By Frank Manganella, head of FIC sales US, Commerzbank
The perfect storm, a phrase made popular by the 1997 novel about a fishing boat crew lost at sea, is a confluence of events that create an ambiguity around certain situations. The global financial markets are in the midst of a perfect storm, born out of the financial crisis of 2007, where regulatory reforms such as the Dodd- Frank Wall Street Reform Act, and stagnant political and economic conditions are affecting financial institutions and institutional investors alike.
Regulatory reforms are prompting financial institutions to maintain higher capital requirements, follow prudent liquidity provisions, reduce proprietary trading risks and revise their overall conduct of business. Regulatory changes also have specific impacts for end-users, such as hedge funds and other private funds. In the US, the Dodd-Frank Act has impacted the Commodity Exchange Act. General partners and advisers of private funds investing in commodity interests, including swaps, will no longer be exempt for registration as a “qualified purchaser”. Hedge funds with more than $150m in assets under management are required to register with the SEC and adhere to the 1940 Investment Advisers Act requirement. These disclosures are similar to the AIFMD directive. Furthermore, the changes to the OTC (over the counter) derivatives markets will increase costs to end-users trading derivatives such as interest rate and credit default swaps. These costs include collateral management and e-trading upgrades. Politically, the Presidential elections in the US created ambiguity in regards to fiscal retrenchment and monetary policy, where the two parties were divided on the benefits of quantitative easing and potential trade wars with China. While risk has abated from a potential withdrawal of monetary and fiscal stimulus, the largest risk factor for the US economy is the ongoing concerns for a number of critical issues – the fiscal cliff, a breach of the debt ceiling, and another potential downgrade by the rating agencies. The election results did not resolve a split Congress, where divided control of the House and Senate remain a challenge for advancing effective fiscal and economic measures to strengthen the economy. Fiscal austerity, as evident by the European debt crisis, could lead to further consolidation in economic activity in the US. This has two major implications: potential for further quantitative easing and the recurring risk-off/risk-on trading in shorter cycles, remaining a theme in 2013. Investors have struggled to manage in an ultra-low yield, low volatility environment, shifting appetite to higher- yielding assets such as real estate and corporate debt. However, financial activity volumes have dropped across asset classes such as foreign exchange and securitisation. Securitisation volumes have decreased due to new capital and disclosure rules. Foreign exchange has experienced lower volatility on converging interest rate policies across developed and emerging countries. Hedge funds have performed in equities, commodities and credit. A further consolidation in economic growth in the US could lead to downward corporate earnings revisions and lower demand for commodities from developing nations, reducing investment opportunities. Alternatives such as real estate and timber are still attractive investments. Credit products, such as corporate loans and emerging market debt continue to gather demand as investors search for yield in an ultra-low yield environment. As hedge funds, alternative asset managers and private funds continue to navigate through this perfect storm of regulatory burdens, political risk and economic uncertainty, it’s important that banks find ways to ‘partner up’ with clients, in order to find solutions. Specialist client support teams are needed to offer expertise across a variety of asset classes, and proven skill sets in areas such as tax, repackaging and regulatory advisory. As the unrelenting search for yield continues in the midst of this perfect storm, banks need to remain steady and prepared to help clients navigate the new world of financial markets.
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