Wednesday was not a pretty day in credit markets but I have seen worse. There was not real panic and one could not, as it is said, smell the fear. That does not mean that the markets didn’t stink.
I think we were all taken slightly by surprise on Tuesday evening when the announcement hit the screen that the UK’s FCA is to put a 12-month moratorium of CoCo/AT1 bonds being sold directly to petty retail.
In the aftermath, everyone suddenly noticed that the eurozone authorities had already issued a warning against the bonds on the basis that the embedded risks were not fully appreciated. All of a sudden voices were being heard asking why anyone would buy equity-style risk at bond-style returns and with such a skewed risk profile.
CoCos went heavily offered but they did not, by any means, collapse. One trader wrote in his opening comment that ”…generically we are 1.5 points to 2 points lower but I’ve had “liquidity” bids hit up to 3 points lower in places” but although there were investors looking for the door we saw nothing of the stampede which some had expected.
Traders have generally been long stock, so they were hurting from the outset while finding it hard to draw in buyers at the lower prices. For once it was retail refusing to provide the street with liquidity and not the other way around.
We certainly didn’t see any buyers ourselves and were also graced with better sellers. Still, as so often in such cases, after the initial “Get me out at any price”, sellers have hit the early bids, the second wave gets greedy, tries to find the mid-market bid which isn’t there and is left long with the opportunity to look for a mid-market the next day, albeit a point below the previous bid which it couldn’t find the heart to hit when it was there.
Been there, done that
The technology, the regulation, the jargon and the base salaries might change over time but the schoolboy errors remain the same. The wisdom that “The first cut is the cheapest” dates back to the days of telegraphs, yield tables and top-hat wearing City messengers.
It is of course funny, if funny is the word, that the regulators first created equity risk-sharing subordinated debt, they subsequently imposed capital constraints making that paper viciously expensive only to then impose an investment constraint that kicks the stool out from under the market. Well done guys! Another classic case of “Sod the consequences, nothing is going to go wrong on my watch!” And what is to become of the mutual funds which invest in CoCos?
I do of course, and this is not news, fundamentally dislike CoCos, not least of all because they have so far not suffered a default and hence nobody has experience of how they perform in the worst case. Without that knowledge, it is impossible to price them correctly. Please don’t tell me that the worst case scenarios have been modelled. The collapse of Long Term Credit Management (LTCM) was deemed by its Nobel Prize laureate partners to be no more than a 22 standard deviation probability and we are just emerging from history’s greatest credit crisis brought about because the lending process had been hijacked by a bunch of statisticians, mathematicians and general rocket scientists and removed from the control of boring but experienced lending bankers.
Credible compliance
Separately, I came across a senior banker yesterday who was tearing his hair out over compliance issues. Having prepared and submitted the requisite, board-approved recovery plan to the regulator, he then found himself faced with a request for a further statement from the board that it had found the measures proposed in the recovery plan to be “credible”.
I’m not quite sure what the people who work for the regulator are on but one might perhaps blithely assume that if the board has approved the plan, that it has found it to be “credible”. Does requesting a further statement to that effect not infer that the regulator believes that the board of the bank might have voted for a recovery plan which it did not find credible? Maybe it will next be asking for the board to issue a letter confirming that the pounds sterling in which the balance sheet and the P&L are expressed in are the same pounds in which they were reported last year? Regulators drunk on their own power?
Douglas Flint, chairman of HSBC, was so on the button.
