derivatives

Central Banks Should Weigh Giving Clearinghouses Access to Funds, BIS Says

September 13, 2009

By Abigail Moses Sept. 13 (Bloomberg) — Central banks should coordinate global oversight of derivatives clearinghouses and consider offering them access to emergency funds to limit systemic risk, according to the Bank for International Settlements . Regulators are pushing for much of the $592 trillion market in over-the-counter derivatives trades to be moved to clearinghouses which act as the buyer to every seller and seller to every buyer, reducing the risk to the financial system from defaults. The drive was spurred by the collapse of Lehman Brothers Holdings Inc. and the rescue of American International Group Inc., two of the biggest credit-default swaps traders. “The crisis has exposed the need for international coordination of the oversight of systemically important” clearinghouses, BIS analysts Stephen Cecchetti , Jacob Gyntelberg and Marc Hollanders wrote in a report published today. An important and unresolved question is whether clearinghouses “should have access to central bank credit facilities and, if so, when,” they wrote. JPMorgan Chase & Co., Goldman Sachs Group Inc. and 13 other derivatives dealers last week told the Federal Reserve Bank of New York they will submit 95 percent of new credit-default swaps trades to clearinghouses. They made similar commitments for interest-rate derivatives. Intercontinental Exchange Inc., owner of the largest credit-default swap clearinghouse, said last week it will make it easier for hedge funds and other bank clients to access its service to guarantee trades starting next month. ‘Fundamental Improvements’ The Basel, Switzerland-based BIS was formed in 1930 to monitor financial markets and regulate banks. “Experience during the recent crisis points to the need for fundamental improvements in the management of counterparty risk and transparency in OTC derivatives markets,” the analysts wrote. Clearinghouses are not sufficient to ensure the “resilience and efficiency of derivatives markets,” according to the report. There needs to more use of automated trading, a central database for trades, enhanced risk management and greater disclosure requirements on traders, according to the report. Derivatives are contracts whose values are tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net

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SEC May Send Staffers to `Fraud College’ to Help Root Out Future Madoffs

September 3, 2009

By Joshua Gallu and Dawn Kopecki Sept. 3 (Bloomberg) — The Securities and Exchange Commission may create a “fraud college” to train staff in detecting market abuses after the agency failed to stop Bernard Madoff ’s $65 billion Ponzi scheme, Chairman Mary Schapiro said. “The fraud college concept is a great one,” Schapiro said today at a joint meeting with the Commodity Futures Trading Commission in Washington. Coordinating fraud-detection training with the CFTC “would be particularly valuable,” she said. The SEC is already training more than 300 examiners on ways to spot fraud after Madoff eluded the SEC for more than 16 years, Schapiro said in response to a suggestion from John Coffee , a securities law professor at Columbia University. SEC Inspector General H. David Kotz yesterday released a summary of a nine-month investigation that showed incompetence and inexperience helped Madoff avoid detection. The SEC is revamping its enforcement division after lawmakers and investors criticized it for missing Madoff’s scheme. Robert Khuzami, SEC enforcement director, last month announced he would form five specialty units focusing on cases in asset management, structured products, municipal securities, foreign corrupt practices and market abuse. “Specialization can be a danger as well as an asset,” said Coffee, who also suggested the SEC and CFTC set up a joint task force to oversee swap contracts. “The greater danger is that specialized units don’t share information well.” Fraud in the derivatives market may be lessened if the CFTC had SEC-like powers to enforce insider trading and market manipulation cases, Coffee said in prepared remarks. Richard Owens , an attorney at Latham & Watkins, said the agencies need to develop a joint set of standards that outline how the commissions will decide what kinds of enforcement cases they will bring. William McLucas , a former SEC enforcement director who’s now at WilmerHale in Washington, said the agencies should convene a group of staff from both agencies to determine how best to cooperate on enforcement. To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net ; Dawn Kopecki in Washington at dkopecki@bloomberg.net .

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CFTC `Seriously Looking’ at Position Limits for Derivatives, Gensler Says

August 27, 2009

By Peter Cook and Dawn Kopecki Aug. 27 (Bloomberg) — U.S. Commodity Futures Trading Commission Chairman Gary Gensler said he is still “seriously looking” at positions limits for energy traders and expects legislation addressing the derivatives market to succeed. “We want to make sure that no one trader has such an outsized or large position that that concentrated position might have a burden to the marketplace,” Gensler said in a Bloomberg Television interview today. The CFTC is seeking a “fair and orderly’ market, he said. To contact the reporters on this story: Peter Cook in Washington at pcook6@bloomberg.net ; Dawn Kopecki in Washington at dkopecki@bloomberg.net .

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Volkswagen to Pay $4.7 Billion for Porsche Auto Stake in Prelude to Merger

August 13, 2009

By Chad Thomas and Cornelius Rahn Aug. 13 (Bloomberg) — Volkswagen AG , Europe’s largest carmaker, will pay about 3.3 billion euros ($4.71 billion) for a 42 percent stake in Porsche SE’s automotive unit as part of a plan for the gradual merger of the two manufacturers. Volkswagen will fully integrate the maker of the 911 sports car in 2011 as long as all merger requirements are met, the two companies said in separate statements today. The carmakers announced plans in July for a transaction that would also include a state-owned Qatari investment fund buying 17 percent of Wolfsburg, Germany-based Volkswagen and a possible holding in Porsche. Executives have said the combined company will eventually overtake Toyota Motor Corp. , the world’s biggest automaker, in sales and profitability. “This merger implies huge synergies,” Stefan Bratzel , head of the Center for Automotive Research Institute in Bergisch-Gladbach, Germany, said before the announcement. “Together, Volkswagen and Porsche can carve up the world’s car markets.” Porsche CEO Wendelin Wiedeking and CFO Holger Haerter stepped down on July 23 and the Stuttgart, Germany-based company named Michael Macht , its personnel chief, to succeed Wiedeking as the head of the automotive business, called Porsche AG. Amassing Debt The planned combination ends a four-year feud for control that led to Porsche amassing at least 10 billion euros ($14.2 billion) in debt as it accumulated 51 percent of Volkswagen’s stock in a failed takeover attempt. Wiedeking left a job he had held for 16 years after his company’s board committed to selling the automotive operations to VW and seeking as much as 5 billion euros in capital, with Qatar as a possible investor. The Persian Gulf state would be the first shareholder outside the Porsche and Piech families to hold voting rights in the 78-year-old company’s history. Porsche’s target stake in Volkswagen was 75 percent, a holding that could have given it access to VW’s cash. The sports-car maker held options for 20 percent of Volkswagen’s stock as part of the takeover effort. Porsche said on July 29 that it aimed to sell some of the options to Qatar and that writedowns on the derivatives would cause a pretax loss of as much as 5 billion euros for the year ended July 31. To contact the reporters on this story: Chad Thomas in Helsinki at cthomas16@bloomberg.net ; Cornelius Rahn in Wolfsburg, Germany, via crahn2@bloomberg.net .

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Lehman Contract Is U.K. Test Case for Billions of Dollars in Other Swaps

August 11, 2009

By Linda Sandler Aug. 11 (Bloomberg) — A U.S. bankruptcy judge may have a controlling say in resolving a dispute in a U.K. court between Lehman Brothers Holdings Inc. and a Bank of New York Mellon Corp. unit over a swap agreement that could affect billions of dollars of similar contracts. At issue is who under U.S. bankruptcy law gets paid first under two swap agreements related to Lehman’s so-called Dante program of credit-linked notes — Lehman or investors who bought the notes. Lehman lost under U.K. contract law. The U.K. judge left the question of U.S. bankruptcy law open as Lehman appeals his ruling. “This issue has never been tested in court in the U.S.,” said Guy Dempsey, co-chair of the derivatives group at the law firm Latham & Watkins LLP. Lehman, the investment bank liquidating in bankruptcy, says it is owed $70 million on the swaps and wants to get paid. BNY Corporate Trustee Services Ltd., acting for the note-holders, wants the case dismissed and cites a U.K. judge who said last month that note-holders are entitled to the payments under U.K. law now that Lehman is bankrupt. The case, being considered in bankruptcy court in New York today, may affect many other swap agreements designed like Lehman’s, which includes an indenture and a sequence of payments, Dempsey and other experts said. Terms of the two Lehman transactions, named Dante after the entity that issued the notes, specify that investors have first claim on whatever money is available if Lehman defaults or goes bankrupt. While the U.K.-based contract favors the noteholders, U.S. bankruptcy law normally protects a debtor company’s assets. Lehman is asking the bankruptcy judge to rule in its favor. Not Yet Tested Not yet tested is whether U.S. law permits the investors to use a written contract to give themselves priority claims after a bankruptcy. In the U.K., the related case was brought against Lehman by a trustee for Australian note-holders, Perpetual Trustee Co. Rating agencies could start to downgrade credit-linked notes if the bankruptcy judge says Lehman can take away assets protecting the investments, debt research firm CreditSights Inc. said in a July 12 report. Insulating such deals from bankruptcy “forms the bedrock of securitization, CreditSights analyst Atish Kakodkar said in the report. Lehman had a similar tussle last month in the U.S. over who owed what to whom with Metavante Corp ., a company involved in another swap agreement. U.S. Bankruptcy Judge James Peck , in charge of Lehman’s bankruptcy, said in that case that he believed Lehman should be paid. He postponed a decision until September to give the opponents time to settle the issue themselves, Dempsey said. Biggest Bankruptcy Last September, Lehman filed the biggest U.S. bankruptcy ever with assets of $639 billion. It sued Bank of New York on May 20 over payments related to the credit-linked notes, issued by an entity it set up, Dante Finance Public Ltd. “The bankruptcy code protects debtors from being penalized for filing a Chapter 11 case, notwithstanding any contractual provisions or applicable law that would have that effect,” Lehman said in its complaint. Lawyers for Bank of New York, Eric Schaffer and Michael Venditto of Reed Smith LLP, didn’t returns calls or e-mails seeking comment. The adversary case is In re: Lehman Brothers Holdings Inc. v. BNY Corporate Trustee Services Ltd., 09-01242, U.S. Bankruptcy Court, Southern District (Manhattan). To contact the reporters responsible for this story: Linda Sandler in New York at lsandler@bloomberg.net ;

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Buffett’s Berkshire Hathaway Swings Back to Profit on Derivative Holdings

August 7, 2009

By Erik Holm and Andrew Frye Aug. 8 (Bloomberg) — Billionaire investor Warren Buffett ’s bet on derivatives tied to world equity markets helped Berkshire Hathaway Inc . return to profitability in the second quarter. Net income rose 14 percent to $3.3 billion, or $2,123 a share, from $2.88 billion, or $1,859, in the same period a year earlier, the Omaha, Nebraska-based company said yesterday in a regulatory filing . The results halted six straight quarters of declining profit at Berkshire that included a first-quarter loss of $1.53 billion. Berkshire benefited as stock markets on three continents rebounded, while preferred shares and debt in Goldman Sachs Group Inc. and General Electric Co. increased investment income. Buffett, the firm’s chairman and chief executive officer, has said Berkshire’s energy business is thriving amid the recession, while jewelry, home-building and airplane units suffered. “It’s shocking how much the derivatives really make a difference,” said Michael Yoshikami , chief investment strategist at Walnut Creek, California-based YCMNet Advisors, which owns Berkshire shares. “If you take those out of the overall result, it doesn’t change the fact that some of the economically sensitive names are still hurting.” Derivatives added $2.36 billion to earnings, compared with $689 million a year earlier. The firm valued the stock portfolio at its insurance units at $45.8 billion, a 22 percent increase from March 31. Goldman Sachs Buffett scaled back on the purchase of common stocks in the past year in favor of preferred shares in Goldman Sachs and GE, municipal bonds, and debt in firms including luxury jeweler Tiffany & Co. and motorcycle maker Harley-Davidson Inc. The shift boosted investment income 9 percent to $1.87 billion at its insurance and finance operations. Berkshire’s own shares passed $100,000 for the first time since January this week, recovering from a six-year low in March. The stock gained $1,150, or 1.1 percent, to $108,100 in New York Stock Exchange composite trading yesterday before results were released. Berkshire is the largest shareholder in American Express Co. , whose stock rose 71 percent in the quarter, Wells Fargo & Co., which increased 70 percent, and Burlington Northern Santa Fe Corp. , which advanced 22 percent. Climbing stock prices helped increase book value to $118.8 billion, an 11 percent increase since March 31. Buffett typically highlights book value, the measure of assets minus liabilities, in the first sentence of his annual letter to shareholders. The figure includes $4.3 billion for non- controlling interests. David Sokol Buffett, 78, has been shuffling managers at businesses pressured by the recession, this week appointing David Sokol , chairman of Berkshire’s MidAmerican Energy Holdings Co. , to run NetJets Inc. on a temporary basis after the head of the plane- rental unit stepped down. The assignment stoked speculation that Sokol may one day succeed Buffett as CEO. The NetJets unit, which leases planes to corporate customers and individuals, posted a $253 million pretax loss, including asset writedowns and “other downsizing costs of $192 million” in the quarter. “NetJets owns more planes than is required for its present level of operations and further downsizing will be required unless demand rebounds,” the filing said. The stock-market rally helped derivative bets called equity-index puts that had weighed on results over the prior year. Buffett sold some of the derivatives when the Standard & Poor’s 500 Index and other markets were approaching peaks in 2006 and 2007, with the promise to pay buyers in 2019 or later if the indexes are lower than when the contracts were arranged. New Terms Berkshire said it renegotiated terms on six of the contracts, shortening their duration by 3.5 to 9.5 years, and reduced the strike price — the level at which Berkshire would pay out — by 29 percent to 39 percent. No funds changed hands between Berkshire and counterparties as a result, the firm said. Buffett repeated an earlier statement to shareholders about the effect of the derivatives on quarterly results. The bets, Berkshire said in a statement yesterday, “will produce extreme volatility in our periodic reported earnings.” Ultimately, Buffett told shareholders in May, he expects Berkshire to make money on the bets. Berkshire also sold credit-default swaps on individual companies, and contracts that require the firm to pay when credit losses occur at borrowers included in high-yield-bond indexes. The company paid about $825 million in the second quarter and $350 million in July, bringing the total for the year to $1.85 billion. Berkshire collected $3.4 billion in premiums on the contracts through the end of 2008. Job Cuts Profit from selling policies at car insurer Geico fell 63 percent to $111 million before taxes on an increase in claims. The unit added about 166,000 policyholders in the quarter, as growth slowed from the first quarter when the company gained 430,000 customers. Revenue was also pressured at smaller Berkshire businesses that sell jewelry and furniture, and make products used in home building. Berkshire last year cut jobs at units including Clayton Homes Inc., which builds manufactured housing, and brickmaker Acme Building Brands. Each of the manufacturing subsidiaries has “taken actions to reduce costs, slow production and reduce or delay capital spending until the economy improves,” Berkshire said yesterday. To contact the reporter on this story: Erik Holm in New York at eholm2@bloomberg.net ; Andrew Frye in New York at afrye@bloomberg.net

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AIG Reports First Profit in Seven Quarters After Investment Losses Shrink

August 7, 2009

By Hugh Son Aug. 7 (Bloomberg) — American International Group Inc. , the insurer rescued by the U.S. government, reported its first profit in seven quarters as investment losses narrowed. Second-quarter net income of $1.82 billion, or $2.30 a share, compares with a net loss of $5.36 billion, or a split- adjusted $41.13, a year earlier, New York-based AIG said today in a regulatory filing. The results may ease pressure on Robert Benmosche , AIG’s fifth chief executive officer since 2005. The former MetLife Inc. head, who replaces Edward Liddy next week, has to dismantle AIG to repay loans within a $182.5 billion bailout. The insurer posted more than $100 billion in net losses driven by failed housing market bets in the six quarters ended March 31. “This buys him more time because its shows they’re getting some traction,” said Haag Sherman , who helps oversee $7.3 billion as chief investment officer of Houston-based Salient Partners. “He can use the operating profit to show that they have good assets and they just need more time to divest them in an orderly fashion to get the best prices for shareholders and the U.S. government.” Share Surge AIG gained 71 percent this week through yesterday in New York Stock Exchange composite trading on speculation results would improve. The stock plunged more than 95 percent in the past 12 months. AIG in June gave investors one new share for every 20 they turned in, a so-called reverse split the company said would help keep the stock above $1 and avoid delisting. AIG closed at $22.53 yesterday. Under Liddy, appointed by the government in September, AIG started a plan to shed most businesses excluding property- casualty operations. He was forced to adjust the plan to include placing three major divisions into special purpose vehicles and seek relaxed terms on AIG’s government loans as the credit crisis hobbled potential buyers’ ability to make bids. The company has struck deals through yesterday to raise about $7.4 billion by selling assets including a U.S. auto insurer, an equipment guarantor and a Japanese building. That compares with $42.2 billion the company owed on a Federal Reserve credit line as of last week, in addition to a $40 billion Treasury investment. Name Change AIG said it will hand over stakes in two of its biggest non-U.S. life insurance units in exchange for a $25 billion reduction of its Fed debt. The insurer’s property-casualty unit was renamed Chartis Inc. and may eventually sell a minority stake to a buyer or in a public offering. The insurer will skip the conference call presentation and question-and-answer session that accompanied results in the past, Christina Pretto , an AIG spokeswoman, said this week. Benmosche starts on Aug. 10. Benmosche, 65, was CEO of MetLife Inc. , the largest U.S. life insurer, for eight years through 2006 and oversaw the company’s change to a publicly traded business from a policyholder-owned firm. Before joining MetLife, he was an executive vice president at PaineWebber Inc. where he directed the merger with Kidder Peabody, AIG said. Benmosche has been on the board of Credit Suisse Group AG since 2002. AIG needed a U.S. rescue in September after handing over more than $18 billion in collateral tied to credit-default swaps sold to banks including Goldman Sachs Group Inc. and Societe Generale SA. The swaps protected against declines on securities backed by U.S. subprime mortgages. European Swaps The insurer said in June that valuation declines on a different book of swaps sold to European banks could have a “material adverse effect” on results. AIG had $192.6 billion in the derivatives as of March 31, and the average weighted length of the swaps protecting residential loans was more than 25 years, while the span tied to corporate loans was about 6 years, the company said in a filing. The government’s rescue includes a $60 billion credit line, $52.5 billion to buy mortgage-linked assets owned or insured by the company, and a Treasury investment of as much as $70 billion. AIG agreed to turn over a stake of almost 80 percent as part of the initial bailout, diluting private shareholders . To contact the reporters on this story: Hugh Son in New York at hson1@bloomberg.net ;

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