FT : CDS markets signal rising fear of euro breakup

CDS markets signal rising fear of euro breakup
The following guest post on credit default swap basis is from Marcello Minenna, the head of Quantitative Analysis and Financial Innovation at Consob, the Italian securities regulator.
Financial markets are well aware that the next few months could be decisive for the future of the Eurozone.
In April, the French will vote in the first round of presidential elections. Marine Le Pen, who is currently expected to make it to the second round in May, has said that if she wins she will dedicate the first six months of her term to lead the country out of the single currency.

Italy is another potential risk, even though there is no imminent election. The country is saddled with high levels of public and private debt, meagre growth prospects, and persistent political instability. The single currency is deeply unpopular in Italy, with only 41 per cent of Italians considering the euro “a good thing” for their country, compared to 47 per cent who think it’s “a bad thing”, according to the latest Eurobarometer survey.
Euro area institutions haven’t been helping.
Germany continues its crusade for fiscal virtue. If countries aren’t willing to cut spending and raise taxes, the German solution is to restructure public debt — starting with Italy — according to the scheme already applied to Greece. Angela Merkel recently declared herself in favor of a “multi-speed Europe”.
At the same time, the European Central Bank’s commitment to defend the irreversibility of the euro is based as much on threats as on positive pledges. Mario Draghi recently said that if a country wants to quit, it must first fully settle its Target2 balance with the rest of the eurosystem. Italy, for example, would have to pay more than €360 billion — the equivalent of a (big) war debt, like the one imposed on Germany a century ago. But those were different times, and a different Europe!
Financial markets understand the risks of “Italexit” and “Frexit” even if the likelihood of either event is still judged to be low.
This can be seen in the data on credit default swaps (CDS), which offer protection in the case of an “insured event” or, in the jargon, a credit event. The widening gap in prices between different types of CDS contracts reflects the rising risk that some euro area sovereign debts may be redenominated into new, depreciating, currencies, which would probably lead to real losses for investors.
To correctly interpret the data on CDS prices, we need a quick flashback to 2012, another year of great tension for the single currency. While the center of the crisis was in Greek sovereign debt and the Spanish banking sector, institutional investors had already begun to think of how to protect themselves from the danger of the euro’s total dissolution, which might be prompted by the exit of a big country such as Italy or France.
Back then, there were no good options available. Buying CDS wouldn’t have helped because the standard contract explicitly excluded debt redenomination from the list of credit events if the issuer were a member of the G7 or an OECD investment-grade sovereign.
Two years later, new ISDA standards entered into force: contracts made since 2014 protect against euro area countries redenominating their debt into new national currencies.
Strictly speaking, it’s still possible to redenominate debt into a different currency without triggering a credit event, but this only works if the debt is switched into a reserve currency: the US dollar, the Canadian dollar, the British pound, the Japanese yen, or the Swiss franc. In all other cases, the only way to avoid the triggering of a credit event is if the switch to the new currency does not result in a loss for the investor: “no reduction in the rate or amount of interest, principal or premium payable”.
Since 2014 two types of sovereign CDS therefore coexist: the old (ISDA 2003) and the new (ISDA 2014). The latter has always traded at spreads wider than the CDS-2003, but the difference (the ISDA basis) has generally been small: 15-20 bps for Italy, 8-12 bps for Spain, 2-4 bps for France, and 1-2 bps for Germany.
The width of the spread between the two types of CDS — the Isda basis — reflects both the perceived risk of redenomination risk and, in addition, the potential scope for depreciation in the event of a return to a national currency.
This year, something has changed. Since late January, the ISDA basis has rocketed upwards in the major Eurozone economies, indicating that investors perceive greater redenomination risk than before. The rest is pure physiology of the financial markets: a greater risk raises the demand for protection which, in turn, leads to an appreciation of the 2014-vintage CDS, which are the most appropriate instrument to smooth out any losses arising from the change of the payment currency of the contract.
The following chart shows the phenomenon in the case of Italy. In February, the difference between CDS-2014 and CDS-2003 has doubled from 20 to 40 basis points:
For France, the phenomenon is even more overwhelming. In February the Isda basis soared from 3 to 24 bps. While the level of this basis is still relatively small in absolute terms, traders think the risk has increased by roughly eight times as they assess the upcoming elections:
Further confirmation comes from the increase in the net notional outstanding amount of CDS contracts linked to the French Republic. Since mid-January, the amount of protection purchased on a credit event by the French government has grown by about €320 billion, or roughly 5 per cent:
“Frexit” would have far more devastating effects than “Brexit” on the resilience of Europe, and especially for the integrity of the euro area. The contagion effect is one of the main components of the widening ISDA basis in Italy.
But no one is completely immune from the possible consequences of a French secession. Even in Germany, the basis shows similar trends to those displayed in France and Italy, especially when viewed as a percentage increase. (In absolute terms it is still laughable, at around 5 basis points.) The differential between CDS-2014 and CDS-2003 has also widened in Spain, although by less than in other countries.
So far we’ve been looking at the gap between CDS-2014 and CDS-2003, both of which are US dollar-denominated contracts. There are similar dynamics at work in the “quanto spread”: the difference between the prices of dollar-denominated and euro-denominated ISDA-2014 CDS contracts insuring against credit events by the same reference entities.
If redenomination affects a liability issued by a sovereign of the euro area, it’s reasonable to expect that euro-denominated CDS would offer only limited protection to investors. It would certainly offer less protection than the corresponding USD-denominated contract could give, presumably because the of the nontrivial possibility the euro would cease to exist.
The next two charts compare the trends of the quanto spread and the ISDA basis for Italy:
And for France:
Markets do not lie. Institutional investors may hope to get special deals from Le Pen. Germans, unnerved by reflation, may not want to increase the size of their Target2 liabilities and demand the interruption of QE. Italy must avoid remaining with short end of the stick. I wonder if our leadership will rise to the challenge.

FT : Pressure on Standard Life merger partners to avoid an own goal

Pressure on Standard Life merger partners to avoid an own goal
Co-chiefs Keith Skeoch and Martin Gilbert share similarities — which is a concern

Would Keith Skeoch, low-key chief executive of Standard Life, have headed from the bar at Davos to Donald Trump’s inauguration? Does he base his management style on that of football supremo and Glaswegian verbal hairdryer Sir Alex Ferguson? Could he have been likened to a “snake oil salesman” by MPs in a probe into split capital investment trusts, and emerged unscathed?

Standard Life’s shareholders might ask themselves such questions given Mr Skeoch’s choice of merger partner. Martin Gilbert, flamboyant co-founder of Aberdeen Asset Management and co-CEO designate of their combined £11bn business, is known for all the above. He appears a very different character to Mr Skeoch. Mr Gilbert has proved the consummate deal consummator. This is his 43rd merger or acquisition in a three-decade career as Aberdeen’s dominant leader, to whom no obvious successor has emerged.

Mr Skeoch, by contrast, is an economist by training, who first opted for a Whitehall job before spending 20 years at conservative London stock broker James Capel.

The two men insist these differences will make being co-CEOs work. On Monday they stressed that being “very different people” who have known — and fly-fished alongside — each other “for a long time” was “why we get on”. Opposites attract, it seems (to which comedian John Cleese once countered: “Ah, the cry of the truly desperate.”)

However, it is not the duo’s differences but their similarities that worry some. The pragmatic Mr Gilbert does what it takes to get deals done, swapping the banks of the Tay for a flat above a Thameside pizza joint when working his contacts in the City.

Mr Skeoch is no less steely — in his role running Standard Life’s investment arm, he began being paid more than, and ended up usurping, group chief executive David Nish.

Could such forceful personalities share the CEO role?

Mr Gilbert should know it doesn’t work in football. At Manchester United, his friend Sir Alex watched rivals Liverpool fall apart when they played under joint managers Roy Evans and Gerard Houllier.

It seldom works in financial services, either. At Citigroup, co-CEOs Sandy Weill and John Reed clashed so often between 1998 to 2000 that Wharton business school uses them as a case study of why “strong people with strong views” should not jointly run companies. CEOs of Fortune 500 businesses in the US rarely share power.

Closer to home — and closer to the bone — one analyst recalls “the ‘Richard & Roger’ show”, when co-CEOs Richard Gamble and Roger Taylor tried ineffectually to integrate Royal Insurance and Sun Alliance.

Single mindedness is all when merging insurance and investment houses. For Standard Life’s shareholders — and regulators — the key question may be whose single mind.

BT’s costly defence play

Footie fans pay almost any price to watch their teams play. At least BT, whose boss Gavin Patterson is a diehard Liverpool supporter, must hope so. The telecoms-to-TV group is paying a whopping £1.2bn for the rights for three years to broadcast European Champions League football to UK audiences, writes Kate Burgess. That is a third up on the price it coughed up to win the rights from rivals Sky and ITV in 2013. What price will Mr P pay next time round?

In BT’s defence, sport underpins the group’s broadband and pay-TV business, luring in and holding subscribers. Before BT Sport, the group was losing 200,000 customer lines per quarter. BT would come a poor second to Sky if all it could offer subscribers was thin coverage of Premier League matches. It is not so much what BT has won but what it would have lost if Sky had won the Uefa rights.

BT can in part justify the price, saying the new Uefa package has improved. And it will be able to offset some of the cash cost by charging for sport. It also has access to EE’s mobile customers.

But Bernstein analysts reckon BT Sport is barely profitable on a standalone basis. And the Uefa package hasn’t improved so much it can guarantee the millions of viewers who will watch a match between, say, Man Utd and Liverpool. BT might have been wiser to hold on to the cash and use it next year to secure the rights to Premier League matches. Other parts of the business will need cash, too. Last month the group warned on profits from its global services division, having found the jiggery pokery in its Italian operations was worse than expected. A massive hole in its pension fund looms over BT, as does its continuing tussle with Ofcom over Openreach.

Securing the rights to show Uefa games is central to Mr Patterson’s plan to turn BT into a “quadplay” provider of TV, telephony and broadband. The worry is that those who believe BT is overpaying are but a penalty kick away from losing faith in Mr Patterson and his strategy.

>>> US Gapping up

Gapping up
In reaction to strong earnings/guidance:
  • POLA +25.9%, MVIS +17.9%
M&A news:
  • CNCE +33.7% (to sell CTP-656 to Vertex Pharmaceuticals (VRTX) for an upfront payment of $160 mln in cash with the potential for $90 mln in future regulatory approval milestone payments, also reported earnings)
Other news:
  • TGTX +66.4% (announces 'positive' topline results from its Phase 3 GENUINE clinical trial of TG-1101 plus ibrutinib)
  • PTCT +14.7% (FDA has acknowledged the filing over protest of PTC's New Drug Application for Translarna)
  • ADXS +9% (announces FDA acceptance of IND for personalized neoepitope immunotherapy, ADXS-NEO)
  • NOVN +8.8% (provides update on SB204 development program, intends to proceed with the SB204 development program)
  • SDRL +8% (modestly rebounding following last week's 37% decline)
  • CXRX +6.8% (US district court awarded the co treble damages of $2.2 mln, an increase from the original damages award of $733k)
  • IMGN +4.7% (files for $200 mln mixed securities shelf offering)
  • RRC +3.6% (Barron's profiles positive view on Range Resources)
  • XRX +3% (Barron's profiles positive view on Xerox)
  • DBVT +2.7% (reports results of 'Viaskin Peanut' study suggesting lasting response and favorable safety profile)
  • RRTS +2.2% (Elliott Associates Friday increased its passive stake to 7.5%)
  • VRX +1.8% (completes about $1.1 bln pay down of senior secured term loans from divestitures; to seek refinancing & amendment of credit agreement)
  • AMD +1% (Mubadala Development Company PJSC proposes the sale of 45 mln shares under form 144)
  • UBNT +0.8% (approved $50 mln stock repurchase program)
Analyst comments:
  • AA +2.1% (upgraded to Buy from Neutral at Goldman)
  • NFLX +1.4% (upgraded to Buy from Neutral at UBS)
  • HPQ +0.9% (upgraded to Outperform from Market Perform at Wells Fargo)

>>> US Gapping down

Gapping down
In reaction to disappointing earnings/guidance:
  • AFI -12.3%
Select EU financial related names showing weakness in sympathy with DB (EUR8 bln capital raise) :
  • CS -3.4%, RBS -2%, LYG -1.5%
Select metals/mining stocks trading lower following China's lowered GDP outlook to ~+6.5%:
  • HMY -2.5%, FCX -2.5%, BBL -2.5%, X -2.5%, RIO -2.1%, BHP -1.9%, AKS -1.7%, MT -1.2%, AU -1%
Other news:
  • DRYS -8% (discloses stock purchase agreement update)
  • TSN -2.4% (WSJ discusses that bird flu was found in chicken farm linked to Tyson Foods)
  • CMG -1.3% (files for 2,882,463 share common stock offering by selling shareholder)
  • TEVA -1.1% (continued weakness)
  • DB -0.9% (announces capital increase of EUR8 bln, refines strategy; announces new financial targets)
Analyst comments:
  • GPRO -2.7% (downgraded to Sell from Neutral at Goldman)
  • MET -1.1% (downgraded to Neutral from Buy at BofA/Merrill)
  • PG -0.8% (downgraded to Neutral from Buy at B. Riley)

>>> US Early premarket gappers

Early premarket gappers

Gapping up: SDRL +8%, XRX +3.1%, RRC +2.3%, MUX +1.8%, NFLX +1.6%, GNC +1.6%, AA +1.4%, MTL +1.4%, AKS +1.3%, TEF +1.2%, VRX +0.8%, HPQ +0.5%

Gapping down: CS -3.9%, HMY -3.8%, GPRO -3.2%, TSN -3.1%, FCX -2.7%, BBL -2.6%, AUY -2.3%, DRYS -2.2%, RIO -2.2%, BHP -2%, RBS -1.8%, LYG -1.8%, DB -1.7%, AMD -1.5%, AU -1.5%, AG -1.3%, TEVA -1.2%, MET -1.1%, MT -1.1%

(GatestoneInstitue) France's Death Spiral

  • In 1990, the "Gayssot law" was passed, stipulating that "any discrimination based on ethnicity, nation, race or religion is prohibited". Since then, it has been used to criminalize any criticism of Arab and African delinquency, any question on immigration from the Muslim world, any negative analysis of Islam. Many writers have been fined and most "politically incorrect" books on those topics have disappeared from bookshops.
  • The French government asked the media to obey the "Gayssot law." It also asked that history textbooks be rewritten to include chapters on the crimes committed by the West against Muslims, and on the "essential contribution" of Islam to humanity. All history textbooks are "Islamically correct."
  • In hospitals, Muslims are increasingly asking to be treated only by Muslim doctors, and refusing to let their wives be treated by male doctors.
February 2, 2017: A "no-go zone" in the eastern suburbs of Paris. Police on patrol hear screams. They decide to check. While there, a young man insults them. They decide to arrest him. He hits them. A fight starts. He accuses a policeman of having raped him with a police baton. A police investigation quickly establishes that the young man was not raped. But it is too late; a toxic process has begun.
Without waiting for any further evidence, the French Interior Minister says that the police officers have "behaved badly." He adds that "police misconduct must be condemned". French President François Hollande goes to the hospital to give his support to the young man. The president says he has conducted himself in a "dignified and responsible manner." The next day, a demonstration against the police is cobbled together. The demonstration turns into a riot.
Riots continue for more than two weeks. They affect more than twenty cities throughout France. They spread to the heart of Paris. Dozens of cars are torched. Shops and restaurants are looted. Official buildings and police stations are attacked.
The police are ordered not to intervene. They do what they are told to do. Few arrests take place.

Calm is slowly returning, but the riots can easily start again. France is a country at the mercy of large-scale uprisings. They can explode anytime, anyplace. French leaders know it, and find refuge in cowardice.
What is happening is the result of a corrosive development initiated five decades ago. In the 1960s, after the war in Algeria, President Charles de Gaulle directed the country toward closer relations with Arab and Muslim states.
Migratory flows of "guest workers" from Algeria, Morocco and Tunisia, which had started a few years earlier, sharply increased. Immigrants were not encouraged to integrate. Everyone assumed they would return home at the end of their employment contracts. They were settled in the outskirts of big cities. The economy was dynamic, with strong job creation. It seemed there would be no problems.
Twenty years later, serious difficulties became obvious. The immigrants now numbered millions. People from sub-Saharan Africa joined those coming from Arab nations. Neighborhoods made up of just Arabs and Africans were formed. The economy had slowed down and mass unemployment settled in. But the jobless immigrants did not go back home, instead relying on social benefits. Integration still did not exist. Although many of these new arrivals had become French citizens, they often sounded resentful of France and the West. Political agitators started teaching them to detest Western civilization. Violent gangs of young Arabs and Africans began to form. Clashes with police were common. Often, when a gang member was wounded, political agitators would help to incite more violence.
The situation grew difficult to control. But nothing was done to fix it; quite the opposite.
In 1984, a movement called SOS Racisme was created by Trotskyist militants, and began to define any criticism of immigration as "racist". Major leftist parties supported SOS Racism. They seem to have thought that by accusing their political opponents of racism, they could attract the votes of "new citizens." The presence of Islamist agitators, alongside agitators in Arab and African neighborhoods, plus the emergence of anti-Western Islamic discourse, alarmed many observers. SOS Racisme immediately designated those who spoke of Islamic danger as "Islamophobic racists."
In 1990, a law drafted by a Communist lawmaker, Jean-Claude Gayssot, was passed. It stipulated that "any discrimination based on ethnicity, nation, race or religion is prohibited." Since then, this law has been used to criminalize any criticism of Arab and African delinquency, any question on immigration from the Muslim world, any negative analysis of Islam. Many writers have been fined, and most "politically incorrect" books on those topics have disappeared from bookshops.
The French government asked the media to obey the "Gayssot law." It also asked that history textbooks be rewritten to include chapters on the crimes committed by the West against Muslims, and on the "essential contribution" of Islam to humanity.
In 2002, the situation in the country became dramatic.
Arab and African neighborhoods had become "no-go zones." Radical Islam was widespread and Islamist attacks began. Dozens of cars would be torched each week. Muslim anti-Semitism was rising rapidly and led to an increase in anti-Jewish attacks. SOS Racisme and other anti-racist organizations were silent on Muslim anti-Semitism. Unwilling to be accused of "Islamophobic racism," organizations tasked with fighting against anti-Semitism were also silent.
A book, The Lost Territories of the Republic, by Georges Bensoussan (under the pen-name "Emmanuel Brenner"), was released. It depicted accurately what was going on. It spoke of the sweeping hatred for the West among young people of immigrant origin, and of the full-blown hatred of Jews among young Muslims. It said that "no-go zones" were on the edge of secession and no longer a part of French territory. The mainstream media ignored the book.
Three years later, in October 2005, riots broke out across the country. More than 9,000 cars were torched. Hundreds of stores, supermarkets and shopping centers were looted and destroyed. Dozens of police officers were seriously injured. The storm stopped when the government reached an agreement to make peace with Muslim associations. Power had changed hands.
Since then, the state scarcely maintains law and order in France.
Another book, A Submissive France, was recently published by the man who had written The Lost Territories of the Republic fifteen years before, the historian Georges Bensoussan. Now, the French Republic itself is a lost territory.
"No go zones" are no longer French territory. Radical Islam and the hatred of the West reign among Muslim populations and, more broadly, among populations of immigrant origin. Muslim anti-Semitism makes life unbearable for Jews who have not yet left France and who cannot afford to relocate to areas where Jews are not yet threatened: the 16th and 17tharrondissements, the Beverly Hills of Paris; or the city of Neuilly, a wealthy suburb of Paris.
Everywhere in France, high school teachers go to work with a Qur'an in their hands, to make sure that what they say in class does not contradict the sacred book of Islam.
All history textbooks are "Islamically correct". One-third of the French Muslims say they want to live according to Islamic sharia law and not according to the laws of France.
In hospitals, Muslims are increasingly asking to be treated by Muslim doctors only, and refusing to let their wives be treated by male doctors.
Attacks on police officers occur on a daily basis. The police have orders: they must not enter "no-go zones." They must not respond to insults and threats. They must flee if they are assaulted. Sometime, they do not have time to flee.
In October 2016, two policemen were burned alive in their car in Viry-Châtillon, south of Paris. In January 2017, three police officers fell into an ambush and were stabbed in in Bobigny, east of Paris.
Police officers did respond to the incident on February 2. When a man became violent, they did not flee. The French government could only find them guilty, accusing a police officer of raping his attacker. But the police officer was not guilty of rape; he was guilty of simply having intervened. The French government also found his colleagues guilty. They were all accused of "violence." They now will have to go to court.
The young man who destroyed the lives of these police officers is not being accused of anything. In all the "no go zones," he is now a hero. Mainstream television channels ask him for interviews. His name is Theodore, or Theo. "Justice for Theo" stickers are everywhere. Banners sporting his name are waved at demonstrations. Rioters shout his name along with the name of Allah.
A few journalists have said that he is not a hero; that "no go zones" are reservoirs of anti-Western, anti-Semitic and anti-French hatred ready to burst. But these journalists are also cautious. They know they might be prosecuted.
Georges Bensoussan, the Moroccan-born author of The Lost Territories of the Republic and of A Submissive France -- is currently on trial. A complaint was filed against him by the Collective against Islamophobia in France (CCIF). They are suing him for having said: "Today we are witnessing a different people in the French nation; they are causing the return of a number of democratic values to which we adhere," and "This visceral anti-Semitism, proven by the Fondapol Survey last year, cannot remain in silence."
Judges were immediately assigned to the case. The verdict is due March 5. If Bensoussan is not sentenced, the CCIF will be sure to appeal. Bensoussan is a man from the left. He is a member of "J Call" (European Jewish Call for Reason), a movement criticizing "Israel's occupation of the West Bank", and asking for "the creation of a viable Palestinian state". Even such positions are no longer enough to protect him. The International League against Racism and Anti-Semitism (LICRA), an organization founded in 1927 to combat anti-Semitism, supported CCIF. Organizations ostensibly fighting anti-Semitism in France instead seem to be clinging to futile fantasies of appeasing their tormentors. They never mention Muslim anti-Semitism, and have now fully joined the fight against "Islamophobic racism" against Jewish authors such as Georges Bensoussan.
Elections will be held in France, in April. The Socialist Party chose a candidate, Benoît Hamon, supported by the UOIF (Union of Islamic Organizations of France), the French branch of the Muslim Brotherhood.
The far-left and the communists will also have a candidate, Jean-Luc Mélenchon, an unconditional admirer of Lenin, Hugo Chavez and Yasser Arafat, and a resolute enemy of Israel.
Hamon and Mélenchon will likely each receive about 15% of the vote.
A third candidate from the left, Emmanuel Macron, is a former member of the French Socialist government under François Hollande. To attract the Muslim vote, Macron went to Algeria and said that French colonization was a "crime against humanity." He stated several times that French culture does not exist, and that Western culture does not exist either; but he added that Arab Muslim culture must have "its place" in France.
The conservative candidate, François Fillon, promises to fight Sunni Islam, but says he wants a "strong alliance" between France, Iran's mullahs and Hezbollah. His reputation is badly damaged by a "fake jobs" scandal. He has attacked France's Jewish community, presumably to secure the Muslim vote. He said it does not respect "all the rules of the Republic." He has said that Israel represents a threat to world peace.
Marine Le Pen, the far-right candidate of the National Front, may seem the most determined to straighten France out, but her economic program is as self-defeatingly Marxist as that of Hamon or Mélenchon. Le Pen also wants to attract the Muslim electorate. She went to Cairo a few months ago to meet the Grand Imam of al-Azhar. Like all other French political parties, her party supported the anti-Israeli positions of former U.S. President Barack Obama,
a
s well as UN Security Council Resolution 2334, passed last year on December 23.
Le Pen will likely win the first round of the two-round election, but will almost certainly be defeated in the second round: all the other candidates will gather behind the candidate facing her, probably Macron or Fillon (if he still is in the race). Le Pen might think that in five years the situation in France will be even worse, and that then she will have a serious chance to be elected President.
A few months ago, in a recently published book, Civil War is Coming, the French columnist Ivan Rioufol wrote: "The danger is not the National Front, which is only the expression of the anger of an abandoned people. The danger is the ever-closer links between leftism and Islamism.... The danger must be stopped."