Due To Deregulation, Liberalization and Globalization The Traditional Bank Business Has Changed
Dramatically.
Banks can enter a business that had been off limits before
Deepening of Capital markets connected corporates directly to the
market.
Corporate Finance business has suffered from highly specialized
securities firms and institutional asset managers.
Traditional Sources Of Bank – Profits Have Shifted
Bank Deposits are decreasing. Liabilities as bank loans are also
decreasing on the assets – side (Table 1,2).
On the other side negotiable liabilities have increased (tradable
securities on the asset side) (Table 3,4).
In Most G7-Countries Bank Deposits in Percent of
Total Liabilities were Decreasing During the Last
Twenty Years
USA
Japan
Germany
France
Italy
UK
Canada
1980
75,5
71,8
73,9
46,3
86,5
79,7
1990
69,9
71,3
71,2
34,1
44,2
84,6
74,3
Table 1. Bank Deposits in percent of total bank liabilities
1995
58,5
71,3
65,7
27,5
36,9
86
72,4
In Some G7-Countries also Bank Loans as in Percent
of Total Bank Assets Decreased
USA
Japan
Germany
France
Italy
UK
Canada
1980
63,3
55,3
83,6
35,7
43,6
70,4
1990
62,9
56,2
81,2
40,4
45,6
57,9
70,8
Table 2. Bank Loans in percent of total Bank Assets
1995
58,9
65,4
77,7
36,4
42,4
52,4
67,6
Banks are Using More and More Capital Market
Instruments to Refinance Their Businesses
USA
Japan
Germany
France
Italy
UK
1980
0,4
2,0
19,2
...
12,2
3,9
1990
0,8
3,9
19,0
21,7
18,7
6,1
Table 3. Negotiable Liabilities in percent of total Bank Liabilities
1995
1,1
4,8
23,5
19,4
22,0
7,3
Banks Have Also Entered resp. Enlarged Their Asset
Management Businesses
USA
Japan
Germany
France
Italy
UK
1980
18,0
14,7
10,2
...
20,4
9,2
1990
18,9
14,3
12,1
7,3
13,0
9,2
Table 4. Tradable Securities Holding in percent of Total Bank Assets
1995
20,1
15,4
15,7
13,7
13,9
17,9
Three Major Changes In The Composition Of
Bank‘s Balance Sheets
Displacement of lending by other activities.
Growth of off-balance-sheet assets in percent of total
assets.
Displacement of deposit loan-income by other operating
income.
Changes Are Reflected By Desegementation And
Restructuring
Expanding into other markets (Securities) to face competition
to the Asset Management Industry.
Entering the insurance markets
Entering Asset Management business providing investment
management services and a wider range of financial services
to their customers.
All this changes are reflected by heavily increasing M & A –
activities.
Source of Bank Profits Have Shifted From
Interest Related Income to Other Income
Other Earning Assets /
1991
33,35
1993
33,78
1996
37,14
14,58
20,81
20,33
49,18
62,00
67,06
86,56
61,09
57,54
24,80
22,06
18,15
Total Assets
Off-Balance-Sheet Items /
Total Assets
Other Operating Income /
Net Interest Revenue
Commission and Fees/
Other Operating Income
Trading Income /
Other Operating Income
Table 5. Balance Sheet Information of Top 50 Banks in percent as noted
The Traditional View of Financial Intermediation
Has Eroded
 Traditionally banks intermediate between borrowers and savers by
using deposits, securities firms were providing the distribution of
new issues of equity and debt to public.
 On the supply side, Nonbank financial institutions have entered
the traditional bank business. Insurance Comp., Investment banks,
even telcos and food companies are providing bank-services.
 On the demand side, households were bypassing banks by
investing directly to those investment firms which could – cause of
theire specializtion – more effective handle the savings.
 As a result from this, the nonbank-sector became larger and larger.
(Table 6,7). In the United States the nonbank-sector is managing
(1995)11,5 trillion US$ compared to 5 Trillion $ in the banking
sector.
Institutional Investors Were Steadily Growing at
High Average Rates
All Institutional Investors
(in Billions of US$)
1990
1993
United States
Japan
Germany
France
Italy
United Kingdom
Canada
6.820,60
2.490,60
641,80
632,00
215,30
1.248,50
348,20
9.262,20
3.576,70
776,20
870,50
244,70
1.637,00
437,20
11.490,20
4.068,20
1.179,80
1.159,00
325,60
1.908,90
509,70
10,99%
10,31%
12,95%
12,89%
8,62%
8,86%
7,92%
Total
12.397,00
16.804,60
20.641,40
10,73%
Table 6. Assets of Institutional Investors
1995
Annual
Growth
Rate
Institutional Investors Were Steadily Growing at
High Average Rates
Total Assets all Investors
(in % of GDP)
1990
1993
1995
Annual
Growth
Rate
United States
Japan
Germany
France
Italy
United Kingdom
Canada
118,70
77,90
39,50
49,80
18,50
117,50
60,30
141,40
84,10
42,50
72,50
26,90
175,20
81,20
158,60
87,00
48,90
74,00
29,10
176,00
89,20
5,97%
2,23%
4,36%
8,24%
9,48%
8,42%
8,15%
Total
84,70
103,70
110,50
5,46%
Table 7. Assets of all Institutional Investors in % of GDP
Globalization
Financial Markets Are Facing Closer Integration
• Liberalization and Development of Information Technologies prepared
the way to globalization and integration
• Securities Portfolios became far more internationally diversified (Table
8). The growth in gross portfolio flows increased by almost more than
200 times.
• Cross border transactions in Bonds and Equities reached up to
between seven and one times GDP. In the US those transactions
between US and foreign investors totaled 17 Trillion US$. (see Table 9)
or 213% of the US - GDP.
• Although investment portfolios are fare away from beeing adequately
internationally diversified, i.e. portfolios still do not reflect the the
structure of the world market capitalization (USA: 42%, Japan 15%, UK:
9%, other industrial countries: 23%, emerging markets: 11%)
Globalization
Financial Markets are Facing Closer Integration
• Mirroring this expansion firms also turned to
international markets to raise funds (see Table 10).
• Even the volume of outstanding issues of international
debt securities reached to 3,7 Trillion US $, sixfold larger
than in 1985.
• Financial Globalization has been a counterpart to
international trade. The foreign exchange market has far
outpaced the growth of trade. In 1995 an annual
worldwide trade volume of 6,1 Trillion US$ was faced by
a daily market turnover of 1,2 Trillion US $. (see T.11.)
• Nonresidents holdings of public debt also increased
substantially (see Table 12)
Foreign Net and Portfolio Investments
(in bn $)
Gross and Net Flows of
Foreign Direct and Portfolio
Investment (billions US$)
1970
1980
1990
1995
1997
14,45
5,26
82,82
60,93
283,24
329,63
369,01
764,34
448,32
1.040,19
-4,05
1,42
-8,14
16,02
-59,58
41,36
-83,18
186,53
-92,60
272,51
Gross Flows
Foreign Direct Investment
Portfolio Investment
Net Flows
Foreign Direct Investment
Portfolio Investment
Table 8. Gross and Net Flows of Foreign Direct and Portfolio Investment (G7)
Cross Border Transactions of Bonds and
Equities
Cross Border
Transactions
Bonds & Equities
(in percent of GDP)
United States
Japan
Germany
France
Italy
Canada
Total
1975
1980
1985
1990
1995
1997
4,00
2,00
5,00
...
1,00
3,00
9,00
8,00
7,00
5,00
1,00
9,00
35,00 89,00 135,00 213,00
62,00 119,00 65,00 96,00
33,00 57,00 172,00 253,00
21,00 54,00 187,00 313,00
4,00 27,00 253,00 672,00
27,00 65,00 189,00 358,00
15,00
39,00
182,00
411,00 1.001,00 1.905,00
Table 9. Cross Border Transactions in Bonds and Equities
Foreign Exchange Trading
(Turnover in bn $ per day)
Foreign Exchange
Trading
1986
1989
1992
1995
188
590
820
1190
7,40
15,80
17,40
19,1
36,70
75,90
86,00
84,30
Global Estimated Turnover
(daily, in billions of US $)
As a percent of
World Exports of Goods
Total reserves minus gold
Table 11. Foreign Exchange Trading
Nonresidents Holdings of Public Debt
(in % of Total Debt)
Nonresident's
Holdings of
Public Debt (in % )
United States
Japan
Germany
Italy
United Kingdom
Canada
1983
14,90
...
14,10
...
7,20
10,70
1988
18,40
2,00
20,70
...
15,70
15,70
Table 12. Nonresidents‘ Holdings of Public Debt
(in percent of total public debt)
1993
22,20
5,40
32,80
10,10
21,80
21,80
1996
35,00
4,30
29,30
15,90
23,80
23,80
•
Accompanying all this, we can observe extending linkages
between international Exchanges (Eurex, CBOT and Eurex)
•
OTC- and Exchange traded markets will merge
•
New Markets for unbundling and trade of risks will emerge
Actually the risk market volume is estimated to reach up to a volume of
more than 130 Bio US$ /year (notional amount outstanding per end of
year). This would be more than the total volume of all traded bonds,
equities and bank assets
Outlook to new market propositions
In future we will face an ongoing increase of methods and
products concerning risk markets, also dealing new kinds of risks
like:
Catastrophe Risks (ART) – will change insurance markets
Credit Risks – will change the business potential of credit
business.
Private Income Risks
New Trends
New Markets
New Chances
New Risks
New Markets and Products for Unbundling,
Pricing, Trading and Managing Risks
Example:
U.S. bank has given a floating – rate Yen denominated loan
to a Japanese bank.
Risk Exposure of U.S. bank:
Foreign Exchange Risk
Interest Rate Risk
Credit Risk
Credit-risk loaded floatingrate, Yen-denominated
loan
Risk Management Tools:
Currency Swap (Y/US$)
Interest Rate Swap (V/F)
Credit Default Swap
Riskless, fixed rate dollar
denominated security
How Risk – Management Works
Japanese Bank
US Bank
100 Bio Y at LIBOR
Floating –
Rate Yen
Loan
Payback in Yen
LIBOR in Yen
Fixed rate in Yen
Yen - Payer
US$ Receiver
Credit Default Swap
Floating –
Rate Yen
Credit
Interest
Rate
Swap
Currency
Swap
OTC - Market
Fixed Rate
Dollar
Loan
LIBOR Payed in Y
Growth in Global Security Issues,
1990-2003
$ Bn
6000
5000
4000
Global debt & equity
3000
2000
U.S. Issuers worldwide
1000
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Derivatives - Notional Amount Outstanding
per 12/1987 to 12/2005
350
316,4
in Thousand
Bio US$
300
280,8
250
221,7
200
150
99,8
100
50
58,3
63,1
69,2
1999
2000
2001
25,5
0,87
3,45
8,48
1987
1990
1993
0
1996
2002
2003
2004
2005
Markets
are
Interlinked
Example:
Spot and Futures Market
Spot
Parity
Spot –– Future
Future –- Parity
Index Arbitrage (Example)
Today, one (theoretical) Index-Future is sold at 5,500 €
(1€ per Index-point). Long and Short-positions can be
described by a profit and loss diagram:
Long Future
= Buyer
Profit
Index
5,500
Short Future
= Seller
Loss
If you are Long-Future,
then you may claim for
delivery of „one index“ at
a price of 5,500 € at the
maturity of the indexfuture. That means, if the
index at delivery is quoted
at more than 5,500, you
will win from your futures
position.
Spot –– Future
Future -–Parity
Parity
Spot
Index Arbitrage (Example)
You hold an Index-Portfolio, currently valued at 5,500 €
(1 Index-point = 1 €). If the annual risk free rate rf is at
3.5 % and the expected dividends on your Index portfolio
are at 100 € (d = 100/5,500) , an Index – Future with
one year to maturity has a fair price of:
F0  S0  1  rF  d 
F0  5 ,500  1  0 ,035  0 ,0182
F0  5 ,592.40 €
To prevent our Index-Portfolio from losses, we could
hedge the price risk by taking a short – future position
(selling a future at 5,592.40).
Spot –– Future
Future -–Parity
Parity
Spot
Index Arbitrage (Example)
The total expected payoffs from
your portfolio will depend on the future state of the environment (see
below payoffs 1-5). A decreasing
stock market will be compensated
by profits from the short future position, increasing stock prices will be
outbalanced by losses due to payment obligations from the future.
Index
5592,40
Loss
Assets
Payoff1
Stock Portfolio
+4500,00
+5000,00
+5500,00
+100,00
+100,00
+100,00
+100,00
+100,00
Short Future
+1092,40
+592,40
+92,40
-407,60
-907,60
Total
+5692,40
+5692,40
+5692,40
Dividends
Payoff2
Profit
Payoff3
Payoff4
Payoff5
+6000,00 +6500,00
+5692,40 +5692,40
Spot –– Future
Future -–Parity
Parity
Spot
Index Arbitrage (Example)
Assets
Payoff1
Stock Portfolio
+4500,00
+5000,00
+5500,00
+100,00
+100,00
+100,00
+100,00
+100,00
Short Future
+1092,40
+592,40
+92,40
-407,60
-907,60
Total
+5692,40
+5692,40
+5692,40
Dividends
Payoff2
Payoff3
Payoff4
Payoff5
+6000,00 +6500,00
+5692,40 +5692,40
Initially you have paid 5,500 € for your stock portfolio. Taking the short future
position, the final outcome of your portfolio will be 5,692,40 €, whatever the
stock price will be, i.e. you will earn 192,40 which equals 3.5%. Obviously,
this profit is riskless:
F
0
 D   S0
 rF
S0
 F0  S0  1  rF  d 
Spot-FutureParity
Spot –– Future
Future -–Parity
Parity
Spot
Index Arbitrage (Example)
Rising future prices will – due to arbitrage trading - induce
rising spot prices. For example, a future traded at 6,000 € is
(relative to a spot market price of 5,500) clearly overpriced, if the
stock price remains unchanged at 5,500 €. In this case, „smart“
traders will make arbitrage profits of 407,50 € per contract and bring
back the market to equilibrium:
Action
t0
t1
Borrow money at rF (3,5%)
+ 5,500.00 - 5,692.50
Buy/Sell Stock Portfolio
- 5,500.00 + Stock
Sell/Buy Future at 6,000
0
+ 6,000.00 - Stock
Total
0
+ 307,50
Note, that the arbitrage profit equals the difference between a fair- and
mispriced future (6,000 – 5,592,40) plus Dividends. Higher Future
prices will lead to massivly increased demand at spot markets until
spot prices and futures are back to equilibrium.
Spot
–
Future
–
Parity
Spot – Future – Parity
Financial
Market(Example)
Stability
Index Arbitrage
• Spot Markets and Future (Forward) Markets are
interlinked.
• Mispriced spot or future market instruments will affect
both markets.
• Future market speculations that drive futures prices
will also drive spot market prices due to arbitrage
trading (et vice versa).
• Speculation on futures markets, resulting in higher
future prices will induce higher spot market prices due
to arbitrage trading. Finally this may result in spot
market bubbles that jeopardizes the allocation
mechanism of real goods markets.
Management of Operational
Risks:
Weather
Derivatives
Weather – Derivatives
History
• Weather – Derivatives occured in 1997 in the USA
after the El Niño effects. (Aquila Energy, Kansas
City/Missouri).
• At the end of 1998 first Weather – Derivatives were
issued in Germany
• Since 1998 Weather – Futures and Weather - Options
are traded at the Chicago Mercantile Exchange .
• In August 2001 London International Financial Futures
Exchange (LIFFE) started trading Weather Futures.
• Eurex planned to launch weather related derivatives in
2004.
Weather – Derivatives
German Temperature Index Xelsius
Weather – Derivatives
German Temperature Index Xelsius
Weather – Derivatives
German Temperature Index Xelsius
HDDInterval = Max { 0, 18°C -  Temp }
CDDInterval = Max { 0,  Temp - 18°C }
Example: On December,
12th 2001 the average
temperature in Berlin has
been - 6° C. This day the
Index shows 24 HDD.
Weather – Derivatives
In many cases operational income is directly weather related
12000
1200
10000
1000
8000
800
6000
600
4000
2000
GWh
Umsatz
Season
1996
1997
1998
1999
2000
HDD
3047
2640
2379
2606
2425
GWh
10908
9785
8785
9247
8357
Turnover
1006
903
810
853
771
per HDD
0,33016081
0,34204545
0,34047919
0,32732157
0,31793814
0
400
200
0
3047
2640
2379
2606
2425
Weather – Derivatives
In many cases operational income is directly weather related
The annual turnover (Business Unit Heating Energy) of the
former Berlin Energy - Supplier BEWAG (now VATTENFALL) 1999 / 2000 mounted to 771 Mio DM. The winter
season 1999/2000 showed 2.425 HDD. This equals an
average turnover per HDD of 320 TDM.
If the winter would have been warmer (for example at only
2000 HDD) this would have caused a lower turnover of
approx. 425 HDD x 320 TDM = 136 Mio DM.
Insofar BEWAG‘s operational income is directly related to
the average temperature in winter season.
Weather – Derivatives
The Payoff-Profile from Heating Business remembers to the payoff profile
of a financial future. Example: If 2500 HDD would represent an average
cold winter, then a higher number of HDD would create additional
turnovers, whereas a lower number would lead to a smaller turnover.
1.100
1.000
900
800
700
600
500
400
3300
3200
3100
3000
2900
2800
2700
2600
2500
2400
2300
2200
2100
2000
1900
1800
1700
1600
Weather – Derivatives
In this example the risk of warmer winters (i.e. < 2500
HDD) could be hedged by weather futures.
At a Standard of 100 € per HDD, a weather future on
the basis of 2500 HDD has a contract value of 2500
x 100 € = 250 T€.
Given a profit-margin of approx. 20% (turnover at
2500 HDD = 2500 x 320 TDM = 800 Mio DM (400
Mio €) i.e. a total average profit of 160 Mio DM or 80
Mio € resp. an average profit per HDD of 32 T€)
BEWAG could hedge the weather risk selling 320
weather – futures at an Index of 2500 HDD.
Weather – Derivatives
If BEWAG takes the short-position this could result in the
following scenarios:
Operational
Income
HDD
2000
2100
2200
2300
2400
2500
2600
2700
2800
2900
3000
Turnover
(Mio €)
320
336
352
368
384
400
416
432
448
464
480
Income from
Short Future
Total Profit
Profit
(Mio €)
64
67
70
74
77
80
83
86
90
93
96
(Mio €)
16
12,8
9,6
6,4
3,2
0
-3,2
-6,4
-9,6
-12,8
-16
(Mio €)
80
80
80
80
80
80
80
80
80
80
80
Weather – Derivatives
Payoff-profiles of a hedged (operational) business are similiar to the payoffprofiles of a future hedged trade.
40
30
29
26
20
22
19
16
16
13
10
10
10
6
-10
-13
-19
-20
-26
3
-
-3
-3
-16
26
13
6
-6
-10
-13
-16
-22
-29
-30
-10
-6
3
19
22
-19
-22
-26
Profit
Future
-40
1500
2000
2500
3000
3500
Weather – Derivatives
Options
Put - Options
Hedging with weather futures
means not only to eliminate
operational risks but also to
eliminate the chance of having a
better result than hedged.
To avoid this, one could lmake
use of weather options (as traded
at LIFFE). To minimize option
premiums, options frequentlly
contain caps or floors.
Cap at
2300 HDD
Short Put at
a Strike of
2500 HDD
2500
HDD
Long Put at
a Strike
of 2500 HDD
Weather – Derivatives
Options
Call - Options
To buy a put at a strike of
2500 HDD leads to
compensations when the
average number of HDD is
below 2500 HDD.
To buy a call wouold mean,
that the buyer can claim fo
compensation-payments if the
number of HDD is above
2.500 HDD.
Short Call at a
Strike of
2500 HDD
2500
HDD
Long Call at a
Strike
of 2500 HDD
Floor at
2700 HDD
Weather Collar
Short Call 2700 HDD and Long Put at 2300 HDD
2.000 2.100 2.200 2.300 2.400 2.500 2.600 2.700 2.800 2.900 3.000
140.000
120.000
100.000
80.000
60.000
40.000
20.000
0
-20.000
-40.000
Max. Chance
Max. Risk
Weather Collar
(Short Call 2700 HDD and
Long Put at 2300 HDD)
A Zero – Cost Weather – Collar (Short Collar) can be designed to
restrict the volatility of weather related profits wo to the boundaries
of an upper and lower limit.
HDD
2.200
2.300
2.400
2.500
2.600
2.700
2.800
Short Call 2700
10.000
10.000
10.000
10.000
10.000
10000
0
Long Put 2300
0
-10000
-10000
-10000
-10000
-10000
-10000
Collar
10.000
0
0
0
0
0
-10.000
Profit
50000
60000
70000
80000
90000
100000
110000
Gesamt
60.000
60.000
70.000
80.000
90.000
100.000
100.000
Management of Operational
Risks:
Non Performing Loans
and
Credit Risk Marktes
Topics Covered:
NPLs in China and Germany
Origin and Dynamics of NPLs
Centralized Problem Solving
Approaches
Decentralized Problem Solving
Approaches
Outlook
Germany: At a Total Volume of 3,500 bn. € Loans
Outstanding approx. 300 bn. € are Non Performing
(estimated in 2004)
Cooperative
Banks
12%
423,5 Mrd.
Mortgage
Savings
3%
121 Mrd.
Credit Banks
26%
956,8 Mrd.
Others
23%
810,6 Mrd.
300
Mrd.
Federal Banks
16%
579,2 Mrd.
Mutual Savings
20%
702,4 Mrd.
Referring to Fundamental Data (Profits) German
Stock Markets Were Overvalued From 1997-2001
350,0%
Index
Unternehmensgewinne
300,0%
250,0%
200,0%
150,0%
100,0%
50,0%
0,0%
1995
1996
1997
1998
1999
2000
2001
2002
2003
Although Investments (Plant, Machinery) Were
Decreasing Loans to Enterprises Remained High
180
175
860
Investments
Loans to Enterpr.
837
825
170
160
820
809
165
840
800
786
155
780
760
150
760
145
740
140
135
151
160
176
165
150
1998
1999
2000
2001
2002
720
70
1400
NPL (Flow)
1200
Losses / Case
60
1200
50
1000
820
40
760
800
700
590
590
620
61,5
30
20
600
400
30,9
10
21,9
19,7
20,1
24
17,3
0
200
0
1996 1997 1998 1999 2000 2001 2002
T€
bn. €
After the Bubble Bad Debt and Bad Debt Losses
Increased
Solving the Problem
Stock
Problem
Flow
Problem
Securitisation
1/3rd of Total Volume
will be transferred
Workout
Smaller Proportions
transferred to Bad Banks
Write-off
Tax Deductible, frequently
in Combin. With Securit.
Credit Restrictions
Due to Measures in
Portfolio Management
Extended & Improved
Approval Procedure
Due to Introduction of
Rating Systems
Enforcement of Controlling New Regulations Issued
Measures
By Supervisory Authority
China: In 2002 Total NPL Amounted to $ 770 bn.
Which Corresponded to 61% of GDP or 37% of Total
Loans
$ 168 bn
$ 168 bn
Approx. 2,508 bn
$ 602 bn
$ 602 bn
Total Outstanding Loans
Total Non Performing Loans
Origin and Characteristics of NPL
Stock
NPL
Flow
Bad loans
undertaken
in the past
Future loans to
debtors, that will
not be able to
serve the loan
Policy directed
Lending to SOE‘s
Financial System
Policy loans
Loans to SOEs
Weak Banking
Directed by government to
support policy. Before
1986 not lending authority,
until 1994/95 obliged to
finance budget deficits.
Since 1995 by State Dev.
Banks
SOE show an accelerated
leverage risk due to extreme D/E – ratios at low
profitability. But:
50% of industrial output,
70% of employment, 80%
of total capital stock.
Poor risk and portfolio
management, high systemic risk, no diversification, no adjustments
for approp. Risk premiums possible; AMC‘s
close to SOB‘s (1:1)
Stock and Flow – Problems Need Different
Approaches
Stock
Solve the Stock Problem:
Debt-Bond Swaps
Securitisation
Cash Funding
Debt – Equity Swaps
Amortisation (write-off)
NPL
Flow
Solve the Flow Problem:
Credit Ceilings
Efficient Legal Framework
Operational Restructuring
Centralized Bad Bank
Hard Budget Constraints
Market for Credit Derivatives
Source: British Bankers Association
(in Bio. US$)
2500
2385
2000
1581
1500
1000
893
1000
450
500
170
0
20
1996
1997
1998
1999
2000
2002
2004
Basics of Credit Derivatives
Asset Swaps
Investor
pays fixed
Swap-rate
(Coupon Rate)
Risk Buyer
receives
LIBOR + var.
Premium (spread)
Receives
fixed
rate
Reference
Value
(z.B. Bond)
The Investor protects his portfolio
against credit quality degradations
by a simple swap construction:
using a interest swap the investor
swaps fixed income from his
portfolio into variable + premium
payments from the risk buyer.
Credit Default Swap (C.D.S.)
Premium: bps x
Notional Value
Risk Seller
(Protection buyer)
Credit Event ?
Yes:
Compensation
Reference
value
(e.g. Bond)
No:
No Compensation
Risk Buyer
(Protection seller)
Total Rate of Return Swap
(Synthetic Sales or Short Sales of Loans)
negative
Market price changes
LIBOR +/-Spread
Total Rate Receiver
Total Rate Payer
(Riskbuyer)
(Riskseller)
Fixed Interest Rates
positive Market price
changes
Reference Value
(e.g. Bondes, Indices
Asset baskets, Loans)
Credit Linked Notes (CLN)
Notional Value of CLN
Risk Buyer
(e.g.Investor)
Fixed Rate CLN
Risk Seller
(e.g. Bank)
Repayment of C.L.N. possibly minus
compensation if Credit Event
Referencial Assets
(e.g. Bonds, Indices,
Asset baskets, Loans)
Credit Spread Put
Construction of strike-spreads
Example:
5-y. € Corp.Bond:
5,95%
5-y. € Swap-rate
(fix against 6-M-EURIBOR): 5,50%
Credit Spread:
0,45% = 45 base
points
At an agreed strike-spread of
45 bps, the short side will
pay a compensation, if the
spread increases.
Strike
Spread:
45 bps
90 bps
25 bps
Spread increases: Spread decreases:
Loan Devaluation Improved C. Qual.
Execution
Forfeiture
Credit Spread Put
Mechanism
Put – Buyer (Long)
(Protection buyer)
Option price in
base points
Right to deliver an
Asset-Swap-Pakets at
LI +/- Credit Spread
Put Seller (Short)
(Protection seller)
Execution
Referencevalue
LI +/- Credit Spread
Put – Buyer (Long)
(Protection buyer)
Fixed Rate (Ref. Val.)
Payment par
Reference value
Put Seller (Short)
(Protection seller)
What is A Credit Event ?
The ideal case would be a reference value (e.g. a bond) that is
highly correlated with the secured loan.
Insolvency
Payment Delay
Down-grading
Payment Reluctance
Risk of Convertibility
Cross Default
Market Inefficiencies
Restructuring
Credit Default Swap / Option
Settlement Versions
Cash Settlement:
CDP = (Par - recovery value)
CDP = (Par - Marktpreis nach Credit Event)
CDP = (Synthetischer Preis - recovery value)
Binary:
Zahlung eines kontrahierten Festbetrags
Physical Settlement:
Lieferung Referenzwert zum Festbetrag bzw.
gegen Zahlung von par
Extension of Risk Management
by Credit Derivatives
Risk of Default
Insolvency
Risk
Market Risks
Spread
Risk
Credit Default
Swap
Credit Spread
Put
Total Rate of Return Swap
Alternative I: ABS – Transactions
(„True Sale“)
Price of the
Credit Pool
Bank
(Originator / Seller)
Sale of a
Credit Pool
Price of
Bonds
S.P.V.
(Buyer)
Investors
Issuance of ABS
Coupon-Payments;
Redemption minus
Losses on ABS
Market Securitisation of Credit Risks
(Europe 2002 in Mrd. $)
60
50
Kreditderivate
4,9
Asset Backed Securities
40
30
50,2
7,0
29,8
20
22,8
10
2,0
20,6
18,7
9,7
9,5
0
GB
I
D
NL
E
F
Alternative II: Synthetic Sales
by Collateralized Debt Obligations (C.D.S.)
Emission CLN
Kuponzahlung
Rückzahlung
CLN abzgl.
Kreditausfälle
Swap-Prämie
S.P.V.
(Buyer)
Bank
(Originator)
Ausfallgarantie
per CDS
Investoren
Bondpreis
Anlage der
Emissionserlöse
Sicherheiten
Pool
Fazit
•
Die Problemkreditbearbeitung wird zukünftig deutlich
stärker von risikopräventiven und/oder risikokurativen
Managementaufgaben geprägt sein.
•
Im risikopräventiven Bereich erwarte ich einerseits eine
intensive Auseinandersetzung mit portfolio-orientierten
Risikostrategien, andererseits eine spürbare Zunahme
des Transfers von Adressen-risiken
•
Im risikokurativen Bereich erwarte ich eine stärkere
Akzentuierung eines fundamentalen (Kredit-)Sanierungsmanagements auch unter Einbeziehung
bankexterner Funktionen
Management of Operational
Risks:
Capital Markets and
Refinancing of
Insurance Industry
Alternativer Risiko Transfer (A.R.T.)
• Katastrophen - Derivate
• Katastrophen – Anleihen (Cat – Bonds)
• Act – of – God - Bonds
A.lternativer R.isiko T.ransfer
Größte versicherte Schäden 1989 - 2001
1.
2.
3.
4.
5.
6.
*
MIO US $
JAHR
EREIGNIS
5.326
5.531
6.420
17.945
13.227
43.000
6.062
1989
1990
1991
1992
1994
2001
2000
Hurricane Hugo
Wintersturm Daria
Wirbelsturm Mireille
Hurricane Andrew
Erdbeben Northridge
WTC - Attentat
EBITDA Allianz
Alternativer Risiko Transfer
Versicherbarkeit von Risiken
Risiken
Zufälligkeit
Max.
Schaden
schätzbar
Ausr. Anzahl
gleichartiger
Risiken
nein
Ausfall Olympische
Spiele
X
Produkthaftpflicht
für Arzneimittel
?
nein
?
Attentat mit
nuklearen Waffen
X
?
nein
X
Klassischer vs. Alternativer Risiko
Transfer
Klassischer versicherungstechnischer Risikotransfer
Versich.
nehmer
Versich.
Untern.
Vers. Unt./
Rückvers.
Alternativer versicherungstechnischer Risikotransfer
Versich.
nehmer
Versich.
Untern.
Kapitalmarkt
Produktentwicklung im Risikogeschäft
A.R.T.
Finanz-
Financial
Tradit.
Vers.
Produkte
Bonding
Produkte
Multiyear
Rein-
Multiline
Funding
surance
Produkte
Produkte
(Finite
Risk)
Integrative Produkte
markt-
produkte
(Derivate,
Securitization)
A.R.T. - Produkte
Finanztitel
originär
derivativ
Bonds
Options
Futures
Verknüpfung mit versicherungstechnischem Risiko
Principal
Coupon
Principal und / oder Coupon at
Risk
Underlying
GCCI , PCS (Property
Claims Services) - Indices
A.R.T. - Produkte
Struktur eines CAT - Bonds mit S.P.V.
Versicherungsnehmer
Prämien
Prämien
Schadensausgleich
Kapitalmärkte
Wertpapiere
Special
Purpose
Vehicle
Kapital
Tilgung
Zinsen
Investoren
Versicherer
Refinanzierung des
Schadenausgleichs
Tilgung, Zinsen
A.R.T. - Produkte
Ausstattungsmerkmale Cat-Bonds
Pionierprodukt war der Cat-Bond (Hagelbond) der
Winterthur Versicherung (WinCat).
Der erste WinCat – Bond enthielt folgende Formulierung:
„Die Zahlungen auf den Zinscoupon entfallen, wenn
die Winterthur während der Beobachtungs-periode,
die jeweils vom 1. November bis zum 31. Oktober
des Folgejahres dauert, als Folge min-destens eines
großen Hagel- oder Sturmereignisses für mehr als
6,000 Motorfahrzeuge ihrer Motorfahrzeug-Kaskoversicherung Leistungen erbringt. Dabei werden
Schäden, die innerhalb eines Kalendertages auftreten, dem gleichen Schadensereignis zugeordnet.“
A.R.T. - Produkte
Beispiel Cat-Bonds
1997 plazierte ein SPV (United Services Automobile
Association und Residential Reiunsurance Limited) einen CatBond über 477 Mio USD in zwei Tranchen mit jeweils
einjähriger Laufzeit: Die erste Tranche war nominalwertgeschützt (Class A-1, LIBOR + 273 bps) und umfaßte 164 Mio
USD, die zweite Tranche (Class A-2, LIBOR + 576 bps) über
333 Mio USD unterlag Tilgungsrisiken. Die Zahlungsströme
der Tranchen waren auf Hurricane Katastrophenschäden
bedingt, soweit diese in ausgewählten Regionen einen
Gesamtbetrag von 1 Mrd. USD übersteigen. Erreichen die
Hurricane - Schäden ein Volumen von 1,5 Mrd. USD, verlieren
die Class-A-2 Investoren ihr gesamtes Kapital.
A.R.T. - Produkte
Optionsprodukte/ Beispiel
An der Chicago Board of Trade werden seit 1992
indexbasierte Optionsprodukte, Puts und Calls, gehandelt.
Der zugrunde-liegende Index ist der PCS - Property Claims
Services - Schadensindex. Jeder Indexpunkt repräsentiert
einen Marktschaden von 10 Mio USD.
Beispiel: Ein Erstversicherer möchte sein Sturmrisiko /
Florida reduzieren. Er nutzt hierzu den an der CBOT
gehandelten Florida PCS - Call Spread 100 / 150, d.h. er
kauft Call Optionen auf einen PCS - Indexstand 100 und
verkauft gleichzeitig Call Optionen auf einen PCS Indexstand von 150.
A.R.T. - Produkte
Wirkung eines 100/150 Call Spreads auf den PCS-Index
100
Long Call 100
Short Call 150
Total
80
60
40
20
0
-20
Gehedgt es Risiko
-40
-60
80
90
100
110
120
130
140
150
160
170
180
190
A.R.T. - Produkte
Optionsprodukte/ Beispiel
Szenario A:
Liegt der PCS -Index aufgrund der in Florida aggregierten Marktschäden bei
weniger als 1 Mrd. USD, verfallen beide Optionen. Per saldo sind Prämien von
5 Mio USD verloren.
Szenario B:
Marktschäden übersteigen 1 Mrd. USD, bleiben jedoch niedriger als 1,4 Mrd.
USD: Die Long Call Position bei einem Strike-Index von 100 gerät ins Geld,
die Short-Position verfällt wertlos. Schadensausgleich wird im Idealfall
kompensiert durch A.R.T. – Gewinne.
Szenario C:
Die Marktschäden liegen bei mehr als 1,4 Mrd. USD. Der Wertzuwachs der
Long-Position wird kompensiert durch Verluste aus der 140er Short-Position.
Alternativer Risiko Transfer
• A.R.T. - Refinanzierung der Versicherer / Rückversicherer über
die Kapitalmärkte eröffnet Chancen zur Kapazitätserweiterung und Versicherung bislang unversicherbarer
Risiken.
• A.R.T. bietet Instrumente, die aufgrund ihrer Kovarianzprofile gut in viele Anlageportfolios passen würden.
• A.R.T. bieten sich an zur kapitalschonenden Risikodiversifkation der Versicherer bzw. zur Ergänzung von klassischen
Investor - Portfolios aus traditionellen Finanzmarktprodukten.
• A.R.T. – Produkte sind schwierig zu bewerten. Es exisitiert kein
allgemein anerkanntes Preisbildungsmodell, Investoren
verhalten sich deshalb abwartend.
• A.R.T. Markt ist klein und entwickelt sich zögerlich.
Financial Markets Imbalances
are
Accompanied By Increasing
Size and Activity
of
Alternative Investments
Alternative Investment Strategies
And Financial Market
Stability
Southwestern University of
Finance and Economics
Chengdu
September 2006
„The only hope to produce a superior record is to do
something different. If you buy the same securities as
other people, you will have the same results as other people“
John Templeton
Prof. Dr. Rainer Stachuletz
Berlin School of Economics
Berlin Klippakademie
Berlin School of Economics
84
Contents
o Business models of hedge fund investors
and their current role in financial markets
o Typical designs, mechanisms and conditions
of hedge funds investment strategies
o Do alternative investments jeopardize the
stability of financial markets
o Summary / Conclusions / What to do ?
The Universe of Alternative Investments
Real Estate and
Natural Resources
Private Equity
Strategies
Public Market
Strategies
Private Real
Estate
Venture Capital
Hedge Funds
REITs
Buyouts
Multy-Strategy
Funds
Commodities /
Energy
Distressed Debt
Arbitrage
Mezzanine
Managed
Futures
General Characteristics of
Alternative Investment Strategies
Features of Trad. Investments
Features of Altern. Investments
(e.g. Investmentfonds)
(e.g. Hedge Fonds)
 Benchmark oriented
 Absolute Return
 High correlation with equity-
 Low or no correlation with
and/or bond markets
other markets
 Must always be invested
 Short sales possible
 Transparent, regulated markets
 Unregulated markets, offshore
 No investments in own funds
 Investments in own funds
 No levered investments
 High levered investments
 Striktly limited use of derivatives
 Usage of derivatives
Hedge Funds Business Model
Mostly unregulated, offshore residing eclectic investment
pools with aggressively managed short term portfolios.
Hedge Funds employ investment techniques like short
selling, leverage, and are allowed to create a variety of
synthetic positions by unlimited usage of derivatives.
Often hedge funds are set up as private partnerships, open
to a limited number of investors and require a very large
initial minimum investment. Typically hedge Funds are
illiquid as they often require investors keep their money in
the fund for a minimum number of years.
Hedge funds managers typically charge a management fee
(1-2% of asset value) and a performance fee of about 20%
of the capital gains and capital appreciation.
Development of Hedge Funds
Number and Portfolio (in Bio US$)
Risk and Return
Hedge Funds Investment Strategies
Global Macro
Managed Futures
Dedicated Short Bias
Long/Short Equity
Directional
Merger Arbitrage
Distressed Securities
Event
Driven
Equity Market Neutral
Convertible Arbitrage
Fixed Income Arbitrage
Relative
Value
(Arbitrage)
Relative Value Strategy
Long / Short Equity – Hedge
PROFIT
Long Home
at 16,7
Expected
Market
Expected
Market
16,7
LOSS
23,9
Short
Lowe‘s at
23,9
P/E - Ratio
Relative Value Strategy
Long / Short Equity – Hedge
Enter spread
position
Directional Strategies
Non Hedge Long-/Short
Directional Strategies represent unhedged, directional
speculations on growing (long) or declining (short selling)
markets. By additional usage of debt (leverage) respectively
completing short– or long-positions synthetically, the total risk
and return – positions can be amplified.
Leverage
Short Call
Long Put
Expect. Market
Exp. Market
Event – Driven Strategies
(Merger Arbitrage)
Bank Austria
1
70
Ad – hoc News
at 28. April 2000
Hypovereinsbank
Bank Austria
3
60
Index value Euro
End of
Purchase
50
Merger Declaration
2
40
2001
Bank Austria
Hypovereinsbank
Event – Driven Strategies
Long–Short–Equity and Merger Arbitrage
50
Expected Share Price
Bank Austria
40
30
Long Bank Austria
20
10
0
Short HVB
-10
Expected Share Price HVB
-20
45
50
55
60
65
70
75
80
85
Event – Driven Strategies
(Merger Arbitrage)
Traditional Investment Fund
Trade:
Shares
Aktien
Anzahl
Number
Bank Austria
1
Purchase
Kauf
Verkauf
Sale
28. April 2000
28. Dezember 2000
- EUR 48,80
+ EUR 58,60
Differenz
Profit
/ Loss
9,80
+ 9,80
Hedge Fund Manager
Trade:
Leerverkauf/
Short
Sales
Kauf
Eindeckungskauf/
Repurchase
/Verkauf
Sales
28. April 2000
28. Dezember 2000
-1
+ EUR 68,10
- EUR 59,74
8,36
1
- EUR 48,80
+ EUR 58,60
9,80
Shares
Aktien
Anzahl
Numberl
HypoVereinsbank
Bank Austria
Differenz
Profit/Loss
+ 18,16
Due to the short selling, the Hedge Fund gains an
approx. 100% higher profit than the trad. Fund.
Three Popular Arguments on Hedge Fund
Investments and Financial Market Stability ?
1. Hedge Funds operate high leveraged portfolios of
mostly risky assets. As a result, market processes
tend to be more volatile and more uncertain. Thus
syestemic market risk will increase !
2. Hedge Fund investments tend – because of their
sheer size – to manipulate asset prices. This will
directly compromise the pricing mechanism and thus
lead to inefficient factor allocations !
3. As Hedge Funds often do not have to follow any regulations that are used to be applied to onshore financial institutions (transparancy of investment styles,
accounting, disclosure and auditing, taxes etc.)
investors are not sufficiently protected.
CSFB/Tremont Hedge Fund Index Returns
1. Do Hedge Funds Increase Market Volatility ?
monthly S&P 500 Volatility
Source: Bloomberg
1. Are Hedge Fund Strategies
Risky Investments ?
-1 4 , 3 2 %
S& P 500
1 0 ,5 5 %
-6 , 4 1 %
Global Macro
1 2 ,0 1 %
-8 , 7 4 %
Equity Long / Short
1 3 ,7 7 %
-1 4 , 6 1 %
Emerging Markets
1 3 ,6 6 %
-4 , 1 0 %
Merger Arbitrage
1 0 ,8 0 %
-5 , 3 3 %
Event Driven
1 3 ,3 5 %
-6 , 5 4 %
Distressed Securities
1 4 ,2 7 %
Convertible Arbitrage
-2 , 9 6 %
Equity Market N eutral
-1 , 8 4 %
Standard Dev.
Annual Return
Hedge Fund Index
-20%
-15%
-10%
1 1 ,7 7 %
9 ,4 0 %
-6 , 9 7 %
-5%
1 5 ,1 3 %
0%
5%
10%
15%
20%
1. Do Hedge Funds Increase Systematic Risk ?
(Theoretical Portfolios of Traditional Assets (MSCI 50%, JP Morgan Global 50%)
and the CSFB-Hedge Fund Index based on monthly figures between 1994-2004)
1,00%
100% HF/
0% TF
Monthly Return
0,90%
0,80%
45 % HF / 55 % TP
0,70%
0 % HF /
100% TP
0,60%
0,50%
0,40%
1 ,8 0 %
2 ,0 0 %
2 ,2 0 %
2 ,4 0 %
Standard Deviation
2 ,6 0 %
2. Hedge Funds and Market Manipulation
Hedge Funds do not rely on momentum – investments and
often take contrary positions. Thus, their engagement will
support the pricing mechanism while providing liquidity and
keeping the market process running. By this, Hedge Funds
help substantially to rebalance the markets and smooth
volatility.
Hedge Funds, that operate in smaller markets generally have
the potential of market manipulation. In the case of arbitrage
trading or related relative value strategies, hedge funds
activities target directly to change market prices. A
„manipulation“ of prices back to the equilibrium is desired. This
may be seen different concerning other investment strategies.
2. Hedge Funds and Market Manipulation
In fact, only 20% of the total investment is arbitrage trading. The rest is more or less directional. The major part
of directional investments is represented by directional
equity-investments (long-/short-only).
120,00%
100,00%
DI RECTI O N AL
EVEN T DRI VEN
ARBI TRAGE
55, 00%
80,00%
67, 40%
47, 90%
60,00%
40,00%
20,00%
0,00%
11, 50%
20, 10%
18, 50%
20, 70%
19, 50%
2002
2004
8, 80%
1994
3. Need Investors to be Protected ?
The Hedge Funds market is dominated by well experienced, well informed
and educated powerful investors (average entry investment at 630 T$ !)
like banks, pension funds, endowments and wealthy individuals (HNI). As
they are strong enough to take care of their specific information needs, no
regulation is required.
Endowments
6%
Pension Funds
14%
High Networth
Individuals
53%
Banks,
Insurances
27%
3. Need Investors to be Protected ?
• Investor protection seems to be a week argument,
if it is focused on the typical hedge fund investor
as shown above.
• As hedge funds have started to copy the profitable
investment model of private equity funds in a short
term version, there are not the hedge fund
investors that need to be protected, but those long
term investors, who are affected by short term
hedge fund investment activities.
• Therefore, to focus investor protection on the
hedge fund investor is misleading. Investors should
be protected against hedge fund investors.
Summary and Conclusions
1. Currently Hedge Funds control an investment volume of
about 1.2 Trillion USD, which means a proportion of 12%
of the total global fund investments.
2. Although they are powerful, Hedge Funds are widely unregulated, e.g. they do not report their acitivities like other
financial institutions, mostly they don‘t have to fol-low
minimum capital requirements, minimum disclosure
standards or minimum audit standards. In a strong sense
they do not contribute to rational decision making.
3. Due to their characteristics – non regulated offshore
residents, excessive leverage, short sales and unlimited
incorporation of derivatives (synthetic assets) – their
investment styles and their sheer size, hedge funds affect
or have the potential to affect market processes.
Summary and Conclusions
4. The total business model including investors who
provide equity, hedge fund corporations that select
investments and investment styles and investment
banks which provide the loan is highly concentrated
and interlinked. That high integrated and concentrated business modell increases the probability of
extensively widespread cascading effects in case of a
failure (see the LTCM – Case in 1998).
5. As Hedge Funds have started to copy typically
„Private-Equity-Engagements“ even those parts of the
real economy that have not been direktly linked to
capital markets, have become the target of short
term financial investments and will be exposed to
intensified leverage risks.
Does The Market Need Hedge Fonds ?



Hedge Funds are in general non transparent, offshore
located and tax avoiding investment strategies beyond any
national jurisdiction.
Hedge Funds have not only the potential but also strong
incentives to manipulate market processes e.g. to generate
price movements that enhance the profitability of their
underlying positions.
With the today known market strategies that includes
desireable arbitrage trading only to a proportion of approximately 20% and the observable move to directional
strategies concerning long equity positions Hedge Funds
need to be regulated to support long term oriented microand macro-policy approaches.
Private Equity Investments
and Regulatory (Tax) Arbitrage
„Private Equity“ means to invest in non-listed, frequently
undervalued corporations and any other (undervalued)
assets. Mostly returns result simply from tax arbitrage.
Assets
E
1.000
D
500
500
Withdraw E. and
replace by D.
(rD: 4%)
Exp.: 60 Sales
Int. : 20
100
Tax:
5
Profit: 15
D(1)
500
Assets
1.000 (rD: 4%)
D(2)
(rD 8%)
Offshore
Tax
0 Int.
Profit 40
40
Exp.:
Int.:
Tax:
60
60
0
500
Sales
100
Loss
20