What bilateral agreements do markets accept?

Germany sold 4.06 billion euros of the bonds on the 4th of January with the average yield of 1.93% on 10 year government bonds. France sold 7.9 billion euros of bonds on the 5th of January with the average yield of 3.29% on 10 year government bonds. It is supposed that Italy’s and Spain’s borrowing in the markets this week could be facilitated as well due to the ECB’s injected liquidity through 3-year refinancing operation worth of 500 billion euros and expectations that the ECB’s Governing Council will cut interest rates on the January 12 meeting. However, despite the European sovereign debt crisis and broken markets’ confidence, China, Japan and South Korea move forward to closer financial cooperation.


After the Asian financial crisis in 1997-98, the leaders of East Asian Countries agreed to promote the Chiang Mai Initiative (CMI) which aimed to create a network of bilateral swap arrangements (BSAs) among ASEAN+3 countries to tackle short-term liquidity issues and to supplement the existing international financial arrangements.

Under the above mentioned initiative, the $120 billion crisis fund was established. In 2001 Finance ministers of ASEAN+3 agreed to exchange data on capital flows bilaterally on a voluntary basis in order the effective policy dialogue was facilitated and in 2005 Finance ministers agreed to enhance the effectiveness of the CMI by (1) integrating and enhancing the ASEAN+3 economic surveillance into the CMI framework, (2) clearly defining the swap activation process and the adoption of a collective decision-making mechanism, (3) significantly increasing the size of swaps, and (4) improving the drawdown mechanism. Moreover, developed bond markets under the same initiative reduced the dependence on short-term foreign currency-denominated financing and helped to mitigate the vulnerability caused by the currency and maturity mismatches aroused due to the volatile short term capital movements.

Japanese Prime Minister Yoshihiko Noda visited the Chinese Premier Wen Jiobao on the 25th of December in 2011 and discussed a bilateral package of financial agreements. According to the Bloomberg, Japanese government-backed entity will sell yuan-denominated bonds in China to deepen China’s domestic capital markets and other measures will be applied to facilitate the trade among Chinese and Japanese companies in their domestic currencies. These actions should reduce trade costs as measures are designed to eliminate the usage of the US dollars in exchange of currencies. Moreover, those agreements will ease the entrenchment of the Chinese yuan as a reserve currency.

However, China’s one-way determined exchange rate’s policy puzzles the most. If Japan, South Korea, US, European and other trade partners decide to set the domestic currencies and China’s yuan exchange rates then who will be right.

Security’s Beta – an indicator of systematic risk

Assessment of creditworthiness of financial institutions or financial instruments is one of the supervision measures. Standard & Poor downgraded the long-term credit rates for major financial institutions including Bank of America, Goldman Sachs, Barclays and HSBC on 30 November. On16 December, Fitch reported the rating cuts for seven largest banks: Bank of America, Goldman Sachs, BNP Paribas, Barclays, Deutsche Bank and Credit Suisse and Citigroup. Even though the downgrades reflect the assessment of the enhanced rating methodologies those involve systematic risk analyses based on macro indicators, industry and regulatory environment, will the valuation reinforce the discipline of the financial performance and reduce systematic risks?

According to the Rating Methodologies for Banks prepared by the Frank Packer and Nikola Tarashev and published in BIS Quarterly Review, June 2011, the assessed tolerance of complex financial instruments, evaluated trends of credit growth and the increase of asset prices as well as greater focus on high quality capital would have provided an important information about the stability of entity during the pre-crisis period. As the intermediation role of banking sector is significant and financial stability is essential for economy’s development, public authorities commit to support banks by additional capital injections, asset purchases or liquidity provisions. Consequently, rating agencies use “stand alone” and “all in” ratings those reflect the financial strength of the institution without the support and with the sovereign and international institutions interventions.

Capital strengthening through the retained earnings is one of the most efficient ways to enhance the resilience of financial institutions during financial shocks. However, financial institutions commit to dividend payments as long as retained earnings are essential to attract investors.

The Goldman Sachs Group, paid dividends on all series of preferred stock on the 10th of November for the following series of its non-cumulative preferred stocks: $239.58per share of Floating Rate Non-Cumulative Preferred Stock, Series A; $387.50 per share of 6.20% Non-Cumulative Preferred Stock, Series B; $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series C; and $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series D.

Barclays paid 1p per ordinary share and 4p for America Depository Security which represents 4 shares on 9 December 2011.

Bank of America Corporation announced about regular quarterly dividend of $18.125 per share on the 7.25 percent Non-Cumulative Perpetual Convertible Preferred Stock, Series L.

HSBC declared that the third interim dividend of $0.09 per ordinary share will be paid on 18 January, 2012, the dividend of $0.45 per American Depositary Share, which represents five ordinary shares will be paid on 18 January 2012, the dividend of $0.3875 per Series A American Depositary Share was paid on 15 december, 2011.

The Board of Directors of Credit Suisse most likely will suggest dividends for financial year 2011 with the results of the fourth quarter of 2011 on February 9, 2012.

Moreover, majority of banks were downgraded because of the challenges in the financial sector, id. est. systematic risks those affect financial stability. Security’s Beta describes the sensitivity of its return to the systematic risk, the average change in the return for each 1% change in the return of market portfolio. Deutsche Bank’s Beta is 2.20, Beta of Bank of America is 2.19. So, those banks are more vulnerable that HSBC, Credit Suisse and Goldman Sachs. Beta of HSBC presents 1.19, Beta of Credit Suisse amounts 1.38 and Beta of Goldman Sachs is 1.39.

Consequently, securities’ Beta should be involved in the assessments of systematic risks and factors those reduce securities sensitivity to the portfolio fluctuations could be explored further.

The end of 2011 - political and economic changes in Russia

Week lasting demonstrations in Russia is a protest against a possible electoral fraud. According to the statement of the Central Election Committee of Russian Federation prepared on the 5th of December, 2011, the preliminary results, those represent 95 % of the overall counted votes of Russian Legislative Election, 2011, were the following: representatives of United Russia got 49.54% of total votes, Communist Party of the Russian Federation received 19.16%, A Just Russia collected 13.22%, Liberal Democratic Party of Russia got 11.66%, Yabloko received 3.3%, Patriots of Russia gathered 0.97% and Right Cause got 0.59%. However, citizens expressed mistrust in counted votes and dissatisfaction with the dominated United Russia party.


Could it be that a long lasting protest lift the prices of energy resources and diminish value of domestic corporations? Similarly, could a shift in political influence be a reason of transformation of state’s corporations?

According to the Balance of Payment of the Russian Federation for January-September of 2011, the estimated $73.6 billion of Current Account’s surpluses are mainly emerged from the oil, oil products and natural gas exports those amount $249.1 billion and represent an increase of 36.34% compared to the data of the previous year. As can be seen from the data of the Key World Energy Statistics, 2011 published by the International Energy Agency, Russian Federation was the largest producer in the world of crude oil in 2010. The production of crude oil, NGL, feedstocks, additives and other hydrocarbons in Russia amounted 502 Mt, which comprised 12.6% of the total world production in 2010. The other largest producers were Saudi Arabia with the annual production of 471 Mt which represented 11.9 % of the total world production and United States with the annual production of 336 Mt and 8.5% of the total world production in 2010. So, long lasting political instability in the country could affect the supply and market prices of energy resources.

Moreover, The World Trade Organization’s Working Party sealed the deal on Russia’s membership negotiations on the 10th of November 2011. The Working Party will send its accession recommendations regarding Russia’s terms of entry to the Ministerial Conference. It is expected that during the conferece held on the 15-17 December the Russia’s WTO membership will be approved. Consequently, Russia’s commitments to pursue open, transparent and non-discriminatory global trading could encourage investment and a new round of privatization of state’s corporations.

Should the strategies of Sovereign Wealth Funds be a subject of regulation?

George Osborne, the Chancellor of the Exchequer of the UK delivered financial statement on Tuesday 29 November, 2011. He announced about the extended Government's enterprise finance guarantee scheme for businesses with annual turnover of up to £44 million. The ceilings were set of £40 billion. The Chancellor also introduced a newly launched National loan guarantee scheme for new loans and overdrafts to businesses with turnover of less than £50 million. The initial £20 billion – worth fund for national loan guarantees will be available within the next two years and it is expected that those guarantees will let to reduce the borrowing interest rates by 1 percentage.


Moreover, along these measures innovative solutions to launch £1 billion business finance partnership was presented. The partnership with other investors such as pension funds and insurance companies could enable the Government to invest in funds those lend directly to mid-sized businesses. Similarly, over 500 investment infrastructure projects to support economic development were identified first time. Alongside the Government guarantee schemes and traditional fund rising through borrowing, the Government had negotiated an agreement with two groups of British pension funds which unlocked an additional £20 billion of private investment for implementation of infrastructure projects.

The Government’s launched partnerships with investors aimed to facilitate funding for development of domestic businesses suggest the following: is it a rudiment of the Sovereign Wealth Fund?

In general, Sovereign Wealth Funds are founded from central bank’s reserves those are accumulated as a result of budget and trade surpluses. Additionally, SWF may be set from the revenues received from the exports of natural resources. The purpose of established SWF may vary. Some of them possess objectives to stabilize the budget and the economy from excessive volatility and intend to diversify the sources of revenues. Others have goals to reduce excessive domestic liquidity and invest in higher return assets. The rest may have political strategies which are aimed to increase savings for future generations or fund domestic social and economic development projects.

Though Sovereign Wealth Funds tend to have longer-term investment horizons, the research made in 2008 revealed that seven least transparent Sovereign Wealth Funds were estimated to account for the half of all holdings. Thus, lack of accountability and transparency evoked concerns whether asset prices could be distorted through non-commercially motivated purchases. (The source: ECB, Occasional Paper Series, No 91/July 2008, The impact of sovereign wealth funds on global financial markets prepared by Roland Beck and Michael Fidora).

Some protective regulations against purely political investment decisions of Sovereign Wealth Funds were mentioned in the draft of Rethinking Global Investment Regulation in the Sovereign Wealth Funds Era prepared by the Dr. Efi Chalamish (02/09/09). Foreign investment may be blocked by national regulations if investment is classified as government-owned entity. Countries may also prohibit foreign investment based on the type of industry in which the invested company operates. Moreover, an individual acquisition may be screened and decisions could be made according to the commercial value and associated risks. Additionally, adopted open market policies could be pursued to ensure that made investment do not serve only to the single foreign country.

Analysing International Economic Law, it could be mentioned the Santiago Principles suggested in 2008. The aim of these principles is to protect state’s interests and increase SWFs’ transparency and accountability. The principles were prepared by the IMF jointly with the World Bank and proposed to adapt on voluntarily bases. However, the other set of rules to avoid adaption of any protectionist measures and be opened to markets policies were created and accepted voluntary by the OECD which represents states of the leading developed economies.

According to the Sovereign Wealth Fund Institute’s data, the 54 SWFs managed over $4.76 trillion in September 2011. The 58% of total funds were set up from oil & gas related sources. The largest owners of the Sovereign Wealth Funds by the region is Asia with 40% of total assets, the second largest region is the Middle East with 35% of total assets and 17% belong to Europe.

The 2011 Pregin Sovereign Wealth Fund Review disclosed that the financial assets under SWF’s management grew about 11% during each several years. Consequently, the rising Sovereign Wealth Funds play bigger role in rebalancing of capital flows.

The influence of the Sovereign Wealth Funds on the financial markets and improved regulations may be explored further. However, my attention is already turned on their investment strategies. The Pregin Sovereign Wealth Fund Review reveals that the Investment Portfolio division of Hong Kong Monetary Authority’s Exchange Fund has plans to move into hedge fund investment, having diversified into investments in emerging markets, private equity funds and overseas property in 2010 as a means of increasing returns while Norway’s Government Pension Fund – Global, one of the largest SWFs in the world, is set to complete its first real estate investment in early 2011 and plans to make further investments in the asset class over the course of the year.

The road to the sound fundamentals

The European Commission’s released a package of new actions for growth, governance and stability on the 23rd of November, 2011. The new economic priorities for the next year set out in the 2012 Annual Growth Survey are underpinned by two Regulations to tighten economic and budgetary surveillance in the euro area and a Green Paper on Stability Bonds. Taking into account the European economy’s stagnation, excessive sovereign debts and rising borrowing costs those simultaneously affect financial stability of the European Union’s region, strengthening monitoring of strategic development and budget discipline is an inevitable step. However, despite of well understood and accepted fundamentals of sustainable development, the recurrence to basics is sluggish.

The AGS indicated five priorities for 2012 involve pursuing differentiated growth-friendly fiscal consolidation, restoring normal lending to the economy, promoting growth and competitiveness for today and tomorrow, tackling unemployment and social consequences of the crisis, modernising public administration. The goals for 2011 were focused on fiscal consolidation, labour market reforms and growth-enhancing measures. So, the Europe 2020 Strategy adopted by the EU leaders in 2010 which foresees the re-launch of the Single Market, Aligning the EU budget and EIB lending with the Strategy and a new trade strategy improving global market access for EU companies alongside with the Integrated Guideline which set out a framework for the strategy’s incorporation into the National Reform Programmes and introduced European Semester for economic and fiscal policy coordination, enforced the implementation of the EU’s economic policy with comprehensive assessment of macroeconomic climate, progress of structural reforms and competitiveness of the member states as well as the overall financial stability. Moreover, the Euro Plus Pact which was agreed in 2011 by euro area leaders and was joined voluntary by other 6 European Union’s states obliged countries to increase competitiveness and employment as well as to contribute further to the sustainability of public finance and financial stability.

Going back further and analysing the scope of strategic decisions in the EU it could be mentioned the Stability and Growth Pact adapted in 1997 and aimed to ensure budgetary discipline as well as Lisbon Strategy for Growth and Jobs launched in 2000. The history of the EU is full of other strategic cooperation decisions with a clear evidence of great visions. However, as long as development ideas foreseen of former and current leaders are clear to themselves, do the rest of the community understand the objectives, the reasons of necessary reforms and the effective measures required to implement in order the competitiveness of the region and wealth of community were maintained in the global economy development context?

The moral hazard and the resistance to pursue consistent strategic reforms led to the following: excessive sovereign debts, downgraded credit ratings, derived mistrust in the financial markets and vulnerability of financial stability, increased borrowing costs and loss of economic competitiveness.

The borrowing costs of European structural reforms

Greece and Italy changed their leaders to restore fiscal discipline. Lucas Papademos, former Governor of the Bank of Greece and Vice-President of the European Central Bank, replaced Prime Minister George A. Papandreou in the 11th of November, 2011 to implement conditions set by European leaders on the 26th of October related to 130 billion European bailout and manage a voluntary debt swap, Prime Minister of Italy Silvio Berlusconi resigned in the 12th of November, 2011 after the 45.5 billion-euro austerity package was approved in parliament and Mario Monti, former European Union Competition Commissioner, is going to form a new Italian government. So, could those changes convince the markets about mastering sovereign debt crisis?

Both new leaders are respected economists whose contributed to the development of European Union. Hence, their understanding of the Union’s benefits and current issues as well as involvement in solving domestic structural reforms required to manage sovereign debt crises could be a successful step. It seems likely that new leaders of Italy and Greece have strong relationships with the EU institutions and their authority may be accepted by domestic citizens. Consequently, it could lead to the greater European unity through smoother critical decision making and decision implementation which is necessary to keep monetary union.

It is expected that if banks accept write-down of 50% on their holdings of Greek government bonds Greece's 350- billion euro debt may be reduced by 100 billion euro and the ratio of Greek debt-to-GDP could fall from 160% to 120%. Current Italy’s debt amount of 1.9 trillion euro which is about 120 percentage of GDP.


Italy auctioned 3 billion euro five year government bonds today and that was an opportunity to check the markets’ reaction on changed leadership. However, lenders in the markets may not be particularly interested in the successors. Whenever considerations involve lending, investors take yields into account. Italy’s demand for additional funds is clear, so massive sales of currently held Italian bonds increase yields and reduce their price. Consequently, the European Central bank is induced to buy Italian government bonds in order to relieve borrowing costs.

It seems that markets will be convinced about governed sovereign debts once countries do not need to borrow at all.

MF Global’s bankruptcy – a fail or a mirage?

A mission of MF Global to bring superior market access as well as to provide the powerful trading and hedging solutions to its clients came to the end with the authorization of the board of directors to file for Chapter 11 Bankruptcy Petition on October 31, 2011. According to the quarterly report, MF Global experienced a $191.6 million net loss and Moody’s Investors Service and Fitch Ratings cut the firm’s credit rating to the junk. MF Global announced that regarding to the Europe’s debt crisis, its $6.3 billion worth Short-Term European Sovereign Portfolio deteriorated and the company failed to raise additional capital. However, making loss in derivatives’ trade is almost impossible.

Strike price and date of expiry matter in derivatives’ trading as long as puts, calls and forwards are related through the put-call parity. This relationship gives flexibility to transform derivatives and gain from whatever the circumstances in the markets are. Moreover, according to the balance sheet for the second quarter of 2011, Revenues, Net of Interest and Transaction-Based Expenses comprised $205.9 million which shows that performance from its main activities was profitable. Additionally, the $133.5 million worth Employee Compensation and Benefits made up more than a half of net revenues, the $6.3 billion short-term European Sovereign Portfolio comprised 15% of the $41.05 billion total assets while the $1.2 billion total equity accounted for 2.9% of the total assets.

Bloomberg reported that MF Global performance is under investigation by U.S. regulators after it filed for bankruptcy protection. The news that the company violated requirements to keep clients’ collateral separate from its own accounts was published on the 1th of November and more mismatches regarding publicly available information and reality may be discovered.