Intelligent home energy management systems should be able to reduce energy bills by up to 28%. (The Economist)
Kauffman Foundation launches Energy Innovation Network so entrepreneurs can accelerate the clean energy revolution
SWFs’ investments rose from $10bn in first half of 2009 to $50bn in second half, but still down 3% for year (IFSL)
It’s Time for Swaps to Lose Their Swagger (NY Times Gretchen Morgenson)
Very poor people in emerging economies surprisingly interested in mobile financial services (McKinsey)
Book Excerpt from ‘The Responsibility Revolution’ – Don’t Ignore the Transparency Imperative (via strategy+business)
Credit Suisse Annual Survey Finds Hedge Fund Managers Moderately Optimistic About Inflow Growth, Fees
Technorati Tags: credit-default-swaps, energy-efficiency, Hedge-Funds, mobile, Sovereign-Wealth-Funds, SWF, transparency, Twitter
Guest Post by Oxford Analytica
While the crisis of 2008 was self-evidently a market failure, in terms of the mis-pricing of certain assets (particularly property), it was also a regulatory failure in three key respects:
- Regulators did not adequately consider the possibility that the short-term credit market could collapse, threatening several major financial institutions with insolvency.
- This was the by-product of an intellectual failure to keep abreast of how the macroeconomic framework was changing as a result of globalisation.
- While there was an arguably correct perception in the late 1990s that the 60-year-old Glass-Steagall framework was outdated, there was no effort to replace it with a 21st century successor.
In the wake of the crisis, political debate has focused on whether to return to the outmoded pre-1999 regulatory framework, rather than on how to adapt this model to address globalisation.
Glass-Steagall no panacea. Even a cursory examination of the old Glass-Steagall framework — which separated deposit-taking commercial banks from investment banks, or ‘broker-dealers’ (BDs) — indicates that it would not have been sufficient to prevent the 2008 crisis:
- Almost all of the banks that failed or were forced into mergers were either BDs (Lehman Brothers, Bear Stearns, Merrill Lynch) or purely commercial banks (eg Washington Mutual or the UK’s Northern Rock).
- The ‘universal banks’ created after Glass-Steagall did not perform noticeably worse — although a few (Citigroup, UBS) were in deep distress before being bailed out by governments. Indeed, some entered the crisis in relatively solid shape (eg JP Morgan Chase, Barclays) and have since benefited from the collapse or absorption of rivals.
Intellectual context of crisis. Thus, the crisis was not simply caused by deregulation, but by a deeper shortfall of risk comprehension in prevailing economic frameworks — which downplay such factors as shifting social contexts and changes in forecasting strategies that determine asset evaluation and market movements.
In other words, difficult-to-quantify human factors and the adaptive interactions of market players were downplayed by many economists and risk managers, who became enamoured of quantitative modelling:
- In the 25 years prior to 2008, academic economics became dominated by an emphasis on numbers — particularly quantitative modelling and statistics associated with ‘rational choice’ theory.
- This intellectual paradigm allowed neoclassical growth theorists to advance a framework with the premises that markets tend to equilibrate around efficient resource allocation and that government policy always does more harm than good in fostering economic growth. This increased the distribution of risk and reliance on complex quantitative modelling techniques to mitigate risk — with disastrous results.
Intellectual reaction. The crisis has significantly undermined this approach, although the economics discipline has been slow to adapt, with the initial impetus to fall back on a Keynesian framework. This reaction drove President Barack Obama’s embrace of the ‘Volcker Rule’ that would prohibit commercial banks from engaging in proprietary trading, and the Senate bill co-sponsored by Republican John McCain and Democrat Maria Cantwell that would reinstate Glass-Steagall in its entirety. However, in order to defuse incipient crises created by asset price bubbles, financial disintermediation and the attendant rise in systemic risk, any new regulatory paradigm would need to incorporate the insights that behavioural economists have developed since the 1970s — eg evolutionary models of how markets reach efficiency and group behavioural studies.
Outlook. Many economists still cling to the validity of their modelling techniques, which appear usefully predictive over the short term — but that are inaccurate as models of human behaviour over time. They tend to protest that improved modelling, rather than a wholesale re-evaluation of their approach, is apposite. This leads many to conclude that any re-regulation would be counter-productive.
However, this fails to account for innovative new research that has emerged from inter-disciplinary and behavioural economists in recent years. This includes the work of John Geanakoplos of Yale University on ‘leverage cycles’, which suggests that leverage cycles have observable and predictable characteristics, targetable by regulators.
Technorati Tags: banks, financial-markets, financial-regulation, Hedge-Funds, private-equity
Moody’s says the hedge fund industry is showing signs of a recovery from the crisis and this is likely to continue in the near term. In a new Industry Outlook for 2010 available for complimentary download the rating agency says that the positive trends merit a degree of caution, especially as a number of individual failures occurred during the crisis and some funds are still dealing with the aftermath.
Moody’s believes the industry as a whole is successfully adapting to the new market conditions and is recovering as performance improves and investors begin making allocations to hedge funds. The recovery should continue in 2010, barring another major economic shock or regulatory shifts. The report also indicates that net inflows and new start-ups will likely increase, albeit at subdued rates, and fund managers will very likely continue expanding their product offerings beyond hedge funds, testing different markets.
The report cautions that these positive trends are largely dependent on economic conditions and investor confidence, as well as the global regulatory and taxation environment, which will remain sources of uncertainty in the coming months.
Another systemic shock or reputation damage caused by a large-scale failure may have knock-on effects on investor confidence and, if sufficiently severe, could undermine the foundations of the recovery.
The report also shows that hedge funds are not immune to market shocks: “This stands to reason, because, although it is true that risk exposures of funds can vary substantially, they are participants in the financial markets and a sudden re-pricing of risk across the board can catch managers off guard, in the same way as other market participants. “A simple analysis using the VIX index as a measure of panic illustrates the point: we can observe that most (industry-wide) negative returns are associated with VIX spikes.
The full report Hedge Funds: 2009 Review and 2010 Outlook has been made available for free download to Research Recap users for 30 days by special arrangement with Moody’s, an Alacra content partner. (After 30 days the report will revert to its regular AlacraStore price of $550.00)
For additional free research reports from the Alacra Store click here
Technorati Tags: free research, Hedge-Funds
As Goldman Sachs (GS) reports record earnings and other big banks announce quarterly results, we are pleased to offer a complimentary download of Plunkett Research’s Profile and Investment and Securities Trend Analysis 2010. In addition to identifying trends for the financial services industry, the 34-page report includes a review of recent developments and an extensive glossary of investment product facts.
Plunkett’s emerging trends to watch for:
- Greatly increased regulatory oversight will restrict investment companies and lenders of all types. Regulatory agencies such as America’s SEC, may get an overhaul. Investment companies, banks and insurance companies will brace for much higher levels of scrutiny.
Unfortunately, the outcome could easily err on the side of too much new oversight enforced by inefficient new bureaucracies.
- An era of much lower risk-taking by traditional lenders has begun that will last for years.
- The creation of higher-risk loans and investments will be taken over to some extent by hedge funds and private equity funds, accelerating a trend that has already been in place for some time, and replacing some of the former roles of commercial banks and investment banks.
- Alternative lending sources will be used to a growing degree by small businesses and some consumers who are unable to get loans elsewhere. For example, peer-to-peer lending companies are growing through enabling lending by and between members of lending clubs, or between friends and family.
- Virgin Money USA, for example, makes it easy for reliable small business owners to set up loans from friends. Prosper.com enables borrowers to apply for three-year, fixed-rate personal loans online by connecting borrowers with individual lenders. On the other end of the spectrum, small businesses that are unable to obtain or renew bank loans will turn to high-cost “factoring,” a method of borrowing against their receivables.
This report has been made available free of charge to Research Recap users for 30 days by special arrangement with Plunkett Research, an Alacra content partner. After 30 days, the report will revert to its regular Alacra Store price of $149.99)
For additional free research reports from the Alacra Store click here
Technorati Tags: Bank-of-America, banks, Citigroup, financial-products, financial-services, Goldman-Sachs, Hedge-Funds, investment banks, morgan-stanley, Virgin Money, Wells Fargo & Co.
Hedge funds averaged a return of 18 percent in 2009 as they finished their best year of the decade with positive performance in December, according to the Credit Suisse/Tremont Hedge Fund Index. This compares with a 27 percent gain in the MSCI World Index.
The best performing strategy was Convertible Arbitrage with a 47 percent gain, while the worst was Dedicated Short Bias with a loss of 25 percent.
Long/Short Equity and Emerging Markets experienced positive performance in the final month of the year with performance largely propelled by rallies in Japanese and certain European equity markets. Following early gains, many managers took risk off the books as markets slowed down in the second half of the month.
Technorati Tags: Hedge-Funds, investment-strategy, short-selling
Guest Post by Darrell Delamaide of OilPrice.com
Do hedge funds have an impact on energy trading?
While the answer might seem intuitive, the debate as to whether they actually do has come to resemble the medieval theological dispute about how many angels can dance on the head of the pin.
Because, like angels, many trades in energy futures are invisible, and it is often not possible to pinpoint where they take place.
And yet, for most of us, including lawmakers on Capitol Hill, it seems obvious that when hedge funds buy and sell billions of dollars worth of oil and gas futures, it must be having an impact on energy prices. While hedge funds and other speculative traders would never dream of taking delivery of a barrel of oil, their trading activity affects the prices for actual consumers of oil and gas and their downstream customers – or so it would seem.
When Gary Gensler, a former Goldman Sachs banker and Treasury Department official, was nominated last year as chairman of the Commodity Futures and Trading Commission – the chief regulator for energy futures trading – he reversed the CFTC party line that speculators don’t have an impact on energy trading.
“I believe that excessive speculation in commodity futures can cause sudden or unreasonable fluctuations or unwarranted changes in commodity prices,” Gensler said in a written response to lawmakers’ questions ahead of his nomination hearing.
Gensler went on to pledge that if confirmed, he would have the CFTC guard against such speculation.
While he stopped short of saying that excessive speculation had taken place in the run-up of energy prices in 2008, he did express the opinion that the rapid growth of commodity index funds and increased hedge fund allocation to commodity assets contributed to the “bubble in commodities prices that peaked in mid-2008.”
He noted that non-commercial investors sometimes account for up to 90% of open interest in a contract. (Open interest is a calculation of the number of active trades for a particular market, and is used as an indicator whether trading is becoming more or less active.)
Gensler’s answer, enshrined in draft legislation currently before Congress, is to make trades more visible by requiring all over-the-counter derivatives to trade through an approved clearing house. While the thrust of new legislation is to get a better handle on financial derivatives such as credit default swaps, it will give regulators a better picture of all derivatives trading, including energy contracts.
At the same time, the CFTC and the Securities and Exchange Commission both are beefing up their ability to monitor hedge fund activity. The SEC for the first time will require hedge funds to register as investment advisors, and Gensler has pledged closer oversight of the funds that it supervises as commodity pool operators.
The industry, predictably, is pushing back. In congressional testimony on the new legislation, the Chicago Mercantile Exchange, the largest futures exchange in the world, and other exchange operators presented studies based on CFTC data to show that large positions held by index funds and other managed money were not “routinely detrimental” to the commodity markets in the period January 2005 to June 2008.
“All of the trader groups displayed instances of non-optimal behavior (including small traders), but none were consistently harmful to the studied markets,” they said.
A task force of the International Organization of Securities Regulators (IOSCO) released a report last March that came to a similar conclusion.
“While reports reviewed by the task force concluded that fundamentals rather than speculative activity was the plausible explanation for price changes, the task force has made a number of recommendations to improve the transparency and supervision of these markets,” IOSCO said.
These included suggestions regarding information about the underlying commodities, access to and sharing of information about trading positions, beefing up enforcement powers, and improving global coordination.
The spectacular collapse of the Amaranth Advisors hedge fund in 2006 when it lost $6 billion on natural gas futures did pull back the veil on hedge fund activity in energy markets. Amaranth built up its huge position in natural gas futures through OTC contracts that exactly mirrored the contracts on the New York Mercantile Exchange but remained hidden from regulators, who were unable to enforce position limits designed to rein in speculative trading.
In hearings about Amaranth before various House and Senate committees as well as at the CFTC itself, it became clear, at least to many lawmakers, that contracts on unregulated trading venues can influence prices.
The case was so straightforward that it prompted the Federal Energy Regulatory Commission to flex its new post-Enron mandate to stop manipulation of energy prices by pursuing disciplinary action against Amaranth.
This led to a turf war with the CFTC, which claimed exclusive jurisdiction over futures trading and argued that FERC’s mandate extended only to spot trading. FERC countered that when activity in the futures market affected spot prices, it was authorized to act.
Those proceedings ended in a joint settlement last August, before either CFTC or FERC held their administrative hearings and before an appellate court could decide the jurisdictional issue.
But the Amaranth case remains as a reminder of what a hedge fund can do in energy markets if these trades are not more transparent. Legislation bringing more visibility to the market and strengthening the hand of regulators will ensure that hedge fund activity in the energy markets will be more closely monitored and limited.
OilPrice.com focuses on Fossil Fuels, Alternative Energy, Metals, Oil Prices and Geopolitics.
Technorati Tags: Amaranth, derivatives, financial-regulation, Hedge-Funds, oil prices
Guest post by Oxford Analytica
Now that some policymakers are shifting out of crisis mode, some of the competitive considerations that dominated regulatory discussions during the tenure of former US Treasury Secretary Henry Paulson period are re-emerging. Nowhere is this more apparent than in contrasting approaches to regulation of alternative investment fund managers — hedge funds and private equity firms — being considered by the EU and the United States.
US approach. The Obama administration seems to be foregoing the traditional US detailed rules-based approach in its foray into regulating alternative investment fund managers:
- Alternative investment fund managers with assets under management above a modest threshold will be required to register with the Securities and Exchange Commission (SEC), but access to information collected will be limited to regulators, and not made publicly available.
- No minimum capital requirements, leverage restrictions or other limitations will be set necessarily for alternative investment fund managers; instead, systemic risk will be managed by requiring banks to have sufficient capital reserves to prevent contagion from any foundering sector or firm.
- For hedge funds registered as ‘investment advisers’, the Obama plan would impose record-keeping requirements, and mandate periodic monitoring by the SEC. The SEC would share information collected with the Federal Reserve, which would be responsible for assessing whether the fund met the criteria for being considered a Tier 1 Financial Holding Company, and subject to the increased regulation that accompanies such status.
EU approach. Whereas the US approach requires mandatory registration as a regulatory ceiling, for Brussels, such registration is the floor for its approach:
- Alternative investment managers operating within the EU will be subject to a plethora of new rules, including limitations on leverage, borrowing restrictions and capital requirements.
- Additionally, a separate set of rules will apply to funds marketed in the EU, but managed from outside the EU, thus indirectly extending the effect of the EU’s regulatory regime (for those funds that wish to market to EU-based customers).
Global regulation. Global coordination of financial regulation will be revisited at September’s G20 meetings, as it remains a priority for European political leaders. The US commitment to a strengthened global framework is much less certain, as the Obama administration has clearly decided, at least in the domestic sphere, not to make wide-ranging financial regulatory overhaul a priority. Global regulation of the hedge fund sector, under the auspices of the G20, looks extremely unlikely, either in the near or longer term:
- There is little common ground between US and EU approaches to hedge fund regulation, and without US support any comprehensive reform initiative will fail.
- Latest earnings results for some major US banks have been positive, and reduce the impetus for greater reform.
The likely G20 outcome on this issue will be a statement of principles, or general non-specific objectives, which could serve as a floor on regulatory approaches.
Outlook. No agreement is likely on the appropriate EU policy until after September’s German elections. Absent a parallel stringent global regulatory framework, an EU decision to adopt stringent restrictions will stimulate migration of the alternative investment fund management sector to Switzerland, where Geneva and Lausanne have the existing legal and professional infrastructure to support such a shift. Furthermore, restrictions on funds operating outside the EU could foster tensions with the United States.
Technorati Tags: financial-regulation, Hedge-Funds, private-equity
Six months after their worst drawdown on record, hedge funds appear to be demonstrating better performance than in previous recovery periods, such as the Asian Currency Crisis and the Tech Bubble Burst events, according to a new report from Credit Suisse/Tremont.
Historically, it has taken hedge funds 13 months to recover from these market disruptions, the report says. With returns of 7.2% through June 30th, hedge funds, as represented by the Credit Suisse/Tremont Hedge Fund Index (the ‘Broad Index’), have posted positive returns for five out of the first six months in 2009.
Other findings:
- Hedge funds have outperformed both equity and bond indices through the first half of the year while maintaining lower levels of volatility.
- Convertible Arbitrage, Emerging Markets, and Global Macro are specific sectors which received increased attention as investors regained their appetite for risk and global markets rallied.
- Performance has improved across most sectors, with the bulk of returns for many strategies falling in positive territory for the year, and 80% of all funds ending the second quarter in positive territory.
- Assets under management have dropped approximately $18 billion since the first quarter of 2009; we estimate industry assets totaled $1.3 trillion as of June 30. This is down from $1.5 trillion at the end of 2008
- As of June 30, an estimated 9.6% of funds were classified as impaired, meaning they have either suspended redemptions, imposed gate provisions or sidepocketed assets. This is down from an estimated 11.6% at the end of 2008.
- Calls for government regulation, increased requests for transparency and the rise of secondary markets are three trends currently developing in the hedge fund space.
Technorati Tags: Hedge-Funds
More competition rather than more regulation is the answer to fixing the financial system, according to a new paper from the Centre for the Study of Financial Innovation, a London-based independent think tank funded primarily by the financial services industry.
In The Road to Long Finance: A systems view of the credit scrunch, co-authors Michael Mainelli and Bob Giffords argue that only systemic wisdom will provide a long-term solution to the crisis.
“A return to business as usual will leave unaddressed such important problems as too big to fail; abusive risk-taking; perverse incentives; and a dangerous lack of diversity within the system. Simply tightening the current system of regulation will not work because the crisis was not a failure of open markets but a failure of highly regulated markets due to unexpected consequences of regulation and private decisions.”
A few highlights:
- Injecting more competition means a serious re-examination of global investment banking concentration, audit firm concentration, credit rating agency concentration and actuarial firm concentration. We believe that the promotion of competition, then supervision, then regulation should be the order of discussion with an objective of promoting “open” markets.
- The debate should be about “open” markets rather than the dogma of “free” or “regulated” markets.
- “Too big to fail” is too late. We have to stop financial institutions either getting to that size or being in that position. Tellingly, one investment bank in the 1990s had as its strategic objective: “to become too big to be allowed to fail”. It succeeded.
- Competition means having companies that can fail. Yes, society wishes to provide a safety net for retail investors and other groups, but that is a separate issue.
The religion of regulation works best when it worships at the altar of competition.
Technorati Tags: banking, financial-regulation, Hedge-Funds
A proposed rule change by the Securities and Exchange Commission to give shareholders much greater power to influence corporate director elections should also benefit creditors, according to Moody’s. That is, unless activist hedge funds hijack the new rights in pursuit of short term gains.
“In play is the so-called “broker vote” rule that allows brokers to vote uninstructed client shares in uncontested (i.e. “routine”) director elections. The issue of broker votes is technical, but significant, since an estimated 70-80% of U.S. public company shares are held in “street name” and managed by brokers. Under current rules, if brokers do not receive voting instructions at least 10 days before the election, they may vote how they wish – usually “for” management’s slate of nominees.
Since many individual shareholders don’t vote, it dilutes the impact of those who do, namely institutional investors and “activist” investors such as hedge funds. Ending the rule (by stipulating that director elections are no longer routine items and brokers cannot vote without receiving client instructions) would therefore give shareholders much more leverage in director elections, including greater ability to remove or signal discontent with underperforming directors.”
We see these moves as largely positive from a creditor perspective, potentially enhancing board accountability and investor awareness. However, short-term investors, namely “activist” hedge funds, could hijack these and other proposed new rights, using them to press companies harder for short-term gains at the cost of long-term credit quality.
“Generally speaking, these new rights, if promulgated, could help improve director and management accountability and awareness if they are used prudently and thoughtfully by long-term shareholders, whose interests are generally aligned with bondholders in terms of long-term value creation. Short-term investors, however, could exercise their new rights to press companies harder for short-term gains, including the adoption of more aggressive financial policy, at the cost of long-term credit quality.”
Moody’s comments are included in its latest Weekly Credit Outlook.
Technorati Tags: activist shareholders, corporate-governance, financial-regulation, Hedge-Funds, SEC
