaller. And Chinese households are required to provide at least 30 per cent equity in any home purchase, so the chances of negative equity and bad debts should be much less than in the US crash.

Shadow Banking

A collapse in the shadow banking sector cannot be ruled out, given the extent of its recent expansion. The St Louis Fed’s economic blog recently estimated the worst case effects of a collapse in the Chinese shadow banking sector by comparing it directly with the US example. They point out that shadow banking in China is less than half as large as it is in the US, so even if the collapse were as painful in the US case, and the economic effects were as bad, the impact on Chinese GDP would be “only” about 4 per cent. This would probably be spread over several years and would directly reduce global GDP by about 0.6 per cent in total.

Conclusion

These worst case effects, at 4 per cent of Chinese GDP, spread over three years, are certainly not negligible. Admittedly, they are little more than stabs in the dark, and the uncertainty is enormous. But they are not of the same scale as the Great Financial Crash.

And, given the increasingly obvious intention of the Chinese authorities to ease policy further, they are far from inevitable.

- ARIA announced, for the first time, data from its Phase 2 trial of Iclusig(ponatinib) in adult patients with refractory metastatic and/or unresectable gastrointestinal stromal tumors (GIST). The initial data show that ponatinib has anti-tumor activity in patients with advanced GIST, particularly in patients with KIT exon 11 mutations, after failure of at least one prior tyrosine kinase inhibitor (TKI). The primary endpoint for the trial, clinical benefit rate (CBR) at 16 weeks for patients with KIT exon 11 mutations, was 50 percent, with a median follow-up of six months. 

- These data are being featured today in an oral presentation at 10:00 a.m. CT at the Annual Meeting of the American Society of Clinical Oncology (ASCO) being held in Chicago. 

- The Phase 2 trial of ponatinib in GIST enrolled 35 patients as of April 7, 2014. The trial is ongoing, and the FDA partial clinical hold to new patient enrollment has been lifted. The patient population in the trial is heavily pre-treated, with 46 percent having failed three prior GIST-approved TKIs. Patients were enrolled into two cohorts based on the presence (Cohort A) or absence (Cohort B) of KIT exon 11 mutations. Primary KIT mutations occur in approximately 85 percent of patients with GIST. The most common mutation is on exon 11 (~70 percent). Preclinically, ponatinib showed compelling activity against activating exon 11 mutations.

- Equal Energy Ltd announces that the May 28, 2014 common stock dividend payment of US $0.05 per share has resulted in an adjustment to its outstanding 6.75% Convertible Debentures due March 31, 2016. Under the terms of the indenture, the conversion price for the Debentures is reduced from CAD $8.55 to $8.47. In addition, each Debenture is now convertible into 118.06 common shares of Equal.

{EQU US Equity CN <GO>}

Private equity investors asking tougher questions

Private equity groups say they have been inundated with questions from concerned investors about fees and expenses in the wake of an early May speech from a senior official at the Securities & Exchange Commission.

The investor relations departments of a range of private equity groups contacted by the FT said they had fielded an increasing number of queries from investors in recent days. These queries included levels of disclosure over fees, how expenses had been allocated by the private equity groups and whether the SEC had raised red flags about the private equity group’s internal workings. “What are the fees I don’t know about?” asked one.

The increased interest follows a speech in May by Andrew Bowden, director of the Office of Compliance Inspections and Examinations at the regulator. He identified potential conflicts of interest between the private equity groups and their fund investors over fees, expenses and portfolio company valuations.

The comments were initially dismissed by many of the big private equity groups and some public pension fund investors. But the speech, which follows increasingly rigorous SEC examinations of the private equity groups, has since led many investors to express concerns that private equity firms are taking advantage both of them and of investee companies.

One of the biggest fears is that investors have been unfairly charged for expenses that the private equity groups should bear, or that firms are not passing to investors all the fees to which they are entitled.

The pressure to generate fees is particularly great for the publicly listed groups – Apollo, Blackstone, Carlyle and KKR – since shareholders value the steady fee income these companies collect.

“The line on many of these issues is very blurry,” said one lawyer specialising in private equity funds. “What is a real fund expense and what should be covered by the management fee needs to be disclosed clearly.”

Mr Bowden’s speech comes as the SEC examines the books and practices of hundreds of private equity groups. Its probe could ultimately affect their profits, analysts said.

It may also boost those groups, including Hellman & Friedman and Warburg Pincus, that do not charge investors fees for doing deals, monitoring portfolio companies, financings they arrange and for other services provided to the companies they control.

“A private equity adviser is faced with temptations and conflicts with which most other advisers do not contend,” Mr Bowden said. “We have seen limited partnership agreements lacking clearly defined valuation procedures, investment strategies and protocols for mitigating certain conflicts of interest. We have identified what we believe are violations of law or material weaknesses in controls over 50 per cent of the time.”

Examinations from the SEC taking place within the last six months have involved increased scrutiny, with the regulator asking for information on deals, fees and other information dating back to about 2007.

“In many cases, the fee split has changed but the magnitude of fees has increased,” says the head of investor relations at a private equity group. “When the share to LPs [limited partners] increases, they add more fees.”

(Reuters) - BlackRock Inc Chief Executive Larry Fink this week dropped a stink bomb on a small corner of the $2.5 trillion global market for exchange-traded funds.

Fink, who runs the world's largest asset manager and ETF provider, said structural problems with leveraged ETFs have the potential to "blow up the whole industry one day." Sponsors of leveraged ETFs and related products, which make up only about $60 billion of global industry assets, called his remarks an exaggeration.

Leveraged ETFs use derivatives and debt in an attempt to enhance returns - often by two or three times - that an investor would receive from putting money in stocks, bonds or other financial instruments. The only problem: if the underlying securities or indexes drop, the losses can be fast and heavy.

Fink, who was speaking at a Deutsche Bank conference in New York, drew parallels between the embedded leverage in some ETFs and two obscure Bear Stearns hedge funds that collapsed in 2007. That ignited an initial wave of panic over Wall Street's exposure to sketchy mortgages - a warning of much worse to come in the 2008 financial crisis.

A systemic risk could emerge from packaging inherently hard-to-trade securities, such as leveraged bank loans, into ETFs. The value of the ETF could collapse if the market for the underlying assets freezes up. That could touch off a rout within the ETF industry if skittish investors decide that many other funds are too dangerous for them.

Fink’s pointed remarks on Wednesday also raised questions about whether too many risky financial products are entering the marketplace.

In the aftermath of the financial crisis, a growing number of complicated and risky products are being aimed at Main Street investors. Hedge funds are making some of their strategies available to Mom and Pop investors willing to come up with as little as $1,000. Part of the pitch is that they need to look beyond plain vanilla investments if they want to have enough money to retire – the downside is that they could lose their shirts if markets take a sharp turn.

FED WARNED

Last month, top money managers aired their concerns during a meeting with New York Federal Reserve President William Dudley.

The group, including hedge fund manager David Tepper of Appaloosa Management LP, worried aloud that investors may be stretching too far for returns in a low volatility, low interest rate environment, prompting "some market participants to take on additional leverage to meet investment targets," according to recently released minutes from the April 10 meeting of the Fed’s Investor Advisory Committee on Financial Markets.

Fink on Wednesday suggested there's systemic risk lurking in leveraged ETFs, in comments that resonated with some other investors.

"I agree with the notion that the leveraged ETFs have the potential to possibly be very upsetting to the market. It is the leverage that concerns me." said Dan Fuss, vice chairman of Loomis Sayles.

Fink said U.S. and European regulators, including the U.S. Securities and Exchange Commission, don't pay enough attention to individual financial products hitting the market.

The SEC in 2012 stopped giving new applicants permission to launch leveraged ETFs, because it was concerned about such funds. However, two fund sponsors – ProShares and Direxion – are still launching leveraged ETFs, using exemptive relief issued by the securities watchdog earlier. The SEC declined to comment on what Fink said.

Fink, whose firm oversees $4.4 trillion in client assets, declined to comment for this story.

BlackRock's iShares ETFs owned 39 percent of the global ETF market with $953 billion in assets at the end of April. State Street Corp was a distant No. 2 with $409 billion in assets, followed by No. 3 Vanguard Group's $368 billion.

None of those three offer leveraged ETFs. Vanguard and State Street executives said they don't share Fink's view that the products pose a systemic risk.

Dave Mazza, head of ETF research for State Street Global Advisors, said, "This is an extreme example of buyer beware." He said it is possible a leveraged ETF meltdown could disrupt industry-wide compound annual growth rates that have topped 25 percent in recent years.

“These products work as advertised,” said Joel Dickson, Vanguard’s senior ETF strategist. “Now, whether investors understand how they work is an education issue.”

Meanwhile, top leveraged ETF providers denounced Fink's comments.

"Direxion Investments completely reject his contention that leveraged ETFs pose a systemic risk," the company said in a statement. As of this week, the gross assets in 140 leveraged ETFs run by Direxion and rival ProShares totaled $22 billion.

The Direxion Daily Gold Miners Bull 3X Shares fund is one of the hottest leveraged ETFs on the market, attracting $1.07 billion in net flows from investors over the past 12 months, according to Lipper Inc, a unit of Thomson Reuters.

A three times leveraged ETF like Direxion's gold miners fund has $2 of leverage for every $1 of capital invested in the product. The ETF is rebalanced daily to maintain the same ratio of capital to exposure each day. This means, as Direxion explained, that leveraged ETFs respond to losses by reducing exposure.

"It is hard to understand how Mr. Fink could conclude that a relatively small, highly liquid, completely transparent suite of products, which systematically reduce risk in response to losses, could generate systemic risk," Direxion said.

But Fink said this week that an inherently illiquid asset doesn't become more liquid because it is wrapped inside a leveraged ETF fund.

"We will not do a bank loan ETF," Fink said at the Deutsche Bank conference. "Why? We believe that the underlying asset is far less liquid than daily liquidity of an ETF. And you know as a banker, sometimes a bank loan market freezes."

(Reuters) - It would be an insider trader's dream to know ahead of time which of Europe's banks will fail or need more capital, and all that data will be stored somewhere in cyberspace as the European Central Bank assesses the euro zone's top banks.

The chances of a leak are multiplied by the thousands of consultants who will work on data for the ECB's Comprehensive Assessment of the currency bloc's most important 128 banks, which include household names like Deutsche Bank and Santander along with national champions Bank of Cyprus and Bank of Valletta.

"It (data security) is of enormous concern," said Dan Keeble, a London-based partner at Deloitte, which is working on part of the ECB's assessment, an Asset Quality Review (AQR) for the euro zone's 13 largest banks and some smaller ones.

"Aside from the fact that much of the information required to conduct the AQR is commercially sensitive to individual banks, details of the conclusions regarding the AQR have the potential to be market influencing, and could damage financial stability."

That is why the consultants working on the centralized data - U.S. firm Oliver Wyman - cannot cut and paste, take screenshots or print out the data they are working on. And they will only have access to their part of the project, and only for as long as it takes to complete their task.

Thousands of other consultants working on individual banks face similar restrictions. Anyone caught leaking the information risks a hefty jail sentence, and the ECB said all access to the data is monitored, so users can be traced.

HIGHEST PRIORITY

The ECB, long used to holding sensitive data about its market operations and keeping secret its plans for interest rate changes, told Reuters data security was the "highest priority" in the review it is undertaking before it becomes the euro zone's financial supervisor in November.

All data communicated to, from and within the ECB is stored on 'Darwin', the ECB’s document and records management system. Anyone who wants access must file a request through a designated security manager at a national financial supervisor, and the central project management office must approve.

"All Comprehensive Assessment data is classified as ECB-Confidential, and access is limited to those who require it for project purposes," the ECB told Reuters in a statement, adding that the project "may be uprated soon to ECB-Secret".

Data about individual banks is stored on isolated servers within Darwin, and elevating it to Secret means access to the database, which is encrypted, is controlled by more senior people.

As well as staff at the ECB's newly created supervisory arm, much of the heavy lifting in the review is being done by private consultancy Oliver Wyman, which is acting as project manager.

"Oliver Wyman maintains strict processes to manage the confidentiality of proprietary client information as standard policy," the ECB said. "Each person working on the Comprehensive Assessment has signed additional confidentiality documents."

Oliver Wyman, whose staff work out of the ECB's Frankfurt premises and use ECB computers and must get security clearance from the ECB, declined to comment.

BEYOND THE FRANKFURT BUBBLE

The data worked on by the ECB and Oliver Wyman in Frankfurt is the final link in a project that spans the euro zone and beyond into countries where the banks have operations.

Almost all of the national supervisors producing information for the ECB have hired auditors to help them with the job, while many of the banks have also hired third parties.

They face a similarly strict list of requirements. Documents are typically reviewed on bank PCs, and any transfer of information to auditors' computers is severely restricted, people familiar with the process told Reuters.

Auditors that do store information in their own environments must prove that access controls are good enough to protect the information, the people added.

A source familiar with the process said data on individual banks is sent to national supervisors using encrypted emails through a specially secured channel. Both sides need keys to code and decode the data. Auditors send their work in the same way.

Deloitte's Keeble said there were also financial penalties built into the audit contracts to deal with data security breaches.

But even the most advanced technology protocols are only as strong as the weakest link in the chain.

“There’s a massive concern about somebody leaving a laptop in a pub,” as one source familiar with the tests put it.