Monday Musings: February 28, 2022

Feb 28, 2022


Public Trust Credit Team

Collateral is collateral damage in Russian invasion of Ukraine

Sanctions on the Russian central bank are driving U.S. clearing houses (BNY in particular) to mark Russian debt to zero. Late last week, Swiss banks UBS and Credit Suisse issued margin calls after marking Russian sovereign debt to zero. These banks are also amongst the largest holders of Russian sovereign debt at $133M and $134M, respectively (per Bloomberg). Given the size of the bank’s investment portfolios, neither figure is concerning, and a complete write-down would only marginally impact the liquidity coverage ratio. 

S&P cut Russian sovereign debt to junk status while Moody’s issued a warning that the debt could also be downgraded to junk, meaning that Russian sovereign debt will not be included collateral or in the collection of securities borrowed or sold in repurchase agreement transactions. At Public Trust, our Credit Team has long maintained that repurchase agreements and asset-backed commercial paper conduits backed by repurchase agreements are among the safest structures available in the money markets. In our view, the swift response of the global financial community reaffirms the strength of repo and repo-derived vehicles.

Will China invade Taiwan? Does it matter?

During the opening ceremony of the Beijing Winter Olympics earlier this month, the world watched closely as China and Russia signed their closest partnership to date amid the buildup of Russian troops along the Ukraine border. The two leaders struck deals on oil and gas before giving a joint press conference directed at the U.S. and NATO, marking China’s most direct support of Russia. However, there is reason to believe that the Russian invasion of Ukraine caught Beijing off-guard and could throw a wrench into the relationship. As early as two days before the invasion, Chinese academics and policy analysts were giving speeches about how they did not believe Russia would invade, and the Chinese State Department reportedly shrugged off intelligence presented by the U.S. and E.U. about a coming attack. Now the Chinese administration is trying to “save face” and issuing public comments aimed at Russia asking that they pursue diplomatic talks instead of incurring more violence. 

All of this brings us to Taiwan with many market participants wondering if China will take this opportunity to invade Taiwan. While we believe that is highly unlikely, we want to note that such a move would be a prime example of a Black Swan Event (an event with such a low or unknown probability it is imprudent to manage to). China knows that aggression against Taiwan at this time would likely provoke a U.S. response, be it militarily or economically, and at a time when Beijing’s economy is already dealing with slowing growth and a real estate bubble. If Beijing were to seize Taiwan, the response and its impact on the global economy/financial system is incredibly uncertain and that is why it is a Black Swan Event; managing to the range of possibilities is so large that picking the correct one would be nearly impossible. At Public Trust, we continue to diligently monitor the ongoing developments, and our team of professionals is ready to make calls no matter what scenario comes across our desk; one of the many advantages of having a credit research team is dedicated risk management during uncertain times.

All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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