Hector Sants, the head of the UK market regulator the FSA, said recently that the market wasn’t scared enough of him. ‘We want people to fear us,’ he said.
Well, on Friday afternoon some Australian bondholders incurred the new-found wrath of the FSA when it told RBS to withhold the return of capital to investors of locally-issued junior bonds.
The FSA, rightly or wrongly, objected to the early redemption of the bonds on the grounds that the UK taxpayer had not tipped billions into the bank’s coffers for the benefit of yield-hungry Australian bond investors.
In truth, the secondary market valuations on these bonds anticipated this action to some degree, but it does show eagerness on the part global watchdogs to show their fangs.
If credit, equity and even commodities investors are not frightened, they will do well to pay careful attention to the behaviour of regulators as they seek to redraft the rules of global capital markets.
Deutsche Bank are attentive. This week the bank shut down a popular exchange traded oil fund because of ‘limitations imposed’ by the NY Mercantile Exchange. The fund used leverage and exposures to oil futures but could not generate returns because it was restricted from buying more contracts once it hit the regulator’s limits.
But it is in the global banking sector where the impact will be largest and there could much at stake depending on the direction and determination of global regulators.
With the Lehman’s anniversary approaching, they will more conscious of the financial reform ‘to do’ list. One item that policymakers will readily admit is too hard to solve, is the ‘too big to fail’ issue whereby financial institutions grew so large that their collapse would unravel the global capitalist system.
It’s been logged as a problem, but perversely some of the organisations that were deemed too big, have swelled even further.
The complex problem becomes even more perplexing when ‘the too big to fails’ extend across multiple jurisdictions.
“Basically it’s an elephant problem. You’ve got all these regulators, each of which controls a very small part of the overall animal. So one guy’s responsible for the trunk, one guy’s taking care of the tail, one is taking care of the left rear toenail, and everybody says, ‘Well my part of the elephant’s doing fine, but somewhere along the line the animal died and It’s not my fault,” explains David Weiss, global chief economist at Standard & Poor’s.
One of the very few ways to tackle the problem, according to Gary Jenkins, head of credit research at Evolution Securities, is to stuff these elephants full of capital.
“They just have to have lots of capital and we have to have much lower risk products being done by the banks and much less risk actually being taken so that they are much safer entities. And the only way you’ll do that is with regulation.”
The end result may be banking systems that are easier to patrol, given there are fewer but more solid institutions. But as Jenkins points out, regulation needs to be conducted on a global scale to be effective.
Regulatory steps in the direction of reducing the ability of big banks to take risks will, on the surface, play into the hands of lenders but reduce the opportunities to equity stakeholders. It may also create a nimble class of smaller banks with higher funding costs, but higher profit potential, operating alongside the caged elephants.
The central banks are the biggest banks around and while there are no imminent signs of their failure, some in the market are most fearful of how they might act.
A professional rate-watcher from a macro hedge fund sent us an observation from a blog.
“There's a large amount of money on sidelines waiting for investment opportunities; this should be felt in market when ‘cheerful sentiment is more firmly intrenched.’ Economists point out that banks and insurance companies never before had so much money lying idle.”
The quote appeared in the Wall Street Journal in August 28 1930 – reproduced in ‘newsfrom1930.blogspot.com’. If it sounds familiar it’s because it’s similar to comments heard recently, including this one from JPMorgan, published this week.
".. the amount of cash still sitting in money market funds and in bank deposits shows many have not enjoyed the rally this year. This suggests further upside from here if/when the economic data continues to be strong."
Our rate-watcher says it’s easy to see how, back then in the 30’s, the central bankers were fooled into thinking it was time to tighten monetary stimulus. He’s very scared they might make a similar mistake this time around.
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