First Impressions

The operational risk enigma
Alun Green – SunGard
Risk is on everyone’s minds nowadays. Although our industry has very sophisticated models and tools for areas such as market risk and counterparty exposure, we have made much less progress on operational risk. Maybe it’s because we don’t willingly take operational risks, since they’re not revenue driven.

The European Commission defines operational risk as “the risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events (including legal risk), differ from the expected losses.” As long as people, systems and processes remain imperfect, operational risk cannot be fully eliminated.

As firms look to reduce cost by outsourcing or offshoring, there is always a concern that the lack of control or experience might impact the business. Balancing the seemingly conflicting demands of quality and cost is a difficult exercise, and it’s hard to see how this can be solved by a broad brush approach.

Instead, there needs to be a considered assessment of business functions or even the activities contained within them to assess the operational risk and client impact. Maybe one of the premium services for FCMs could be for a “white glove” client services experience.

A key trend among regulatory-ready firms is the distinctive move to a decentralized model and an increased front office role in mitigating operational risk. This is being fueled by a need for greater proactive measures, risk modeling and forecasting, as well as controls and processes that better align to the business. There’s no doubt that operational risk is one of those industry bugaboos that still needs to be addressed. Firms that are able to analyse and quantify operational risk within their operating model will be at an advantage in the coming years.

Quote of the Day

“They are different from the typical residential mortgage-backed security transaction in that they offer exposure to the most affluent areas in London. The bonds will likely get a lot of attention from investors.”

Gareth Davies, the London-based head of European asset-backed securities research at JPMorgan Chase & Co in the story, “Oligarch Enclaves in London Opening to Bond Buyers”.

Lead Stories

Abenomics Could Hang in Balance By A Yen
Hiroyuki Kachi and A.D. Pruitt – MoneyBeat – WSJ
A single aluminum one yen coin doesn’t work in vending machines and there’s nothing you can buy with it, but the direction of Prime Minister Shinzo Abe’s pro-growth policies could be riding on which way the smallest denomination of the Japanese currency flips.
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***DA: In Japan, a strong currency is cause for alarm. In other parts of the world, a weak currency is causing panic.

Through train could expand to bonds and currencies, HKEx chief says
South China Morning Post
The upcoming tie-up between the Hong Kong and Shanghai financial markets could expand from stocks to fixed-income and currency products, Hong Kong Exchanges and Clearing chief executive Charles Li Xiaojia said.
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London FX Investigator-in-Chief Says Nothing Surprises
Suzi Ring – Bloomberg
“Manage your guilt.”
That’s Tracey McDermott’s strategy for not beating up on herself about missing dinner at home with her kids or skipping exercise, which the director of enforcement and financial crime at the U.K.’s Financial Conduct Authority has plenty of opportunity to do these days.
The daughter of a road paver and a primary school teacher, McDermott also spends a lot of time thinking about other people’s guilt. She has to decide whether traders who exchanged messages in chat rooms with names such as “The Bandits’ Club” and “The Mafia” were colluding to manipulate benchmarks in the $5.3 trillion-a-day currency market.
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***DA: More important is managing the message being sent to the trading community.

China, the Fragile Epicenter of a Digital-Finance Revolution
Michael J. Casey – MoneyBeat – WSJ
China is not one, but two economies, each fueled by a competing financial system. There’s the old, centrally planned economy dominated by too-big-to-fail state-owned enterprises and politically connected property developers. It’s kept afloat by cheap loans from state-run banks subsidized by repressed Chinese savers. It’s on a collision course with a second economy powered by cutting-edge technology.
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***DA: Will there be enough largesse from the latter to bail out the former?

Turkish central bank cuts main interest rate in surprise move
Reuters
Turkey’s central bank lowered its main interest rate for the first time in a year on Thursday despite stubbornly high inflation, in a surprise move weeks after Prime Minister Tayyip Erdogan called for a rate cut.
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***DA: Surprise move? That’s putting it mildly.

Oligarch Enclaves in London Opening to Bond Buyers
Alastair Marsh – Bloomberg
Buying a home in London’s most affluent areas is becoming unattainable for anyone without a billionaire’s bank balance. For those feeling squeezed out, a Swiss private bank is offering a side door to the market.
The U.K. unit of Zurich-based EFG International AG (EFGN) sold bonds backed by mortgages on homes in the Knightsbridge and Chelsea districts, where Russian oligarch Roman Abramovich and billionaire shipowner John Fredriksen own homes. The average value of the mortgages is 1.5 million pounds ($2.5 million) and the loans account for about 50 percent of property values, according to data compiled by Bloomberg.
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Yellen Tells N.Y.U. Graduates to Expect Failure and Learn From It
DIONNE SEARCEY – NYTimes.com
Janet L. Yellen has long occupied a front-row seat as Washington grappled with the financial crisis and the weak economy that has plagued the nation. Standing over second base at Yankee Stadium, where she delivered a commencement speech on Wednesday, Ms. Yellen suggested that playing the game is a lot harder than it looks from the stands.
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***DA: Will the Fed continue to backstop all of these failures?

FOMC minutes: rev-repo facility working how it should
Cardiff Garcia | FT Alphaville
Robin Harding summarises the discussion about the Fed’s exit strategy revealed in the FOMC minutes from the April meeting, when the committee also talked about the need for additional forward guidance.
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Ivory Coast and Ecuador to return to bond markets
Elaine Moore in London and Javier Blas in Kigali – FT.com
Two frontier countries with a chequered history of debt defaults are returning to sovereign bond markets just five years after they last suspended payments to investors.
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***DA: A good time to raise capital as plenty of folks are reaching for yield.

Janet Yellen’s low rates gift is Mario Draghi’s burden
Ralph Atkins in London – FT.com
Call it Janet Yellen’s gift to the US people – and snub to Europe. The big market surprise of 2014 has been the fall in US Treasury yields, which move inversely with prices. Rather than rising this year, 10-year US government borrowing costs actually slipped last week to a 10-month low. So much for the end of the bull market.
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The debt that’s only for those on the A-list
Ayesha Javed – Financial News
Nobody likes gate-crashers. Least of all private equity firms keen to keep a firm grip on portfolio companies that are at risk from aggressive debt holders.
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Correction warning as end of zero rates approaches
Jamie Chisholm – FT.com
Much ink has been spilled, and many hedge fund careers hurt, by the conundrum of US stocks at record highs alongside Treasury yields near historically low levels. But Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, reckons this phenomenon can continue for a while yet with equities holding their own even as borrowing costs nudge lower still.
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New Faces Behind Fed Dots Seen Roiling Markets as Forecasts Move
Jeff Kearns – Bloomberg
Turnover among Federal Reserve policy makers gives investors more reason to heed Chair Janet Yellen’s advice: don’t pay too much attention to officials’ interest-rate forecasts.
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A dash for cash and a grope for volatility
David Keohane | FT Alphaville
Here is how a (now very sad) institutional investor was positioned during this year’s rally in bonds, commodities and equities according to Michael Hartnett’s latest Thundering Word at BofAML:
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In which Mohamed El-Erian compares the Fed to a Disney villain
Izabella Kaminska | FT Alphaville
From Mohamed El-Erian’s latest offering to Project Syndicate: Like Princess Anna in Frozen, it will take time for markets to recognize that their relationship with the Fed is changing (and should change); and, similar to the movie, some sort of shock may be involved in socializing the new understanding.
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Hedge Funds Clash With Wall Street Bankers in Argentina
Katia Porzecanski – Bloomberg
The surge in Argentina’s securiti
es tied to economic growth is rekindling a decade-old disagreement between investors and Wall Street.
The warrants, which provide payouts when growth exceeds targets, have jumped 29 percent from a nine-month low in March on speculation a data revision that boosted the size of the economy will lead to bigger payments in the future.
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Central Banks

BOE’s Bean Says Crisis Shows Worse Things Can Happen Than You’d Imagine
Jason Douglas – MoneyBeat – WSJ
Central banks are routinely criticized for failing to foresee the crisis that tipped the world into recession in 2009. Charles Bean, the Bank of England’s outgoing deputy governor for monetary policy, on Tuesday underscored how other things kept monetary policy makers awake at night.
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***DA: Great – now I can’t sleep. Thanks, Beano.

Is the BOE Bluffing When it Says Rates Are Staying Low?
Alen Mattich – MoneyBeat – WSJ
Bank of England Governor Mark Carney seems determined to leave U.K. rates as low as possible as long as possible, when they finally start to go up, to raise them slowly, and then to take them to a summit that’s well below previous norms. But could it be that he’s playing a dangerous game of bluff with the markets?
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***DA: It’s hard to call the bluff of an entity who can go all in with a currency it can print in unlimited sums.

BoJ offers brighter view on economy
Business Standard
The Bank of Japan kept policy steady on Wednesday and painted a slightly more optimistic view of the economy, dropping a reference to the country being in deflation and further dashing expectations it will offer more stimulus any time soon.
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***DA: Does Japan have any other choice but to put on a happy face?

Kocherlakota: Fed Doing a Bad Job Of Meeting Job, Inflation Goals
Michael S. Derby and Jacob Bunge – WSJ
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Wednesday that the U.S. central bank is still failing to deliver on its employment and inflation goals.
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***DA: The Fed’s job is not to deliver jobs, but rather support an environment conducive to long term stability.

Fed begins policy exit talks, split on view of U.S. job market
Reuters
Federal Reserve policymakers last month began laying groundwork for an eventual retreat from easy monetary policy with a discussion of how to best control interest rates as they remove trillions of dollars from the financial system.
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European Central Bank: Annual Report Shows TARGET2 Processed A Greater Total Volume Of Payments In 2013
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Bank Of England: Minutes Of The Monetary Policy Committee Meeting Held On 7 And 8 May 2014
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Currencies

Euro Bears Look to Be Right as Futures Show Shift
Andrea Wong – Bloomberg
The stars are finally aligning for euro bears. Firms from Morgan Stanley to Bank of America Corp. that for almost a year called for weakness in the 18-nation currency, only to see it soar to the highest level since 2011, say they’re about to be vindicated.
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***DA: Not wrong, just early. Been there.

China Money Rates Rise as Pickup in PMI Offsets Fewer PBOC Repos
Bloomberg
China’s money-market rates increased as manufacturing data suggesting the economy is improving spurred speculation the central bank will curb cash injections.
A preliminary Purchasing Managers’ Index by HSBC Holdings Plc and Markit Economics rose to 49.7 this month, higher than the median estimate of 48.3 in a Bloomberg News survey and a final 48.1 in April. The People’s Bank of China’s open-market operations added a net 120 billion yuan ($19.2 billion) to the financial system this week, the most in four months. It sold 30 billion yuan of 28-day repurchase agreements today at a yield of 4 percent, while 85 billion yuan of the contracts matured.
jlne.ws/TxReLc

Bank of Russia Trims Daily Currency Interventions
WSJ.com
The Bank of Russia said Thursday it cut the amount of daily currency interventions, aimed at limiting ruble volatility, moving closer to inflation targeting. The central bank plans to let the ruble float freely starting from 2015 and instead focus on taming inflation through interest rates.
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Indexes & Index Products

Trader Spends $13 Million Betting VIX Index Will Surge 56%
Callie Bost – Bloomberg
A trader paid almost $13 million to buy call options that pay off if the Chicago Board Options Exchange Volatility Index rises at least 56 percent in the next four months.
The person used a strategy known as a call spread, designed for bets that a security will trade within a certain range. About 150,000 bullish contracts on the VIX expiring in September with a strike price of 19 were bought, according to an e-mailed note from Lake Hill Capital Management LLC, which specializes in derivatives trading and research. The cost was offset by selling the same amount of Sept. 28 calls.
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***DA:

Scenes from an Independent Brokerage Firm
Joshua M Brown | The Reformed Broker
I consider non-traded REITs or nREITS to be part of the group of investments that are just absolute murderholes for clients – they pay the brokers so much that they cannot possibly work out (and they rarely do wihout all kinds of aggravation and additional costs). Further, I have yet to hear a single credible explanation as to why a broker would recommend a non-traded REIT over a public REIT other than compensation.
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S&P, BlackRock plan ‘smart’ bond indexes and funds
Ashley Lau – Reuters
Companies such as BlackRock Inc and Standard & Poor’s are taking a popular stock fund strategy and applying it to bonds.
For more than a decade, asset managers have been creating stock funds that track indexes designed to outperform those based on their components’ market value. Bond funds are the next frontier for index designers who use this “smart beta” approach to boost returns by taking advantage of market inefficiencies.
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Gold

Gold Bull Kaplan Eyes First Fund for Outside Investors
WSJ.com
One of the biggest believers in gold is prospecting for outside investors after seeing the value of his personal holdings cut sharply in the metal’s steep fall. New York investor Thomas Kaplan is looking to raise $500 million for a private-equity-style fund to make more bets on gold and other precious metals, say people familiar with the matter.
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Gold Imports by India Seen Rising as RBI Relaxes Curbs
Swansy Afonso – Bloomberg
Gold imports by India, the world’s second-biggest user, will probably rise after the Reserve Bank of India allowed more companies to buy the metal from overseas.
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Polymetal Agrees to Buy Kazakh Gold Project for $618.5 M
Ilya Khrennikov and Yuliya Fedorinova – Bloomberg
Polymetal International Plc (POLY), the gold and silver producer part-owned by Russian billionaire Alexander Nesis, agreed to buy the Kyzyl project in northeast Kazakhstan for $618.5 million to add 50 percent to its reserves.
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