There are some fundamental divergences in the LIBOR rates, quoted in USD, British Pounds, the Euros, and Japanese Yen, which could have an interesting implication in how markets priced risks in different asset classes in different regions of the world. The divergence is probably mainly due to the lag or should I uncoordinated balance sheet shrinkage and rate adjustments by global central banks, which paints a strict contrast to the 2017 ‘coordinated global growth’ coined by the market. LIBOR, also known as London-Interbank Offered Rate, is the benchmark rate banks charges to lend to other banks, and is well suited to called the mother of all rates.
However, the rate that has been used to priced almost all assets (business loans, mortgages, auto, and credit card) in the developed and almost all emerging markets is coming to an end.
*I say most emerging markets because for example, China has their own Hong Kong Interbank Offered Rate (HIBOR) and Shanghai Interbank Offered Rate (SHIBOR), both of which has made headlines as People’s Bank of China (PBOC) has injected 0.50 Trillion Yuan via reverse repo in just a week timeline in mid-November. PBOC injet net 310bn yuan via #OMO #reverserepo on Thursday, 4th consecutive day of net inject. And just last last Friday, 11/17/2017, Shenzhen Index (semi-equivalent of the NASDAQ) fell by 3%+ in the last 45 minutes into the close. All Chinese related data can be located in Xinhua and Caixin.
The central bank’s net inject earlier this week:
- 11/16/2017: 310bn yuan
- 11/15/2017: 220bn yuan
- 11/14/2017: 140bn yuan
- 11/13/2017: 150bn yuan
On July 27, 2017, the Chief Executive of the U.K. Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that the FCA intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR rates to the LIBOR administrator after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. One might wonder what and which country will take over one of the, if not the most, important benchmark rates in the world. Even though this is somewhat considered an unknown risks to the global financial markets, at least, we know the last day it will be phased out, unlike global central banks’ policy which was well communicated to the market but fail to delivery i.e. The US Federal Reserve promised balance sheet shrinkage aka selling of US Treasuries then Mortgaged-backed Securities (MBS) starting in October 2017 ,but now that December 2017 is around the corner, the balance sheet shrinkage promise has yet to materialize.
But this brings into another study of the risks associated with structured investment products, more specifically by the name of “Fixed to Floating Rate Notes Linked to 10-Year U.S. Dollar ICE Swap Rate due November 30, 2027.” Three top-level points this structured investment product offers to the market is:
- Fixed interest rate for a period of time then floating interest rate soon until notes due date of 11/30/2027
- Interest rate on the notes is fixed @ 3.00%+ for the first few years and then is hedged on London Interbank Offered Rate (LIBOR), which, besides the duration risks (these structured investment products shouldn’t be called notes in the first places as they are debt with a 10-year maturity schedule), but also the risks of LIBOR getting phased out by 2021, which is only 40% through the maturity schedule (and perhaps why it is on a floating rate schedule after Year 3).
- Lack of Liquidity hence minimal, if none, price discovery mechanism. This is noted in the footnotes of the SEC filings – “The notes will not be listed on any securities exchange. JPMS intends to offer to purchase the notes in the secondary market but is not required to do so. Even if there is a secondary market, it may not provide enough liquidity to allow you to trade or sell the notes easily.”
- Potential hinting of the Federal Reserve and global central banks deploying deeper into the nominal interest rate (real interest rate which is inclusive of inflation/deflation, is already negative in all developed countries) as a strategy in the next slowdown and potentially pairing it with temporary price-level targeting (i.e. purchase of specific company public and private equities) noted by Mr. Ben Benanke on Brookings Institution blog page HERE.
5. Unlimited cap in the amount raised. After studying the multi-billion worth of structured investment products being released in the market this year so far (hundreds of billions were released since 2011), this is one of the small handful of structured investment products that does not have a cap, cap meaning the maximum amount that can be raised with this notes offering. Most single structured investment product have a cap in the $2.50M to $10.00M range.
One of the more complex footnotes description (but also where you can find the juicy stuff). For example, of the things noted below is, “The notes will be issued under an Indenture dated May 25, 2001, between us and Deutsche Bank Trust Company Americas (formerly Bankers Trust Company), as trustee (as has been and as may be further supplemented from time to time, the “Indenture”). Deutsche Bank has been on the edge for some years now, perhaps in part due to European Central Bank’s (ECB) policies but also perhaps due to mismanagement. Bear in mind they manage 10’s of trillions of dollars worth of derivatives and is also majority-owned by HNA, a Chinese conglomerate. HNA has been going on a M&A binge since mid-2015 and recently their M&A activity came a halt due to criticism of Chinese-yuan based debt-fueled M&A activities. Also as of November 2017, they also have to ask their debt holders for an quarter-long”extension” of interest and principal payments in exchange for higher interest rate payments. *Which by the way, does not look good as they are just postponing reality and rolling over debt by raising more debt. I am exciting to see how the pairing of this structured investment products with DB will fare in the near future. HERE is the structured investment page I am looking at.
Intersection notepad 