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Belize loses $3 million on cross-currency swap with Citigroup

The government of Belize has revealed that a dollar/yen interest rate swap left it on the wrong side of changes in the strength of the dollar – and more than $3 million out of pocket.

Citigroup proposed the transaction in 2001, which involved swapping the dollar obligations on $29.1 million in 9.25% Belize government notes into a yen liability to take advantage of lower Japanese interest rates, as well as a favourable dollar/yen exchange rate. Under the terms of the swap, the obligation would be converted back into dollars at the prevailing market rate when the bonds matured last month. Although the advantage in interest rates gave the government a $2.3 million net gain, this was outweighed by the $5.6 million conversion loss, giving the government a total net loss of $3.2 million.

The Belize treasury and central bank said the transaction was its first foray into the derivatives market since a law change in the country in 2001 that enabled the body to engage in derivatives transactions.

Aman Capital $240 million fund returns money

A $240 million Singapore-based hedge fund run by Aman Capital Management is closing out positions to meet investor redemptions after reportedly losing millions in derivatives trading earlier this year.

Aman confirmed that the Aman Capital Global Fund, the only one it manages, was "taking steps to make distributions to shareholders".

However, it refused to comment on press reports that the fund would close down, stating only that: "Aman Capital Management is currently in operation. The fund was brought into cash in an orderly and professional manner."

Allianz Dresdner Asset Management (Adam) commented in May that the reported derivatives losses could be a blow to Singapore's growing hedge fund market: "The recent report in the Financial Times that the Aman Capital Fund, one of Singapore's biggest hedge funds, may have lost more than $43 million, or 18% of its assets in April, investing in derivatives based on the Korea Composite Stock Price Index, will be viewed as a blow for the Asia region's fast-developing hedge fund industry," wrote Mark Konyn, chief executive of Adam, in a report on Asian mutual fund investors.

Aman's head of derivatives trading, Michael Syn, is also reported to have left the company.

In a statement, the firm said: "We also do not consider it useful to comment on various matters that have been reported."

US data helps drive derivatives volumes

Stronger economic indicators in the US have pushed the derivatives markets into heightened activity this year, according to the quarterly review of the Bank for International Settlements (BIS), published in mid-June.

Currency hedging markets were notably active in the first quarter of the year, with turnover rising to $2.7 trillion, up 15% from the previous quarter. The BIS said the hedging was not a precaution against expected increases in uncertainty – in fact, implied volatility dropped significantly over the quarter – but could instead represent a growing belief that the dollar is set to hold its value or even appreciate against the euro after a prolonged period of decline. This would require hedge buyers to adjust their positions.

Trading in longer-term interest rate contracts – those with maturities of more than a year – also continued to rise in the first quarter of 2005, up 20% to $43 trillion. This increased trading activity could represent an anticipated divergence between US and euro-area interest rates, the industry body said.

As the BIS revealed in its semi-annual OTC report in May, credit default swaps (CDSs) are still a comparatively small sector of the derivatives market, with a notional outstanding total of $6.4 trillion compared with $187 trillion for interest rate products at the end of last year. But the CDS market grew at a rate of 568% in the period June 2001–June 2004, compared with 121% overall growth for over-the-counter derivatives. The BIS expects this rapid growth to continue or even accelerate following the introduction of a weekly credit derivatives fixing service by US broker Creditex and UK data provider Markit in March.

TriOptima run eliminates $880 billion in surplus CDSs

Five software runs by the Scandinavian service company TriOptima have resolved $880 billion in single-name and index credit default swaps (CDSs), the company has announced.

The firm's TriReduce software identified 39,000 CDSs held by 19 subscribers that could be torn up, leading to an overall $16.2 billion reduction in mark-to-market exposure.

The five cycles covered European and US indexes, European and US single names, and a special index cycle covering transactions involving Michigan-based auto parts manufacturer Collins & Aikman, which filed for Chapter 11 bankruptcy protection in May.

The $880 billion total tear-up represents 17% of the total outstanding notional value of CDS at the end of last year, which was $6.4 trillion, according to the Bank for International Settlements.

TriOptima's managing director for North America, Susan Hinko, said the company conducts tear-ups with the top 15–20 dealers, which represent about 90% of the inter-dealer CDS market.

Future runs of the programme could yield similar returns, she added. "I don't think further runs would be smaller. We haven't cycled through all the sectors of the single-name side yet. On the index side we have made a dent, but on the other hand there has been considerable growth in the market... The terminations that TriOptima achieved thus far in 2005 represent 20% of the growth in the inter-dealer market. But the market grew at 40% this year. Therefore we have only terminated one half of the growth in the market this year."

China bond forwards start trading

The People's Bank of China has taken a major step forward in relaxing the renminbi derivatives market following the launch of a bond forwards market in mid-June.

Under the new rules, any licensed bank or corporation can now trade bond forwards with a contract length of less than 365 days, so long as the size of the contracts falls within a limit set by the buyer's own capital strength. But further classes of derivatives will probably have to wait for the underlying market to evolve, says David Liao, treasurer for China at HSBC.

"The key to the success of China's financial market is to promote a liquid and representative underlying market. I expect the primary focus by regulators would be to continue to work on the liquidity of existing markets, such as the government bond market, the People's Bank of China bill market and the money market," Liao told Risk. "Once these markets are liquid and representative, you would have a useful foundation to build credible fixings for a swap market, credit spreads for corporate bonds, and so on," he adds.

The opening up of the bond futures market follows the publication last year of the China Banking Regulatory Commission's (CBRC) long-awaited derivatives regulations. The new rules mean that licensed local and foreign banks can trade derivatives on their own account. Previously, derivatives could only be used for hedging and not for speculative purposes.

The regulations also allow foreign banks to carry out business with domestic corporate clients in China. Previously, they could only trade foreign-currency denominated derivatives with Chinese institutions that had appropriate foreign exchange licences.

However, despite the new regulatory framework, the rules are still not entirely clear, says Liao. "The derivatives regulation stipulated by the CBRC specifies that licence holders can trade derivatives for profit. However, the environment for a derivatives market in China is not entirely clear, as corresponding regulations for insurance companies, securities companies and funds are governed under different regulatory bodies and have yet to appear," he says "Products are also governed under different regulators, so the process to obtain approval is still unclear for cases where, for example, a bank [governed under CBRC] tries to structure an overseas equity index product [governed by the China Securities Regulatory Commission]."

Greenspan warns of investor backlash

US Federal Reserve chairman Alan Greenspan believes investors' pursuit of improving yields by investing in hedge funds and complex investment products – notably collateralised debt obligations – may spark a backlash when the instruments fail to perform as well as expected.

"Continuing efforts to seek above-average returns could create risks for which compensation is inadequate," said Greenspan in an address via satellite to delegates attending the International Monetary Conference in Beijing in June. "Significant numbers of trading strategies are already destined to prove disappointing, a point that recent data on the distribution of hedge fund returns seems to be confirming."

He warned the hedge fund industry could shrink temporarily, and many wealthy fund managers and investors could become less wealthy, adding: "I trust such an episode would not induce us to lose sight of the very important contributions hedge funds and new financial products have made to financial stability by increasing market liquidity and spreading financial risk, and thereby enhancing economic flexibility and resilience."

But Greenspan said he was not particularly concerned that this may have a negative impact on financial stability, as long as banks and other lenders are managing their credit risks effectively.

Mexican structured bond issuance in 2005 hits $2 billion

Standard & Poor's (S&P) says $2.03 billion worth of Mexican structured bonds have been issued so far this year. And with US dollar-denominated paper becoming more popular, the use of derivatives in transactions is increasing.

Total Mexican issuance in the first quarter of 2005 is 114% higher than for the same period in 2004. "For Mexican issuers, the use of the derivatives market has expanded their financing alternatives to the cross-border market," said Guillermo Valle, a credit analyst at S&P in Mexico City.

The currency and interest rate risk of cross-border transactions are typically hedged using swaps. "Combining domestic and cross-border transactions, investors purchased approximately $9.9 billion in Mexican structured bonds," he added.

S&P assigned ratings to 28 new transactions in 2004. The rating agency said it expects Mexican mortgage originators' execution of cross-border transactions via the use of derivatives to be one of the drivers of asset-backed securities issuance for the remainder of the year.

UK property derivatives under the spotlight

Although the UK commercial property derivatives market appears to be finally taking off, barriers to liquidity and efficiency remain, said derivatives professionals at a seminar held by law firm Field Fisher Waterhouse in June.

Currently, activity is focused on total return swaps linked to the UK Investment Property Databank (IPD) commercial property indexes. The IPD has licensed four indexes for use in derivatives contracts: the UK annual index; UK quarterly valued funds; UK annual index estimate; and the UK monthly index.

Liquidity in the market remains limited and deals have to be matched between buyers and sellers. This reduces the speed of transactions, which further constrains liquidity, claimed seminar participants.

Mark Herne, a member of Deutsche Bank's UK institutional client group in London, believes that once liquidity improves, there will be less need to match all buyers and sellers, increasing price transparency and resulting in even greater investor appetite.

However, Charles Clark, a director at Atisreal, a UK-based consultancy that provides real estate investment advice to institutional investors, is dubious about whether liquidity is the main issue. Illiquidity, he argued, differentiates property from other asset classes, making it attractive from a portfolio diversification perspective.

Gary Walker, a partner specialising in derivatives at Field Fisher Waterhouse, pointed to documentation as a major constraint on the market's development. Current contracts use standard International Swaps and Derivatives Association terminology, but market participants say full Isda documentation would be a great boost. "Once an Isda working group has been set up, the market will have arrived," Walker said.

Refco buys Cargill Investor Services

New York-based financial services group Refco has agreed to buy Cargill Investor Services (CIS) from its parent, agricultural group Cargill, for up to $400 million.

Refco will pay $208 million in cash immediately for CIS – a brokerage that offers clients exchange-traded futures and options as well as other securities – plus an additional performance-related payment of between $67 million and $192 million, depending on CIS' results after the merger.

Phillip Bennett, chief executive of Refco, said: "We have always had the greatest regard for the CIS team and their business model, which is highly complementary to our own."

As part of the takeover deal, Refco has signed an agreement to take over clearing services for Cargill, which are currently provided by CIS.

CIS has 500 employees at its offices in Chicago, Kansas City, London, Minneapolis, New York, Paris and Singapore. As Cargill is a privately owned company, no details of CIS' finances have been released.

Misys profits from increased bank IT spending

Software and services provider Misys will report higher revenues and profits from its banking division in July, as banks continue to increase their IT budgets.

Speaking in advance of the company's full-year results announcement next month, Misys chief executive Kevin Lomax said: "Overall I am quite pleased. This demonstrates continuing momentum in the second half of the year."

Sales to both wholesale and retail banks had been strong, Lomax said, with overall banking revenues up 7%. Initial licence sales were up 16% and operating margin increased from 16% to around 18%.

The company's order book also rose, which, Lomax said, was partly due to a trend for larger contracts running for longer periods. Misys made banking sales of £240.2 million last year, with total sales of £899.9 million. Final results are due on July 21.

Axiom agrees to buy out partners

The dispute over control of derivatives brokerage Axiom Global Partners has been settled. The company has agreed to buy out two dissident shareholders and reappoint former chief executive James Cawley to run the credit derivatives brokerage.

In early June, two of the company's three founders, Nicholas Stephan and Wesley Wang, called for the New York State Supreme Court to dissolve the company. In affidavits attached to the petition, former employees claim most of Axiom's traders resigned when they heard that Cawley – ousted as chief executive at a board meeting in December last year – would be returning to the company. Stephan and Wang have acted as chief executive and chief marketing officer respectively since his departure, but an arbitrator ruled in May that Cawley had been improperly removed from office and should return.

Stephan and Wang claimed that Cawley's management style was mendacious, bullying and manipulative, adding that he would find it very difficult to recruit new traders to get the company back to strength. With Cawley still involved in the company and given his management and the tensions between him and themselves, "dissolution is not only warranted, but is the most favourable option", Stephan and Wang said in the affidavit

Cawley could not be reached for comment immediately after the petition was filed, but in an interview posted on Bloomberg, he said that the allegations were entirely baseless and that his team would "respond vigorously in court".

After a court hearing on June 20, the parties reached a deal under which Stephan and Wang would agree to withdraw their allegations and resign in exchange for having their shares bought back by Axiom. Under the terms of the settlement, neither the parties involved nor their lawyers are permitted to discuss details of the buyback.

In a statement issued after the settlement, Cawley said: "My priority is to stabilise the firm – retain our best people, strengthen systems and re-establish proper financial controls. There is much to be done, but with good people and the support of our clients we can rebuild the company."

The buyback should redress an imbalance of power between the shareholders and the board. Cawley, Stephan and Wang were three of the five members of the board; the others are John McCabe and John Park, both considered Cawley's allies. Each of the three founders owned 25.5% of the shares, according to documents filed by Stephan and Wang, meaning the dissidents were unable to run a company of which they together owned a 51% majority stake.

Axiom has not disclosed the amount Stephan and Wang will receive in exchange for their shares. According to the court filing, Axiom has $850,000 in cash and $2.4 million in receivables, set against $1.6 million in liabilities and payables, but it will also have to use these reserves to hire replacements for the departed traders.

Alexander Campbell

CDS on ABS documentation published

Asset-backed security (ABS) derivatives look set to gain in popularity following release of a template for ABS credit default swap (CDS) trading by the International Swaps and Derivatives Association.

ABN Amro's head of consumer ABSs, Steve Curry, said the widening of corporate bond spreads over the past few months has driven some investors to the more stable ABS paper. ABS spreads widened only 4–5 basis points in some cases, compared with 40–50bp for some corporate bonds in the wake of the Ford and General Motors downgrades on May 5. This stability may bring more investors and issuers to the ABS market, Curry said.

The template, released on June 13, is intended to document CDSs on ABSs for cash or physical settlement. On June 21, the association also published another template for pay-as-you-go settlement. The pay-as-you-go template is primarily designed for use with residential or commercial mortgage-backed securities, which are more commonly the subject of CDSs on ABSs in North America.

"The continuing growth in the size and product range of credit derivatives is opening up this important asset class to an ever broader range of investors. Providing robust legal and documentation solutions to support this evolution is fundamental to our mission," says Bob Pickel, New York-based chief executive of Isda.

Christopher Flanagan, managing director of ABS research at JP Morgan, said in May that the emergence of CDSs on ABSs was "a major development in the evolution of the ABS market", allowing investors to take on risk synthetically for the first time, short the market or hedge their existing positions. At that time he said there were two obstacles to the market's growth. One was a lack of investors, which Curry says is now improving; the other was the absence of standard documentation. Isda's work should address this issue.

Alexander Campbell

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