How clearing houses aim to avert market disasters
In the last past decade global authorities have promoted elevated the role and importance of CCPs as
Clearing houses have been cast into the spotlight after soured bets from Norwegian trader Einar Aas blew a €114m hole in the buffers that are designed to stem systemic losses from trading derivative contracts in the European power markets.
In the past decade global authorities have elevated clearing houses as central pillars of market stability. This in turn has raised concerns that these utilities are the new “too big to fail” institutions.
For some the episode is a perfect example of a system working as intended after the financial crisis. For others, it is a sober warning of what could go wrong in stressed markets.
“The reserves clearing houses put in place are calculated according to the probability of trades like this happening,” said Stephen Connelly, an associate law professor at the University of Warwick. “In this case the clearing house has taken a huge hit from Mr Aas’s trades and may not be able to take another such hit if a similar event asks tomorrow.”
How clearing houses aim to avert disaster
A clearing house stands between two parties in a trade and helps manage the credit risk to the counterparty if one side defaults on payments. Any position it takes on with one party is offset by an opposite position taken with a second party. In normal circumstances the clearer avoids taking on the risk when there is a change in the market value of the trades they enter into.
But when a counterparty can no longer support its trades, the clearing house is exposed on those outstanding contracts.
The first layer of defence begins before it is too late. The clearing house demands more margin, or insurance, from the struggling party or the market, to cover any potential losses. This happened in the eurozone debt crisis when London’s LCH raised the margin on trading several European sovereign bonds.
This is the biggest shield and usually suffices in most cases. The margin of the defaulter covers any losses caused by the clearing house closing out the positions. Defaulted positions can also be transferred or auctioned off to other solvent members of the clearing house.
But the size of Mr Aas’s position on the European power markets meant there was not enough margin at Nasdaq Clearing. Even a late transfer of $36m from Mr Aas was not enough to cover the widening losses.
For a clearing house, this is a rare occurrence. By comparison LCH used around a third of the $2bn of initial margin it had called from Lehman Brothers in 2008 to close its positions.
Layers of protection
If margin calls fail to cover the losses from the defaulter, there are broadly three resolutions on offer:
Capital from the clearing house
A mutual default fund made up of contributions from clearing members
Other resources from the clearing house, such as capital from its parent company
Mr Aas’s positions burnt through Nasdaq’s own capital of €7m, which is likely to reignite a debate between clearing houses and its biggest members, the banks, over a clearing house’s “skin in the game”. Banks such as JPMorgan have long called for clearing houses to include more of their resources as a backstop.
After that, the Nasdaq turned to the default fund consisting of contributions from all clearing members to share extreme losses. It acts like insurance for unforeseen market events. Nasdaq allows institutions and traders to become a clearing member if they have at least €1m in equity to support themselves.
Shared losses
It was this layer that cushioned the impact from Mr Aas’s trades, although the losses used up two-thirds of the default fund.
After the financial crisis regulators toughened the rules over how much resources clearing houses should hold. They demanded the biggest and most systemically important clearing houses in Europe should hold enough resources to meet the losses that could arise from the default of their two largest clearing members in extreme but plausible market conditions.
The pre-funded financial resources at UK clearing houses totalled around £120bn on average in 2016, according to the Bank of England.
In the case of Lehman Brothers, the default fund was not required and so all the counterparties to Lehman’s trades did not incur a loss. Not so with the members of Nasdaq Clearing. For example Fortum, a Finnish energy company, said on Friday it had lost around two-third of its €30m contribution to the fund.
As clearing houses are required to replenish the fund as soon as possible, its members have to pay up before Monday morning. Members like Fortum will have to find €20m while others will demand to know how a single private trader managed to inflict a loss on them.
Staples to acquire Essendant for USD 12.80 per share in cash
14 SEP 2018
Staples, Inc., the Framingham, Massachusetts-based office supply giant, and Essendant Inc. [NASDAQ: ESND], the office supply company based in Deerfield, Illinois, entered into an agreement under which Staples will acquire all of the outstanding shares of Essendant common stock for USD 12.80 per share in cash, or a transaction value of USD 996m including net debt.
Barclays and Morgan Stanley & Co. LLC are acting as financial advisors and Kirkland & Ellis LLP is acting legal counsel to Staples. Citigroup Global Markets Inc. is acting as financial advisor and Skadden, Arps, Slate, Meagher & Flom LLP is acting as legal counsel to Essendant.
Press release:
Staples, Inc. and Essendant Inc. (NASDAQ: ESND) today announced that they have entered into a definitive agreement under which an affiliate of Staples, the world's largest office solutions provider, will acquire all of the outstanding shares of Essendant common stock for USD 12.80 per share in cash, or a transaction value of USD 996m including net debt.
The transaction follows the determination by Essendant's Board of Directors, after consultation with Essendant's legal and financial advisors, that the Staples proposal constituted a "Superior Proposal" as defined in Essendant's previously announced merger agreement to combine with Genuine Parts Company's (NYSE: GPC) ("GPC") S.P. Richards business (the "S.P. Richards agreement"). Consistent with that determination, and following the expiration of the three-day waiting period during which GPC did not propose any amendments to the S.P. Richards agreement, Essendant terminated that agreement. In connection with the termination, GPC is entitled to a USD 12m break-up fee, which Staples is paying as part of its agreement with Essendant.
"We are excited about the opportunity to move forward with this agreement, and to work with the Essendant team to complete the partnership of these two great companies, which will ultimately deliver significant value to independent resellers and end customers across the U.S.," Staples said.
"After carefully evaluating Staples' revised offer, including taking into account the extended regulatory process and risks associated with the S.P. Richards transaction and the continued challenges presented by the rapidly changing industry dynamics on our ability to realize value in combination with S.P. Richards, we are confident that the Staples transaction is in the best interest of Essendant shareholders," said Charles Crovitz, Chairman of Essendant. "While our agreement to merge with S.P. Richards presented an attractive opportunity, we believe the Staples transaction provides superior and immediate value to our shareholders."
Ric Phillips, President and Chief Executive Officer of Essendant added, "We believe combining with Staples provides a tremendous opportunity to enhance our resources and ability to serve customers, while delivering compelling and certain value to shareholders. I want to thank all our associates for their continued commitment and dedication as we have navigated this process over the past several months."
Transaction Terms
The USD 12.80 per share purchase price reflects a 51% premium to Essendant's share price on April 11, 2018, the day before the company announced plans to merge with GPC's S.P. Richards business, and a 10.3x multiple of last-twelve-months Adjusted EBITDA.
The transaction will be implemented through a cash tender offer at USD 12.80 per share. The transaction is conditioned upon, among other things, the number of Essendant shares included in the tender offer, together with the 11.15% of Essendant's outstanding common shares currently owned by Staples and its affiliates, representing more than 50% of Essendant's outstanding common shares, expiration of all applicable waiting periods under the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976, and other customary closing conditions. If the tender offer is consummated, the tender offer will be followed by a merger in which any shares of Essendant common stock not purchased in the offer will be converted into the right to receive the same USD 12.80 per share in cash. The transaction is not subject to a financing condition and is expected to close in the fourth quarter.
Barclays and Morgan Stanley & Co. LLC are acting as financial advisors and Kirkland & Ellis LLP is acting legal counsel to Staples. Citigroup Global Markets Inc. is acting as financial advisor and Skadden, Arps, Slate, Meagher & Flom LLP is acting as legal counsel to Essendant.
Gapping down
In reaction to disappointing earnings/guidance:
- N/A.
Select Marijuana related stocks are pulling back on potential border restrictions for investors/workers in the industry:
- TLRY -17.7%, CRON -9.9%, CGC -6.7%, MJ -5.7%
Other news:
- PDD -2.4% (after closing up nearly 7 pts)
- RCII -1.9% (lower on light volume after the company and Vintage Capital receive second request from FTC Under HSR Act; RCII special meeting to approve the Merger remains scheduled for September 18)
- PGTI -1.5% (prices offering of 7 mln shares of its common stock at a price to the public of $23.00 per share)
- NNBR -0.9% (prices offering of 12.5 mln shares of common stock at $16.00 per share)
Analyst comments:
- TNDM -5% (downgraded to Neutral from Outperform at Robert Baird)
- COST -1.6% (downgraded to Market Perform from Outperform at Wells Fargo)
- STZ -1.3% (initiated with Sell at Guggenheim)
- WMT -0.5% (resumed with a Neutral at Goldman)
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Gapping up
In reaction to strong earnings/guidance:
- CSBR +19.5%, SHLD +18.2%, RLGT +16.3%, ADBE +0.4%
Other news:
- STAA +10.4% (continued strength after announcing FDA approval of the PMA Supplement for the Visian Toric ICL)
- RLGY +5.2% (to replace Education Realty Trust (EDR) in the S&P MidCap 400)
- EXTR +2.2% (CFO to leave co; Co also reaffirms Q1 guidance, given Aug 8)
- CASI +2.1% (announces $48.5 mln private placement)
- LB +2% (to close all 23 Henri Bendel stores and the Henri Bendel e-commerce website in 2019)
- DOCU +1.3% (prices secondary offering of 8,060,550 shares of common stock at $55.00 per share, prices upsized offering of $500 mln principal amount of 0.50% Convertible Senior Notes due 2023)
- INXN +1.2% (increases its 2018 annual capital expenditure guidance range to EUR 425 million to EUR 450 million)
Analyst comments:
- ARGX +6.1% (initiated with Buy at Stifel)
- GLW +2% (upgraded to Buy from Neutral at Citigroup)
- PRSP +1.9% (upgraded to Outperform from Market Perform at Wells Fargo)
- WIX +1.6% (initiated with a Outperform at Wedbush)
- ESPR +1.4% (ticking higher; resumed with Buy at Stifel)
- YELP +1.2% (initiated with a Outperform at Wedbush)
- VNDA +1.1% (initiated with Buy at Stifel)
- ZGNX +1.1% (initiated with a Buy at BofA/Merrill)
- SHOP +1% (initiated with a Outperform at Wedbush)
- GRUB +1% (initiated with a Outperform at Wedbush ; tgt $180 and also added to Best Ideas List)
- PH +1% (upgraded to Buy from Neutral at Buckingham Research)
- VFC +0.9% (upgraded to Outperform from Market Perform at Cowen)
- SRPT +0.8% (resumed with a Buy at BofA/Merrill)
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Early premarket gappersGapping up:
- CSBR +18.5%, RLGT +17.4%, STAA +8.6%, ARGX +5.1%, SHLD +5%, RLGY +4.2%, EXTR +2.2%, ESPR +1.4%, VNDA +1.1%, HRTX +0.7%, DOCU +0.6%
Gapping down:
- TLRY -11.7%, NI -10.6%, CRON -5.4%, PDD -3.9%, MJ -3.4%, CGC -3.4%, NNBR -2.8%, RCII -1.9%, PGTI -1.9%, FOMX -1.6%, COLD -1.3%, STZ -1%, SUPN -0.7%
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