MLPs break ECM silence

Credit Suisse CEO Tidjane Thiam tried to put a brave face on the latest shake-up at his troubled bank last week, but many in the market were not exactly buying it – including some of his own staff. Thiam said the size of the bank’s illiquid positions, which occasioned nearly US$1bn of losses, had been a “surprise” to him and others at the bank. But two Credit Suisse bankers told IFR the real surprise was that Thiam, installed as chief executive less than a year ago, could claim that the bank’s positions were not known about. The bankers, who asked not to be named, said it was inconceivable that the bank’s Capital Allocation and Risk Management Committee (CARMC) was unaware of the holdings. CARMC reports to Thiam and the Credit Suisse board. The illiquid positions in the distressed credit and structured finance trading books led to a US$633m writedown in the fourth quarter of 2015 and another US$346m for the first quarter of this year. “Clearly, something didn’t go right there,” Thiam told an analyst call last week. “Even internally the scale of those positions was a surprise for a number of people.” But one senior Credit Suisse banker suggested that Thiam had in fact “gone off-script” when speaking with analysts and in later media appearances. “He went off the agreed line,” the banker said. “The COO, the CFO knew about the [positions taken by] these businesses. CARMC happens every month. The notion that people didn’t know is simply not believable. It is incredible that a man of his experience should do this.” Bankers outside of CS also questioned the claim. “It isn’t a rogue trader thing,” said one banker who formerly worked at Credit Suisse and retains contacts at the bank. Indeed, hours after saying that positions had been taken that senior management didn’t know about as a consequence of “unacceptable” practices, Thiam had to issue a statement confirming that traders were in fact trading inside their limits. All in confidence Thiam appeared to confound observers still further last week when he named the two men who had overseen those positions as co-heads of a new global markets division. Brian Chin and David Miller had run, respectively, the credit and structured finance operations – the very books responsible for the supposedly surprise losses. “There have been consequences,” Thiam said on the analyst call. “I don’t want to name names, but there have been changes.” Yet with Chin and Miller now running a new division – a merger of the credit and structured operations – many were left wondering exactly who had borne the consequences of what. Meanwhile, CFO David Mathers abruptly pulled out of an industry conference last week – something “that caused a lot of speculation”, the former CS banker said. Thiam was asked by reporters if Mathers still had his total confidence. “Absolutely,” he said. More to come While Thiam will surely have been frustrated by the number of questions swirling around last week’s activity, some of the biggest may be yet to come. After booking the nearly US$1bn of writedowns, some in the market are now wondering how much Thiam knew – or should have known – when the bank raised capital via a December rights issue after the markets had weakened so much the previous month. “Does this create additional litigation risk?” asked Huw van Steenis and other Morgan Stanley analysts in a report on Thursday. One investor who took part in the rights issue told IFR that the bank had not given any sign of trouble in the offing. “They made it very clear they wanted to chuck everything at this rights issue so that they didn’t have to come back to the market,” the investor said. “So for them to come back now with losses and gaps they need to fill is close to negligence. It’s pretty bloody awful.” Trying again Last week’s reorganisation was Thiam’s second in the past six months. He brought equities, fixed income and derivatives under the same roof in October in an effort to boost profits. Securitised products and credit t

Credit Suisse boss Tidjane Thiam said he only became aware in January of big adverse positions in the bank’s distressed credit book, prompting him to make more savage cuts to its markets business just five months after a strategic review. Thiam, who became chief executive in June, said last week that he and senior executives only found out about the positions two months ago and since then he has been assessing them closely. “In October, I was not aware of the positions on that scale,” he told analysts. “There have since been changes in fixed income and accountability for that.” Thiam said the misinformation on the distressed trades was “completely unacceptable” and showed “a cultural change” was needed. He said there had been consequences for staff involved, without providing further details. (For more on Thiam’s reaction see story on page 4.) A day after the warning of problems were disclosed, Credit Suisse’s annual report showed the bonus pool for 2015 was down 36% from the previous year. Thiam said he would have his variable pay cut by 40%. He was still awarded SFr18.9m (US$19.4m) last year, mostly relating to a SFr14.3m buyout of Prudential shares after he left the insurer to take up his position at Credit Suisse last June. Since October, market conditions have worsened considerably and unexpected credit losses have prompted Thiam to make more drastic action to shore up the Swiss bank’s global markets business. Credit Suisse said it will close its global distressed credit and European securitised product trading desks as part of a wider reworking of its first restructuring announced plan in October. It will cut a further 2,000 jobs this year, on top of 4,000 cuts announced five months ago, of which 2,800 have already gone. The bank expects to make a further SFr1bn of cost cuts to reduce its annual expenses to below SFr18bn by the end of 2018. Risk-weighted assets in the markets division will be reduced by 30% to US$60bn from a previous target of US$85bn. Some US$10bn will be moved to the bank’s strategic reduction unit, or “bad bank”, which already had SFr65bn of risk-weighted assets at the end of 2015. Thiam said that beyond distressed, he would also seek to chop out other illiquid holdings in the trading book, such as certain collateralised loan obligation exposures in Europe and the US, as well as derivative positions, even if the sale incurs losses. “We have taken immediate action to reduce outsized positions in activities not consistent with our new strategy and systematically reduced our exposures,” he said. Writedowns were US$633m in 4Q 2015 and were US$346m so far this year. The markets business had its worst ever trading period in January, following on from an already weak fourth quarter. “Historically low levels of client activity and challenging market conditions have led to disappointing financial results,” said Thiam. Since the end of the year, the distressed credit inventory has been reduced by US$800m to US$2.1bn and US CLO positions cut by US$500m to US$300m. Thiam said he expected trading revenues across global markets in the first quarter to be 40% to 45% lower than in the same period a year earlier. One insider at the bank said the restructuring had been accelerated by poor performance. “If it hadn’t been such an awful Q1, it would have been a lot slower,” he said. “All of this stuff needs to be done in a negative environment, which doesn’t help. “The tree got too big and had to be trimmed.” As well as closing the distressed credit and European securitised product desks, Credit Suisse will no longer provide long-term illiquid funding and will shift its derivatives activities so they function across asset classes as a client-focused “solutions” business rather than a standalone unit. FX trading will be moved into the Swiss universal bank unit set up last October, reducing the need to have two separate businesses doing the same thing. The bank said it will also sell SFr1bn of assets this year, mainly real

New rules aimed at cooling the UK’s rapidly expanding buy-to-let market will hit amateur landlords the hardest, posing fresh hurdles for securitisations backed by loans to small-scale borrowers. Lending volumes in the UK buy-to-let sector surged by 39% to about £38.1bn in 2015. This spurred concerns among lawmakers that the boom could jeopardise economic stability, with the Bank of England’s financial policy committee stating in a December report that it “remains alert to financial stability risks arising from rapid growth in buy-to-let mortgage lending”. These concerns prompted the government to introduce new curbs on buying second homes that begin taking effect in April. The timing is particularly bad for mutuals that are making their first tentative steps to return to the market, with Coventry Building Society placing its first publicly sold post-crisis buy-to-let RMBS trade earlier this month. Specialist lenders such as Precise Mortgages and Paragon Mortgages have dominated the UK buy-to-let RMBS sector in recent years. These firms primarily lend to professional landlords, while the new regulations threaten building societies’ biggest customer: the small-scale landlord. “The landlords that are going to be displaced are the marginal guys; typically amateur, single property holders operating at or near the margins of affordability,” said Seb Maloney, chief financial officer of Precise Mortgages. “For this marginal segment of the current market, all of a sudden the economics are going to be tougher to make work, and they may reconsider whether their investment decision makes sense in the longer term.” New challenges The new regulatory measures include a 3% stamp duty on purchases of second properties and a sharp reduction on tax relief for buy-to-let owners. Policymakers delivered another blow with last week’s budget, which introduced an 8% charge on asset sale profits for property investors. Large-scale landlords can in effect side-step the new regulation by incorporating and holding their buy-to-let properties through a separate company. But amateur landlords, for whom incorporation could seem too complex, are likely to be hit hard by the new rules. The tax relief cuts, which are expected to take effect next year, could deeply upset the economics of the buy-to-let market for these smaller players. The cuts restrict the level of relief landlords can deduct on mortgage interest payments from rental income for tax purposes to a flat rate of 20%, in effect wiping out the benefits from a broader cut to the capital gains tax. This could knock securitisations as borrowers wind up with less cash to pour into their buy-to-let mortgages and issuers have fewer receivables to service bonds. Even if the asset class resists these pressures, it could face disruption if small-scale landlords opt to leave the buy-to-let space completely. “It may be for them more hassle than it’s worth and they may be put off by the additional complexity of owning a buy-to-let property,” said Sally Onions, a partner in Allen & Overy’s capital markets practice. “So people may find their bonds are being repaid at a quicker rate than they otherwise expected, as people look to divest themselves from the properties.” Shut out of RMBS These factors could make securitisation even more difficult for lenders who cater to amateur landlords, sapping their fragile return to the buy-to-let RMBS space. The amateur lending space is largely dominated by building societies, which have been almost entirely absent from buy-to-let securitisation since the crisis. Tainted by the dramatic downfall of several large mutuals in 2008, many building societies have struggled to regain the trust of investors even as underwriting standards have dramatically improved. As a result, few of these groups have ventured into the public market with buy-to-let deals in recent years. Earlier this month, Coventry Building Society fuelled hopes that the sector might finally be opening to mutuals

Despite March’s strong rally in commodity and equity markets severely denting the outperformance in the year to date of trend-following managed futures programmes, such strategies are still set to top the alternative investment quarterly performance tables after global hedge fund benchmarks languished in negative territory in the first two months of the year. Commodity Trading Advisors, a US regulatory designation that encompasses futures and swaps-based investment programmes, provided a lone bright spot for the hedge fund industry during the first two months of 2016. Multi-billion dollar futures programmes operated by Aspect Capital, Transtrend and Winton Capital Management, which use price and volume indicators to play medium to long-term trends via ultra-liquid futures markets, reaped the benefits of strong and sustained price trends that were set in motion at the end of 2015. Societe Generale’s CTA Index, comprising the 20 largest CTAs that provide daily return data and remain open for investment, posted 7.2% returns through January and February. Netherlands-based Transtrend, meanwhile, posted gains of over 10% to the end of February in its Enhanced Risk Diversified Trend programme. But a difficult March has already slashed year-to-date performance on SG’s index by more than half, taking returns to 3.34% by March 22. “Through January and February, markets were very conducive to managed futures strategies as we saw a continuation of trends that began in December. That meant CTAs had exactly the right positioning,” said James Skeggs, head of alternative investments consulting at Societe Generale. “A strong rebound in equity and energy markets made March performance more difficult, but managed futures still provided one of the few strategies that made money for clients over the first quarter and it continues to represent an important source of non-correlated returns for institutional investors.” Well positioned CTAs were quick to rack up returns this year due to their short positioning in stocks and commodities. Brent crude oil fell from US$45 to US$37 per barrel in December and had slumped below US$28 by mid-January. That delivered hefty gains in the early weeks of the year, but performance was derailed later in the quarter as oil prices bounced back to US$40. Similarly, CTAs went into 2016 with short equity positioning, enabling them to reap the rewards of a 12% fall in the S&P 500 to mid-February. The US equity benchmark has since rebounded by almost 10%, leaving mid-term to long-term CTA strategies, which typically hold positions for three to six months, in the red this month. Widespread long bond market positioning also took its toll after 10-year US Treasury yields jumped by 25bp during the first two weeks in March alone. For a sector that is struggling to win sentiment after posting its first negative performance in a decade for 2015, the latest figures could come as a blow to the optimism generated earlier in the year. Many hope that positive performance will be back on track if Treasury yields head back down following April’s FOMC meeting, but there are other factors driving investors to quantitative strategies more generally. In its 14th annual Alternative Investment Survey, Deutsche Bank found that half of respondents planned to add more quantitative strategies in 2014, driven by demand from the largest investment consultants and pension funds. “The return dispersion seen in 2015 means that choosing the right manager and constructing the right portfolio is ever more critical,” said Anita Nemes, global head of capital introduction at Deutsche. “Investors are concentrating and redesigning their portfolios in search of less correlated, diversified return streams.” CTAs stand to win their fair share of that growth. Given that the building blocks are some of the most liquid exchange-traded assets in the world, the funds are typically more liquid and transparent than most of their hedge fund counterparts. According

US companies including payment technology firm First Data and electricity generator Atlantic Power are refinancing leveraged loans in a sign that conditions in the beleaguered market could be improving slightly as inflows and increased investor demand create a window of opportunity for firms to extend debt maturities. Leveraged loans have seen two weeks of small inflows, breaking a 32-week streak of outflows and refinancing activity that first reappeared in the US high-yield bond market after five weeks of strong inflows, finally starting to appear in the more selective loan market. Volume is sharply lower in the US leveraged loan market this year after volatility pushed pricing higher in late 2015 and banks have struggled to underwrite new deals as they tried to sell an overhang of deals left over from last year. Only US$34.5bn of loans have been refinanced so far this year, which is 33% lower than the same period of 2015. Companies refinanced a total of US$377.4bn of debt last year. “After a long lull with very infrequent or even absent refinancing activity, the tone has improved enough that at least the higher-quality end is starting to be able to tap the market,” said a senior investment banker. Healthcare company HCA reopened the refinancing market on March 4 with a US$1.5bn deal and more companies are expected to follow to extend looming maturity dates up to 2018, particularly after high-yield bond and leveraged loan yields dipped in February. First Data and Atlantic Power announced plans to tackle 2018 maturities last week, after chemicals firm Huntsman unveiled a deal the previous week to refinance nearer term 2016 and 2017 maturities with a new US$550m seven-year term loan. Huntsman was able to trim its borrowing cost slightly by tightening the discount to 99.5 last week from 99 as the deal was well received by investors. “Given the high-yield index has tightened 200bp since February 11, we’re seeing more opportunistic issuers decide to access the market,” said another senior investment banker. Last week, payment technology firm First Data added a US$3.7bn tranche to its existing US$1bn term loan due in 2021 to refinance debt. The new loan allowed the company to replace the entirety of its existing term loan due in March 2018. Atlantic Power also launched a US$910m refinancing to address a 2018 maturity and refinance other existing debt. The deal, led by Goldman Sachs and Bank of America Merrill Lynch comprises a US$700m seven-year term loan and a US$210m five-year revolver. The revolver will replace Atlantic Power’s existing revolver due in February 2018, and also refinances an existing term loan due in February 2021, which has US$473.2m outstanding. “Given the high-yield index has tightened 200bp since February 11, we’re seeing more opportunistic issuers decide to access the market” Gelatin capsule manufacturer Capsugel is also asking lenders to extend US$747m of outstanding debt due in 2018 to 2021 by adding on a US$200m term loan and increasing the spread by 25bp. Drumming up business? The impetus for the return of refinancings may be coming from banks trying to drum up business after months of inactivity as concerns over oil prices and the economic situation in China combined with slow earnings in the US caused banks and investors to back away from highly leveraged deals. Leveraged buyout activity and leveraged corporate acquisition activity has fallen dramatically as well as refinancing volume, potentially leaving a big hole in banks’ first-quarter earnings and budget targets. Fitch said last Tuesday that underwriting revenue at banks had dropped off dramatically. JP Morgan saw a 43% drop in bank debt underwriting revenue to just US$602m in the fourth quarter of 2015 compared with US$1.05bn a year earlier. Bank of America saw a 31% drop for the same period, posting underwriting revenue of US$618m in the fourth quarter of 2015. “Our pipeline has thinned out as you might imagine, so we are looking to see what kind

Credit Suisse said January was the worst ever start to the year for its trading business and Deutsche Bank reckons February was not much better, deepening gloom about the performance of investment banks in a grim first quarter. Analysts have for some time been warning that investment bank revenues in the first quarter could be down 15%–20% from a year ago, but even that may be optimistic and revenues could drop by a quarter, based on the latest comments. “If you look at markets, January was the worst January ever,” Credit Suisse chief executive Tidjane Thiam said last week. That prompted him to take a knife to his investment bank again just five months after a previous restructuring plan, and cut 2,000 more jobs and product areas. “We had a plan that was robust and designed for most conditions, but not the worst January ever,” Thiam said. Credit Suisse said its trading revenues so far this year were down 40%–45% from a year ago. Its M&A revenues had more than doubled from the same period in 2015, but industry equity capital markets issuance was running 58% lower than a year ago and leveraged finance was down 74%. “Q1 is shaping up to be extremely challenging, with activity across all major revenue areas slow” The Swiss bank’s warning came a day after Deutsche Bank’s finance chief said the first two months of 2016 were the worst start to a year for banks he had seen in his career. “That has left its marks on our business. All operations that are close to capital markets are affected,” Marcus Schenck was reported as saying. Slow start There is a growing list of bankers warning about a slow start to the year. Citigroup has said its markets revenues were running 15% lower than in the first quarter of 2015 and its advisory and investment banking revenues were off by 25%. Jefferies reported an 82% slump in sales and trading revenues in the three months to the end of February. Results from US banks start from April 13 and major European banks start reporting in late April. Bankers said March had shown signs of improvement and Schenck said it had been much better. But with Easter this year falling in late March compared with April 5 last year, holidays could limit that improvement and leave the first quarter down sharply. “Q1 is shaping up to be extremely challenging, with activity across all major revenue areas slow,” Goldman Sachs analyst Jernej Omahen said in a note last week. He said equity and debt capital markets, trading revenues, investment banking divisions and private banking were all struggling. Omahen forecast European investment bank revenues would be down about 25% from last year on aggregate. European banks are expected to have lost market share to US rivals, continuing the trend of recent years. Investment banking analysis firm Tricumen has estimated global sales and trading revenue in the first quarter are likely to be down by up to 20% from year-ago levels. The first quarter of the year is the most important period for investment banks, often accounting for more than 30% of annual income. That has raised fears that it is setting the industry up for another bleak year, and that more job cuts and pruning of unprofitable business lines is needed.

Australia is gearing up for possibly its largest listing of the year as Reliance Worldwide Corporation prepares to launch an IPO that bankers hope will boost market confidence and spur further new issues. RWC, which makes plumbing equipment, aims to file the prospectus for the A$1bn (US$720m) ASX listing at the beginning of next month, formally kicking off the process for an IPO that will dwarf most of the equity raisings in Australia so far this year. RWC intends to follow up the prospectus filing with an April roadshow before the proposed listing in early May. “The market conditions are still conducive for quality floats,” said one ECM banker, based in Sydney. “I expect that, if it goes, it will give others confidence to float.” The float will give the company a market capitalisation of around A$1.5bn, and ECM bankers hope a strong response will prove to be a shot in the arm for the country’s stuttering IPO market. “There are a number of issuers that are ready,” said a second ECM banker in Sydney. “It’s nice to have a starting gun. The pipeline is starting to build and some of the companies are seeing that the markets are not that bad.” This year, Australia has registered six IPOs for proceeds totalling less than US$20m, according to Thomson Reuters data. One notable IPO that may also come to market in the first half of the year is that of financial adviser Stateplus, which is expected to raise an amount similar to RWC. Cloud-based software solutions developer Wisetech is set to sneak in ahead with a deal that could raise up to A$219m when it sets a final listing price around April 7. Credit Suisse and Morgan Stanley are joint lead managers on that deal. However, RWC looms largest on the horizon in the short term. JP Morgan is sole global coordinator. Macquarie Capital is also working on the deal as joint lead manager. Litmus test “The market conditions have improved remarkably over the last couple of weeks. I don’t think [RWC] is so big it will suck liquidity out of the market, but it will be a good litmus test for others,” said the first banker. The ASX 200 index is down 4.5% since the beginning of the year, but has rebounded 6.6% from its mid-February low on an improving outlook for the Australian economy. “Clearly, if it goes well, it’s a big help in the sense that it’s a big transaction,” said a third ECM banker. “We are not like the US that has a big deal a week. The beauty about this is it’s a family company, it has a good track record and it’s not resources.”

Breaking Citigroup in two could unlock US$72bn in market value, raising the spectre that the bank could face growing calls to break up. Last week, the bank brushed off a shareholder proposal to split itself up, but as calls for a two-Citi solution grow, the fourth largest US bank may be forced to offer a more detailed defence of its current configuration and size. Keefe Bruyette & Woods analyst Brian Kleinhanzl said in a research note last week the value of Citi’s consumer banking would be about US$91bn on a standalone basis and Citi’s corporate banking business would have a market value of US$100bn. The sale of its international consumer banking business, Banamex, and some small and medium enterprises could fetch another US$7.5bn for a total market value of US$198bn, compared with the bank’s market cap of US$126bn. “One of the primary benefits of becoming smaller is escaping the vice that is the current regulatory environment,” Kleinhanzl said. “We have made conservative assumptions and yet there is a path for Citi to improve its valuation by almost 60% versus where the combined company trades currently.” The bank has so far been successful in its plans to simplify and shrink, but the strategy has not generated improved returns, he said. KBW projects Citi will earn 8.5% tangible returns on tangible common equity in 2017, down from 9.3% in 2015 and below Citi’s cost of equity of almost 11%, KBW estimated. “We believe Citi will not break up in the next year or so, but we do see a break-up of Citi as a potential outcome given returns may not increase above the company’s cost of capital for the foreseeable future and shares have traded consistently below the company’s tangible book value for an extended period of time,” Kleinhanzl wrote. At the crux of Kleinhanzl’s argument for breaking the bank in two is that as one of the eight largest US banks Citi will be subject to ever-increasing capital requirements that will keep the bank from handing capital to its investors, in sufficient quantity or with sufficient speed. “We fully believe that regulators are more than comfortable having capital build at the largest banks,” Kleinhanzl said. Further, capital is going to be trapped at Citi for longer than anyone is currently expecting, he said. ”While management say that they will get to a point that they can release capital, we are not seeing that,” he said. The next big leap in requiring the biggest banks to hold more capital will come if the Federal Reserve forces banks to account for G-SIB surcharges during the stress test process. But Kleinhanzl warned that if regulators are trying to get banks to become smaller, an unintended consequence may be increased risk. Citi’s institutional business, divorced from the consumer business, could have increased systemic risk, he said. The bank told IFR its board remains confident the current strategy being executed by the existing management team will yield the best long-term results for shareholders. Last week, responding to a proposal to split the bank from shareholder activist Bartlett Naylor, the bank said it has relied on expert counsel for its chosen strategy. Citi has reduced assets in its Citi Holding “bad bank” to US$74bn, or 4% of assets, down from US$619bn, or 32% of assets, at the end of 2008.

The appearance of significantly different margin levels at competing clearinghouses is undermining buyside derivative users as they get set for the launch of mandatory clearing over the coming months. Initial margin levels for the same product can vary by as much as 30% depending on the clearing houses at which it is managed, according to one estimate. And while clearing houses claim their margin methodologies are transparent, buyside firms often struggle to obtain the information they need. At two of the largest clearing houses “the margin methodology documents would require a very high level of investment from an individual to actually understand the implications on their margin,” said one clearing consultant. “What they really want is the understanding of the level of margin on a particular portfolio – and for this they would need to phone up the CCP for an explanation.” In other cases clearing houses view margin models as proprietary. “They provide the minimum disclosure necessary to deflect attention, but not enough to actually expose the core methodology,” the consultant said. “Given there is a regulatory requirement for margin model transparency, this is obviously a sensitive topic.” One way buyside firms can understand their margin commitments is through tools provided by individual CCPs, but if firms clear through multiple CCPs the requirement to deploy a number of tools requires significant investment, while there is a challenge in comparing across different tool formats. Clearing brokers also provide tools, but there is resistance among buyside firms to share details of their trading book,, the consultant said. For their part, CCPs insist that detailed margin methodologies are published on their websites and provide sufficient transparency. CME pointed towards weblinks that describe the types of initial margin model it uses, with a description and key model design parameters for each model. Those include confidence level, look back period, close out period, frequency of parameter review, back testing, coverage level and size of margin breaches, a spokesperson for the clearing house said. ICE Clear Europe, Eurex Clearing and LCH.Clearnet also cited online resources. ”We provide full transparency to our members, including detailed specifications of the models and the tools to replicate margin calculations for a given portfolio, real or hypothetical,” said David Horner, head of business risk at LCH.Clearnet’s SwapClear. Front and central Still, some buyside firms remain to be convinced, and even among pension funds, which are exempt from the clearing obligation in Europe until August 2017, there are worries about costs. “We understand that we will need to clear but our estimate is that it will cost individual pensioners as much as 3% of their pension,” said Roelof van der Struik, an investment analyst at Dutch pension fund manager PGGM. “We are talking to the CCPs and trying to make ourselves ready but we are moving forward with reluctance.” The frontloading period for Category 2 users of standardised over-the-counter interest rate swaps (non-financials that use derivatives above a threshold) will begin on May 21, following which date all trades entered into bilaterally will eventually need to be cleared. Mandatory clearing starts on December 21. “For some firms subject to Category 2 mandatory clearing, this has gone from something they didn’t have to worry about yet to something that is front and central,” said Peter Rippon, chief operating officer of OpenGamma, a risk solutions and analytics firm. “The biggest challenge is to find collateral to post as initial margin and there is quite a lot of analysis they need to do to find out where they should clear and what works best for them.” One key question will be based on the fund’s wider portfolio, Rippon said. For example, where a firm trades a lot of futures with offsetting OTC exposure it may make sense to clear OTC trades at the same place as its futures portfolio,

GMAC UK priced its first auto ABS trade in a year at wide levels on Tuesday, demonstrating just how much Brexit worries are weighing on sterling paper. On Monday, the UK subsidiary of General Motors Financial set IPTs on E-Carat 6’s Class A notes at 85bp area over one-month Libor. The Class B notes were listed as “call desk”. The group then cleared a £300m Class A tranche at 85bp over one-month Libor on Tuesday. The tranche was 1.4x covered. A £29.6m Class B tranche was retained, with the spread at 130bp over one-month Libor. The levels on the senior notes are some 10bp wider than where the last UK sterling deal cleared in early February. At that time, FirstRand Bank placed Triple As as part of its Turbo Finance 6 trade at 75bp. FirstRand ultimately purchased £80.675m of the Triple A notes, with the remaining publicly placed notes just 1x covered. The Turbo trade came in the midst of a sharp credit sell-off, as broader market volatility pushed investors to the sidelines last month. However, levels on sterling paper have remained wide even as global markets have improved, as many investors step away from UK risk ahead of the upcoming EU membership referendum in June. “Some investors remain a bit concerned about a possible Brexit – they’re all a bit afraid of the volatility in advance,” one trader said. “So not many people are looking to buy any paper at the moment and some investors are trying to get rid of their UK-related products.” The E-Carat transaction, which will include 1.5-year notes and 3.4-year paper, is backed by a static pool of UK auto loans originated by GMAC UK. The loans in the portfolio have weighted average seasoning of 9.2 months. The transaction is the first from GMAC’s E-Carat shelf since March 2015, when it printed its £525.1m E-Carat 5 trade. That deal saw £460m in Triple A notes cleared at 40bp over one-month Libor and £38.8m in Double As at 95bp. Subsequently, the broader auto space has been hit by massive widening on the back of Volkswagen’s emissions manipulation scandal. The E-Carat 6 deal was allocated to 17 investors, 96% of which were based in the UK. Fund managers made up 49%, bank treasuries 35% and central banks and official institutions 16%. Bank of America Merrill Lynch was arranger. Joint-leads were Lloyds Bank, Bank of America Merrill Lynch and RBC. LBBW and UniCredit are co-managers.

Core investment bank assets held by Deutsche Bank and Credit Suisse have risen significantly, even as both banks undertook to shrink in response to new regulations that make holding assets painfully expensive. Deutsche’s core investment bank assets have risen by 18% in the past two years, while Credit Suisse’s rose by about 6% last year, according to IFR calculations. Morgan Stanley analysts even predict that both banks’ risk-weighted assets will continue to increase in the next two years. Credit Suisse is seen adding another 2% of RWAs, while Deutsche’s will rise by 9%, the analysts estimate (see chart). Credit Suisse’s investment bank assets are spread across several units after chief executive Tidjane Thiam restructured the bank in October. RWAs held by global markets, investment banking and capital markets and its Asian capital markets assets totalled about SFr113bn at the end of 2015, up 6% from the end of 2014, IFR estimates. Deutsche’s corporate banking and securities arm had €195bn of assets at the end of 2015, up 11% on last year and up 18% from €165bn at the end of March 2014. Uphill Deutsche chief executive John Cryan has said cutting assets will be an uphill task as reductions are being countered by the inflationary impact of new regulations. The tougher regulations have increased the risk weightings on trading positions, legacy credit positions, securitisation and other assets – resulting in higher RWAs. Cryan aims to cut group RWAs by €90bn by 2020, including €28bn in CB&S by 2018. But he has estimated that regulatory inflation will add about €100bn to Deutsche’s RWAs, keeping group RWAs at nearly €400bn. Deutsche is potentially most impacted by regulatory inflation, but the same trend has hurt rivals and will continue to do so. For example, HSBC cut assets in its global banking and markets business by US$75bn last year, or 15%, to US$441bn, achieving more than half of a three-year target. But in the previous year, when HSBC was already trying to slim down, GBM’s RWAs jumped by almost US$100bn as the bank shifted to full Basel III rules. So despite last year’s substantial cuts, RWAs in HSBC’s investment bank are still higher than two years ago – albeit under tougher reporting rules. “Many of the RWAs being shed by the European banks are in unprofitable businesses where the US banks have no desire to bulk up” The Morgan Stanley analysts forecast European investment banks as a whole will reduce their risk-weighted assets by about 10% over the next two years. But they said there will be a wide divergence: Barclays and HSBC are each predicted to cut assets by 21%, just as RWAs at Credit Suisse and Deutsche rise. Harder Europe’s investment banks are under pressure to get rid of more assets to make themselves leaner and more profitable, but doing so is likely to become even harder – even ignoring the issue of RWAs being inflated by regulations. Many markets are difficult and illiquid, all banks are trying to avoid capital-intensive products, and lots of the most marketable assets have already been picked off. “Many of the RWAs being shed by the European banks are in unprofitable businesses where the US banks have no desire to bulk up,” said Chris Wheeler, an analyst at Atlantic Equities. Other European banks, including UBS, Barclays and HSBC, made earlier moves and have shrunk more successfully. The pressure remains on because most European investment banks are not delivering returns above their cost of capital. Cutting costs and assets are two ways to improve that – especially given the struggle most are having in growing revenues. The average return on equity at European investment banks was 7%–9% last year and is likely to remain there in the next two years, compared with 11%–13% for US rivals, Morgan Stanley estimates. UBS and Barclays have shown the biggest reductions in Europe in recent years, and they and Deutsche and Credit Suisse have put substantial amounts of their investment bank assets in non-core unit

The US Supreme Court last week heard arguments over whether or not to allow the indebted commonwealth of Puerto Rico to write its own bankruptcy code or continue to exist in what Justice Ruth Bader Ginsberg called “never never land”, unable to access the bankruptcy court and unable to use its own system. The case focused on a narrow interpretation of what the US Congress intended when it barred Puerto Rico from using Chapter 9 of the bankruptcy code. The commonwealth is arguing that the language that excludes it from Chapter 9 also excludes it from prohibitions that would keep states from writing their own bankruptcy rules. If that’s what lawmakers intended, it would be a “cryptic, odd way to make such a major change in the law”, said Justice Elana Kagan. An attorney for bondholders, Matthew McGill, told the court the choice for US states is to allow their municipalities to restructure under Chapter 9 of the bankruptcy code or nothing. McGill said the only choice for Puerto Rico is to go to Congress. McGill said Puerto Rico racked up a massive debt burden selling tax-free bonds in municipal markets across the country. The nature of that debt enticed investors of all stripes to buy it, as Congress predicted. Rather than having the island’s debts restructured in bankruptcy court, maybe Congress intended to directly supervise any restructuring, McGill said. He was responding to Justice Ginsberg, who asked what explained Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debt. “Congress has micromanaged Puerto Rico’s debt for a long time,” McGill said. In the past, that had included limiting the amount of debt the island could amass and forcing Puerto Rico to include restrictions in its own constitution. Congress is currently considering a range of options for Puerto Rico, including allowing it to access Chapter 9 and creating a financial control board to manage the island finances. The case raises the question of whether Congress has stripped Puerto Rico of access to any legal mechanism to restructure the debts of its public utilities, which provide essential services to its citizens such as electricity and water, said Christopher Landau, attorney for the commonwealth. Justice Sonia Sotomayor pressed the bondholder’s attorney on whether he thought Congress intended to stop Puerto Rico from passing emergency legislation to keep the lights on. Congress removed Puerto Rico from Chapter 9 but the island may still be able to pass a law that stops the lights from going out until Congress acts, she said. Still, the court is likely to uphold the lower court’s decision striking Puerto Rico’s bankruptcy law. Justice Stephen Breyer noted that Congress’s last word on the subject might be the only word that matters. Congress has already passed legislation that make clear that holders of municipal bonds, which are widely held, can only be compelled to accept a restructured debt under federal law, he said. A ruling is expected in June.