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The Second City of the US may not need two separate financial exchanges. The Financial Times has reported that Chicago-based CME approached smaller neighbour CBOE about an all-stock takeover. The deal would roughly value the company behind the Vix volatility index at $16bn. Even with a 20 per cent premium, CBOE would be a minnow in the consolidating world of exchanges.

CME’s own market worth is roughly $70bn. The business said it is not currently in acquisition talks. Given sharp new scrutiny on corporate consolidation, the window for a deal may already have closed. But combining the two exchange groups spawned by Chicago’s huge heft as a US trading hub would make a lot of sense

Global exchange groups have coalesced into just a handful of groups. Trading efficiencies created by deregulation and new technology have made combinations necessary. Lower friction has benefited buyers and sellers of securities alike.

The two groups would fit together nicely. CME operates a series of derivative exchanges for interest rates, as well as for commodities such as metals, agriculture and energy. CBOE is known for its venues for trading index and equity options as well as its ownership of the Vix, the so-called “fear index” for US equities.

Option trading has exploded during the pandemic driven by retail traders using the Robinhood app. CBOE has said daily volumes in 2020 rose more than 40 per cent, year-over-year. Still, its shares are just flat over the past two years. Selling at a premium, even for stock, would be attractive to investors.

CME shares have fallen nearly a tenth in the last two years. Compare that to Nasdaq and to Intercontinental Exchange, owner of the NYSE. Their stocks are up at least 25 per cent in that timeframe.

The shares of the Windy City’s exchange groups may have lagged. But CME still boasts a valuation of roughly 28 times forward earnings. That is nearly a quarter higher than CBOE, providing firepower for a stock-based deal.

Exchange operators have lately been expanding horizontally into data and analytics, as the London Stock Exchange has done. The reasons are that full-on exchange mergers are politically unpopular and most possible combinations have been executed.

Suppose CME and CBOE could revive talks that have apparently lapsed. They would still have to square a Biden administration that might prove hostile. Chicago may — anomalously — remain the sweet home to two exchange groups for some time to come.

Research from Moody’s suggests ‘fallen angels’ and ‘rising stars’ experience step changes in borrowing costs

The yield effect of declining credit ratings is mostly a smooth one. But then it resembles a jagged cliff. Companies in the investment-grade universe trade within a tight band of credit spreads. Businesses rated across junk status largely stay within a range as well. But according to recent research from Moody’s, “fallen angels” that tumble from high-grade to high-yield, and “rising stars” who do the opposite, experience step changes in their borrowing costs.

The average yield spread to comparable Treasury bonds soars 85 basis points, moving from Moody’s lowest investment rating Baa3 to the junk rating Ba1. The difference depends not merely upon mechanical debt-to-cash flow ratios. Credit investors typically segregate themselves as either investment-grade or high-yield investors, with their own distinct expectations about how companies manage their balance sheets. As junk bond yields have fallen to as low as five per cent, rating agencies are worried about an eventual default wave.

Until the 1980s, an active US junk bond market hardly existed. But the rise of corporate raiders and private equity showed that heavy leverage could juice up equity returns regardless of elevated default risk. Still, most large public companies prefer to keep net debt-to-ebitda below about four times.

Large corporates such as General Electric and Kraft Heinz exert great effort to persuade agencies to maintain their investment-grade status, even as their operations deteriorate. It is as much about marketing as it is about fundamental creditworthiness.

There is good reason for this. Within investment-grade, the penalty for being at the lower end of the spectrum is less onerous. From 1991 through to 2020, an A2-rated company faced an average yield spread of 138 basis points. The spread widened to just 220 at the lowest end, Baa3. Many firms within this band could still issue more debt to make acquisitions or buy back shares. But dropping one more notch through the junk threshold takes the average spread to 305 basis points, partly because of a forced sell-off by investment-grade portfolio managers and their restrictions. 

Moody’s research reveals that ratings at the low end of the investment-grade range are sticky. Companies work hard to stay investment-grade, while rating agencies take care about further downgrades. Despite the fact that large, prominent companies eschew leverage, paradoxically, a thriving private equity industry embraces it.

Investors back country’s biggest manager of bad debts prompting rally in company’s bonds

State-backed Chinese investors will bail out Huarong Asset Management, as the under-pressure bad debt manager unveiled losses of Rmb103bn ($15.9bn) after months of uncertainty over its finances.

The state-owned company said late on Wednesday that Citic, the Chinese bank, fellow bad debt manager Cinda Asset Management, China Insurance Investment, China Life Asset Management and Sino-Ocean Capital Holding, the asset manager, intended to make strategic investments of an undisclosed amount.

The proposed capital injection for Huarong prompted a rally in the company’s bonds on international markets, where it has borrowed more than $20bn. On Thursday, its perpetual bonds rose 11 per cent to trade at 95 cents on the dollar, compared to as low as 49 cents in April following a sell-off.

The announcement is a turning point for China’s biggest distressed debt investor. The company’s failure to release its annual financial results in April plunged it into turmoil and sparked wider concerns across Asian credit markets over whether Beijing would allow companies to default.

“The doomsday scenario which some suggested would materialise is being averted,” said Paul Lukaszewski, head of corporate debt for Asia-Pacific at Aberdeen Standard Investments. He added that state-owned enterprises should “maintain status quo in the eyes of investors with respect to expectations of state support and thus their ongoing access to capital markets”.

Huarong said it had “no plans” to restructure its debt in a statement published on WeChat, the Chinese social media platform.

The crippling losses confirmed fears that the company has a gaping hole in its finances. Huarong attributed the losses to the impact of the coronavirus pandemic and the tenure of Lai Xiaomin, its former chair who oversaw a period of aggressive expansion in China and internationally and was executed for financial crimes in January. 

“In 2020, as the trial against former chairman Lai Xiaomin for bribery, embezzlement and bigamy commenced and the sentence was pronounced, the group constantly cleared and disposed the risk assets caused by his aggressive operation and disorderly expansion during his tenure,” it said in an exchange filing.

Huarong, which counts international private equity group Warburg Pincus among its big investors, said its more than Rmb100bn of losses in 2020 were based on unaudited financial data. In 2019, net profit attributable to shareholders was Rmb1.4bn.

Huarong held a shareholder meeting on Tuesday at which it received shareholder approval to exit one of its non-core units, a consumer finance business. The company was also given backing to appoint Liang Qiang as its new president. Liang was recently promoted to head Great Wall Asset Management, another bad debt business.

Huarong was founded in the late 1990s to help clean up China’s banking sector after the Asian financial crisis, and listed in Hong Kong in 2015. Trading in its Hong Kong-listed shares remained suspended following its announcements this week.

Deal for NN Investment Partners is largest for Wall Street bank since David Solomon became chief executive

Goldman Sachs’ asset management unit has agreed to buy Dutch insurer NN Group’s investment management arm for about €1.6bn, marking the Wall Street bank’s largest acquisition since David Solomon became chief executive in 2018.

The deal for NN Investment Partners, which has $355bn of assets under management, will significantly expand Goldman’s presence in European asset management and is the latest example of the consolidation that is sweeping across the industry.

It is also a further sign of Solomon’s determination to grow the US bank in areas that earn regular fees, such as asset and wealth management while reducing its reliance on volatile businesses like equities and bond trading.

Solomon told the Financial Times that the acquisition “helps us scale our asset management platform, particularly by strengthening our position in Europe”.

Goldman Sachs Asset Management, which has $2.3tn in assets under supervision, beat Frankfurt-based asset manager DWS in the final round of bidding to clinch NN Investment Partners. UBS Asset Management, Janus Henderson and US insurer Prudential Financial had also registered interest. 

“Everything that NN does, we already do, and this is adding and accelerating our growth . . . and continues to help us scale,” said Solomon.

Asset managers globally are pursuing scale to shield profits from rising costs and falling fees. Solomon said that Goldman would “certainly take a serious look” at further acquisitions in asset management, if they could accelerate its growth. 

“The asset management industry continues to consolidate,” he added. “If you look at most of the leading players, the thing that most of them have is their businesses are global and at scale.”

Of NN Investment Partners’ assets under management, $190bn is managed on behalf of its insurance parent company, with the remainder run for external investors.

NN Group will now become a client of GSAM, bringing the total amount of outsourced insurance advisory business that it manages to $550bn. “Being a partner with the NN Group on their insurance assets going forward was an attractive opportunity for us,” said Solomon.

NN Investment Partners has a strong position in ESG investing, notably in areas such as green bonds, impact equity and sustainable equity. “We’re focused on responding to our clients’ needs and desires around ESG,” said Solomon.

Goldman reported record revenue from asset management in the second quarter, but only about a quarter of this came from managing assets on behalf of clients — the part of the business it wants to expand.

The bulk of the revenue was generated by investments that Goldman had made with its own capital, a source of income that the bank is trying to shrink. 

The bank’s assets under supervision totalled $2.3tn at the end of June, up from $2.2tn three months earlier. Goldman in 2020 outlined a target for the next five years to raise $150bn for alternative asset management vehicles, which include private equity, credit and real estate. The bank has had net inflows in asset management of more than $70bn since the start of 2020.

NN Group, which is based in The Hague, came under pressure last year from activist hedge fund Elliott Management to improve returns and streamline its operations. It said in April it was considering options for its investment management business, including a merger, joint venture or a partial divestment of the division, which has more than 900 employees in 15 countries. 

The insurance sector as a whole is grappling with a prolonged period of low interest rates and higher capital requirements under Solvency II rules, which is prompting groups to weigh up where they allocate their capital, and retreat from subscale asset management divisions.