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Posts tagged ‘Credit Suisse’

We had Mortgage Derivatives ,Now we have Death Derivatives!

  Death Derivatives

 
An Elderly British Couple
 Photographer: Linda Davidson/The Washington Post via Getty Images

Pension funds sitting on $17 trillion of assets are buying insurance against the risk their members live longer than expected. Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK) and JPMorgan Chase & Co. (JPM), which bundled and sold billions of dollars of mortgage loans, now want to help investors bet on people’s deaths.

Pension funds sitting on more than $23 trillion of assets are buying insurance against the risk their members live longer than expected. Banks are looking to earn fees from packaging that risk into bonds and other securities to sell to investors. The hard part: Finding buyers willing to take the other side of bets that may take 20 years or more to play out.

“Banks are increasingly looking to offer derivative solutions,” said Nardeep Sangha, 43, chief executive officer of Abbey Life Assurance Co., a London-based Deutsche Bank unit that helps pension funds manage the risk of retirees living longer than expected. “Making the long maturity of the risks palatable for investors, including sovereign wealth funds, private-equity firms and specialist funds, is the challenge.”

As insurers reach the limit of how much pension-fund liability they’re willing to shoulder, companies such as JPMorgan and Prudential Plc (PRU) last year set up a trade group aimed at establishing and standardizing a secondary market for so- called longevity risks. They’re also developing indexes that measure mortality rates and securities to let pension funds pay fixed premiums to investors in return for coverage against major deviations from projections.

Swiss Reinsurance Co., the second-biggest reinsurer, sold the world’s first longevity bond in December in what it called a “test case” to sell risk to the capital markets.

‘Run Dry’

Goldman Sachs, based in New York, and Deutsche Bank in Frankfurt have set up insurance companies that promise to pay pensions if retirees live beyond a certain age. They typically receive a portion of the pension plan’s assets in return. The banks, along with Morgan Stanley (MS), Credit Suisse Group AG (CSGN) and UBS AG (UBSN), are looking for ways to offer this risk to investors.

“Ultimately, reinsurance capacity for longevity risks will run dry, and that’s why it’s imperative that as the market grows and develops it is able to bring in new types of risk-takers,” Sangha said. “The obvious channel is the capital markets.”

Medical advances and healthier lifestyles have made predicting life spans more difficult for pension funds. Life expectancy in the U.K. is increasing by one to three months every year, according to Dutch insurer Aegon NV. (AGN) Every year of additional life expectancy typically adds as much as 4 percent to future pension requirements, Aegon said in a report in March.

Aegon reported last week that first-quarter profit fell 12 percent as the company set aside money to cover the risk of policyholders in the Netherlands living longer than expected.

Glaxo Transfer

Pension funds can hedge against life-expectancy risk by transferring assets to an insurer or other counterparty that promises to pay some or all of the future liabilities. Last year, GlaxoSmithKline Plc (GSK), the U.K.’s biggest drugmaker, became the 10th FTSE 100 firm to buy insurance on about 900 million pounds ($1.5 billion), or 15 percent, of its U.K. obligations.

That means Prudential, the U.K.’s largest insurer, rather than the pension fund, will pay some GlaxoSmithKline pensioners should they live longer than expected. Most longevity risk transferred from pension funds is held by insurers.

Regulators are just beginning to focus on the new products.

“We’re seeing more and more sophisticated mechanisms being offered,” said Bill Galvin, CEO of the U.K.’s Pensions Regulator. “From a regulatory perspective, we are concerned to ensure that trustees understand the extent to which longevity risk has been passed from their scheme and the precise shape of any residual risk.”

‘Early Days’

The Frankfurt-based European Insurance & Occupational Pensions Authority isn’t reviewing longevity transfers, said Sybille Reitz, a spokeswoman for the organization, because “the market is still in its early days.”

The U.K. is the world’s biggest market for insuring pension liabilities after a change in accounting rules in 2004 forced companies to include pension plans on their balance sheets, increasing the volatility of earnings. Since then, 30 billion pounds of liabilities have been insured, about 3 percent of the total outstanding, according to estimates by Hymans Robertson LLP., a London-based pension consultant.

Banks and insurers completed a record 8.2 billion pounds in longevity-risk transfers last year. Goldman Sachs-owned Rothesay Life Ltd. sold the most pension-plan insurance in 2010, while Deutsche Bank’s Abbey Life completed the biggest swaps deal.

Longevity Risks

With $17 trillion of the $23 trillion in pension-fund assets worldwide exposed to longevity risks, according to Zurich-based Swiss Re, investment banks see this as an opportunity to create a new market for those willing to bet on life-expectancy rates. If pensioners die sooner than expected, investors profit. If they live longer, investors must compensate the pension fund for the additional costs it faces.

Investors may be attracted to such bets because longevity trends aren’t linked to movements in equities, bonds or commodity markets, said David Blake, director of the pensions institute at Cass Business School in London, who has worked with JPMorgan on the derivatives.

The complexity and risk involved in longevity assets with timelines of more than 20 years means banks are looking to create bonds that offer 5 percent to 9 percent in annual returns, according to Guy Coughlan, former head of longevity structuring at JPMorgan. Returns as high as the “mid-teens” are possible, he said.

‘Structural Problems’

Investors remain unconvinced. Not knowing whether a bet on a group of pensioners’ life spans is correct for decades prevents hedge funds such as London-based Leadenhall Capital Partners LLP from entering the marketplace.

“There are big structural problems with the longevity market,” said Luca Albertini, CEO of Leadenhall, which has $120 million under management and invests in insurance-linked securities such as catastrophe bonds used to help cover hurricanes and other extreme risks. With clients able to withdraw investments only every month or quarter, “the only way I can invest is if the market is truly liquid,” he said. “No one has proven that to me yet.”

Subprime mortgages sold in the past decade were the genesis of the biggest financial meltdown since the Great Depression. Investment banks passed the risk of borrowers defaulting to the capital markets by packaging, or securitizing, the loans into bonds and selling them to investors and one another.

‘Fully Collateralized’

Collateralized debt obligations were created and sold in such volume that when mortgage holders defaulted, governments in the U.S. and Europe had to bail out the financial system. Banks are now looking to investors in much the same way to securitize the risk of pensioners living longer than expected.

Securities based on life expectancy don’t hold the same risks as those linked to subprime mortgages because they are “fully collateralized,” minimizing the risk from a counterparty failing to meet its obligations, Coughlan said.

Cass Business School’s Blake said it’s unfair to compare the securitization of mortality expectations to the subprime- mortgage market.

“Subprime was highly leveraged,” Blake said. “This is different.”

Still, longevity transfers expose investors to the credit risk of issuers for many years. Once a pension fund agrees to transfer its assets in return for protection against pensioners living longer than expected, they are tied into a long-term contract that can be difficult to unwind, said David McCourt, senior policy adviser at the U.K.’s National Association of Pension Funds. That means the insurer, bank or hedge fund that a pension plan chooses to deal with is important, he said.

‘No Going Back’

“There’s a massive counterparty risk,” McCourt said. “People say insurance companies don’t go bust, but they do. We’ve seen AIG and investment banks going under like Lehman. There’s a lot of pressure on the trustees to make sure they’re comfortable the deal is right because there’s no going back.”

Pension funds outside the U.K. also remain hesitant.

APG Algemene Pensioen Groep NV in Amsterdam, which manages 277 billion euros ($396 billion) of assets for seven pension funds, “will not do transactions to actively hedge longevity risk,” according to Harmen Geers, a spokesman for the firm.

“The market is unbalanced, since there are no natural counterparties to take up a risk of that size in absolute terms,” Geers said.

Life Settlements

There has been less interest in the U.S. because regulatory pressure on pension funds hasn’t been as intense as in the U.K., said Pretty Sagoo, director of structuring at Deutsche Bank in London. In the U.S., investors can bet instead on life expectancy through so-called life settlements.

Rather than exchanging assets and liabilities with a pension plan, the life-settlement market allows investors to buy insurance policies from individuals and pay the premiums until that person dies. Investors then receive the death benefits.

The secondary market for U.S. life settlements began in the 1980s when the AIDS epidemic led some patients to sell their insurance policies to pay for treatment. The industry was valued at $2 billion in 2001 and, once it became regulated, quickly grew to a maturity value of $35 billion by 2009, according to Conning & Co., a Hartford, Connecticut-based research firm.

Goldman Sachs-owned Rothesay Life, started in 2007, was the biggest pension liability insurer in the U.K. last year after insuring 1.3 billion pounds of liabilities from the British Airways Plc pension plan. The largest swaps deal was completed between Deutsche Bank’s Abbey Life unit and Bayerische Motoren Werke AG’s U.K. pension plan.

Q-Forward Swaps

Rothesay Life CEO Addy Loudiadis was the architect of a Goldman Sachs deal in 2001 that allowed Greece to mask its indebtedness, according to London-based Risk magazine. Sophie Bullock, a spokeswoman for the firm in London, declined to comment on Loudiadis’s involvement in Greece and said she was unavailable to comment.

Goldman Sachs isn’t part of the new industry group, the London-based Life & Longevity Markets Association, preferring to develop the market alone, according to Tom Pearce, managing director of Rothesay Life. Pearce said it won’t be easy trading a security linked to life expectancy.

“Clearly, if there was a capital market solution that would be helpful for the market generally, but there are some challenges,” he said. “The biggest challenge is selling these very long-term risks to shorter-dated investors.”

Mortality Indexes

Unlike Deutsche Bank and Goldman Sachs, New York-based JPMorgan doesn’t carry any of the risk of pensioners living longer than expected. Instead, it arranges swaps, called q- Forwards, which allow a pension fund to pay a fixed premium to a counterparty based on its members living to a specified age. If members live longer than expected, the counterparty reimburses the fund; if they die sooner, the counterparty profits.

Credit Suisse and JPMorgan have developed indexes that measure mortality rates and life expectancy for the U.S., Germany, the Netherlands, England and Wales. The indexes act as a basis for pricing individual swaps and bonds, according to Cass Business School’s Blake, who helped develop them with JPMorgan in 2007. They will help buyers and sellers price derivatives more accurately and give them confidence to trade them, creating a liquid market, Blake said.

Swiss Re sold the world’s first longevity bond in December, passing the risk from its own balance sheet to investors. The $50 million bond, named Kortis, was a “test case,” said Alison McKie, head of life and health products at the firm.

The bond pays investors a fixed sum from reinsurers for taking the risk that people live longer than projected. If there is a large divergence in mortality improvements between British men aged 75 to 85 and U.S. males aged 55 to 65, investors risk losing some or all of their money, Swiss Re said in December. The bond is rated BB+ by Standard & Poor’s.

BNP, Munich Re

Previously, Paris-based BNP Paribas SA and the European Investment Bank, the European Union’s financing institution in Luxembourg, created a longevity bond in 2004. A year later they withdrew the notes, which had a maturity of 25 years, after they didn’t find a buyer.

Munich Re, the world’s biggest reinsurer, hasn’t participated in longevity transfers “as the deals we’ve seen haven’t met our profitability requirements,” said Joachim Wenning, the management board member responsible for life reinsurance. “The future longevity trend is not easy to predict. If your assumptions are wrong, the cost is high.”

Nevertheless, the Munich-based reinsurer recently became the 12th member of the Life & Longevity Markets Association.

To contact the reporters on this story: Oliver Suess in Munich at osuess@bloomberg.net; Carolyn Bandel in Zurich at cbandel@bloomberg.net; Kevin Crowley in London at kcrowley1@bloomberg.net

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Edward Evans at eevans3@bloomberg.net

 

Comment:

Unbelievable ,Goldman sacks is involved so It must be true !

Hangover for Irish Banks

Central Bank of Ireland located on Dame Street...

Image via Wikipedia

MONDAY’S jump in banking stocks was followed by a hangover yesterday as the country’s lenders pared most of the gains posted in the session.

Bank of Ireland fell 4pc to 69c after Standard & Poor’s (S&P) cut its outlook to “negative” from “stable” and warned that the lender faces “considerable challenges” restoring its credit profile as the Irish economy recovers slowly.

“Our view is that the Irish economy is likely to recover only quite slowly, with household finances remaining stretched, asset prices unlikely to start appreciating materially for a couple of years and credit demand remaining muted for many years,” S&P said in a gloomy forecast.

Allied Irish Banks, fresh from celebrating the sale of its stake in Bank Zachodni, tumbled 4.6pc to 75c as ING Group said the bank “is not out of the woods yet”, following the sale and is still “likely” to end up in majority state ownership.

Another stock feeling groggy yesterday was Norkom which tumbled 15.8pc to 80c, extending the previous session’s 24 decline following a profit warning.

CRH was another loser, slipping 1.9pc to €13.20 after the building materials company was downgraded to “neutral” from “outperform” at Credit Suisse by equity analyst Harry Goad. His target price is €14 per share.

The ISEQ ended the session down 20.44 points, or 0.7pc, to 2795.04 points. Elsewhere in Europe, stocks were little changed with the Stoxx Europe 600 Index close to a four-month high, as better-than-estimated US retail sales offset a selloff in utilities and a slump in German investor confidence.

Stocks initially rallied after a government report showed sales at US retailers climbed in August for a second consecutive month. Separate figures from the ZEW Centre for European Economic Research showed German investor confidence fell more than economists forecast to a 19-month low in September.

In the UK inflation unexpectedly exceeded the government’s 3pc limit for a sixth month in August; while a UK housing-market gauge fell more than economists expected in August to the lowest since May 2009, according to the Royal Institution of Chartered Surveyors.

Electricity companies RWE and E.ON dropped after brokers downgraded Germany’s largest utilities. Philips lost 3.9pc after the world’s biggest lighting company set new financial targets for the next five years. Gamesa Corporacion Tecnologica paced advancing shares amid takeover speculation.

ARM Holdings retreated 4pc after the company said a number of executives sold shares in the UK designer of semiconductors that power Apple’s iPhone.

Ladbrokes dropped 1.2pc after Goldman Sachs downgraded its recommendation on the bookie to “sell” from “neutral.”

– Thomas Molloy

Irish Independent

 

Comment:

This comes as no surprise to me as I have pointed out in previous posts the two main banks are from any normal booking keeping standards, they are both bankrupt

They are engaged in hiding enormous losses behind dioubious financial instruments called derivates as they are not going to disclose these losses

I believe they are trying to drip feed the markets over the next 3-5 years if they can get the time from the government or they will try to pass them off to NAMA

There is some credence to this method as NAMA is the ideal vehicle to do so through the Toxic toilet that is Anglo Irish Bank

Stay away from Irish  bank shares as I expect the State will eventually end up owing a majority holding of Allied Irish Bank and possibly a 49% stake holding of Bank of Ireland at best!

Recent Market “Events”

If like me you have become puzzled by the recent Market “events” you should find this excellent article sent to me to-day helpful

Recent Market “Events”


Following quite a number of requests from students and clients this brief will deal with my understanding of what transpired last Thursday the 6th. May when just after 2.30 PM the Dow Industrials collapsed by nearly 10% and then suddenly recovered in 11 minutes.

The implications of what occurred are far reaching and unless the regulatory issues are resolved we can expect similar “events” of like nature.

In the main to comprehend the situation in the “Market” one must realise that there are now many markets. In the good old days, in America, all we had was the New York Stock Exchange where real people dealt with real market makers in real time. But computers in general and the internet in particular have changed all that. In addition as well as the “public market” we now have the (OTC) Over the Counter Market. The OTC is basically a private market between banks and large institutions which has little or no active supervision. I find this development strange because the trading activity on the OTC is 60 trillion dollars annually, while turnover on the public market is 5 trillion. Now in addition to public markets and private markets let us now bring in “Dark Pools” to our explanation.

“Dark Pools” What are they? ” Dark pools of liquidity” are crossing networks that provide liquidity that is not displayed on order books. This situation is highly advantageous for institutions that wish to trade very large numbers of shares without showing their hand. Dark liquidity pools thus offer institutions many of the efficiencies associated with trading on the exchanges’ public limit order books but without showing their actions to other parties. This is achieved because neither the price nor the identity of the trading entity needs to be displayed. Many of the OTC “exchanges ” used by the dark pools use high frequency trading programmes to minimise order size and maximise order execution. Now you may think that this manner of doing business on the “stock market” is carried out by minor unknown entities but this is not the case. Below I list the Independent dark pools, the broker-dealer dark pools and exchange-owned dark pools.

Independent dark pools: Instinet, Smartpool, Posit, Liquidnet, Nyfix,Pulse Trading, RiverCross

and Pipeline Trading.

Broker-dealer dark pools: BNP Paribas, Bank of New York Mellon, Citi, Credit Suisse, Fidelity, Goldman Sachs, Knight Capital, Deutsch Bank, Merrill Lynch, Morgan Stanley, USB, Ballista ATS, BlocSec and Bloomberg.

Exchange-owned dark pools: International Securities Exchange, NYSE Euronext, BATS Trading and Direct Edge.

When you understand that all the big players in banking and finance are using the OTC system and have a turnover 12 times that of the “public” markets you get to wonder why there is a New York Stock Exchange at all. Well you see there is a big difference between the OTC “private” market and the NYSE “public” market. The NYSE is comprised of market makers. These market makers are specialists who are obliged to buy and sell on their own and the publics’ account to create a liquid active market. The OTC market faces no such obligation. Over the past number of years attempts have been made to abolish the specialist role and remove the “human” engagement.

What happened on Thursday was the high frequency OTC trading programmes

created “trades” which did not make sense to the NYSE specialists. Accordingly the NYSE stopped handling orders so that the situation could be analysed. The OTC computerized networks then began rerouting orders to other “markets” and with no “public” markets participating prices collapsed through sell stops and the rest is history.

There are many lessons to be learned from this event. But for me the main question is whether a “market” that is only 8% “transparent” is actually a market (5 trillion as a ratio of 60 trillion). Going forward it is obvious that additional “circuit breakers” must be brought in to modify the exchange activity of high frequency dark pools. Whatever the eventual fallout from last Thursday’s events are it is clear that the issues I have touched upon are only the tip of the iceberg and any trader or investor worth his salt must reflect upon what happened and adjust his or her strategies appropriately.

Wealthbuilder.ie


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