03 Aug 2011, Christopher Jeffery, Risk magazine
Market participants in the Australian financial sector have received some interesting deliveries during the past six months. These tricky shifts have come as many participants have only recently adjusted to the new, post-global financial crisis order.
The new ‘norms’ appeared to include increased government debt issuance, an Australian dollar trading above parity against the greenback, reduced use of exotic instruments, a strong domestic property market and a tight onshore loan market.
Reform by the Basel Committee on Banking Supervision aimed at improving both the capital and liquidity positions of financial institutions – which will be largely adopted in Australia – would mean large Australian institutions, such as ANZ, Commonwealth Bank of Australia and National Australia Bank, would need to consistently seek long-dated, assets offshore to bolster their capital bases. In turn, this would continue to drive spreads of the floating-to-floating, cross-currency basis swap market wider as financial institutions would need to swap their long-term debt raised in the US dollar and euro markets back into Australian dollars.
Despite relatively robust economic growth – the International Monetary Fund still expects Australian gross domestic product to rise by 3% this year – fundraising by Australian banks offshore has fallen well below expectations. This is partly due to banks aggressively moving to attract domestic deposits as an alternative to raising money in the capital markets. It is also partly due to loan growth onshore being lower than expected, in part due to some Australian corporates having raised substantial funds offshore themselves during the past year, sometimes at lower spreads than Australian financials.
Meanwhile, derivatives use is picking up in some market segments due to a lack of real direction or momentum in a number of asset classes, including equities – perhaps with the exception of the mining sector. Concern about range-bound markets has resulted in some investors using derivatives to conduct relative-value and other trades in a bid for excess returns.
Indeed, derivatives based on the strength of the Australian economy have been used as the basis of bets made by a number of international hedge funds. This involves fund managers protecting themselves in the event of an Australian default by buying credit default swaps (CDSs) referencing Australia’s sovereign debt. The idea is to obtain cheap insurance against the possibility of a downturn in China, which would likely cause Australian sovereign CDS spreads to widen substantially given China’s high demand for Australian commodities and other goods.
Australia’s financial markets have been tougher to read during the past few months and it looks likely that the next few months could prove just as challenging.