Navigating the Post-GameStop Regulatory Environment
Whether you look as far back as the stock market crash of 1929 or the global financial crisis of the late 2000s, there is a continuum of market regulators playing catch-up after the fact. That process is manifesting itself again, one year after the GameStop stock trading drama.
The recent meme-stock phenomenon is a direct consequence of cost-free trading connected with social media-driven interactions around trading activities. Retail trading apps have made it effortless for retail investors to trade stocks. Simultaneously, social media networks have become an accelerator where anyone can propose and back investment ideas, creating the perfect storm for a GameStop-like stock trading frenzy.
The meme-stock phenomenon laid bare the imbalance between institutional and inexperienced investors. Institutional investors were able to exploit the meme-stock phenomenon for short-term ROI. And while some smaller retail investors were able to walk away with profits or minor losses, others suffered deeply—some losing all their savings.
How do these challenges present regulatory opportunities? While GameStop—and the retail trading phenomenon generally—operate outside the same market sphere as professional traders, it affects the entire economic spectrum. It has raised clearing issues and has led to a more stringent regulatory environment. While retail investors may exist in their own trading universe, regulators are moving to institute market-wide changes.
Last November, the U.S. Securities and Exchange Commission (SEC) proposed Exchange Act Rule 10c-1, expanding investment position reporting requirements. The Rule compels lenders of securities to provide details within 15 minutes of a transaction to a regulatory body, which would make some of the transaction details public. The SEC will likely also proceed with a rule change in the coming months that limits gamification and digital engagement prompts on investing apps.
Given that the markets are supported by outdated regulatory infrastructure, FinTechs—which allow open access to this kind of trading ecosystem—need to take the initiative and institute tech-savvy practices and systems to get ahead of the curve.
The kind of tech-driven automation and ease-of-use that has made trading easy for retail traders has been missing from important areas of financial services. What the post-GameStop regulatory environment has done is present an urgency for those underserved areas of the markets to take advantage of this technology.
In contrast, private markets operate in a different regulatory environment. The barrier has been set high and is being lowered over time—without compromising appropriate safeguards. For example, one of the more productive strides in recent years has been lowering the accredited investor and non-accredited investor standards, making it easier for private market investors to make private market investments. We have a unique opportunity to ensure that as market-entry barriers go down, robust regulatory plumbing continues to protect accredited and retail-grade investors in the private markets.
What financial institutions need to do now is thoroughly examine how their compliance infrastructure works—and how it will do so for a more stringent regulatory environment in the years to come.
Even as technology has propelled us to this point, it will also serve as a key tool for private market participants to navigate a more stringent regulatory environment. Tech-enabled compliance solutions can enhance risk management, boost time and cost efficiencies, improve accountability and accuracy, and reduce human error.
Today’s technology advances, when coupled with the right compliance approach, allow us to challenge the conventional wisdom that more regulation needs to come at the expense of market innovation.
It’s long past time to bring the financial technology revolution to the compliance space. An innovative and pro-compliance technology focus allows the financial services industry to strike a balance between providing adequate protection and stimulating business, proving that it doesn’t have to be an either-or decision.
Originally posted by Federico Baradello on Traders Magazine.
SEC Issues Proposal to Reduce Risks in Clearance and Settlement
The Securities and Exchange Commission voted on February 9th, 2022, to propose rule changes to reduce risks in the clearance and settlement of securities, including by shortening the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one business day after the trade date (T+1). The proposed changes are designed to reduce the credit, market, and liquidity risks in securities transactions faced by market participants and U.S. investors.
“These proposed amendments to the securities clearing and settling process, if adopted, could lower risk to the financial system and drive greater efficiencies in the markets,” said SEC Chair Gary Gensler. “First, these amendments would shorten the standard settlement cycle. As the old saying goes, time is money. Shortening the settlement cycle should reduce the amount of margin that counterparties would need to post with clearinghouses. Second, these changes would require affirmations, confirmations, and allocations to take place as soon as technologically practicable on trade date (“T+0”). Finally, the release would require clearing agencies that provide central matching services to have policies and procedures to facilitate straight-through processing — i.e., fully automated transactions processing.”
In addition to shortening the standard settlement cycle, the proposal includes rules directed at broker-dealers and registered investment advisers to shorten the process of confirming and affirming the trade information necessary to prepare a transaction for settlement so that it can be completed by the end of the trade date. Further, the proposal includes a new requirement to facilitate straight-through processing, which would apply to certain types of clearing agencies that provide central matching services. Central matching service providers help facilitate the processing of institutional trades between broker-dealers and their institutional customers. The proposed rule would require new policies and procedures directed to straight-through processing and require an annual report on progress with the process.
With the goal of shortening the settlement cycle further, the proposal solicits comments on challenges associated with and potential paths to achieving a same-day settlement cycle.
The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
Source: SEC
Details on the US SEC Rule 10c-1 Proposal and the Impact on Securities Lending
Changes are always possible from the US Securities and Exchange Commission. One of those impending changes is the proposal known as Rule 10c-1. This proposal, if put in place as written, would establish vast new reporting and disclosure requirements. Anyone in the securities lending markets would need to react accordingly if and when Rule 10c-1 becomes reality. Currently, comments on the new rule proposal are due by January 7, 2022.
Purpose of the Proposal
Rule 10c-1 would put in place a requirement that any individual who does security lending on his or her own behalf, or on the behalf of another, needs to disseminate information on that transaction to the proper authority. In this case, that is a registered national securities association (RNSA). At this current time, the only qualifying RNSA that can serve this need is the Financial Industry Regulatory Authority (FINRA).
So why is the US Securities and Exchange Commission moving forward with this rule proposal to securities lending? The goal for the SEC is to provide data access to more parties in the securities lending space. Investors as well as other participants in the market could access pricing, as well as other material information on securities lending transactions quickly.
It all comes down to transparency for the SEC. The more information that is out there, and the more real-time it is made available, the easier it will be for those playing in the market to react. The information in which FINRA collects will allow regulators to survey the market in real-time, be aware of investor behavior that requires their attention, as well as create a more open environment for all.
Details of the Rule Proposal
At a high level, the Rule 10c-1 proposal would have broad application. Any single individual who loans any security for its own sake or on behalf of another would see an impact. Section 3(a)(10) of the Exchange Act defines what security constitutes regarding this rule proposal. Banks, insurance companies, pension plans, and any other entity under oversight by the SEC of FINRA also must comply.
Reporting Requirements and Transaction Data
Specific transaction data needs transmission within 15 minutes after a loan is “effected” under the rule proposal change. FINRA also sees a requirement where each loan needs a unique transaction identification number. FINRA, once they receive the information, also needs to make the data public “as soon as practicable.”
The required data elements that parties must put forth and transmit to FINRA include examples such as:
- Date and time loan effected
- The legal name of the issuer of the security and Legal Entity Identifier
- Ticket symbol
- Amount of security loan
- Whether a borrower is a broker or dealer
These are just some examples of the requirements set forth in the new reporting requirements.
Meeting the Reporting Requirements
Lenders and lending agents, under the rule proposal, can engage a reporting agency such as a registered broker-dealer to help with compliance. The reporting agent would work to take the information and transmit it to FINRA, meeting the requirements on behalf of the parties.
Reporting agents have requirements as part of the rule proposal. These include policies and procedures to provide the required information to FINRA. A written agreement also much be in place with FINRA, permitting the reporting agent to act on behalf of other parties. Reporting agents also must provide an initial, as well as end-of-day list, of anyone whom they are acting on behalf of with data transmission. Finally, reporting agents must have three years of records kept for retention. The first two years need to be easily accessible.
Loan Modifications and Confidential Data
Other pieces of the rule proposal that need awareness include impacts to loan modification and confidential data. Any loan modification needs transmission of information to FINRA. These data elements include the date and time of the loan modification, a description of the modification, as well as the loan’s unique identification number.
Confidential data requiring submission to FINRA as part of the rule change include:
- Legal names of each party to the transaction
- Details on if security is loaned from a broker-dealer to a customer
- Details on if the loan is used to close out a Regulation SHO
RNSA Also Need to Prepare
RNSA is also getting direction on how to implement the rule changes. How they receive the data, format it, and administer it is all detailed in the rule proposal. Again, the timeline allows until early January for commentary in 2022, and it will be interesting to see how this commentary impacts what the final rule proposal ends up being.
ESMA Highlights Issues and Recommends Improvements in Algo Trading
Algo trading has been on a constant rise over the past few years. With many platforms selling algorithms and programs that place trades automatically, the job has surely become a lot easier for traders. Prior to 2007, national stock exchanges had a monopoly in equity. But in 2007, the Markets in Financial Instruments Directive (MiFID) opened the market to competition by other platforms. This opened the avenues for smart order routers and dark pool algorithms in this fragmented market structure. As a result, more complex benchmark algorithms were introduced, and opportunities for more high-frequency trading came to the fore. As algo trading became popular, the MiFID II introduced further compliance and operational requirements for all algo platforms. These new regulations have been in force since January 2018.
Published 📤 #ESMA #MIFIDII Final Report on Algorithmic Trading → https://t.co/69miJWH3s7.
▪️ no fundamental issues have emerged
▪️ ESMA makes recommendations to @EU_Finance → aim at simplifying the regime and making it more efficient pic.twitter.com/1hi5lZq4qC— ESMA - EU Securities Markets Regulator 🇪🇺 (@ESMAComms) September 29, 2021
Very recently on 28 September 2021, the European Securities and Markets Authority (ESMA) has published the MiFID II/MiFIR review report to highlight issues and recommend improvement in algo trading. This comes as a means to contemplate the various risk involved in the increased use of technology in trading. These risks include the generation of duplicate or erroneous orders, overreaction to market events that aggravate volatility in the market or market abuse. The review tries to identify potential risks of malfunctioning in algorithmic trading platforms that may create disorder in the market.
The ESMA report, however, concluded that no significant fundamental issues emerged during the review, meaning that MiFID II has delivered what it promised to in terms of the algorithmic trading regime. ESMA did recommend some improvements to make the regime simpler and much more efficient, though. The report also identified a few issues that need to be followed up. One of these issues is regarding the application of algo trading and high-frequency trading rules to direct electronic access and third-country algorithmic trading firms that deployed their strategies on EU trading venues. Another issue that the ESMA identified is related to the MiFID II provisions on tick size and market-making.
Impact of Brexit
Markets Media spoke to Martin Appiah, the director of regulatory affairs at Eventus Systems, to get his views on the ESMA report. Martin Appiah agreed that there were no major surprises for them but some significant material changes were expected after the review. He highlighted the impact that Brexit, or UK's departure from the EU, may have on this whole matter.
He reminded that as a result of Brexit the relationship between the UK and the European Union has changed. The UK is now considered a third country like others, in the EU.
Appiah elaborated that many non-EU affiliates of the same group have been using direct electronic access (DEA) from the UK to access the EU markets, after Brexit. The ESMA recognizes and acknowledges the new financial paradigm that has arisen from Brexit and how it can bring several competitive advantages for a third country, including the UK, in certain areas. But it is also worth noting that ESMA made it clear in the report that they will be taking initiatives to ensure judicial use of DEA. The ESMA plans to review the responsibilities of all DEA users and carry out sub-delegation so that everyone has equal opportunity, said Appiah.
Sub-delegation in DEA allows small-time brokers and intermediaries to access EU markets. Brokers who do not have the capacity to become direct members of all the EU trading venues can provide their clients access to these pools of liquidity. Albeit, without having to bear the costs or maneuver the complexities of attaining memberships at all EU trading venues. These DEA sub-delegation providers may have to adhere to some very stringent rules and operational requirements to ensure compliance to market standards by their clients.
The World Federation of Exchanges has also responded to the ESMA review report. The WFE said that including users in the scope of DEA regulations is not needed. They said that DEA regulations for providers are already in place, be it under the MiFID or some other similar regime in a third country. So they see no need to duplicate the regulations.
The WFE also said that proportionality is the biggest benefit of this consultation. The streamlining of the provisions related to DEA is likely to create a more consistent approach throughout all the EU member states. This will further support business between EU members and third countries, promoting a better model for business across borders.
Industry response to the ESMA review
Several industry experts have analyzed the ESMA review report and presented their opinions on what it could mean for algo trading in the future. A white paper summarising the likely outcomes of the review and its impact on market abuses, systems, and controls has been published by a leading trading surveillance company. One possible impact is an increased focus on bonds. Until 2019, there was a negligible volume of algo trading in bonds. But by the third quarter of 2019, algo trading in bonds rose up to 80%
According to analysts, this sudden growth is because of how bilateral over-the-counter trading has undergone electronification, with negligible high-frequency trading activity in this case. Seeing this trend, the ESMA review has proposed to selectively extend algo trading requirements to systematic internalizers or SIs. This brings several bond trading activities under the algorithmic trading regulations. It is seen that the focus, in this case, will primarily be on the governance of algo trading in bonds and the systemic control of algo platforms. It is also likely that notification by SIs to their national regulators, regarding the use of algo trading techniques, may be made mandatory in the near future.
However, most firms already use algorithmic trading techniques in compliance with MiFID II regulations. So applying the same regulations to other SI units will not be difficult for such firms. But for sell-side firms that operate as systematic internalizers, this proposal may not go down well. Also, experts added that there are many opt-in SIs that do not use algorithmic trading techniques. So simply extending the algo trading regulations to all SIs may not be useful or relevant.
A careful evaluation of the report also shows that market abuse in various areas has been highlighted in the ESMA review, and the need for stringent procedures and timely reporting is mentioned. This could mean that these areas will be audited more strictly by national regulators once new regulations come into effect. So systems must ensure compliance with all requirements in these areas.
The ESMA report will be submitted to the European Commission, which may then propose amendments to the existing MiFID II regime. On the other hand, the UK government is carrying out its own review of wholesale market regulations. The outcomes of this review are likely to diverge from the EU regulations. The UK report is set to be published in 2022.
Cboe Acquires NEO Exchange - Boosts Equities Offering In North America & Canada
Cboe Global Markets, Inc. recently announced plans to close a major acquisition deal in the first half of 2022.
The leading Chicago-based exchange operator is set to acquire Toronto-based NEO exchange, a move that will expand its footprint in both Canada and North America.
However, the terms of the deal are yet to be disclosed since the deal is still undergoing regulatory review.
What’s the Background Story on NEO and Cboe?
Cboe Global Markets, Inc. (Cboe) is a global exchange operator that provides a range of market-defining tradable products, such as options, futures, and US and European-based equities. Besides its innovative products, Cboe also excels in creating and acquiring new markets or market models and is the global exchange operator behind the first-listed options marketplace and other pioneer achievements.
Overall, Cboe Global Markets is committed to defining markets through leading technology, product innovation, and streamlined trading solutions. Currently, the CEO of Cboe is Edward T. Tilly, while the Executive Vice President and Chief Operating Officer is Chris Isaacson.
NEO Exchange, a Canadian capital markets technology firm, launched in 2015 and quickly became one of the country’s top three active marketplaces. As a leading fintech organization, NEO operates a fully registered Tier-1 Canadian securities exchange that offers various products and services.
The fintech company’s parent company is Aequitas Innovations, Inc., and during the time it has been in operation, it has managed to build thriving corporate listings offerings for Canadian companies that want to capitalize on the thriving economy. NEO also comprises NEO Connect, a multi-asset distribution platform that has enabled Canadian corporates to invest in mutual funds, private funds, and private placements.
Details of the Agreement Between Cboe and NEO Exchange
As stated, the terms and conditions of the acquisition agreement between Cboe and NEO are yet to be fully disclosed since the deal is going through regulatory review. However, both the CEOs of NEO and Cboe released statements expressing positive sentiments about the agreement. Jos Schmitt, President, and CEO of NEO expressed their excitement at becoming part of the leading global market infrastructure provider Cboe. The CEO of NEO admitted that the fintech organization will now be able to draw on the strengths of Cboe and expand its innovative range of solutions to further satisfy the needs of investors and capital-raisers on a global scale.
In turn, the CEO of Cboe Global Markets, Ed Tilly, expressed similar sentiments stating that the acquisition of NEO is perfectly in line with his organization’s vision. As such, Cboe plans to expand on the groundwork already built by NEO and continue supporting Canadian corporates internationally by providing global capital raising opportunities. In addition, Cboe plans to help NEO successfully execute its five-year growth plan. This is a move that NEO fully supports, making both firms ideal partners who share the same vision.
What the Future Looks like for Cboe Global Markets After the Acquisition
With the addition of NEO, Cboe is now looking to expand its global market reach. The global exchange operator already has significant equity offerings in North America, Europe, and the Asia Pacific. Based on a statement from Ed Tilly, the CEO of Cboe Global markets, NEO is a first-class acquisition and a step in the right direction towards the organization’s vision of expanding into one of the world’s top global derivatives and securities trading networks.
This is not a far-fetched notion, considering that Cboe has ownership of MATCHNow. MATCHNow is another Canadian entity and an alternative trading system acquired by Cboe in 2020. With MATCHNow already in the picture, the acquisition of NEO enables Cboe to scale up its operations in Canada and North America and boost efficiencies for its combined customers through established technologies and consistent market models. The MATCHNow and NEO Exchange acquisition means Cboe now has a 16.5% Canada equities market share.
This is only part of the bigger picture for Cboe, which plans to further expand globally with more targeted acquisitions. For instance, before announcing its acquisition of NEO, Cboe brought to light its plans to acquire Eris Digital Holdings LLC. In addition, the global exchange operator announced its plans to establish a platform for US treasuries interdealer trading.
The Essence of Timing Within the U.S. Equities Settlement System
The United States equities settlement system is reliant on timing. The essence of timing is never more apparent than the risk exposure seen following a current standard T+2 settlement cycle. Now is the time to enhance that cycle and move it forward leveraging technology and other advancements to T+1. The Depository Trust & Clearing Corporation is aiming to do just that over the next few years.
A move to T+1 would reduce systemic #risk, operational risk, liquidity needs, buy-side counterparty exposure, and broker-to-broker counterparty risk. Read more in this article from Michele Hillery: https://t.co/sk48vUZqHi #settlement pic.twitter.com/NyzeQC4oQV
— DTCC (@The_DTCC) November 11, 2021
Risk Exposure Around the T+2 Cycle
The concept of the T+2 settlement cycle is that there are two whole business days between when the transaction takes place and the settlement finalizes. Think about everything that can happen within that timeframe.
The parties of the settlement transaction face risks in the areas of:
- Operational Risk
- Liquidity Risk
- Systemic Risk
- Broker to Broker Risk
- Buy-Side Risk
All of these risks see elevation due to the T+2 cycle. With a move to a T+1 cycle, eliminating an entire business day, you see gains and more certainty around settlement transactions.
Margin and Collateral Requirements
The T+2 U.S. equities settlement cycle requires excess margin and collateral requirements. The risk of counterparty default is high within the system and the margins requiring holding is due to the timing of everything. When you cut down on the settlement cycle, you improve the balance between the parties, reduce risk, and lower margin requirements.
Collateral is another piece in play here when it comes to the settlement cycle. Putting up collateral helps ensure that, if something were to happen before settlement finalization, it is there to settle the transaction. Collateral reduction due to shortening of the timing makes the transaction more seamless.
The Push for Real-Time Gross Settlement
There is an industry-wide push in many pockets for what is known as real-time gross settlement (RTGS). With the RTGS approach, you are funding all transactions one at a time. Netting and financing are not necessary in this scenario, since funding is in place just-in-time when the settlement processes. Many think this is the same as a T+0 settlement, but it is different. With T+0, the transaction settles on the same day, but not in real-time. This distinction is critical in understanding the differences and benefits of RTGS.
So will RTGS be the go-forward approach? Not likely. There would be a lot of strain on back-office operations to put RTGS in place. Brokers and asset managers would face the strain that goes with it, and suffer the consequences. This is why the push to T+1 is what is coming instead.
Technology and Process Enhancements
The Depository Trust & Clearing Corporation (DTCC) is aiming to cut the time it takes for equity trades to T+1 by the year 2023. The DTCC runs the largest U.S. securities clearinghouse. How do we get to a shorter transaction cycle when it comes to the U.S. equities system? Technology is going to be the key to everything.
There are technology road maps on the horizon that will bring new applications, new infrastructure, all with the intent of reducing the cycle time of a settlement. Much of the delay today is due to the process, with much of it still manual, being in place. By employing technology platforms to speed things up, it gets to the end goal many seek.
Improvement of the U.S. equities settlement cycle is within reach. By cutting down on the cycle time, the risk exposure also sees a drop. Technology is going to pave the way, as well as a general openness to change. Market participants will need to embrace the future, and by doing so will realize the gains that go along with it.
Waiting for the SPX Godot?
By Nikolay Stoykov, Managing Director, Alaric Securities
If anybody had asked me 12 months ago where do I think SPX will be in May 2020 if unemployment in the US, and most developed countries, is near 20% I probably would have laughed it off as a ridiculous question. However, if that person insisted, I probably would have said something like 1000 for SPX and 10000 for Dow Industrial.
On May 24 2019 SPX closed 2826 with unemployment at around 4% and on May 21 2020 SPX closed 2948 with unemployment at least 14% and probably closer to 20%, if expectations for May 2020 are to be taken into account. What is going on here, many people are asking – economic data is abysmal and expected to continue to be bad but markets seem oblivious and actually trading at a higher level than a year ago when economic data was actually quite good…
That is a very difficult question to answer as markets tend to move without giving us a clear explanation why but I believe that the answer/explanation lies in the interest rate environment we are facing. Let’s take a look at some historical comparisons:
In 2000, SPX dividend yield was around 1.1% with 30 year Treasury bonds trading at 5.8%.
In 2007, SPX dividend yield was around 1.9% with 30 year Treasury bonds trading at 4.6%
In May 2019, SPX dividend yield was around 1.9% with 30 year Treasury bonds trading at 3%.
In May 2020, SPX dividend yield was around 2% with 30 year Treasury bonds trading at 1.4%.
It is true that everybody expects the future dividend yield in SPX to be lower than the 12-month historical yield but even with a hefty drop of 30%, which is a lot worse than most expectations, SPX dividend yield will be still higher than the 30 year Treasury bond yield. From a historical perspective, unless there are waves of defaults and SPX dividends are cut by more than 50%, equity markets still offer quite good value relative to government bond yields.
Now with yields so low, I can not help but remember Alan Greenspan’s words – “People buying government bonds here are desirous for losing money” but they are still buying them… Anyway, all I am trying to say is that equity markets seem to be a lot more attractive investment than US government bonds.
In this low-interest rate environment, I feel like the Fed is pushing investors into risky assets and if there is anything I learned in 2009 is that one should not fight the Fed… Here is what I like:
- Equity Markets – broad cap ETFs like SPY or still distressed sectors like XLE or EEM
- High Yield Markets – HYG/JNK ETFs, still yielding nearly 7% with a 5-year maturity
- Hybrid Securities – PFF (preferred stock ETF), CWB (convertible bond ETF)
This is not a recommendation. The information provided is an objective and independent explanation of the matter. Alaric Securities OOD and other entities of the group do not trade in the above financial instruments.
Euro to Fall Below Parity With the US Dollar: The Case!
With EURUSD pair making new 52 week low today, one begins to wonder – is this the bottom (time to buy) or are we going lower (time to sell)?
It is our humble opinion that what we are seeing today in the market is the beginning of a dramatic depreciation of the EUR relative to USD.
There are three reasons for Alaric Trader's bearish view on EURUSD:
Coronavirus Spread
- Europe is a lot more impacted by the new virus. It is our expectation that due to the delayed reaction of Spain, the number of cases in that country could potentially be bigger than Italy.
- The unorthodox approach, already somewhat abandoned, by the UK government to seek “herd immunity” to the disease is causing most experts to expect the number of cases in the country to be close to(or exceed) the number in China.
- It is our expectation that, given the trajectory of the spread of the virus, we can see close to 500 000 cases in Europe in the next 30 days with UK, Spain and Italy accounting for half the cases.
Weak Fiscal Response ( Fiscal Irresponsibility)
Given the magnitude of the crisis, the ECB response has been grossly inadequate. The launch of the 750 Billion EUR PEPP is just a fraction of what the situation requires. Alaric Trader professionals believe that the magnitude of the facility should be in excess of 3 Trillion EUR and should include recapitalization of the systematically important banks within the EU.
Excessive Leverage in the EU Economy
European interest rates have been negative since the beginning of 2016 or close to 4 years now. During that time the availability of credit has dramatically increased while interest rates have dropped even for the riskiest securities and loans. While we did have the Brexit Crisis in the summer of 2016, overall this time period is best described as smooth sailing.
In a peculiar way, it reminds us of Vasco Balboa, who called the newly discovered ocean the Pacific Ocean just because he experienced balmy weather.
The Pacific Ocean is hardly characterized as balmy just like leverage is not danger-free even if the cost of leverage is zero or close to zero. We believe that many market participants have grossly underestimated how volatile the deleveraging process can become. What our traders are observing in the high yield space in Europe this week is a cascade of margin calls with illiquidity and wild price fluctuations not seen since the 2008 crisis with bonds sometimes trading at 10% discount to their fair market value implied by the CDS market.
Given the unprecedented mixture of problems that existed in the European economies even before the pandemic, the easiest way out of trouble, and almost inseparable part of any recovery, is a devaluation of the EUR relative to USD.
In our opinion, it possible to see 15-20% (0.85-0.90 EURUSD) devaluation in the next several months.
This is not a recommendation. The information provided is an objective and independent explanation of the matter. Alaric Securities OOD and other entities of the group do not trade in the above financial instruments.
Coronavirus and the Global Stock Market Shock
According to many experts, COVID-2019 will exacerbate the already expected recession. On Monday, March 9, the world was shaken by an economic shocker. After the collapse of oil quotes, the leading Asian, European and American indices collapsed, and trading in the US was suspended for 15 minutes.Â
The oil prices drop led to the first since 2012 gold price increase to $1,700 per ounce. Among the causes of such shocks in the markets, experts call the coronavirus pandemic, in which more than 126 thousand people have already contracted worldwide. Of these, 4,640 people died, and 62,325 have recovered. While doctors around the world are looking for a medical solution to the problem, the business community is anxiously watching the decline in stock quotes and indices.
The world economic crisis was first discussed in the summer of last year. However, it is COVID-2019, according to many experts, that will become the catalyst aggravating the already expected recession.Â
Catalyst Epicenter
China is the country, in which coronavirus was first detected, and most patients are there. The fight against the disease forces local authorities to introduce quarantine measures that adversely affect production and business activity.Â
China is a significant component of the global economy. And for many companies worldwide, the production processes in China are tied to their own output. Thus, if the pandemic continues and intensifies, it is difficult to name businesses that will not suffer from the upcoming market imbalance. Electronics, engineering products, clothing, raw materials- all these and more industries will experience huge losses.
Chronicles of the Financial Fever
On February 24, the coronavirus officially reached Europe. The pandemic on the continent began with Italy; later, large outbreaks occurred in France and Germany. As of March 2, cases of infection with the COVID-19 virus were recorded in more than 60 countries, 20 of them are European.
The world's major stock exchanges (Tokyo, Shanghai, London, Frankfurt, New York) reacted to this news with a real panic. Key stock indices (Dow Jones, NASDAQ, FTSE, DAX, Shanghai Composite, Nikkei) lost an average of 10-12% in a matter of days. Brent crude for the first time in two years fell to $50 per barrel.
According to the results of the trading day on March 9, world stock indices have fallen to record numbers since the last big crisis. Japanese NIKKEI 225 lost - 5%, British FTSE 100 - 7.7%, German DAX almost 8%. A few hours after the opening, the US market crashed by 7% of the S&P 500.
The “coronavirus” market crash was the largest in the past 12 years: the last time it happened was in 2008; a comparable collapse occurred in the early 2000s with the so-called collapse of the dot-com bubble (a large drop in the shares of technology companies).
Main Causes of the Stock Market Shock
There are actually two main causes of what’s happening in the market. Firstly, it is the fact that Russia and Saudi Arabia launched an oil price war. The result: oil prices fell by 30%, reaching $31.2 per barrel (Brent); later, the price rose to $35. Recall that at the beginning of the year, the price of oil was above $60. Investors ran to sell off shares in energy companies, primarily American ones as many of them would not survive at that price. But not only energy is under attack. Oil is the queen of commodity markets, and such a decline will lead to price adjustments in other sectors.
The fall in prices and the expected sale in the stock markets provoked a tremendous movement of assets. Investors are looking for protected instruments and they traditionally find them in American debt. The demand for US government bonds led to a decrease in their yield below 0.5% per annum, this is another record.
The spread of coronavirus leads to ever greater problems in the economy. According to analysts at Bank of America, the current year will be the worst for the global economy since the global economic crisis ended in 2009. They expect the world economic growth rate to fall to 2.8% by the end of the year.Â
The slowdown in the Chinese economy due to the outbreak of coronavirus will lead to this in the first place. The OECD estimated the impact of coronavirus at 0.5% of global GDP. The virus is already in more than 100 countries in the world. And even countries with well-developed medicine cannot stop its spread.