Brace yourself. Here come the zombies. Sure, you’ll still get a variety of trick-or-treaters at the door this year – Miley Cyrus and Si Robertson sightings should be plentiful – but make no mistake, the undead will walk the streets in record numbers. Our zombie fascination is still growing, and yet they already seem more popular than those soulful Twilight vampires ever were. Hollywood has both cultivated and capitalized on our undying interest, with hit movies like I am Legend and World War Z, and top rated shows like AMC’s The Walking Dead (entering its 4th season). There’s even a zombie romantic comedy, Warm Bodies, that’s a decent choice for date night. It should surprise no one, then, if a band of zombies rings your doorbell, demanding brains, but settling for your Snickers® and Kit-Kats®, this Halloween.
The zombie apocalypse might be upon us, but it draws less inspiration from prime time TV and Hollywood movies than you might think. There are all too many real zombies in this world, but either we or they just don’t know it. The real zombies are in financial markets, peering out from those Bloomberg terminals, delivered daily through Reuters data feeds, or squawked about on CNBC. It turns out that zombies are everywhere in derivatives-land, and you need only tune to the latest news to find them. What follows are a few reports of zombie sightings in recent weeks, as if your Halloween weren’t spooky enough!
The curious case of Lehman Brothers. It should have died five years ago. At least that’s what everyone thought. But something strange happened last week. Lehman Brothers sued the New York Giants Football team for $100 million over some cancelled interest rate swap contracts. Yes, that Lehman Brothers, the one that went under in September 2008, sparking the financial crisis. The swap contracts were intended to hedge the interest rate risk on bonds issued to build the Giants’ arena, aka MetLife Stadium. The dispute boils down to what should be the “proper calculation” of the settlement amount on the swaps in question, and Lehman’s suit is a counter to the other side’s even larger claim in their favor. It turns out this is just one of the many cases still winding its way through the courts. Maybe it’s extra creepy because it’s Halloween, or because the firm was recently profiled in several looking-back-at-the-crisis TV specials, but don’t be surprised if Lehman Brothers lives on in litigation for years to come, a financial zombie trying to collect what it can to satisfy its creditors.
LIBOR lives on … for now. First came charges of underreporting borrowing costs by the LIBOR rate setting panel banks, who allegedly wanted to hide any signs of financial weakness that higher rate settings would signal. Then came the allegations and emails from specific traders, asking their friends and colleagues for a favored fixing, to bump LIBOR in a specific way for short-term trading gain. Following the Wheatley Review’s suggestions, LIBOR has been cut back from fifteen tenors to only seven, and from ten currencies down to five. Individual bank submissions to LIBOR are now embargoed for three months, and the index itself is now a regulated activity under an amendment to the UK’s Financial Services and Markets Act of 2000. LIBOR is the benchmark interest rate for over $300 trillion in financial contracts, but despite reforms there are open calls for replacing the index. There is talk of a dual-track system, including survey-based lending rates and transaction-linked indices, that could replace LIBOR, and regulators have called for other proposals and alternatives. Will LIBOR continue to govern future contracts? Or is it already a vacuous index, undead yet unknowingly so? We may need to wait a few more Halloweens to figure this one out!
European Banks…zombie take two. Do you remember the first round of European bank stress tests a few years back? In 2011 eight banks, including two Greek banks, five Spanish banks, and one Austrian bank failed, out of a total 90 tested. As big as this news was back then, a new zombie hunter is on the trail of even more undead financial institutions. In all, more than 120 banks will be stress tested under an upcoming “asset quality review,” and it is expected that European Central Bank president Mario Draghi will find more than a few zombies in the bunch. While banks were dealing with sovereign debt, they took few opportunities to deal with the even more problematic corporate and consumer debts outstanding. More than 30% of debt in some countries, including Portugal, Spain, and Italy, is owed by companies that cannot cover their interest payments out of pre-tax earnings, according to a recent article in The Economist. If its customers are zombies, it’s only a matter of time before the bank succumbs as well. Expect to hear more about this outbreak late into 2014, when the next round of undead banks will be disclosed and dealt with – just in time for next Halloween!
The walking dead … your ISDA lines. When was the last time you traded on your ISDA line? You may think that these agreements are negotiated once and done, but that is hardly the case. If you have not traded on an ISDA line in some time, it could be a zombie requiring major updates to keep it alive. If your agreement was negotiated prior to 2013, and if it has not had any recent updates, then your swap dealer counterparty would be unable to trade again under this agreement without your adherence to the Dodd Frank protocols, or to a bilateral amendment to capture the protocol provisions. Even with these updates, regulation is evolving fast enough to make recent documents go stale quickly. You may also find that with several counterparties available to you, you may want to refresh lines to keep them all consistent, especially if you have recently negotiated favorable terms with one that you would want to see in your other agreements. Credit decisions also evolve, meaning the terms you got last year based on last year’s financials need to be updated by your counterparty based on a new credit determination. The bottom line is that your ISDA lines are part of the world of undead financial contracts without periodic attention, amendment, or recalibration of the trading relationship.
Now that you know where to look, no doubt you will see financial zombies everywhere. Don’t hesitate to call 610.925.3120 or email us about your undead dealings this Halloween, especially if you just need peace of mind. Figuratively, of course!