U.S. Regulators Seek Trace-like Reporting for OTC Derivatives

By Matthew Leising

May 14 (Bloomberg) -- U.S. regulators may impose the same price reporting and transparency requirements on over-the- counter derivatives that reduced bank profits by almost half in the corporate bond market when the Trace system was adopted seven years ago.

“I think it’s something we’ll look at very closely as a potential model,” Securities and Exchange Chairwoman Mary Schapiro said yesterday at a news conference in Washington, in which regulators laid out potential structural changes to improve policing of the $684 trillion OTC derivatives market.

Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, gives anyone with an Internet connection access to trading data for corporate bonds. The system, in full operation since February 2005, reduced the difference in prices that banks charge to buy and sell bonds by almost half.

Treasury Secretary Timothy Geithner, Schapiro and Michael Dunn, the acting chairman of the Commodity Futures Trading Commission, called for increased oversight of over-the-counter derivatives to reduce risk to the financial system. Lax regulation contributed to the failures last year of Lehman Brothers Holdings Inc. and American International Group Inc., leading to the seizure of credit markets and causing more than $1.4 trillion in writedowns amid the worst financial crisis since the Great Depression.

‘Accept the Reality’

“Dealers have to accept the reality that this business -- where margins were compressing already -- is getting less profitable,” said Stephen Bruel, research director for securities and capital markets for Tower Group, a research and advisory firm in Needham, Massachusetts. “A lot of the action you’ll see is to contain the size and scope and profitability of this market.”

The bid-ask spread on investment-grade corporate bonds was about seven basis points before Trace was implemented and about four basis points immediately after, according to a study by Kumar Venkataraman, an associate finance professor at Southern Methodist University’s Cox School of Business in Dallas, published in the Journal of Financial Economics. A basis point is 0.01 percentage point.

Schapiro helped developed the Trace system in 2002 when she was president of the NASD, which was consolidated into Finra. Schapiro, Geithner and Dunn pledged at the news conference to work together on changes in the market.

‘Significant Gaps’

“Significant gaps in the basic framework of oversight over critical institutions” helped cause the financial crisis, Geithner told reporters. “A series of comprehensive reforms to create a stronger system, less vulnerable to crisis, with stronger protections for consumers and investors” will be hashed out with Congress, he said.

Part of his plan is to push banks to increase price transparency by adopting electronic trading systems for over- the-counter derivatives. Over-the-counter derivatives transactions are now typically conducted over the phone between banks and customers.

Geithner sent a proposal to Congressional leaders listing four main objectives: to protect against systemic risk by creating a more resilient market, improve efficiency and transparency, prevent manipulation and fraud and reduce risks to less-sophisticated investors, Geithner said.

“Some of the U.S. authorities have said we were pretty close to a meltdown and I actually think listed marketplaces with multilateral clearing are part of the answer to that question,” said Thomas Kloet, chief executive officer of TMX Group Inc., owner of Canada’s main equities and derivatives market. “I hope authorities don’t let go of that. I think they have to address that.”

Shares Rise

Shares of CME Group Inc. and Intercontinental Exchange Inc. rose yesterday after Bloomberg News reported Geithner’s plan. Chicago-based CME Group, the world’s largest futures exchange, soared $15.62, or 6 percent, to $274.10 as of 4 p.m. in Nasdaq Stock Market trading. Intercontinental of Atlanta, the second- largest U.S. futures market, rose as much as 5.2 percent, before closing up 9 cents to $96.59 on the New York Stock Exchange.

“This is the best Wall Street can hope for,” said James Cox, a securities law professor at Duke University in Durham, North Carolina. “This will allow them to stay in business and still make money. It also cuts off what potentially would have been more regulation.”

Once a Day

Only about 10 percent of bank customers use electronic systems to trade over-the-counter derivatives, according to Paul Zubulake, a senior analyst with Boston-based Aite Group. That compares with about 90 percent of inter-bank trades that are done electronically through inter-dealer brokers such as London- based ICAP Plc or Dealerweb, according to Zubulake.

Prices for indexes of credit-default swaps, contracts used to hedge against or speculate on corporate debt, have been made public once a day since March by Markit Group Ltd. and Intercontinental Exchange, the first company to guarantee the contracts with a clearinghouse. Prices for other over-the- counter contracts, such as interest-rate swaps, are not widely available.

The need for transparency in the over-the-counter derivatives market was stressed by Theo Lubke, a senior vice president at the Federal Reserve Bank of New York, last month at a derivatives industry conference in Beijing.

More Information

Lubke, who was appointed in 2007 to oversee OTC derivatives by Geithner when he was president of the New York Fed, said the credit swap prices now available are not sufficient, according to a transcript of his comments.

Because investors don’t know when trades took place or how many occurred, more information is needed, he said April 23 at the International Swaps and Derivatives Association general meeting in Beijing.

“That window of opportunity to make changes as opposed to having those changes brought to the market by external forces is narrowing,” he said. “It is in market participants’ interest as well as the interest of regulators to see continued rapid movement.”

Derivatives are contracts whose values are tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

“ISDA welcomes the recognition of industry measures to safeguard smooth functioning of privately negotiated derivatives,” Robert Pickel, chief executive officer of ISDA, said in an e-mailed statement.

Lubke said at the ISDA conference that the major banks’ control of the over-the-counter derivatives market must end by allowing hedge funds and other investors more input into how market decisions are made.

“It is simply unacceptable in today’s environment that the design and structure of the OTC derivatives market can be controlled by a handful of large dealers,” Lubke said. “There is opacity in the OTC market that doesn’t have commensurate public policy benefits,” he said. “This is not something that can continue.”

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net

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TMX Says Derivatives on Exchanges May Align Buffett, Greenspan

By Doug Alexander

May 14 (Bloomberg) -- Over-the-counter derivatives contracts should clear on exchanges to improve transparency and reduce risk in the financial system, the head of Canada’s main bourse said.

“Almost all of the problems that relate to the economic crisis” stem from OTC derivatives, TMX Group Inc. Chief Executive Officer Thomas Kloet said in an interview yesterday in New York. “Listed derivatives are actually part of the solution, not part of the crisis.”

Kloet joins U.S. Treasury Secretary Timothy Geithner in calling for over-the-counter derivatives markets to be moved onto regulated exchanges and trading platforms. Transactions in this $684 trillion market are now typically conducted over the phone between banks and customers. Toronto-based TMX gets about 16 percent of its revenue from derivatives trading.

The shift may also create common ground between Warren Buffett and Alan Greenspan, Kloet, 51, said. Buffett, Berkshire Hathaway Inc.’s chairman and CEO, once called derivatives “financial weapons of mass destruction.”

In his annual letter to shareholders released in February he said that increased transparency won’t solve the problems derivatives pose. Carrie Kizer, Buffett’s assistant, didn’t immediately respond to an e-mail seeking comment.

“We think the derivative markets as they evolved have done more public damage than public benefit,” said Berkshire Vice Chairman Charles Munger, in a Bloomberg Television interview earlier this month.

Greenspan, the former U.S. Federal Reserve chairman, said for years that derivatives -- contracts used to bet on everything from bond prices to weather patterns -- reduce risk.

Closes Gap

“I actually do” think it bridges the gap in the views held by Buffett and Greenspan because over-the-counter derivatives cleared through exchanges are less risky, said Kloet.

Bank trading in unregulated markets such as over-the- counter derivatives was singled out by Geithner yesterday as he promised a more conservative oversight regime.

“The regulatory authorities have a unique window of opportunity to clean this mess up,” Kloet said. “I think the U.S. Fed very quietly gets it.”

TMX is in talks with the Bank of Canada to allow it to clear over-the-counter contracts such as interest-rate repurchase agreements and interest-rate swaps on its own platform, Kloet said. TMX operates the Toronto Stock Exchange, Canada’s main equities market, and the country’s derivatives market in Montreal.

Rates Swaps

“It’s a natural edge onto our fixed-income derivative markets,” Kloet said.

TMX may provide clearing of repurchase agreements within the year, followed by interest-rate swap contracts by 2011, he said. TMX is unveiling a new clearing system by the end of this month, which will allow it to handle these contracts, Kloet said.

The move to exchange-traded contracts would add transparency, increase liquidity and may help avoid the problems sparked by the subprime-mortgage collapse in the U.S., said John Aiken, a financial services analyst at Dundee Securities Corp. in Toronto.

“From a TMX standpoint, it’s definitely a positive because you’re putting one more product through the system,” Aiken said.

U.S. Expansion

TMX may also develop a new exchange in the U.S., modeled after the Toronto-based TSX Venture Exchange, a junior marketplace for 2,269 companies. This would allow TMX to attract more listings from U.S. companies, while adding more trading from foreign investors, he said.

“That kind of approach would make sense in an American exchange,” Kloet said. “That’s something we’ll continue to look at.”

Kloet expects to see more consolidation among global stock exchanges and that his bourse may expand through acquisitions.

“We would consider anything that adds a strategic niche to the organization and helps us with our overall strategy,” Kloet said in an interview on Bloomberg Television.

TMX has diversified from equity trading in the past year after buying a 20 percent stake in London Stock Exchange Group Plc’s derivatives market, acquiring majority ownership in Boston Options Exchange and spending about C$1.1 billion ($940 million) for the Montreal Exchange.

Kloet, who took over as CEO 10 months ago, said the investment with the London bourse isn’t necessarily the first step toward a merger of the two companies.

“We’re going to walk before we run,” he said. “Getting big just to get big doesn’t make a whole lot of sense.”

“The institution’s not for sale and not actively on the prowl” for mergers, he said.

To contact the reporter on this story: Doug Alexander in Toronto at dalexander3@bloomberg.net.

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Harvard Buys Korea, Brazil ETFs as Emerging Markets Beat U.S.

By Gillian Wee

May 14 (Bloomberg) -- Harvard University, the richest U.S. college, raised its holdings of exchange-traded funds that track stocks in Brazil, China and Mexico in the first quarter as emerging markets outperformed U.S. equities.

The biggest new purchase reported by Harvard Management Co., which oversees the school’s $28.8 billion endowment, was 1.74 million shares of iShares MSCI South Korea Index Fund valued at $49 million, according to a filing yesterday with the U.S. Securities and Exchange Commission. Its largest stake was 8.28 million shares of iShares MSCI Emerging Markets Index valued at $205 million.

The quarterly 13F filing, which doesn’t reflect all of Harvard’s equities, offers a glimpse of how the Cambridge, Massachusetts, school is navigating the worst financial crisis since the Great Depression. The MSCI Emerging Market Index rose 0.52 percent in the quarter, while the Standard & Poor’s 500 Index, a benchmark of U.S. stocks, fell 12 percent.

Harvard Management Co. reported buying 61 U.S. listed securities in the quarter and selling off 28, leaving 90 issues. The value of its holdings rose 35 percent to $771 million.

Harvard’s endowment fell 22 percent from July 1 through Oct. 31, and is headed for its worst performance in at least four decades. The fund has been run since July by Jane Mendillo, former chief investment officer of nearby Wellesley College.

The report doesn’t show the school’s investments in stocks outside of the U.S. or in hedge funds, private equity, commodities and real estate. In addition, more than half of the endowment is overseen by outside firms. John Longbrake, a Harvard spokesman, didn’t respond to an e-mail seeking comment.

Vanguard Emerging Markets

Harvard added to its ETF holdings in the quarter by buying 2.27 million shares of Vanguard Emerging Markets, as well as 1.5 million shares of iShares MSCI Brazil Index Fund and 1.14 million iShares FTSE/Xinhua China 25 Index Fund.

Exchange-traded funds typically are designed to mimic the performance of market indexes. Unlike mutual funds, whose shares are priced once daily after the end of each trading session, ETFs are listed on an exchange where shares are bought and sold throughout the day like stocks.

Harvard’s new purchases during the quarter include 1.47 million Class A shares of News Corp., the media company run by Rupert Murdoch, and 1 million shares of wireless phone company Sprint Nextel Corp. The school sold all 722,000 shares of GenCorp Inc., a manufacturer of aerospace and defense products; 605,000 shares of Heckmann Corp., which sells bottled water in China; and 575,000 shares of Columbus Acquisition Corp., a company set up to make acquisitions.

Harvard, projecting an endowment loss of as much as 30 percent, has frozen hiring and salaries and fired staff. Harvard raised cash by issuing $2.5 billion in bonds in December after failing to sell $1.5 billion in private-equity stakes.

Harvard Management in February said it planned to fire as many as 50 workers, including investment professionals, as part of an effort by Mendillo to “rebalance and reengineer the organization,” Longbrake said at the time.

To contact the reporter on this story: Gillian Wee in New York at gwee3@bloomberg.net;

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MSCI Boosts Taiwan Companies; Argentina Downgraded

By Patrick Rial and Reinie Booysen

May 14 (Bloomberg) -- MSCI Inc. boosted the number of Taiwanese companies in its indexes, while Argentina’s equities were downgraded following a semi-annual review. Maxim Integrated Products Inc. is among the three largest additions to the MSCI World Index.

The MSCI Taiwan Index will see 22 companies added and one deleted. The additions will result in $687 million in capital inflows to Taiwan, according to estimates by Merrill Lynch & Co., the most of any country. Argentina was downgraded from the Emerging Markets Indices to the Frontier Markets Index.

“The only real surprise was the magnitude of changes and additions for Taiwan,” said Chris Lobello, a risk and trading strategist at CLSA Ltd. Argentina’s cut is “a message from MSCI that the trading environment is just too difficult.”

Taiwan’s Taiex index has soared 39 percent this year, the second-best performance in Asia behind China, on optimism improved relations between the two countries will boost investments.

MSCI’s changes may trigger $687 million of inflows from fund managers who use the indexes, according to Merrill Lynch & Co. estimates. The Merval Index has climbed 35 percent in Argentina this year, following a 50 percent slide in 2008 after the South American nation’s government nationalized pension funds with stock investments.

Weight Increase

The weighting of Taiwan stocks in the MSCI Asia ex-Japan Index will likely rise to 17.9 percent from 16.9 percent, Lobello wrote in a report. He said stocks getting added to the benchmarks typically rise in the period up to the change and fall afterward.

U.S. companies Maxim, Crown Holdings Inc. and Myriad Genetics Inc. will be the three largest additions in the MSCI World, a dollar-based, free-float market weighted benchmark of stocks in 23 developed nations, MSCI said in a statement dated yesterday. The changes will occur after the May 29 close.

Maxim, a maker of microchips for laptop computers, has climbed 19 percent this year, outpacing a 2.1 percent decline by the Standard & Poor’s 500 Index. Aluminum can producer Crown has added 18 percent, while cancer test-maker Myriad lost 0.7 percent.

Global Contraction

The gauge has slumped 40 percent in the past year amid what the International Monetary Fund is predicting to be the first contraction in global growth since the end of World War II.

MSCI provides a variety of indexes divided into countries, industry groups, value metrics and other categories. The company estimates more than $3 trillion in funds are benchmarked against their indexes globally.

Changes to the MSCI indexes can cause shares that are chosen for inclusion to advance and those slated for deletion to drop as passively managed funds designed to mirror the benchmarks buy and sell stocks in accordance with those changes.

Hong Kong-listed Kingboard Chemical Holdings Ltd. and Renhe Commercial Holdings Co. and South Korea’s NCSoft Corp. are the three largest inclusions to the MSCI Emerging Markets Index.

Wintek Corp., a supplier of flat-panel displays for Apple Inc., and Farglory Land Development Co., Taiwan’s largest developer, both rose by their daily limit of 6.9 percent in Taipei after being added to MSCI’s indexes. Argentina’s Banco Macro SA, which appointed a government director to its board in April, climbed 38 percent this month prior to the announcement it will be deleted from MSCI’s gauges.

Trinidad and Tobago was added to the Frontier Markets Index.

Noble Energy Inc., TD Ameritrade Holding Corp. and Autozone Inc. were the biggest additions to the MSCI U.S. Large Cap 300 Index.

To contact the reporters on this story: Reinie Booysen at rbooysen@bloomberg.net; Patrick Rial in Tokyo at prial@bloomberg.net.

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CommVault, Forest City, MBIA, Whole Foods: U.S. Equity Preview

By Lu Wang

May 14 (Bloomberg) -- Shares of the following companies may have unusual moves in U.S. trading. Stock symbols are in parentheses.

Clearwire Corp. (CLWR US): The U.S. provider of high-speed WiMax mobile services reported a narrower first-quarter loss after adding customers in new markets.

Coca-Cola Enterprises Inc. (CCE US): The world’s largest soft-drink bottler was added to Goldman Sachs Group Inc.’s “conviction buy list” on expectation growing soda demand and falling commodity prices will bolster earnings.

CommVault Systems Inc. (CVLT US): The supplier of data- management software reported earnings of 9 cents a share in the fiscal fourth quarter, missing the average analyst estimate by 40 percent.

Forest City Enterprises Inc. (FCE/A US): The developer of New York’s $4.2 billion Atlantic Yards project said it plans to sell 40 million shares in a public offering and it’s in talks with lenders to extend its $750 million revolving credit line, which matures next March.

MBIA Inc. (MBI US): The biggest bond insurer was sued by Bank of America Corp., JPMorgan Chas & Co., UBS AG and 15 more of the world’s largest financial companies, which said the split of MBIA’s guarantee business illegally cut their odds of getting paid on policies.

Whole Foods Markets Inc. (WFMI US): The largest natural- goods grocer in the U.S. posted an adjusted second-quarter profit of 25 cents a share, exceeding the average analyst estimate by 34 percent.

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

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Japanese Stocks Slump on U.S. Retail Sales, Yen; Inpex Drops

By Masaki Kondo

May 14 (Bloomberg) -- Japanese stocks fell the most this month after U.S. retail sales unexpectedly dropped in April, clouding the earnings outlook for makers of cars and electronics.

Toyota Motor Corp., the world’s biggest automaker by market value, retreated 3 percent. Sony Corp., which gets a quarter of its sales from the U.S., declined 4.9 percent after the yen strengthened. Inpex Corp., Japan’s largest oil and gas explorer, sank 5.1 percent after it forecast a drop in full-year profit and oil prices slid. Nippon Telegraph & Telephone Corp. surged 4.1 percent after saying it will raise its dividend.

The Nikkei 225 Stock Average declined 208.02, or 2.2 percent, to 9,132.47 as of 9:42 a.m. in Tokyo, the steepest drop since April 28. The broader Topix index fell 19.47, or 2.2 percent, to 869.28. The Nikkei traded at 130 times estimated profit for its member companies yesterday.

“The U.S. retail report stole confidence from investors that the global economy was headed for a recovery,” said Mitsushige Akino, who oversees about $629 million at Ichiyoshi Investment Management Co. in Tokyo. “Current valuations are prohibitive unless you believe companies will raise annual forecasts later this year.”

The Nikkei gained 5.4 percent this year through yesterday, and companies on the measure are estimated to pay dividends equivalent to 1.68 percent of average share prices, according to gauge compiler Nikkei Inc. That compares to the 1.45 percent return on 10-year Japanese government bonds.

In New York, the Standard & Poor’s 500 Index slid 2.7 percent as the Commerce Department reported a 0.4 percent decline in retail sales last month. Economists had estimated the number would be unchanged.

Yen, Oil

Toyota lost 3 percent to 3,550 yen, while closest rival Honda Motor Co. dropped 3.4 percent to 2,730 yen. Sony, the world’s No. 2 electronics maker, sank 4.9 percent to 2,450 yen.

The yen appreciated against the dollar to as much as 95.14 today, the strongest level since March 20, from 96.47 at the close of stock trading in Tokyo yesterday. Japanese businesses expect the currency to average 97.18 this fiscal year, according the Bank of Japan’s quarterly Tankan survey.

The U.S. sales report fanned concern falling consumer spending will curb demand for resources. Crude oil for June delivery lost 1.4 percent to $58.02 a barrel in New York, the steepest drop since April 27. Copper futures fell 2.6 percent.

Lower crude prices prompted Inpex to forecast a 61 percent tumble in net income this fiscal year, a filing with the exchange showed yesterday. Inpex fell 5.1 percent to 689,000 yen.

MSCI Index

Mitsubishi Corp., Japan’s biggest trading company by value, declined 4.9 percent to 1,642 yen, and rival Mitsui & Co. lost 4.5 percent to 1,126 yen. Both companies derive more than half their earnings from commodities.

NEC Electronics Corp., the fourth-largest chipmaker in Japan, decreased 11 percent to 921 yen. Rinnai Corp., which makes gas appliances, soared 6.6 percent to 4,190 yen.

MSCI Inc. said yesterday NEC Electronics, Takefuji Corp., Alps Electric Co. and Haseko Corp. will be removed from its MSCI Japan Index as of the close on May 29. Rinnai, GS Yuasa Corp. and McDonald’s Holdings Co. Japan Ltd. will be added, MSCI said. Changes to indexes can alter share prices as passively managed funds buy and sell stocks to mirror the benchmarks.

NTT, Japan’s largest telecommunications provider, surged 4.1 percent to 4,050 yen after saying it plans to raise its dividend by 9.1 percent to 120 yen ($1.26). That will bring the stock’s dividend yield to 3.1 percent based on yesterday’s close.

Nikkei futures expiring in June retreated 2.4 percent to 9,140 in Osaka and slumped 2.3 percent to 9,145 in Singapore.

To contact the reporter for this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net.

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Maxim Added to MSCI World Index; Argentina Downgraded

By Reinie Booysen and Patrick Rial

May 14 (Bloomberg) -- MSCI Inc. said shares of U.S.-based Maxim Integrated Products Inc. are among the three largest additions to the MSCI World Index, while Argentina’s equities were downgraded.

Maxim, Crown Holdings Inc. and Myriad Genetics Inc. will be the three largest additions in the MSCI World, a dollar-based benchmark of stocks in 23 developed nations, MSCI said in a statement today. The changes will occur after the May 29 close.

The gauge has slumped 40 percent in the past year amid what the International Monetary Fund is predicting to be the first contraction in global growth since the end of World War II.

MSCI provides a variety of indexes divided into countries, industry groups, value metrics and other categories. The company estimates over $3 trillion in funds are benchmarked against their indexes globally.

Changes to the MSCI indexes can cause shares that are chosen for inclusion to advance, while those slated for deletion to drop as passively managed funds designed to mirror the benchmarks buy and sell stocks in accordance with those changes.

Hong Kong-listed Kingboard Chemical Holdings Ltd. and Renhe Commercial Holdings Co. and South Korea’s NCSoft Corp. are the three largest inclusions to the MSCI Emerging Markets Index. NCSoft gained 1.4 percent even as the nation’s benchmark Kospi index lost 1.3 percent.

Argentina was downgraded from the Emerging Markets Indices to the Frontier Markets Index. Trinidad and Tobago was added to the Frontier Markets Index.

Noble Energy Inc., TD Ameritrade Holding Corp. and Autozone Inc. were the biggest additions to the MSCI U.S. Large Cap 300 Index.

To contact the reporters on this story: Reinie Booysen at rbooysen@bloomberg.net; Patrick Rial in Tokyo at prial@bloomberg.net.

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