Macaskill on markets: Vorsprung durch Vorschrift

By:
Jon Macaskill
Published on:

Volkswagen’s bonds head into the red.

dashboard_illus-500
Illustration: Kevin February

Confidence in car emissions measurement has been undermined by the disclosure of test cheating by Volkswagen, but there is no doubt that auto company securities can provide an extremely effective way to lose money.

After Volkswagen’s systematic evasion of regulatory emissions tests became public in mid-September, the company lost close to 40% of its stock market value, or roughly €25 billion. 

The volatility in Volkswagen’s stock was not quite as dramatic as the short squeeze in its shares seen in October 2008, when its price briefly more than doubled after option market manipulation by Porsche, which at the time was plotting a takeover of its bigger rival, and would eventually end up as part of the same group.

But more value has been destroyed by the recent fall in Volkswagen stock than in the 2008 squeeze that cost short-selling hedge funds such as Elliott Associates and Greenlight Capital, along with proprietary dealers at banks, at least €5 billion and likely nearer to €10 billion. 

Volkswagen’s bonds were also marked down sharply as the recent emissions scandal began to unfold and the cost of its credit default swap protection trebled from around 70bp to 215bp. Hybrid bonds issued by Volkswagen, which was a pioneer in corporate issuance of securities with both debt and equity characteristics, were hit particularly hard, falling by as much as 10 full cash points.

That is a substantial dip in price for a corner of the corporate debt markets that generally enjoys price stability and was a reminder of the difficulty in anticipating or hedging against idiosyncratic credit risk.

The fallout from the Volkswagen scandal may end up being felt disproportionately in the credit markets, partly because it is a bellwether issuer, but also because investors increasingly see corporate bonds as a safe-haven asset class, despite issues with liquidity and transparency compared to equities.

The big surprise is arguably why so many people trusted
CEO Ivan Glasenberg’s assurances

This could lead to closer oversight of the credit markets, especially if the European Central Bank (ECB) decides to extend its quantitative easing programme with purchases of corporate bonds in a bid to stimulate growth in the region.

The ECB is well aware that direct purchases of corporate bonds would create moral hazard and bring an array of technical challenges. It is therefore likely to accompany any shift in policy with increased supervision of credit instruments, if only to provide itself with some cover against accusations of unwise investment.

The central bank was quick to suspend the eligibility of Volkswagen asset backed securities for its limited and ineffective programme of purchases of securitized instruments after the emissions scandal began. It will presumably wish to put other controls in place before any move to buy unsecured corporate debt.

Volkswagen’s test cheating could accordingly end up causing increased regulation in the financial markets, as well as a tightening of standards within auto manufacturing and selling.

Volkswagen was well known to viewers of TV ads in Europe in previous decades for selling its Audi cars with a slogan of 'Vorsprung durch Technik’, or advancement though technology.

Its chief contribution in the coming years may be to the cause of 'Vorsprung durch Vorschrift’, or advancement through regulation.

The firm’s recent troubles may also serve as a wake-up call to private investors in corporate credit, if only because its fall from grace was so unexpected. 

Glencore decline

The other great corporate value destruction story of 2015 has been the decline of Glencore. The 75% fall in Glencore’s stock since the start of the year and the widening of its credit default swap protection spreads to over 700bp – a level signalling great distress if not imminent default – has shocked many investors with the ferocity of the price movement.

But there is nothing inherently surprising about financial stress for a leveraged trading company that also owns physical mining assets during a slump in prices for the commodities that Glencore produces and deals.

The big surprise is arguably why so many people trusted CEO Ivan Glasenberg’s assurances that trading profits would mysteriously manage to make up for any shortfalls caused by the plunge in commodities, regardless of market direction. This type of magical thinking has since been replaced by a much simpler rule of thumb, as Glencore’s stock price has become virtually correlated with the price of copper.