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Enron Mail |
ISDA Press Report - March 21, 2001
Ministers urged to back Lamfalussy report - Financial Times Liberalisation of financial services tops summit agenda - Financial Times Crisis-hit Argentina continued to dominate credit derivatives... - Reuters CREDIT DERIVATIVES MAY SUBJECT INVESTORS TO UNEXPECTED RISKS - Moody's How traders in capacity can make rapid new connections - Financial Times Watchful eye on energy traders - Financial Times Ministers urged to back Lamfalussy report Financial Times - March 21, 2001 By Peter Norman The European Banking Federation, representing 3,000 mainly private-sector banks in the European Union, yesterday urged an immediate end to the institutional wrangling holding up agreement on the Lamfalussy report on faster financial market legislation in the EU, Peter Norman reports from Brussels. Ambassadors from EU member states meet today in Brussels to try to resolve the three-way squabble between the council of ministers, the Commission and the European parliament over the powers each institution should cede to enable the EU securities committee, proposed by Baron Alexandre Lamfalussy, to enact legislation. EU finance ministers will discuss it tomorrow evening in Stockholm before the EU summit on Friday and Saturday. Writing to each finance minister, Maurizio Sella, the federation's chairman, said any delay would damage development of European financial markets Liberalisation of financial services tops summit agenda Financial Times - March 21, 2001 By Brian Groom Liberalisation of financial services will be Britain's priority for this week's Stockholm summit, the government said yesterday as it rejected claims economic reform in the European Union was going too slowly. Tony Blair, prime minister, suffered a setback, however, when Lionel Jospin, his French counterpart, said he would resist early deadlines for full liberalisation of gas and electricity. A dispute with the French would overshadow the summit of EU leaders on Friday and Saturday, which comes as Mr. Blair prepares to call the general election, expected on May 3. Britain wants full liberalisation of energy markets by 2003. Alastair Campbell, Mr. Blair's spokesman, rejected claims by the European Round Table of Industrialists that there had been little action since last year's Lisbon summit on issues such as liberalisation of energy, postal services, financial markets, air traffic control and creation of a union-wide patent. "Those who say the impetus is not for economic reform and that there hasn't been progress have got it wrong," he said. "We think Europe has got the message on economic and social liberalisation. Stockholm is about accelerating the change." He said 2.5m jobs had been created in the EU last year. Denmark and the Netherlands had joined Sweden in overtaking the US for the percentage of homes with internet access: the EU average had doubled to 28 per cent compared with 47 per cent in the US, with Britain on 41 per cent. EU investment in information and communications technology had outstripped the US as a proportion of gross domestic product for the first time last year. Mr. Campbell said faster liberalisation of financial services would help investors, the finance industry and consumers. Britain wants the Lamfalussy group's report on financial reform implemented by the year-end, but it is caught up in a dispute over jurisdiction between member states, the European Commission and European Parliament. Mr. Blair and Wim Kok, the Dutch prime minister, published a joint paper calling for action to close the gap with the US on biotechnology. Other British objectives include a business-led taskforce to address skills gaps and moves to improve mutual recognition of professional qualifications, lighten regulation on small business, cut air traffic control delays and cut car prices. * The government was accused yesterday of trying to "rig" a Brussels competition inquiry by organising a write-in campaign by MPs. Opposition Conservative MPs were angry after discovering the Department of Trade and Industry had supplied a "core script" that MPs and others could use to lobby the European Commission to approve a Pounds 60m (Dollars 86m) regional venture capital proposed by Gordon Brown, chancellor. The Commission is likely to approve the scheme, but Mr. Brown has accused officials of dragging their feet. Crisis-hit Argentina continued to dominate credit derivatives trading on Tuesday.... Reuters - March 20, 2001 LONDON, March 20 (Reuters) - Crisis-hit Argentina continued to dominate credit derivatives trading on Tuesday, almost knocking the Federal Reserve's decision on U.S interest rates due later in the day off its perch as chief talking point. The price of five year default swaps for Argentina widened out to 1,000/1,200 from 950/1,050 at the start of the week, traders said. The move was even more dramatic at the shorter-end of the curve, with one-year credit protection on Argentine debt being quoted at 1,200/1,300 from 950. Credit default swaps, the most active part of the credit derivatives market, are insurance-like tools that enable investors to juggle exposure to the risk of an issuer defaulting on a debt or loan. The resignation of economy minister Ricardo Lopez Murphy after just two weeks in office has heightened a political crisis in Argentina that threatens to spill over into other emerging markets. This follows Lopez Murphy's efforts to lift the economy out of recession with a searing austerity programme aimed at raising investor confidence. Domingo Cavallo, the architect of Argentina's embattled ten year-old fixed exchange rate regime, was named his successor. With Cavallo yet to set out his policy programme to cut $3 billion off the Argentine fiscal deficit and tackle the country's crisis, it remained to be seen how the U.S. market would open. "For Argentina, the liquidity has just dried up on the default swaps. What offers are out there are distressed," a New York based trader at a U.S. bank said. Events in Argentina hit the rest of the emerging markets asset class. "Latin America generally is better bid and offers are few and far between," a broker said. Among the other sovereigns affected was South Africa. "The five year default swap is at 185/235 and the three year is at 125/175, and that's more than 10% worse than last week," he added. BACK IN EUROPE Trading conditions elsewhere were described as relatively thin, but if traders were keeping their powder dry ahead of the U.S. FOMC meeting, they weren't saying. In Europe, the story remained one of default swap prices on corporate debt edging inwards and edging outwards on telecoms debt. "The general trend for European corporates for the past week has been one of prices trading lower, with bids being hit and offers being lifted," a broker said. "We're talking small, mind," he added, "maybe 2-3 basis points tighter below a price of 50 and around 5 bps at 50-plus." Five year default swaps on BASF traded at 21/28 on Tuesday from 23/29 on Monday. The German chemical group posted better than expected fourth quarter earnings last week and is forecasting double-digit growth this year and next. Not so the embattled telecoms sector. On Tuesday morning five-year default swaps on the debt of British Telecom widened five basis points from Monday to a bid/offer spread of 162/169, before settling back to 160/165. In comparison, the spread between BT's February 2006 euro-denominated bond has a mid-rate yield spread of 125bps over 3-month Libor, while the December 2005 dollar bond was 145bps over Libor. Five-year default swaps on the debt of France Telecom were cited by the dealer at 158/165, unchanged since Monday, and 155/165 on Deutsche Telekom, also unchanged. CREDIT DERIVATIVES MAY SUBJECT INVESTORS TO UNEXPECTED RISKS Moody's - March 20, 2001 New York, March 20, 2001 -- In a new special report outlining potential risks in credit default swaps, Moody's Investors Service says that if credit events are defined too broadly, a credit default swap may pass along the risk of loss following mere credit deterioration instead of the risk of loss following an actual default. "Investors often assume the risk of a synthetic investment, by way of a credit derivative, is equivalent to the risk of a cash investment in the same credit. However, if not structured carefully, the synthetic investment can be riskier than the cash investment," says Jeffrey Tolk, a Moody's analyst and author of the report, "Understanding the Risks of Credit Default Swaps." Among Moody's key sources of concern are the prevailing standard definitions for "credit events." Under a credit default swap, losses to investors are determined synthetically, based on credit events occurring in a reference credit. Thus, investors' risk is driven largely by the definition of credit events in the swap. The broader the definition, the broader the risk, according to Moody's. SOME STANDARD DEFINITIONS ARE BROAD Moody's report includes a detailed look at the International Swaps and Derivatives Association's (ISDA) widely referenced "credit event" definitions. "In some critical areas, ISDA's current definitions are broader than the market's understanding of "default," and could, in some cases, increase the risk of loss by triggering payouts for events that are not actually defaults," says Tolk. "An obligation that has been restructured to defer principal payments may not technically be a default if the lender has been properly compensated. But ISDA would nonetheless define this as a credit event," he says. Conversely, under ISDA's definition of "obligation acceleration," a credit default swap investor might suffer a loss although an investor in the underlying cash position would suffer no loss. OTHER SOURCES OF RISK: VALUATION DISCREPANCY, MORAL HAZARD In addition to "credit events," Tolk cites the risks that arise from the difficulty of valuing defaulted credits to determine the extent of loss to investors under a cash-settled credit default swap. "Calculated losses may vary based on liquidity, market conditions, and the identity of the parties supplying bids. In analyzing a credit default swap, Moody's looks carefully at the methods and procedures for calculating loss given default," he says. The report also says that investors should be aware of moral hazard - the inherent conflict of interest that exists because the sponsoring financial institution determines the timing of a loss event as well as how much loss is imposed on investors. "The sponsor's incentive is to construe 'credit events' as expansively as possible and to calculate losses as generously as possible," says Tolk. "Moody's considers these factors carefully when rating securities supported by credit default swaps." Tolk believes that these risks can be addressed by tightening the credit event and loss calculation provisions, increasing transparency, and providing more objective mechanisms for verifying loss determinations. The capital markets have an enormous capacity for absorbing credit risk, and this capacity has only been partially tapped by the credit derivatives market. In Moody's opinion, for capital markets investors to participate fully in the growing credit derivatives market, the risks inherent in credit default swaps should be more precisely defined, more transparently managed, and more readily quantifiable. How traders in capacity can make rapid new connections Financial Times - March 21, 2001 By Alan Stewart Online trading exchanges have been set up in many sectors of commerce, and telecommunications is no exception. But while some exchanges focus on physical goods, such as car components or hospital supplies, the telecoms version is dealing with something more intangible - bandwidth. A number of online exchanges have been set up to trade in bandwidth, matching buyers and sellers via bid and offer prices, and taking a percentage of the price paid. According to research by Arthur Andersen, the telecoms market will be transformed by bandwidth trading. The bandwidth being traded may take the form of physical circuits linking two cities, or the data packets and voice calls sent over them. A recent Europe-wide survey by Andersen revealed a market in flux, but one which believed in the inevitability of bandwidth commoditisation. "Online bandwidth trading exchanges have arrived in response to a need, because of a bandwidth glut," says Simon Forge, principal telecommunications analyst at UK consultancy OSI. "For some of the latest networks going in, people are claiming petabits per second - that's a billion megabits per second." Exchanges have been set up by Arbinet (based in New York), Band-X (London), and RateXchange (San Francisco) - see accompanying stories. Other exchanges already running or being set up include GlobalTeleExchange (GTE in Washington), Asia Capacity Exchange (ACE in Hong Kong), International Telecommunications Clearing Corporation (ITCC in Dubai), and eSwitch (Sydney). Buyers and sellers of bandwidth are linked up through interconnecting facilities at the switching hubs of the exchanges. RateXchange has nine of these in the US, plus three in Europe, while ITCC intends to have hubs in London, Hong Kong, Los Angeles, New York, and Miami. The exchanges stress that these connections mean that bandwidth trades will be able to be carried out in seconds. At present, it can take up to three months to arrange a trade, with most of those arranged not actually taking place at all. According to investment bank CIBC World Markets, Dollars 16bn in revenues (20 per cent of the wholesale bandwidth market) may be traded by 2004. Andersen says the bandwidth market has suffered from a lack of liquidity and price transparency, combined with a paucity of offers and bids on the exchanges. The company believes, however, that the presence of big energy companies, such as Enron and Williams, in bandwidth trading is stimulating the appetite of customers for greater product innovation and pricing. Bandwidth is expected to follow a shorter timeline to liquidity than any other current traded commodity. Although the detail of the emerging market has still to be defined, Andersen expects 'city-pairs', that is, two named cities connected by fiber optic cable, to form the basic product. Jon Merriman, president and chief executive of RateXchange, foresees four market segments becoming involved in bandwidth trading within the next year. "The first are the energy merchants, the second the telecommunications companies as a business line, the third the financial houses, and the fourth the pure commodity players," he says. "A fifth market segment - and this is longer term - will be large corporates, who'll want to trade and optimise their use of bandwidth," says Mr. Merriman. "It'll become a treasury function at some point for large companies. That's at least a year down the road, but there is interest right now from some large corporates." Andersen points out that energy businesses, such as Enron, Williams, Aquila, El Paso, TXU, and Dynegy have made significant investments in backbone, customer and skills development in the last few years. Those companies' presence has had a considerable influence on the growing bandwidth market. Steve Elliott, chief executive of Enron Broadband Services (EBS) Europe, says the communications market needs to become much more open and robust, and that this will change the supply and demand dynamics. "It's already moving that way," says Mr. Elliott, who stresses that EBS does not see itself in competition with bandwidth exchanges. "Exchanges exist in all the markets we participate in, and they're an overlay to the actual market itself," he says. "We're not an exchange, nor are we an 'independent player' at the exchange level, nor a bulletin board type of facilitator. We're a market maker, a principal in all transactions that we do, with contractual terms and physical delivery obligations." EBS is creating pooling points to provide physical interconnectivity between bandwidth trading principals. Although EBS's plans for doing business in Europe are still at a fairly early stage, the company has set up a pooling point in London, to provide bandwidth trading between the US and Europe. Further European pooling points are in Amsterdam, Brussels, Dusseldorf, Frankfurt, and Paris. Enron Online Bandwidth-related commodities have recently been added to the Enron Online web-enabled e-commerce platform, where the company posts its prices and carries out commodity trading. "Enron Online is the largest e-commerce web platform in the world for buying and selling commodities," says Mr. Elliott. "We've transacted a notional value of over Dollars 380bn since its inception around a year ago." "The energy companies are all copying Enron, which is a very progressive, rather fabulous company," says Marcus de Ferranti, co- founder of the Band-X. He points out that Enron is leveraging its own network into its trading, and thereby becoming a kind of telecommunications company in its own right. Mr. de Ferranti suggests the other energy companies are desperately trying to get into the broadband revolution, having seen Enron's share price double on the announcement of broadband. "They're coming along in a frenzy, trying to copy it and leverage their own infrastructures by sticking fiber along the top of their gas pipes, and sticking cables along their electricity highways," he says. But how do the telecommunications companies view bandwidth trading exchanges? Do they see them as speeding up the commoditisation of bandwidth, leading to a deterioration of prices? "At the most senior level, the telecoms companies are attracted by what we're providing," says Anthony Craig, chairman and chief executive of Arbinet. "As you come down, some see it as a threat, or even say that we're a catalysing force for commoditisation. I find that on the verge of ludicrous, because bandwidth is commoditising anyway," says Mr. Craig. "Anything that commoditises needs a more efficient process to manage the product. We're responding to commoditisation." As for the future, the online bandwidth exchanges may face some of the pressures which have caused problems for other B2B (business-to-business) marketplaces. US analyst International Data Corporation (IDC) foresees a challenge for bandwidth trading companies in collecting fees, and believes exchanges may suffer payment defaults. IDC warns also that profit margins could dwindle as bandwidth costs fall, taking margins with them. "I suspect that bandwidth exchanges will have a relatively limited window of opportunity, during which time they will make good money," says Ian Beeby, UK managing director of US consultancy Wireless Facilities. Mr. Forge at OSI agrees that some of the exchanges will go out of business. However, he argues: "Long-term, this is something that's here to stay." Watchful eye on energy traders Financial Times - March 21, 2001 By Anthony Cox After the sharp falls in their shares since last summer, telcos worldwide might despair at the threat from US energy traders, such as Enron, to revolutionise how capacity on carriers networks is bought and sold - further depressing the prices operators can charge for bandwidth, their staple product. In two to three years, real-time trades on bandwidth, for immediate delivery, will be possible. These will replace, at least to some extent, the drawn out negotiations between operators when selling space on their networks to one another. But if new trading models will exert downward pressure on bandwidth prices by increasing transparency and ironing out market inefficiencies, an environment where bandwidth is traded through purpose-built exchanges has its benefits to operators. "In the short term, it will provide a more liquid channel for selling spare capacity," says Stuart McIntosh, vice president of the Boston-based consultancy Adventis. Longer term, it may have an impact on how operators manage the roll out of their networks, he says. Leasing capacity in the short term will become increasingly attractive, and operators will opt more and more to buy or rent capacity from their rivals, instead of building their own infrastructure. Bandwidth trading may also increase volumes for operators by creating new sales avenues: "Exchanges open up new segments in the market, many of which you wouldn't do business with if it was down to personal relationships," says Cecilia Herslow, carrier manager at Telia UK. Further, operators could benefit from lower sales costs, as the expense of setting up long-term capacity deals between operators is replaced with lower per trade costs at the exchanges, says Martin Smillie, vice president for marketing wholesale at KPNQwest. He notes, however, that the operator will incur costs to set up and maintain trading capability, whether on its own behalf or via third- party trading houses. Some 94 per cent of carriers expecting a liquid, traded bandwidth market to emerge within three years, according to research by Arthur Andersen. A market for derivatives, which could eventually dwarf the primary market, will follow close on the heels of a market for physical bandwidth. Two types of bandwidth exchanges are emerging: those that trade bandwidth capacity on specific routes - say London to New York, so-called routed capacity; and those that trade data and voice minutes, usually via internet exchanges, such as Arbinet and Band-X. According to Ciara Ryan, a senior manager in Arthur Andersen's bandwidth trading team, the routed capacity market will be the most significant in terms of revenues for operators, due to increased pressure to find new channels to market the capacity they own on these routes. "Owners of capacity are eager to sell their bandwidth as quickly as possible, without destroying margins completely," he says, noting that bandwidth prices are falling by up to 70 per cent annually on transatlantic and European routes. Several routes, or city pairs, will provide a yardstick for the prices for capacity between other cities. Capacity on these other routes will trade at a discount or a premium to those that have become the benchmarks, says Mr. Ryan. Some loss of margins may be an acceptable trade-off for more efficient markets and possible higher volumes of traffic for operators, particularly since bandwidth prices are expected to come down in any case, due to capacity oversupply. Turn to next page From facing page But bandwidth exchanges' impact on pricing could be more significant: "The whole pricing structure is potentially at risk," says Nigel Pitcher, director of marketing at UK-based carrier Fibernet. If spare capacity is sold on an anonymous basis to an exchange, the operator's existing 'list price' customers could pick up the same capacity at an exchange at a knock-down price, while unknowingly remaining with the provider they had originally, he says. This could cause bandwidth prices to fall dramatically. Downward pressure on the price of capacity would be increased if large users were to curtail existing relationships with their operators altogether, buying direct from the bandwidth exchanges. This threat is dismissed by telecoms industry players, however: "There is no reason why large telecom users could not lease bandwidth today under most regulatory regimes," says Ian Beeby, managing director of WFI, a wireless telecommunications consultancy. Mr. Beeby notes that most large corporations have spent the last years trying to outsource their telecom networks and that they are unlikely to change direction now. The extent to which operators either embrace the new status quo or reject it may define their success in an environment where long-term bandwidth contracts are being replaced by more immediate trading models: "Carriers will either take on a very pro-active approach or a more defensive strategy," says Ms Herslow at Telia. If a player does not move fast enough a "penalty of ignorance" may result in some operators losing the first mover advantage, suggest analysts. This, in turn, may result in a loss of competitiveness relative to other players, fuelling consolidation among global carriers, says Christian Jepsen, the founder of Pangea, a pan-European carrier with a focus on Scandinavia. "Ultimately, there may be three to four global carriers and only a handful of regional ones left," he says. In anticipation of significant changes in the market, Pangea is already establishing a separate sales team to focus exclusively on capacity sales via bandwidth exchanges. In an increasingly complex market, telecommunications operators have no choice but to explore new ways to exchange telecom capacity. The sheer number of telecoms players now means that bilateral agreements between carriers will become increasingly obsolete. Internationally there are some 2,000 carriers. If they all were all to lease some capacity from one another, nearly 2.5m interconnects, contracts and settlements would be required across the industry. Avoiding a proliferation of contracts alone is likely to change the way operators deal with one another on bandwidth deals. Although it is too early to see the full implications of bandwidth trading on today's telecoms market, operators are keeping the developments under very close review. "Bandwidth trading may prove to be a interesting idea which simply did not make it - but it would be rash to conclude that today," says Mr. McIntosh at Adventis. He also warns that the US energy players could leverage their experience of establishing trading in the energy market to carve a significant niche in the telecoms sector. This is borne out by recent developments: energy operators Williams and Enron are understood to have joined forces recently with AT&T, Sprint, Global Crossing and Dow Jones to provide the first index for routed bandwidth capacity. "If I were in a telecoms company, I would be watching the energy traders very closely," says Mr. McIntosh. **End of ISDA Press Report for March 21, 2001.** THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA. THIS PRESS REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT. Scott Marra Administrator for Policy & Media Relations ISDA 600 Fifth Avenue Rockefeller Center - 27th floor New York, NY 10020 Phone: (212) 332-2578 Fax: (212) 332-1212 Email: smarra@isda.org
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