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A FEAR of further fallout stemming from single-stock futures (SFF) trade was widely expressed when Absa said it had assumed strategic stakes in companies due to SSF positions and when Rand Merchant Bank's exposure to Dealstream came to light.
The problems at these two banks stem from the fact that they were exposed to large positions (when expressed as a percentage of market cap) in illiquid stocks.
It is notable that seven out of the 10 top exposures in recent history by percentage of market cap in the single-stock futures universe, featured in the problem exposures for RMB and Absa.
Speculation now runs riot that the other three of the big five banks could also be exposed.
I don't think so. The total value of the net open interest of the top 10 stocks by percentage of market cap was worth R4.1bn in July 2008.
As of February 1, the exposure of the net open interest of the new top 10 amounted to only R890m. R525m of that comprises Dealstream to which RMB remains exposed and one leg of a hedged-out collar structure. Of course, these figures are illustrative as opposed to scientific, but all other market exposures are headed the right way.
The banks taking over these positions will allow for an orderly market to prevail in the affected securities. Accordingly I'm not concerned about exposure by the banks to SSFs any more. There may be some sour over-the-counter (OTC) contracts, but I haven't heard anything to that effect. Otherwise banks and brokers are now being very stern with credit control.
More?
Other columnists have pondered here whether this was opportunism by the banks to take over desirable assets. I don't think so.
To all intents and purposes, the banks were caught with their pants down, not only in that these positions went vrot, but also the exposure to the risk of clearing for the system vastly outweighed the profitability.
What made things worse was that margin was set far too low by the exchanges - for example, 8c in the case of the thinly traded Convergenet (which has now been hiked up by 420%). In future, I expect there will be far fewer contracts doing the rounds.
Why did the banks get involved in SSFs? Bear in mind that futures are effectively credit extension by the banks - a good implied interest rate, large simple transactions and first port of call was stockbrokers and their clients.
Trading clients went for SSFs to dodge market securities tax and mainly to get gearing. My concern that they could get reckless about it was reflected in several columns in 2007.
What may surprise the lay public is that for a while, the derivatives industry knew there was a bad problem which needed fixing - the media did not.
The banks panicked, which kept the brokers under pressure - a matter which was exacerbated as clients would battle to sell assets and brokers remained wary of everyone else's liquidity.
Fortunately, as everyone knew the system needed to be righted, no one spoke out as they knew it would destroy any chance of an orderly shutdown.
Repeat?
Anyone reading this with growing horror may think, "what's to prevent a repeat?" First, the banks have learned a fat lesson. Second, new margin limits also make a lot more sense and are way more conservative. In particular, strategic stakes held by SSFs will be reined in.
This also has corporate governance issues. Think of Porsche's acquisition of a huge VW position via SSFs in Germany, which caused bedlam in crushing hedge fund shorts.
As far as I'm concerned, that was a concert-party action and should have triggered takeover rules much sooner. How do we know that this couldn't have happened on the JSE too?
Also noteworthy is the fact that the contracts for difference (CFD) market in SA isn't regulated. So how do we know whether insider trading doesn't go through these instruments? This of course should be a matter for national regulators rather than the JSE.
The area in which the market may be expected to focus on regarding concern for the banks will be the arena of BEE deals. I think a majority of these deals will at least in the short term be resilient against problems from debt structures.
The reason I say this is because of the structure of said deals. They tend to be of a "loop"-type structure, whereby money was lent to issuing companies, these issuing companies then injected the money into empowerment partners who subscribed for shares in the issuer and took a preference share in return as an "investment".
Of course, this is a very general type of view; there were many empowerment structures, with all sorts of construction, but the broad description is sufficiently valid to be useful here. Recourse by the banks is to the issuing company, not the partner, and these investments are of a long duration.
And BEE?
I note Absa's call for aid in embattled BEE mines, but note that there is also an inference that the banks cannot issue more deals for some time.
Those BEE deals that I would be concerned about are the situations in which a complete takeover has occurred and there is massive gearing, with little residual hard asset in event of default. I will not name any names here.
I neither to be complacent here, nor a Chicken Little. The market should know that when several of these deals blow up (and some will) there is not likely to be a wider contagion that'll tear down the banking system. The bang may be noisy and the smoke voluminous, but it won't go nuclear.
However, there is clearly little capacity to do BEE deals as the banking system is in reasonable nick, but can't easily expand credit extension.
At a time like this, we need to revisit what we seek to achieve with BEE, which I discussed in May 2008.
In 1945 Europe lay in ruins, yet the pace of rebuilding that followed was astonishing. How did they do it? Knowledge. Their homes and factories were bombed but they knew what needed to be done to rebuild.
The pressure is on an asset-focused form of BEE, because the funding has dried up. If this country is to successfully transform, BEE needs reinvention with a drive to training, education and mentoring.
The main thing is that our banking system is viable, and the reserve bank more than ready to step in should there be any systemic troubles. Our 2002 troubles stood us in good stead for now.
*Lucas is an industrials and quants analyst at Imara SP Reid Bona fide questions may be mailed to: warwickl at ispr.co.za
- Fin24.com
