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AIMA/S3 study on Basel III impact

AIMA has published a member survey on how the cost and availability of financing is being impacted by Basel III. The survey is short and straightforward and will take you no more than 20 minutes to complete. You will be able to view the results later this year when AIMA and S3 Partners publish a research paper on the findings. Access the survey here.

The survey looks at:

o    How prime brokerage and financing relationships have changed over the last two years and the reasons for this, covering both cost and nature of service

o    How hedge fund managers expect these relationships to evolve further in the coming years as Basel III rules bite

o    How the hedge fund industry understands some of the key concepts that underpin banks’ response to Basel III, from “optimization” to “collateral management”

All questions in this survey are fully optional and it is open to any hedge fund manager to complete regardless of whether you are an AIMA member or S3 Partners client. The survey should be completed by an individual within the firm who is familiar with your prime brokerage and financing relationships. For further information, contact Adam Jacobs.


EU – AIMA response and ESMA reports on the EMIR Review

Last week AIMA submitted a response to the European Commission consultation on the EMIR Review. The response set out AIMA’s central positions on possible changes to the EMIR framework as part of the formal review of EMIR currently being undertaken by the European Commission. Among other things, the response called for: (i) the availability of third-country equivalence under Article 13 of EMIR for transactions involving at least one counterparty ‘subject to the rules of’ an equivalent third-country jurisdiction; (ii) the replacement of dual-sided reporting with a robust single sided mechanism; (iii) the abolition of the frontloading requirement currently contained within Article 4(1)(b)(ii) of EMIR; (iv) the development of a fast-track process for the suspension of the EMIR mandatory clearing obligation; (v) an alternative mechanism for direct access to CCPs rather than as a formal ‘clearing member’; and (vi) the swift removal of issues currently experienced around the definition of an ‘OTC Derivative’ under Article 2(7) of EMIR.  In addition to industry feedback relating to its consultation, the European Commission last week received four reports published by ESMA on the functioning of the EMIR framework. Three of the reports, required under Article 85(3) of EMIR, cover: non-financial counterparties; pro-cyclicality; and the segregation and portability for central counterparties (CCPs), respectively. The fourth report responds directly to the European Commission’s EMIR Review and includes recommendations on amending EMIR in relation to: the clearing obligation; the recognition of third country CCPs; and the supervision and enforcement procedures for trade repositories. Of particular interest to AIMA are ESMA’s calls for the Commission to provide for the suspension of the clearing obligation upon particular market conditions, as well as the abolition of frontloading and an entire rethink of the EMIR equivalence and recognition process for CCPs.


The European Commission will now use the consultation responses and the ESMA reports to assist in the compilation of a final report that the Commission will submit to the European Parliament and European Council. If members have any questions or comments, please contact Oliver Robinson or Adam Jacobs

Other news


US -  SEC Division of Corporate Finance Interprets “General Solicitation”

The Securities and Exchange Commission’s Division of Corporation Finance has recently updated its interpretations related to the scope of the term “general solicitation” as used in SEC Rule 506 of Regulation D under the Securities Act of 1933.  These interpretations confirm and reiterate many previously existing views and include some new flexibility around the communications and activities that could be undertaken without being deemed a general solicitation.  The interpretations also provide further guidance on the concept of “pre-existing substantive relationships”.  If you have any questions in relation to this, please contact Jennifer Wood.


EU – European Commission responds on Article 13 equivalence

The European Commission has responded to the Joint Trade Associations letter AIMA sent alongside a number of other trade associations on 22 June 2015 positing questions on a number of issues around equivalence under Article 13 of EMIR and Article 33 of MiFID. Jonathan Faull of the European Commission, responding on behalf of Commissioner Hill, has confirmed that the wording of Article 13 of EMIR does require at least one counterparty to a trade to be established in an equivalent third-county in order for the transaction to benefit from equivalence of third country clearing, reporting and risk mitigation rules. The response letter also confirms that the European Commission may move ahead with an equivalence determination under Article 13 on a rule-by-rule basis, rather than requiring a single holistic determination of the equivalence of numerous third-country requirements. If members have any questions, please contact Oliver Robinson or Adam Jacobs.


Luxembourg - FATCA deadline postponed to 31 August 2015

On 31 July the Luxembourg tax authority (‘Administration des contributions directes’) issued a circular granting the exceptional extension of the deadline from 30 June to 31 August 2015 for FATCA reporting in Luxembourg. According to the Intergovernmental Agreement (“IGA”) on FATCA signed between the USA and Luxembourg as well as the Luxembourg regulations implementing the relevant provisions this Agreement, each Luxembourg Reporting Financial Institution will have to file a report to the Luxembourg tax authorities prior to 30 June of each year. This report will have to include each US reportable account and must be done in a specific format defined by the circulars issued by the Luxembourg tax authorities. If you require further details please contact Paul Hale or Enrique Clemente.

Global – IBA seeks stakeholder views on proposed changes on LIBOR administration

ICE Benchmark Administration (IBA) has been in touch with AIMA in relation to its work on the evolution of ICE LIBOR to a transaction-based rate, in line with the recommendations of the FSB. IBA recently released a Second Position Paper for which it is seeking feedback from all stakeholders who may be impacted by changes in calculation methodology for LIBOR. A questionnaire is available on the IBA website, to which the latter will be accepting responses until Friday 16 October 2016. If you have any questions, please contact Andrew Hill.


Global – OECD takes further steps for implementing automatic exchange of information

On 7 August, the OECD released three reports to help jurisdictions and financial institutions implement the global standard for automatic exchange of financial account information. The first publication is a Common Reporting Standard Implementation Handbook (here), which will provide practical guidance to assist government officials and financial institutions in the implementation of CRS, and to help promote the consistent use of optional provisions or identify areas of alignment with FATCA. The Handbook is intended to be updated on a regular basis. The other OECD publications are an updated edition of the report on Offshore Voluntary Disclosure programmes (here) and a Model Protocol to Tax Information Exchange Agreements that provides the basis for jurisdictions wishing to extend the scope of their existing TIEAs to also cover the automatic and/or spontaneous exchange of tax information. If you require further details please contact Paul Hale or Enrique Clemente.


India - Minimum Alternative Tax (MAT) – Shah Committee Report and Castleton appeal

On 24 July, the Shah Committee submitted its report on the MAT, which has not been made public by the Indian Government. AIMA submitted a written representation (here) to the Committee on 22 June, arguing that the MAT provisions should not apply to Foreign Portfolio Investors (FPIs) for years prior to 1 April 2015 (the position from that date has been clarified by legislation). We understand that the report concludes that foreign investors are not liable to MAT for that period. However, the report seems to be silent on the position of foreign companies that are not FPIs or Foreign Institutional Investors (FIIs) because its terms of reference as framed by the Finance Ministry did not mandate the Committee to review this aspect, even though many of the MAT dispute cases concern such foreign companies. Given its relevance, the Indian Supreme Court has decided to adjourn to 29 September 2015 the Castleton case appeal hearing so that the court may consider the Shah Committee report. If you require further details, please contact Paul Hale or Enrique Clemente in London, Heide Blunt in Hong Kong or Merima Arleback in Singapore.


EU - ICMA study on evolution of European repo market

ICMA has approached AIMA regarding a study that it is conducting into the current state and future evolution of the European Repo Market. The study will be largely qualitative and based on interviews with a broad range of market participants, including repo trading desks, buy-side users of the product, voice and electronic intermediaries, infrastructure providers, as well as central banks and DMOs. The resulting report is envisaged to be similar in format to the 2014 ICMA study into the European Corporate Bond markets.

If you would be happy to be interviewed for this project, please contact Andy Hill at ICMA. Interviews can be by phone, and should take between 30 and 45 minutes. Ideally ICMA would like to interview the main person(s) responsible for the firm’s European repo/funding activity. All responses are anonymized and will only be presented in aggregate. All participants will also have the opportunity to review the draft report before it is published.

The tortoise vs the hare: The role of term structure vs spot price trends in determining commodity futures returns

Hilary Till

Premia Capital Management, LLC, and Research Associate, EDHEC Risk and Asset Management Research Centre

Q1 2006


In the past, even if spot commodity prices declined, a commodity futures investor could still have a positive statistical expectation of profit and that has been through the “roll yield” embedded in certain commodity futures contracts.

When a near-month futures contract is trading at a premium to more distant contracts, we say that a commodity futures curve is in “backwardation”. Conversely, when a near-month contract is trading at a discount to more distant contracts, we say that the curve is in “contango”.

When a commodity futures contract is in backwardation, an investor has two potential sources of returns. Since backwardation typically indicates scarcity, one is on the correct side of a potential price spike in the commodity by being long at that time.

The other source of return involves a bit more explanation. In a backwardated futures market, a futures contract converges (or rolls up) to the spot price. This is the “roll yield” that a futures investor captures. The spot price can stay constant (or mean revert) but an investor will still earn returns from buying discounted futures contracts, which continuously roll up to the spot price. A bond investor might liken this situation to one of earning “positive carry”. In a contango market, the reverse occurs. An investor continuously locks in losses from futures contracts converging to a lower spot price. Correspondingly, a bond investor might liken this scenario to one of earning “negative carry”.

Over very long timeframes, a number of authors have shown how the term structure of a commodity futures curve has been the dominant driver of returns for individual futures contracts.

In particular, Nash and Shrayer of Morgan Stanley (2004) have illustrated how over a single 21-year timeframe, the returns of a commodity futures contract have been linearly related to how backwardated the contract has been. Over the period, 1983 to 2004, the commodity futures contracts, that have had the highest returns, are those in which the front-month contract traded at a premium to the deferred-delivery contracts; that is, those contracts that had the highest levels of backwardation had the highest returns. Figure 1 illustrates this empirical result.


Figure 1: Annualised total return vs average backwardation (Apr 93 - Apr 04)

Tortoise versus the hare - Figure 1 

Note: The contracts that have traded in backwardation (gasoline, crude oil, copper, heating oil and live cattle) have had the highest average returns over the period, 1983 to 2004.

Source: Nash and Shrayer (2004).

In Feldman and Till (2006b), we extend this framework. We find evidence that the power of backwardation to explain commodity futures returns is indeed valid but require that investors have a long investment horizon when relying on this indicator, at least for the futures contracts that we studied. Specifically, we examine the soybean, corn, and wheat futures markets over the period, 1950 to 2004. We find that a contract’s average level of backwardation has only explained 24% of the variation in futures returns over 1-year timeframes and 39% of variation over 2-year timeframes. One must extend the evaluation period to five years and then at that time horizon, average levels of backwardation have explained 64% of the variation in the returns of these futures contracts. Figure 2 illustrates this result.

Figure 2: Five-year annualised excess return vs average backwardation (1950 - 2004)

Tortoise versus the hare - Figure 2 

Source: Feldman and Till (2006a)

Our results show the cumulative effects of the slight short-term predictability of a slow-moving variable over long time horizons, paraphrasing Cochrane (1999).

While we found that backwardation has been the driver of returns over long time horizons for three futures contracts, there is another noteworthy feature of these results. While normally over five-year periods, the futures contract’s curve shape has been the driver of returns, there is one exception and that is the 1970-to-1974 period. These are the data points in Figure 2 that do not fit the nearly linear trend-lines of annualised returns as a function of average backwardation.

What this means for an investor is that there can be an additional fundamental rationale for a long-term, passive investment in a commodity futures contract besides predicting structural backwardation for the contract. The second rationale would be to predict that the factors are in place to repeat the 1970-to-1974 experience of a rare trend shift in prices.

Now obviously one needs to be very careful about predicting trend shifts in asset prices. Grantham (2005) notes that his firm has completed research on “30 completed [asset price] bubbles … all of which came back to the pre-existing trend”. But, he states, “of these, we now believe 29 were genuine bubbles and one – oil – was a paradigm shift …” that occurred in 1973. Grantham, a dedicated mean-reverter, who underweighted Japanese equities in the late 1980s and later underweighted U.S. technology stocks in the late 1990s, is pausing in calling for oil to mean-revert from its present levels at this time. Even if oil becomes $80 per barrel, “given the unique features of oil, we cannot be sure it has not ratcheted up again with another trend shift”.

One challenging aspect of investing in oil futures at this time is that they appear to have shifted into “structural contango”. Historically, the behaviour of oil prices has been one of “structural backwardation”, consistent with crude oil inventories generally being scarce.

That crude oil futures have shifted into structural contango seems to contradict the tightness that is implied by this commodity’s high spot price. What has changed?

One theory from a prominent hedge fund is that the true inventories for crude oil should be represented as above-ground stocks plus excess capacity. Historically, the markets could tolerate relatively low oil inventories because there was sufficient swing capacity that could be brought on stream relatively quickly in the case of any supply disruption. This excess supply cushion has dropped to sufficiently low levels that there have been two market responses; (1) there have been continuously high spot prices to encourage either consumer conservation or the development of alternative energy supplies and; (2) the market has undertaken precautionary stock building, which has led to the steep contangos that the crude oil market has been experiencing.

Stuart of UBS (2006) has examined the predicted supply and demand growth through 2010 and it appears that on trend there will be no meaningful increase in oil spare capacity over the next four years.

The implication of this structural change in the oil markets is that the returns to energy-focused commodity investments could become ever more long-option-like. The investor will pay away option-like premia in the form of negative carry from the persistent contango in the oil markets but will simultaneously be positioned for periodic (and entirely unpredictable) price spikes until an adequate supply cushion re-emerges in the oil markets.

That said, as Murti et al. (2005) predict, one would expect that eventually a supply cushion will re-emerge, either through behavioural changes on the part of consumers or through new infrastructure finally being constructed by producers. These changes may not occur until the end of the decade, given the very long lead time for large-scale energy projects. It is at that point one may see oil spot-prices dramatically mean-reverting, which would be consistent with the expectation that a futures curve signal is only useful at very long investment horizons.


Cochrane, John, 1999, “New Facts in Finance”, Economic Perspectives, Federal Reserve Board of Chicago, Third Quarter, pp. 36-58.

Feldman, Barry and Hilary Till, 2006a, “Separating the Wheat from the Chaff: Backwardation as the Long-Term Driver of Commodity Futures Performance: Evidence from Soy, Corn and Wheat Futures Markets from 1950 to 2004”, EDHEC-Risk Publication & Premia Capital and Prism Analytics White Paper.

Feldman, Barry and Hilary Till, 2006b, “Backwardation and Commodity Futures Performance: Evidence from Evolving Agricultural Futures Markets”, forthcoming Journal of Alternative Investments.

Grantham, Jeremy, 2005, “GMO Quarterly Letter”, July.

Murti, Arjun N., Brian Singer, Luis Ahn, Jonathan Stein, Ashwin Panjabi and Zachary Podolsky, 2005, “Oil Bull Market in the Early Part of its Middle Phase”, Goldman Sachs Global Investment Research, 12 December.

Nash, Daniel and Boris Shrayer, 2004, “Morgan Stanley Presentation”, IQPC Conference on Portfolio Diversification with Commodity Assets. London, 27 May.

Stuart, Jon, 2006, “The Fundamentally Bullish Case for Oil Stretches Through 2008, At Least”, UBS Securities Presentation, April.

Till, Hilary, 2006a, “Structural Sources of Return & Risk in Commodity Futures Investments”, Commodities Now, June 2006, pp. 57-65.

Till, Hilary, 2006b, "What the Future Holds for Commodities”, Global Alternatives Magazine, June, pp. 39-40.

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