TheChek News Flow

SEC should reconsider proposed rules on capital lock-ups

Mooted changes could have a negative impact on how the US Treasuries market functions

To maintain financial stability and protect investors, it is critical that companies dealing in government securities are well capitalised at all times.

That seems a clear and obvious goal for regulators. But changes to regulations proposed by the Securities and Exchange Commission may have unintended consequences in this regard, potentially damaging the world’s most important financial market.

Much of the attention over the SEC’s rule changes so far has focused on the proposed expansion of the definition of a “government securities dealer”, drawing complaints from the likes of BlackRock and Citadel. 

If a firm buys or sells enough US Treasuries within a given period of time, the SEC proposes to classify it as a dealer, subject to all of the associated capital, reporting and other requirements. Some commenters (including me) believe that a quantity threshold, on its own, is inappropriate. That rule could capture firms that aren’t actually in the business of providing liquidity to the market, a standard criterion for being considered a dealer.

But the main concern I have raised in a comment submission on the SEC proposals is the potential adverse implications for Treasury market liquidity of putting the newly registered dealers under an existing “capital lock-up” rule. This rule states that a capital contribution to a dealer does not count towards its regulatory capital if it is withdrawn within a year. 

This lock-up could exacerbate episodes of market dysfunction, which will probably become more frequent and severe given the burgeoning size of the Treasury market relative to the capacity of the dealers to cope with the volumes of trading.

Some of the firms that will be required by the SEC to register as government securities dealers rely for capital on parent companies that have other trading businesses.

A parent has the option to move, or downstream, capital to its trading subsidiaries opportunistically, whenever market conditions suggest that expected returns are higher, relative to risk.

If a subsidiary becomes registered as a government securities dealer, then capital downstreamed to that business must not be redeemed for at least a year if it is to be taken into account for regulatory capital requirements.

Thus, to make efficient use of its capital, the parent is likely to choose to trap less of its funds in its government securities dealer.

As a result, when US Treasury market liquidity deteriorates, as happened in the Covid shock of March of 2020, we can expect less capital to be committed to the US Treasury market by firms that must newly register as government securities dealers. Further, capital formation by hedge funds and principal trading firms with separately capitalised trading businesses would probably also be reduced.

As a simplified illustrative example, suppose a parent has trading subsidiaries A and B that are not regulated as dealers. In March of a given year, a supply shock presents a significant profit opportunity for firm A. The parent transfers $100mn of capital to firm A to backstop risky new positions. 

By April, the positions that were added by firm A in March are liquidated and $100mn of capital is returned to the parent. Then, in June, a big profit opportunity for firm B leads the parent to downstream $100mn of capital to B. Had firm A been subject to the SEC’s capital lock-up rule, however, this flexible approach to deploying parent capital would not be possible. 

The $100mn capital contribution to firm A would not count towards the regulatory definition of capital for the business unless it stays with it for a year. Aware of this in March, perhaps the parent would have invested only, say, $40mn of its capital in firm A. This would leave $60mn of discretionary parent capital available to address new profit opportunities for firms A and B at later points in time over the subsequent year.

I think the SEC is right to expand the definition of a dealer. However, the commission may also want to consider an amendment to its capital lock-up rule. It should allow capital contributions to count towards the definition of regulatory capital even if withdrawn within a much shorter period of time than one year, provided that the dealer meets its other capital requirements.

I do not see a good case for requiring contributions of capital to remain in a dealer long after they are needed to buffer actual solvency risks. This is a chance for the SEC to reconsider the impact of its rules on Treasury market liquidity.

Documents show administrator does not expect the money to be recouped

A Signa Group company transferred more than €300mn to two entities controlled by the family of its Austrian founder René Benko before the collapse of the property giant, according to financial documents reviewed by the Financial Times.

Signa Development, one of the three companies that oversaw the conglomerate’s investments — which include a stake in New York’s Chrysler building — lent €125mn to Laura Finance Holding GmbH and another €190mn to Laura Holding GmbH, as part of large outflows of money last year, the documents show.

Both recipients are subsidiaries of the Innsbruck, Austria-based Laura Foundation. While its beneficiaries are not disclosed, the foundation is controlled by Benko’s mother, Ingeborg, according to Austrian public records. Benko’s daughter is called Laura.

The failure of Signa, whose portfolio also includes stakes in London’s Selfridges and Berlin’s KaDeWe, has been a high-profile sign of the stress across the European commercial property market following a rise in interest rates. But lenders facing billions of losses are now raising questions over how the complex, leveraged web of companies was run under the effective control of its 46-year-old politically connected billionaire founder.

The Financial Times spoke with Signa creditors and advisers to the group and reviewed three years of internal accounts, shareholder presentations, and its non-public insolvency filings for Signa Development to substantiate information about the transfers.

Details of the transfers to the Laura entities only came to light on December 29, when after weeks of silence, creditors received documents from Signa’s lawyers relating to insolvency proceedings and the group’s balance sheet. Creditors have been given no explanation of what the transfers were for, people close to the lenders said.

The administrator expects to recover none of the money, according to Signa Development’s insolvency filing.

As well as the payments to the Laura companies, Signa Development transferred hundreds of millions to other Signa group entities.

The way Benko ran the Signa group meant large sums of money were often lent between corporate entities in its structure, without explanation to investors. That practice ramped up in the last year as the Signa Group’s finances came under increasing strain.

Signa Development’s management and administrator did not respond to requests for comment.

Benko did not respond to a request for comment via his personal corporate email address.

Under the Austrian “self-administration” insolvency procedure, Signa Development’s own management team is overseeing the restructuring of the company. Erhard Grossnigg, an insolvency expert, has been brought on to the company’s board to help. A third-party administrator, Andrea Fruhstorfer of the Austrian law firm EcoLaw is supervising the process.

The Signa Group’s collapse is one of the most complicated corporate bankruptcies in Europe. The conglomerate never published consolidated accounts, and its three holding companies have different administrators, management teams and creditor groups.

Before its collapse, Signa estimated its property assets to be worth €28bn.

Christoph Stapf, the administrator appointed to oversee the wind-down of Signa Holding, the group’s main company, said last month that the group’s organisation chart, which he had only just finished reviewing, ran to 46 A3 pages.

The group comprises more than 1,000 corporate entities. Signa Development alone sits on top of more than 250 of them.

Benko held no formal managerial role in Signa after being convicted for bribery by an Austrian court in 2013. However, he exercised control through a shareholding structure ultimately linked to his family foundations that made him one of only a handful of people able to understand the functioning of the group.

The line between his personal interests and those of the company was often blurred. Privately controlled shell companies linked to the Laura Foundation invested in developments alongside other Signa entities, and Signa Holding funded personal properties used by the tycoon and his private jet, according to corporate organisation charts seen by the FT.

Over the years Benko succeeded in bringing on board dozens of external shareholders and lenders at various levels of the Signa structure.

Signa Development creditors — which include dozens of European banks, owners of profit participation notes bondholders and third-party shareholders — were blindsided by disclosures in November about the company’s health, said several of them, speaking under the condition of anonymity.

Signa Development disclosed long-overdue accounts for the first half of the year to them early that month, revealing only €32mn left as cash equivalents.

Following the successful sale of several large assets in the second quarter, creditors had been expecting to see a figure nearly 10 times that sum, people close to them said.

In its first-quarter earnings, Signa Development had also told investors the company had a €1bn capital cushion.

In explaining where the cash had gone, Signa Development said that it had lent hundreds of millions of euros “through the ordinary course of business cash management operations with Signa Group entities”.

Signa Developments parent company, Signa Holding, filed for bankruptcy four weeks later.

On December 11, Signa Development’s board announced it had fired the company’s chief executive, Timo Herzberg, with immediate effect, for what it claimed were “gross violations” of his duties. Herzberg did not respond to a request for comment.

Signa Development itself entered insolvency three weeks later — on the final business day of the year.

If regulators win US banks would look expensive

US banks are watching a film that their European peers will feel they have already seen: Basel III, the Endgame.

An updated US bank capital regime, announced by watchdogs in July last year, has its origins in the work of the Basel Committee on Banking Supervision following the financial crisis. US banks worry this will weigh them down with more capital, hurting their returns. In doing so, that could narrow their long-standing lead over beleaguered European peers.

EU and UK regulators are well advanced in implementing the Basel III principles, which require added capital buffers for more volatile business units. Most banks have prepared for adjustments, which primarily concern credit risks. European bank bosses have groaned but generally have followed the lead of the European Central Bank or Bank of England.

US banks just see a horror show. Prominent bankers, including JPMorgan Chase’s Jamie Dimon, complain that the US proposals are more punitive than in other jurisdictions. Very conservative weighting recommendations will push up risk-weighted assets. For corporate and investment bank divisions alone, this means a 35 per cent jump in risk-weighted assets, more than double that proportion for European banks, according to a Morgan Stanley/Oliver Wyman report.

More risk-weighted assets require more capital as loss buffers. Even strong banks such as JPMorgan, generating excess (common equity tier one) capital of half a point quarterly, would have less for shareholder payouts via buybacks. In turn, more capital can depress the crucial return on equity measure.

For years, US banks outstripped their European counterparts here. US bank returns have averaged about 10 per cent since 2019, about 4 percentage points ahead of Europe, according to MSCI and Bloomberg data. That is one reason global investors steer clear of Europe’s banks, thinks Joseph Dickerson at Jefferies.

Higher interest rates, and subsequent higher income, in the past two years have enabled Europe to close the ROE gap in the past year. Should the US Basel proposals be fully implemented, US bank returns on equity could potentially fall below that of the counterparts. A 37 per cent jump in overall risk-weighted assets for US banks, in the harshest scenario, would depress US bank returns by up to 6 percentage points, say Morgan Stanley/Oliver Wyman. A lower return on equity usually means a lower price to book valuation, a key metric to judge financial institutions.

US regulators, not unreasonably, point to the mess following the Silicon Valley Bank failure last year as proof the system needs reinforcing. One suggested that banks should look at their dividends and buybacks, before complaining.

If the watchdogs win out — a big if given America’s powerful bank lobby — US banks would look expensive, confirming an obvious relative value trade into Europe. Already the shares of some, such as UniCredit, have left world banks in their trails.

Most, however, persistently trade 40 to 50 per cent of their book values. No wonder US bank chiefs do not like the story they are watching.

New technologies and old skills are helping producers cope with tough conditions

Pucci Giuffrida’s Al-Cantàra winery stands on the cool slopes of Sicily’s Mount Etna, where he cultivate grapes on 15 hectares of rich volcanic soil to produce about 100,000 bottles of wine each year.

Mount Etna normally provides an ideal microclimate for viticulture, with lower temperatures and better air circulation than the scorching Sicilian plains below. But, last year, southern Italy was hit by incessant rain in May and June, leading to a proliferation of the fungus Plasmopara viticola, which thrives in warm, humid conditions.

This fungus — first discovered in the US and introduced to Europe with the onset of transatlantic shipping — causes grapevine downy mildew and wreaked havoc in vineyards across southern Italy. Al-Cantàra’s autumn harvest was less than 60 tonnes — about half of the normal yield of 100 to 120 tonnes.

“In these 18 years, I have never seen such a damaged harvest,” says Giuffrida, 72, a retired accountant who started making wine in 2005. “The clusters of grapes were petrified — like small stones. Some of our neighbours did not harvest even a single cluster.”

In southern Italy’s key wine-producing regions, many vineyards lost 80 to 100 per cent of their crop, while the country’s wine production overall dropped by about 15 to 20 per cent.

“Producers do not remember such a strong attack of downy mildew, unseasonable rain and significant humidity — or such a loss of production — in the past 20 years,” says Palma Esposito, senior policy adviser on wine and olive oil for Confagricoltura, Italy’s oldest farming and agribusiness association. “It was really notable.”

Italy’s coveted status as the world’s largest wine producer — held for the past nine years — was lost to France. Experts warn the pathogen’s impact will be felt this year too, highlighting the threats to Italian viticulture from climate change.

Italian grape cultivation once took place amid fairly predictable seasonal patterns. But increasingly erratic weather and the growing frequency of extreme events — such as droughts, excessive off-season precipitation, and hail — are posing new challenges.

Chiara Lungarotti, chief executive of the Umbria-based Lungarotti Estate, says growers need to be more attentive in tending their vines to keep them healthy amid climatic vagaries.

“We have to be extremely elastic in our approach,” she explains. “The weather will change continuously. We won’t have any more of the fixed seasons that we were used to. We will need to understand how to get into the vineyard at the right moment to make a difference.”

Esposito says Italian authorities, grape growers and winemakers are now focused on making vineyards more resilient to secure the future of the sector, which exported €8bn worth of wine in 2022. “It’s a very urgent topic,” she says. “We are discussing it at the national and European level.”

Grapevines are hardy plants, and winemakers have long considered a little water stress as a benefit, creating grapes with a good level of sugar and flavour. However, excessive moisture generates an overabundance of lower-quality grapes. And severe water shortages, amid the extreme heat experienced with global warming, can raise grapes’ sugar levels too much — resulting in stronger wines that are unpopular with consumers. 

Many winemakers are worried about this happening in southern Italy, which is already hot and dry. “The market doesn’t want wines that are too alcoholic,” Esposito says.

Many growers are now looking to technology, including soil sensors and overhead drones, to monitor vineyards and determine precisely where interventions are required to help maintain a healthy equilibrium.

“Precision viticulture can really help a lot,” Lungarotti suggests. “The drones can really help in mapping the vineyards in an incredible way. You make this map that gives you all the different colours according to the strength and vigour of the plant . . . We can go and be most focused on certain points of the estate.”

Interventions can include emergency irrigation — once anathema — or the application of kaolin or other clays on grape clusters, which helps deflect the sun and keep the fruit cooler in case of extreme heat.

Digital sensors can also help farmers in the battle against Plasmopara viticola, which can be controlled by timely, targeted application of a copper-based fungicide approved for use in the EU, albeit in limited quantities.

“If the plant is suffering, you may know it much earlier,” says Riccardo Velasco, director of the Research Centre for Viticulture and Oenology at Crea, Italy’s pre-eminent public agricultural research centre. “The sensors tell you which part is healthy and which part is at risk, and you can intervene only in those areas that are suffering.”

New grape varieties may help, too. Velasco, a geneticist, is breeding pathogen-resistant varieties by crossbreeding local grapes with a gene found in wild grapevines in the US, which have a natural resistance to Plasmopara viticola. These new varieties — whose development is being partly funded by Confagricoltura — are now being field tested.

Velasco is using new breeding technologies, as well, to try to develop rootstocks that are more resilient to water stress, with the first field trials of these beginning soon. Meanwhile, other research institutes are using traditional crossbreeding techniques to develop more drought-tolerant rootstocks.

Lungarotti, however, stresses that technology is only part of the solution. Careful attention to the basics of running a vineyard — managing the canopy (the stems and leaves), working the soil and maintaining its biodiversity, and keeping water channels clear to allow run-off after rain — also makes a difference in helping plants to withstand a harsher climate. 

“It’s a matter of balance,” she says. “The extremely modern technologies are something you can’t live without today. But, on the other hand, you have to preserve the local environment. An essential part of our job is very attentive maintenance.” 

Despite this, rising temperatures are pushing vineyards to ever higher altitudes. On Mount Etna, new vineyards have been established at up to 1,200 metres above sea level — a height previously thought unfavourable for grape growing.

Giuffrida says he is now keeping an eye out for potential higher-altitude properties to rent or buy as he confronts a warming world. “It’s a solution we are evaluating,” he says. “But I’m confident that, with technology, we can maintain the quantity and quality of our production.”

Commission president to hold talks in bid to end escalating demonstrations against EU green policies

EU farmers egged on by the far right have taken to spreading muck outside government buildings, barricading roads and creating widespread havoc as Brussels fights to keep the agriculture sector on board with its green transition.

In an effort to placate farmers and neutralise a campaign issue ahead of June’s European parliament elections, Ursula von der Leyen, who is likely to seek a second term as head of the European Commission, will open “strategic dialogues” with 30 farming groups, NGOs and academics on Thursday.

The protests are in large part driven by dissatisfaction with policymakers who prioritise cutting carbon emissions and preserving biodiversity over supplying consumers with homegrown food.

Farmers are particularly angry with the bloc’s “farm-to-fork” strategy and other regulations they say damage their competitiveness against imports, even as they struggle with inflation and more extreme weather.

“We don’t have much faith,” said Ana Mahe of Farmers’ Alliance Ireland, at a protest outside the EU parliament in Brussels on Wednesday. The demonstration was organised by MCC Brussels, a think-tank backed by the arch-Eurosceptic Hungarian Prime Minister Viktor Orbán and chaired by his political director Balazs Orbán, of no relation. “We are here to create a coalition of farmers in Europe,” Mahe said.

The most violent clashes have occurred in France, where farmers have barricaded motorways, causing a deadly accident, and a radical group of wine producers set off a bomb outside a regional government building in the southern city of Carcassonne.

The German government’s attempts to scrap an agricultural diesel subsidy, an edict to cull cattle herds in Ireland and an influx of Ukrainian grain into neighbouring EU countries has further infuriated the sector.

Agriculture contributed 1.4 per cent to the EU’s gross domestic product in 2022, according to the commission, but it employs some 8.7mn people, many of which are in eastern and southern Europe.

The EU’s €387bn flagship Common Agricultural Policy, a framework of subsidies for farmers, accounts for around a third of the bloc’s 2021-27 joint budget.

Claus Hochrein, a farmer from Eisenheim in Bavaria, said the subsidy cut was the last straw but rising bureaucracy was also a problem, such as tougher EU rules on the use of fertilisers and pesticides. “In the last few years the government has talked to the NGOs, they’ve talked to each other, over our heads, and never with us — and that has to change.”

Guillaume Dumoulin, who runs an organic hemp farm in Deux-Sevres in eastern France, said farming “is a risky business in which it’s hard to make a predictable living”. “We are no longer guaranteed to see the harvest purchased at a consistent price that allows us to cover production costs,” he said.

Yet there is another undercurrent: liberal and leftwing politicians fear that rural groups are being radicalised by far-right parties and Eurosceptic groups prepared to grasp any cause as a way to infiltrate mainstream politics ahead of EU elections in June.

In Poland, protests sparked by the glut of Ukrainian grain have been seized upon by the far-right Confederation party, which is looking to rebound this year in local and EU elections after falling short in October’s vote for the national parliament.

Confederation leaders have travelled on several occasions to border areas to show their support for rural voters and condemn the EU for being both too generous to Ukraine and too harsh on Polish businesses.

The Brussels protest was also attended by French politician Marion Maréchal-Le Pen, the niece of Marine Le Pen, from the far-right Rassemblement National and rightwing European parliament lawmakers.

Edwige Diaz, an MP from the RN in the French parliament from the Gironde region of south-west France, said their message of defending farmers from the excesses of Brussels regulation and unbridled globalisation was hitting home.

“We want to cancel the EU’s farm-to-fork strategy, which would drastically cut farm yields in the name of preserving nature and the planet, yet make us more reliant on imports that do not respect any such rules,” she said. “Farmers will have little hope of things changing unless those in government are replaced.”

A poll published by the European Council on Foreign Relations think-tank this week showed that the far-right Identity and Democracy Group (ID), which includes the RN and Alternative for Germany party, could go from being the fifth to the third-largest bloc in the EU parliament this year.

Mahe said that Farmers’ Alliance Ireland had registered to run as a political party in Ireland and in the EU elections because farmers felt that mainstream politics had ceased to represent them.

Dickens Bart, a dairy farmer and president of the Farmers Defence Force Belgium, said protests could become more violent as elections approach. The politicians “don’t do anything and it seems like they don’t want to listen. So we must do something . . . we don’t have anything to lose. And that’s dangerous. The man who has nothing to lose.”

At a gathering of EU agriculture ministers on Tuesday, several accused the commission of being too slow to act after a dialogue with farmers was announced in Von der Leyen’s annual policy speech in September.

Dutch agriculture minister Piet Adema, whose Christian Union party suffered in the Dutch elections in favour of the upstart BBB farmers movement and far-right firebrand Geert Wilders last November, said: “The most important thing is to involve and reach out to farmers. We shouldn’t just talk about farmers. We need to talk with them.”

Bram Van Hecke, a Belgian farmer who plans to run in the EU elections, said that the farmers’ struggle was not against what was needed to counter climate change but against top-down legislation.

“The government is harsh in saying these are the rules, the market is harsh and you are right in the middle and that pressure has gone up to a very high level . . . the cri du coeur of the farmers is not a far-right cri du coeur. It is one from the heart.”

Call comes day after EDF flagged more delays of construction of power plant at Hinkley Point

The French government is pressing the UK to help plug a multibillion-pound hole in the budget of nuclear power projects being built in Britain by France’s electricity operator EDF.

The call for a contribution from the UK is likely to cause tensions between Paris and London, a day after state-owned EDF admitted its construction of a new nuclear power station at Hinkley Point in Somerset would suffer further costly delays, taking the bill to as much as £46bn.

The UK has said it will not put cash into the project, which counts EDF as a majority shareholder, and is already backed by a government guarantee on its revenues once it is up and running.

But Paris is pushing for a “global solution” that would also encompass funding issues at another planned UK plant, Sizewell C, said a French economy ministry official and another person close to the talks.

“It’s a Franco-British matter,” the French economy ministry official said. “The British government cannot at the same time say EDF has to figure it out alone on Hinkley Point and at the same time ask EDF to put money into Sizewell. We’re determined to find a global solution to see these projects through.”

Sizewell in Suffolk has a different financial set-up to Hinkley. The UK this week said it would inject another £800mn of state funds, bringing its total contribution to £2.5bn at the £20bn plant, where it is the top shareholder. Its partner EDF has no obligation to put more money in.

French officials said discussions on various options had begun several months ago with British counterparts, although they acknowledged London had flagged budgetary constraints that would have to be taken into account.

In the UK, a government official played down the talks, adding that on Hinkley Point: “Costs will be the responsibility of EDF.”

An EDF executive told the BBC on Wednesday that the French company picks up “the tab for the cost overruns”.

EDF on Tuesday warned Hinkley Point would not now be completed until 2029 at the earliest, four years later than its original start date, while the two reactors could cost up to £46bn to build at today’s prices, compared with a £18bn budget in 2016.

Other factors might play into the discussions, however. Under Prime Minister Rishi Sunak, Britain took the political initiative to eject Chinese group CGN as an investor in Sizewell — leaving that project in need of fresh private capital, but also prompting CGN to pull back from Hinkley, where it is a 33.5 per cent shareholder.

The Chinese group has fulfilled its contracted payments on Hinkley but has no obligation to fund over-costs and stopped doing so a few months ago.

“The French don’t have many levers here but the CGN issue is a very real one,” a third person close to the talks said.

Finding private investors to make up the Hinkley shortfall may be tough, several people close to the group said, although formulas such as state guarantees could be discussed.

EDF is only just coming out of a period of financial turmoil, and has big investments to make at home, too, in the coming decades. It was fully renationalised last year.

“Our goal here . . . is for what’s happening at Hinkley Point, with the delays and the issue with the Chinese partner’s decision, not to impact EDF’s financial trajectory excessively,” the French economy ministry official said. 

However, one UK nuclear industry figure said that EDF’s plight at Hinkley was the consequence of signing up to a deal with the UK government a decade ago, which at the time was criticised for being too generous to the French group.

Under a so-called contract for difference signed with the state, construction costs are not covered but future electricity production is backed up by subsidies in case power prices fall below a certain threshold.