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Non-Tech : Derivatives: Darth Vader's Revenge

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From: Worswick9/24/2018 9:17:25 AM
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The ongoing now pervasive world wide unraveling ...

First the nonsense of China ... China being on of my fields for the last 40 years .... and the world's greatest current Ponzi ....ranking just after the repayment of government debt.

As Paul T said to me last year, "Everyone who doesn't have both feet nailed to the floor is trying to escape China with his money."

The belt road and opening central Asia and Middle Europe/ Africa ... of course these markets are absolutely central to the world of the future ... according to China.

For the sort of of China non issue drivel out there ... just today!

The now turning to more weighty matters: Europe and dislocation and derivatives.

Brexit: Circling the Drain? Posted on September 14, 2018 by Yves Smith

Due to managing to take a bit of holiday (and that meant not keeping up with the news) and being distracted by CalPERS (that will hopefully tail off by the end of the month) I have been neglecting Brexit. Even though I am writing this post in the form of an update, it is as much a forcing device for reader to tell me about stories and issues I may have missed that would affect some of the tentative conclusions below.

As this very far remove, I don’t see anything that has happened in the last two weeks that would change the very high odds of a crash out next March.

The EU graciously offering some token concessions is not tantamount to a softening of position. The new “we are gonna have a deal” date is now November, moved back from October. This is not a surprise; some commentators have opined that the negotiations could go as late as January….if there were actual negotiations, as opposed to the EU having to figure out what to do with UK inaction followed by obviously unworkable offers.

Jean-Claude Juncker making positive noises about Checquers is awfully reminiscent of his behavior during the 2015 Greece negotiation, where he would regularly try to play a more central role in the dealmaking than he really had, only to be slapped down or quietly pushed to the sidelines. Juncker has been looking statesmanlike compared to 2015, but that is also not hard with the likes of David Davis and Boris Johnson setting a baseline.

Another rumor, that the EU would let the UK largely out of the “defining the future relationship” seems dodgy. If you recall early on, many Tories, including some noisy Ultras, were insisting that the UK not agree to the Brexit bill unless it also got an “iron clad” trade agreement along with it. Someone apparently pulled them aside and told them it was impossible to get a trade pact done in anything less than a few years, with “five” a realistic minimum.

Shorter: quite a few people on the UK side were noisily of the view that the UK should firm up its trade deal as much as it could before Brexit because it would have more negotiating leverage then than during the transition period. Since all the exit agreement would include is a political statement of intent, it’s not binding.

However, the idea that the UK would manage to get an exit agreement done but decide to omit or fudge the “future relationship” part would seem daft, until you remember that we are already well into asylum territory. The UK needs to come to an agreement as to what sort of trade/legal relationship it wants with the EU going forward. If it can’t get that done in the context of a transition deal, pray tell how will it ever sort that out?

It makes every sense for the EU to be as gracious-appearing as it can be, not just for appearance’s sake, but for the historical record.

The Chequers plan is dead, yet May keeps flogging it. Even EU business leaders are telling the UK to get real. F rom the Financial Times earlier this month:

German business leaders have raised the alarm over the state of Brexit negotiations and are urging the UK government to soften its position ahead of make-or-break talks with Brussels in the coming weeks…

Mr [Joachim] Lang [director-general of Germany’s BDI industry federation] also voiced criticism of the UK position as set out in London’s recent Brexit white paper, in particular with regard to its proposal on trade. Among other points, the paper calls for a post-Brexit scenario in which the UK remains part of a single market for goods with the EU, while excluding the free movement of services, capital and people.

“The UK says it wants to keep the free movement for goods but become independent with regard to the other freedoms. We believe that cannot work,” said Mr Lang. Separating goods from services and the flow of people and finance, he added, was simply not possible in the modern economy.

“When we sell a piece of machinery today, we don’t just sell the product. We also sell services, data and maintenance,” he said. “You cannot pick one freedom but leave the other three on the sidelines. That simply does not work with modern industrial goods. We are not selling a piece of chocolate.”

His stance was supported by Bernhard Mattes, the president of Germany’s VDA car industry federation, which represents groups such as Volkswagen, Daimler and Bosch. Mr Mattes told the FT: “When you sell an industrial good you don’t just sell iron, steel and plastic — there is always a service that comes with the product.”

Honestly, this is all you need to know about the Checquers plan. As with every half-baked UK idea, it does not solve the problem it purports to solve. But these barmy proposals allow British pols to present themselves falsely as being oh-so-reasonable and depict the EU as obstructionist when they reject them.

No progress on the Irish border. No surprise, but this is yet another “crash out is coming” indicator.

Possible fading cred of the Ultras not likely to make much difference. Over the weekend, Richard North described how the Ultra’s alternative to May’s Chequers plan was widely ridiculed by the UK press. On the one hand, finally having the media willing to treat the rabid Brexiteers with scorn is long overdue. However, even in decline (if that is really happening), they still have enough votes in Parliament, and enough loyalists in the heartlands to be able to thwart reasonable outcomes, and in particular, a retreat.

Latest dire warning unlikely to have the impact it should. Yesterday, Mark Carney told the Cabinet that Brexit could be as crippling as the crisis of 2008.

Carney is wrong. A crash-out would be worse.

I hope to work this out in more detail in a future post, but the short version is that the financial crisis hit the heart of the financial system. While as we saw, the potential knock-on effects were catastrophic, the concentrated nature of the banking system in the UK and Europe meant that the authorities could identify the institutions and markets that were failing. They had to scramble to find and in some cases create the mechanisms to rescue them, but as we saw, the scale of the problem, although it taxed them to the max, was not beyond the operational capacity of central bankers, financial regulators, and politicians to handle on an emergency basis (as we know, for reasons of convenience and intellectual capture, they were uninterested in holding executives accountable, in restructuring the financial system so as to reduce the risk of large crises, and providing adequate support to real economy victims of the crisis).

The UK civil service is so crippled it can’t even manage to prepare competent Brexit white papers. How is it going to negotiate a trade with the EU and every other country with which it needs to enter into new treaties, let alone negotiate a new airlines pact, gear up massively for new customs requirements, while coping with the immediate chaos of a crashout or hard Brexit at the end of 2020? Another ugly secret is given the UK’s inability to get anything done, it is highly unlikely to be in all that much better shape at the end of a transition period than it will be in March 2019 (however, the damage would be less by virtue of the EU and multinationals being better prepared).

The point is that the UK government will be utterly overwhelmed. It will face real economy problems it is not remotely equipped to handle, and worse, for which it is making hardly any preparation, and will also be hit with stress to its banking system and a probable banking crisis.

The one difference with 2008 is my guess is the damage will not come as fast and dramatically as the Lehman collapse, but will accelerate as real economy and financial upheaval play into each other.

Again, I hate to seem high level and unduly simplistic, but it does not seem that anything significant has changed in the last two weeks. Please feel free to correct me if you think I am wrong, or as important, flag developments that could lead to shifts in due course.

Disorderly Brexit Would Trigger Mayhem in Derivatives Market by Don Quijones • Sep 20, 2018 • 22 Comments Time is running out. March 29 is the deadline. Urgent action is needed. But it’s not happening. By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET. With less than six-and-a-half months to go before the UK’s deadline to leave the EU expires, progress is still lacking in the Brexit negotiations, in particular on crunch issues such as the Irish border and the equivalency of financial services. As the doomsday clock ticks down, jitters are rising on both sides of the English Channel, particularly the English-speaking one.

On Monday, Moody’s said the probability of a no-deal Brexit has “risen materially,” and “would be negative for an array of issuers.” Such an outcome could bring with it a host of ugly consequences for the UK economy, ranging from a further weakening pound to higher inflation and sliding real wages, as well as undesirable knock-on effects for EU economies.

The longer the uncertainty drags on, the more likely it is that companies and banks will activate plan-B contingency plans, which in many cases involve moving a large chunk of their UK-based operations across the Channel. Once those plans are activated, stalling or reversing them will not be easy.

Deutsche Bank is mulling transferring up to three-quarters of the capital it has invested in the City — estimated to be worth around €600 billion — to its Frankfurt headquarters, the Financial Times reported on Sunday, citing sources close to the bank’s senior management. Tellingly, Deutsche Bank hasn’t made the move yet, since it knows that relocating key operations and staff across the channel is a costly, complex undertaking. It would much prefer to play a waiting game in the hope that the need for such drastic measures can be averted.

Most of the corporate moves that have taken place so far have involved small parts of firms’ operations, with few jobs lost in the City. But that dynamic appears to be changing as the Brexit deadline approaches. According, UK-based brokers and traders have already started activating contingency plans for a no-deal Brexit. Not even a last-minute agreement between UK and EU politicians will be enough to reverse those plans, they claim.

For the City of London, arguably its biggest fear is losing its hold over the global clearings business, which it has dominated for decades. Clearing is where a company acts as a middleman between financial trades, collecting collateral and standing between derivatives and swaps traders to prevent a default from spiraling out of control. London is home to the world’s largest clearing-house, LCH, which clears almost €1 trillion in euro-denominated derivatives a day, representing around three-quarters of the global market.

For City-based firms, the clearing business provides jobs and billions of pounds in annual profits. But those are now on the line. Euro-denominated contracts make up roughly a quarter of LCH’s daily volumes and with Brexit fast approaching, the ECB and certain European governments, with France leading the way, want a sizeable piece of that action, for largely justifiable reasons.

They’ll probably get it, said UBS analysts in a note last week. The analysts expect LCH to suffer a “25% loss of market share of the euro-denominated clearing market.” The authors also warn the clearing house will lose sales volumes “no matter the outcome” of Brexit, as “regulators like the European Banking Authority are encouraging institutions to prepare for a worst-case outcome to mitigate Brexit-related market disruptions.

This is spurring financial institutions to increase their business with Eurex, Germany’s largest clearing house, in a bid to reduce their Brexit exposure. The more customers Eurex attracts, the more competitive it becomes. Deutsche Bank shifted around half of its euro clearing volumes from LCH to Eurex in July. HSBC and Barclays also transferred volumes to Eurex earlier in the year, according to the FT.

In the UBS analysts’ best-case scenario, in which the UK and EU sign a provisional exit agreement by the March 29 deadline, LCH’s owner, the London Stock Exchange, will lose around 2-3% of its earnings per share.

In their worst-case scenario — a hard or no-deal Brexit — the resulting economic carnage could be huge. If the UK crashes out of the EU without any deal on future trading arrangements, it “would prohibit the clearing at LCH of ANY derivative contracts (not just euro-denominated contracts) by EU-domiciled entities,” the UBS analysts warn.

This doom-laden prognosis chimes with recent warnings by the Bank of England and the UK’s Financial Conduct Authority that derivatives contracts, valued in the tens of trillions of pounds, could be thrown into confusion by a disorderly Brexit. The London Metal Exchange (LME), the world’s largest market in options and futures contracts on base and other metals, has also chipped in, warning that its clearing house could struggle to provide services to European Economic Area ( EEA) countries after Britain leaves the European Union.

Of course, these dire predictions could be construed as good old-fashioned Brexit fearmongering, which is in endless supply these days. But it’s no longer just the Brits who are peddling this narrative. So, too, is the German financial regulatory authority, BaFin, which recently exhorted EU officials to take urgent action to prevent mayhem in the derivatives market and insurance industry after Brexit.

“It is almost impossible to fix that problem exclusively just by one side of the stakeholders involved, let it be the industry itself or individual supervisors,” BaFin’s president, Felix Hufeld said at a forum in Frankfurt at the end of August. There has to be “a solution on a political level” aimed at building a legislative or regulatory structure to prevent disruption, Hufeld said.

Time is running out. Until now, the European Commission and ECB have shown scant willingness to accept any form of equivalency between British and EU financial services. And without that, there is a genuine risk that a disorderly Brexit on March 29 could set in motion an unraveling of an already hugely volatile, highly interconnected derivatives industry.
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