FT : Roman theatre clashes with the EU rule book

Roman theatre clashes with the EU rule book
The dispute over Italy’s budget risks sparking severe market turmoil

The budget battle between Italy’s government and the EU authorities is intensifying. On Monday the headstrong populists of Rome refused to curtail plans for a rules-busting increase in deficit-financed expenditure. On Tuesday the European Commission, taking a step without precedent in the euro’s 20-year life, demanded that Italy should re-submit its 2019 budget. In coming weeks the two sides must do their best to defuse a confrontation that risks generating dangerous financial market turmoil.

Like many showdowns between Brussels and a eurozone government, the dispute encompasses elements of political theatre as well as principles of economic governance. Yet the theatrics are on display mostly in Rome. There the ruling coalition of anti-establishment mavericks, anti-immigrant rightists and puppet technocrats appears to believe that every artificially manufactured clash with the EU represents a political gain for itself.

In particular, the Five Star Movement and League, the coalition’s dominant parties, have at least one eye on the European Parliament elections in May. They hope that victory for themselves, and for like-minded parties elsewhere in Europe, might lead to the appointment in Brussels of a commission with a very different political complexion and economic policy outlook. Five Star and the League would be off the hook and free to pursue their unorthodox populist visions.

These tactics underestimate the way that investors see deadly serious matters at stake in the budget dispute, starting with the sustainability of Italian public debt and ending with the stability of the eurozone. Matteo Salvini and Luigi Di Maio, the Italian government’s most powerful figures, risk repeating the errors of other eurozone leaders who tried to defy or outsmart the markets. The corridors of Greek power are strewn with the political corpses of such men.

Italian brinkmanship, though misguided, does not justify intransigence on the part of Brussels. As the guardian of the eurozone’s fiscal rule book, the commission has a mandate to hold wayward governments to account. However, it must take care not to play into the Italian populists’ hands by making it seem that a freely and fairly elected government cannot pursue economic policies of its own choice. A balance needs to be struck between, on one hand, the shared responsibilities of all eurozone states to the currency union and, on the other, the right and duty of governments to carry out policies on which they were elected.

Not all the Italian government’s ideas are wrong. The “universal basic income” that is Five Star’s flagship policy is too costly, but it responds to chronic problems such as regional poverty and the shortcomings of Italy’s welfare state. The League’s call for tax cuts has merit, if executed in the right way. By contrast, the government’s proposed rollback of pension reform is a mistake. But let it never be forgotten that these parties won power because Italian voters finally tired of the moderate political and technocratic elites that had presided over a 20-year spell of almost total economic stagnation.

Italy’s woeful record includes high unemployment, a brain drain of talented citizens abroad, squeezed living standards for the millions who remain at home and banks burdened with non-performing loans. The new leaders are entitled to seek change. The problem is that, in their desperation to pull Italy out of the mire, they are governing in a disorderly, unpredictable manner that alarms the markets and gives rise to deep suspicion in Brussels and among fellow eurozone governments.

FT : Bid target Intu sells the advantages of living at the mall

Bid target Intu sells the advantages of living at the mall
Shopping centre group discovers residential attractions as suitor circles

“Convenient for local shops” is notorious estate agent speak (expressing either a proximity to those of the kebab variety, or a 30-minute drive to the nearest Waitrose). It is up there with “Excellent transport links” (meaning you won’t sleep because of the traffic) and “Cash buyer preferred” (indicating no bank will lend on the property). But it seems shopping mall owner Intu wants to make “convenient” less of euphemism — by having up to 5,000 new homes built literally in and around its centres.

On Monday, the group said it was considering “opportunities within the portfolio for alternative uses of some of our available land”. These included residential developments, hotels and flexible office space. According to Intu, at six of its main shopping centres, there are 470 acres that could be built on. And there are another 34 sites valued at £65m but “with negligible income”, that it thinks could generate returns in other ways. One building intended as an extension to an adjacent mall was valued at £3m in June, and is now being sold to a student housing provider for £7m. Hence Intu’s belief that changes of use could “create value directly but, moreover, would increase the overall attractiveness and catchment of the centres”.

Turning shops into homes is not a new idea. The first US shopping mall was built in Rhode Island in 1828 but turned into a residential and mixed-use building in 2013. This year, shopping centres in Bristol, Buckinghamshire, Cheshire, Newcastle, and Sheffield have all been sold to residential developers, or are the subject of planning applications. Adding homes to shops — which is actually what Intu is proposing — is not new, either. Intu’s own Nottingham centre includes 400 apartments, and it was built in 1972.

But turning shops — or retail land — into homes is becoming a new political idea. In next week’s Budget, chancellor Philip Hammond is expected to announce planning reforms to speed up the conversion of shops into homes. It is one of the most cost effective ways to add urban housing — especially for older people — as the transport infrastructure and civic amenities are already in place.

However, as with estate agent speak, Intu’s announcement may require a little interpretation.

It suggests an initial 1,700 private rental units could yield 5 per cent on development costs of £240m. But that yield is calculated without the cost of the land and is lower than the 6-10 per cent achieved on retail rents. So turning to residential tenants as shop tenancies prove harder to fill may mean average yields become lower.

It also suddenly quotes residential unit numbers, development costs, yields and valuation uplifts — just five days after a consortium led by John Whittaker’s Peel Group made a preliminary £2.9bn offer for the group. With the consortium’s existing 29.9 per cent stake likely to deter rival bids, Intu may be left with only one way to secure a higher price. Or “Talking up a property”, as estate agents call it.

Lloyds: whose £80bn?
Lloyds Banking Group was finally able to disclose the details of its much-anticipated tie-up with Schroders on Tuesday. It has appointed the asset manager to look after £80bn of a £109bn investment portfolio, and will take a 20 per cent stake in Schroders’ wealth management business, plus a majority stake in their new financial planning joint venture. But see if you can spot whose interests appear absent from Lloyds’ main reasons for the deal:

“Lloyds Banking Group and Schroders plc today announce that they are entering into a strategic partnership to create a market-leading wealth management proposition.

“This strategic partnership will combine Lloyds’ significant client base, multichannel distribution and digital capabilities with Schroders’ investment and wealth management expertise and technology capabilities.

“For Lloyds, the partnership is in line with the strategic objectives outlined in its latest strategic review and will accelerate the development of its Financial Planning and Retirement business, and deliver significant additional growth.

“For Schroders, the partnership will continue its expansion into the strategically important UK wealth management market, building on its core strengths in active investment management. It will also leverage Benchmark Capital’s award-winning adviser platform technology.”

Did you spot that? No mention of customers — the people to whom the £80bn belongs — in any of the first four paragraphs. It is almost as if an £80bn investment mandate has been awarded principally on the basis of what Lloyds gains in return — ie a chunk of Schroder’s profit and all that “strategic” product distribution.

To be fair to Schroders, its investment performance is highly regarded and boss Peter Harrison does talk about being “focused on the evolving needs of UK savers and investors”. So, too, does Lloyds’ head of wealth management. It was probably just Lloyds’ head office that briefly forgot whose money it is.

(ZH) Inside China's 5 Trillion Yuan Ticking "Margin Call" Timebomb

Inside China's 5 Trillion Yuan Ticking "Margin Call" Timebomb
by Tyler Durden
Tue, 10/23/2018 - 13:22
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Now that even China's president has joined the verbal jawboning campaign to inspire confidence in retail investors and get them to buy Chinese stocks, vowing "unwavering" support for the country's private sector (just so Trump will finally stop pointing to the Shanghai Composite's bear market as proof the US president is winning the trade war), and following last Friday's dramatic plunge in Chinese A shares followed by a just as dramatic rebound on Monday (which however fizzled on Tuesday), analysts are finally taking a deep dive inside the risks and perils facing the Chinese stock market, and the biggest danger they find is a ticking 5 trillion pledged share time bomb.
In a note released this morning by Goldman's Kinger Lau, the China strategist looks at the recent rout (and modest rebound) in China, and compares is to the 2015 bubble and bust cycle.
What he finds is - good news - that the current episode is "less systemic" compared to 2015 because:
  • Brokers’ margin financing balance has been significantly reduced, from Rmb2.3tn at the peak of June 2015, to around Rmb765bn as of last Friday, representing only 1.8% of listed market cap (3.8% of free-float cap);
  • Off-balance-sheet (hidden) leverage is less prevalent based on our bottom-up aggregates and channel checks, and the overall leveraged positions in equities are significantly down from 2015;
  • On the whole, retail investors’ exposures to equities remains low in terms of their asset allocation, with equities accounting for roughly 3% of Chinese households’ balance sheets (vs. 63% for real estate);
But in a key shift, "users of financial leverage in equities have shifted from individuals to major shareholders in the form of Stock Pledged Loans (SPL)" this time around with "the risks revolving around SPLs being the major concerns in this market downturn."
And yet is this massive stock pledged overhang which precipitated a huge margin call last week, and which we first noted almost half a year ago quite as benign as Goldman would like to make it? Here are the facts:
  • By aggregating more than 40,000 transactions from WIND, around 5 trillion yuan worth of A-shares have been collateralized for financing (11% of listed market cap with 3,478 A-share companies engaging in SPLs, 98% of total listed companies). That said, CNY5 trillion represents the aggregate notional value of the collateral as brokers (and banks) usually provide 35-40% loan-to-value (LTV) for stock-pledged loans, implying around 2 trillion yuan of outstanding SPLs based on a 40% LTV assumption;
  • Given the weak market performance YTD, Goldman then estimate that around 1 trillion yuan of SPLs are at margin call/liquidation risk, representing 49% of total loans outstanding, 2% of market cap, with the potential loss on SPLs accounting for 2% of aggregate brokers’ capital
And while the above risks look largely manageable according to Lau, the threat is that the self-reinforcing nature of SPLs (which applies to all kinds of financial leverage) makes this a dynamic risk factor. In this vein, one can assume that if the market falls another 10%/30% from here, largely matching Goldman's “Bear” and “Crisis” scenarios, 1.2 trillion and 1.7 trillion yuan of the outstanding SPLs would be facing margin call/liquidation risks.
And here Goldman makes a bold assumption, namely that whereas historical data on actual defaults/liquidation is spares, the bank believes that most borrowers facing margin call pressures were able to come up with more collateral (i.e. cash, equity, or even properties) to top-up margin.
Even for those who couldn’t secure additional collateral and stock prices fell below liquidation levels, forced selling by brokers has seldom happened, because:
  1. there are many restrictions on major shareholders disposing shares in China A;
  2. brokers tended not to liquidate the positions as doing so would trigger more selling pressure and deplete the value of other collateralized shares,
  3. brokers don’t want to damage the relationship with their corporate clients; and,
  4. in some cases, regulators gave window guidance to brokers to avoid forced selling.
The above four may well be accurate, and yet the question then emerges: why did precisely the kind of marketwide margin call and subsequent liquidation take place last Thursday...
... when it was, according to Goldman, not supposed to? Would it, perhaps, indicate that borrowers have run out of more collateral to pledged? And if so, just how long until the next major market selloff triggers the remainder of China's ticking 5 trillion yuan pledged stock time bomb.

(ZH) Quant Funds Are Searching For Alpha In Dangerously Illiquid 'Exotic' Assets

Quant Funds Are Searching For Alpha In Dangerously Illiquid 'Exotic' Assets

Given the (until very recently) persistent upward trajectory of benchmark market returns since the financial crisis, many traders have become numb to the risks stemming from an over-reliance on leverage. This concept is even more applicable to illiquid, exotic markets like, say, betting on European power spreads, a strategy that last month forced one uber-wealthy Norwegian power trader into bankruptcy and nearly brought down the Nasdaq Nordic commodities exchange, because, as the trader, who was once the largest taxpayer in Norway, learned the hard way, when buyers are scarce, a chasm can open up between bids and asks, causing prices to plunge whenever a trader is forced into a firesale, leading to staggering losses.
Now, with US stocks poised to catch down to the ROW following months of decoupling as the bout of market turbulence that started earlier this month stretches into its second week, Bloomberg has brought us a story about the growing popularity of a "niche" investing strategy being embraced by CTAs and other quant funds. The strategy hopes to generate "uncorrelated returns" (particularly useful when stocks enter correction territory) and some extra alpha by investing in the aforementioned power markets, Turkish scrap steel, obscure chemical products, or eggs in China.
These funds have septupled in size over the past five years, climbing from $1 billion to $7 billion in total AUM among CTAs alone. However, as speculative flows into these tiny markets intensify, it could create problems for investors hoping to recover their money in a selloff.
With at least $7 billion invested across at least eight such funds, up from one fund and $1 billion five years ago, these alternative CTAs remain very much a niche strategy. But trend-following funds have been blamed in the past for amplifying selloffs in some of the most liquid assets, because they tend to rely on similar models. As more money is targeting much smaller markets, even some managers warn of risks if funds pile into the same trade or unforeseen events cause a selloff.
"These assets are less arbitrated and subject to wider moves," said Philippe Ferreira, a Paris-based senior cross-asset strategist at Lyxor Asset Management, which invests in hedge funds.
Still, with equities already so richly priced, the lure of uncorrelated returns has proven too strong to resist.
Investors have flocked to exotic trend followers because they promise diversification and a way to shield portfolios from broad market shocks. Electricity markets in Northern Europe, for instance, may be relatively more dependent on rainfall in Norway than on global market trends. Prices of purified terephthalic acid, a chemical used to make polyester, depend on sales of yoga pants or plastic bottles.
Outside of CTAs, funds targeting alternative assets have multiplied over the past few years as capital has poured in...
Since last year, five new funds have joined the fray from money managers such as Aspect Capital and GAM Holding AG. One reason is that traditional trend-following funds struggled this year as volatility returned and some investors shifted to cheaper smart beta funds.

After attracting net inflows of about $51 billion in three years through 2017, investors pulled about $14 billion this year, according to Eurekahedge. The strategy suffered its worst loss in years in February when a particularly popular trade -- a bet that volatility would remain low -- imploded in sudden market selloff. They are suffering another tough month in October, with the SG Trend Index, which tracks returns for 10 such funds, down 5.4 percent through Oct. 18.
...And they recently received the blessing of pension funds.
Their alternative siblings, by contrast, have mostly made money this year, attracting investors. The latest stamp of approval came from the pension funds for New York City’s police and fire departments, which in August allocated a combined $134 million to London-based Florin Court Capital that runs one of these money pools.
Cambridge Associates, a consultant which guides some of the world’s largest pensions and endowments on where to invest, approved alternative market fund Gresham Quant ACAR earlier this year, according to people with knowledge of the matter. CERN Pension Fund, which invests for employees of the European nuclear physics research organization, allocated $10 million to the AHL Evolution last year even as it cut exposure to hedge funds, according to its annual report.
But the increasing popularity of these strategies can amplify risks as an influx of trend followers more easily distorts prices, increasingly the likelihood of a devastating crash.
Critics fear that their popularity could become their biggest enemy as more money chases higher returns in relatively small markets. Often, firms will use over-the-counter contracts to place their bets because there’s no exchange where futures on these assets are traded. That means fewer buyers when markets go south, and it means fewer data points for the computer models to build on.
Fund mangers acknowledge that crowded trades in alternative markets could pose a risk, but they argue the strategy will always be a niche, the icing on the cake for sophisticated investors who understand the illiquidity risk. They also say that such funds will be capped because there’s a limit to how much money each can put to work in their exotic markets.
"Growth of such strategies should be naturally limited by the liquidity and tradability of the underlying alternative markets and the first mover is likely to take all," said Nicolas Roth, head of alternative assets at Geneva-based investment firm Reyl & Cie.
Though others argue that, since speculators are more likely to interact with actual producers who need these assets for different purposes, like providing power to swaths of northern Europe, it could be easier for both sides of the trade to declare a "win", since the buyer can have a material need that would be impossible to fulfill else where.
But regardless, if the selloff in US stocks continues, expect more investors to look elsewhere for opportunities to continue earning that alpha as volatility returns to traditional markets