>OTC derivatives: A new market infrastructure is taking shape

The global derivatives market has expanded enormously in recent years. Interest rate products (options and futures) have seen a particularly rapid increase over the past eight years. When volumes peaked in 2007, gross notional amounts outstanding of over-the-counter (OTC) derivatives amounted to USD 605 trillion.

A number of structural deficiencies in the market infrastructure of OTC derivatives were revealed during the financial crisis. Inherent counterparty risk and its inadequate management, the intransparency and complexity concerning actual risk exposures, and the danger of contagion, i.e. the risk of a default of one firm spreading through the financial system, are the issues that were brought to the collective consciousness in conjunction with the systemic relevance of these markets.

Traditionally, counterparty risk used to be mitigated between trading partners by means of bilateral collateralisation. While in principle collateral can be an effective insurance against counterparty credit exposure, prevalent market practices such as asynchronous collateral cycles or incomprehensive collateral coverage resulted in uncollateralised exposures in the past.

Central counterparty (CCP) clearing is the most immediate way of addressing these limitations. CCPs also reduce systemic risk, as they reduce the likelihood of contagion. Hence, regulators in the EU and the US are pushing for more OTC business to be cleared via CCPs.

Reform of market infrastructure will alter competitive structures in the industry. Rules on the eligibility of contracts for central clearing, interoperability of CCPs and ownership of the market infrastructure are issues set to shape the industry, but are undetermined at the moment.

Regulators should ensure that legislation drafted is commensurate with the risks faced. While transparency and standardisation are objectives worth of being promoted, the future of the industry will critically hinge not so much on market forces but on the outcome of the regulatory process. Regulation must strike an appropriate balance between greater stability and preserving the benefits of solid, yet dynamic derivatives markets.

To read the full report: OTC DERIVATIVES

>Global Opportunity Asset Locator (GOLDMAN SACHS)

GS GOAL: We are introducing a new quarterly product GS GOAL. This draws on research from across ECS (Economics, commodities and strategy research) to locate investment opportunities across asset classes. We focus on key themes, recommendations and how to implement them.

Most assets offer opportunities: We expect above consensus global economic growth in 2010-11. Due to large output gaps in DM economies, and our view that global trend growth is c.4%, we believe this will occur alongside very low inflation and interest rates, at least in DM. This combination should support most assets in absolute terms. On a relative basis, we have a pro-risk stance, recommending overweight commodities and equities, neutral on credit and underweight government bonds and cash.

Commodities and equities offer best risk/return: Equities returns should be underpinned by strong profit growth in all regions, falling volatility and attractive valuations. For the next 12 months, we see the highest local currency returns in parts of Asia (China, Taiwan and Korea particularly), followed by Europe, the US and finally Japan. In commodities, our high aggregate return expectations mask a differentiated view within the group; the strongest prospects are in oil, followed by copper and gold. Agriculture offers little upside in our view. In corporate bonds, we would avoid adding risk in lowquality credit, preferring BB-rated bonds, and favoring the US to Europe. Government bonds remain supported by ongoing accommodative monetary policies and falling inflation. We expect 10-year rates to decline in the US and remain stable elsewhere.

To read the full report: ASSET LOCATOR

>What questions should be asked about fiscal deficits and sovereign debts? (NATIXIS)

We suggest the following interpretation grid for countries posting high fiscal deficits and public debt ratios:

1. Was it justified to run up these fiscal deficits?
That is the case if the economic situation will be better in the future, which justifies transferring
income from the future to the present via fiscal deficits;

2. Are the fiscal deficits squeezing out private investment, or are there sufficient savings to prevent this?

3. If fiscal deficits are very large in the short term, is fiscal credibility maintained? If it is ensured, even if the fiscal deficit is very high in the short term, investors expect fiscal solvency to be restored and long-term interest rates not to rise.

4. If a country is in a budget crisis, is this a liquidity crisis or a solvency crisis? In the first case, the remedy is loans from other countries (or from the IMF) that enable countries to continue to finance themselves. In the second case, these loans are useless and solvency must be restored.

To read the full report: SOVEREIGN DEBTS

>ACC: C1Q10: A Strong Quarter (MORGAN STANLEY)

Quick Comment – Impact on our views: ACC reported C1Q10 standalone earnings at Rs4bn (flat YoY), ahead of consensus and our estimate. The earnings beat was driven by mix of higher than expected realization and lower cost. In our view realization will remain flattish / improve marginally while costs would see some uptick in the near term. We expect margins to remain broadly stable. Volumes were down 3% YoY and we expect volume progression to remain muted in C2010 given delay in ACC’s new plants.

We remain positive on the sector given our view that robust demand and modest increase in effective capacity will support near term prices. While increasing costs is a risk, we expect margins to remain stable supported by stable / increasing realization.

What’s new: ACC reported 2% YoY and 9% sequential growth in revenues to Rs21bn. EBITDA grew ahead of revenues on sequential basis at 44% to Rs6.2bn aided by 720bps margin expansion (part of this was driven by other expenses which is seasonal in nature). On a YoY
basis however, margin contracted by 190bps on account of higher cost – material and other expenses. PAT was flat YoY but grew 44% sequentially driven by robust EBITDA growth.

Key Result Highlights Are:
Realization improved 5% sequentially, ahead of our estimates. ACC’s realization improved 5% YoY and QoQ (it had declined by 9% QoQ in Dec-09 quarter) to Rs3767/T and is only 4% below the peak in Sep-09. In our view, exit realization was around 2-3% higher than this. However, volume progression was muted having declined 3% YoY to 5.65mnT leading to muted revenue growth of 2% YoY. Going ahead, we believe revenue progression will be under pressure given our estimate of muted volume growth.

Costs were lower than expected; likely to rise going ahead: ACC’s costs on a per ton basis declined 5% sequentially against our expectation of 4% decline. The key highlight however was sequential decline in per ton power (5%) and freight cost (1%). We believe this was driven by lower clinker production and lead distance, respectively. In our view, this is unlikely to sustain and we expect some uptick in costs in ensuing quarters. In near term though margins are likely to be maintained given strong cement price trend.

To read the full report: ACC

>PETRONET LNG: 4QFY10 marginally lower than our estimate (JM FINANCIAL)

■ Marginally lower PAT: Petronet LNG reported 4QFY10 sales at Rs23,855mn, lower than our estimate of Rs24,860mn by 10% primarily due to gas volume being lower at 92TBTU against our estimate of 97TBTU. EBIDTA at Rs.202mn was lower than our estimate of Rs2,278mn by 13% on the back of lower volumes. However, higher than estimated other income (Rs331mn against estimate of Rs171mn) ensured that PAT at Rs974mn was only marginally lower than our estimate of Rs984mn.

■ Volume led growth in the near-term: Over the next three quarters, we expect volume led growth for Petronet LNG. For 1QFY11E, we had estimated that GSPC would import three cargoes, and the first cargo has recently been imported. In our previous report, we factored in LNG for Pragati Power and ONGC (C2-C3) extraction in 2QFY11E and 3QFY12E. However, with lack of clarity on Pragati Power and ONGC contracts, we defer volumes from both potential customers by one quarter each. Hence, we now estimate Pragati Power start-up in 3QFY11E and ONGC in 4QFY11E. However, our volume estimate for FY11E remains unaffected due to this change.

■ We retain our regas margin assumption: In our previous note, we highlighted the impact of the gas purchase cost on the company and estimated net regas margins at Rs27.0/mmbtu in FY11E. The 4QFY10 regas margin at Rs26.9/mmbtu is in line with our estimate and hence, we do not change the regas margin assumption.

■ Valuations; March’11 target price Rs91, BUY: Since our last report dated 25th January, 2010, Petronet LNG stock price has risen by c.7.5% from Rs76 to Rs81.8. With no change in volume or margins as highlighted above, we retain our target price of Rs91, indicating an upside of 11% from current levels and maintain our BUY rating.

To read the full report: PETRONET LNG

>EXIDE INDUSTRIES (INDIA INFOLINE)

■ Revenues increase by 28.9% yoy on back of strong volume growth in the automobile and industrial segments

■ OPM jumps 434bps yoy and NPM nearly doubles on yoy basis owing to sharp fall in raw material cost which was on back of higher consumption of recycled lead.

■ However, on sequential basis company registered a fall of 280bps and 147 bps in NPM and OPm respectively.

■ We maintain BUY with a revised target price of Rs 137.

To read the full report: EXIDE INDUSTRIES