Hungary’s brokerage fraud scandal continues to develop and London-based analysts are already estimating what implications it could have on the market, as well as on the country’s macro and financial stability. Peter Attard Montalto, a strategist at Nomura, said in a research note that there is still much uncertainty and although he does not forecast direct effects into the fiscus, he does expect “higher charges to the wider financial sector to remove potential lending growth upside." Whereas he does not believe the political connections involved in failed brokerage Quaestor are likely to concern investors immediately, he does think that “the political choices on compensation and the scandal reflect increasing pressure" on the ruling Fidesz party.
What is this about?
The brokerage scandal first erupted, quite suddenly, in early March. The crux was three brokerages were involved in fraudulent activity, the biggest of which was Quaestor, which had issued some HUF 150 bn of unregulated bonds, Attard Montalto summed up the start of this still evolving story that has since become only murkier.
In particular, he noted that very serious questions have been raised about insider trading by the public sector on withdrawing funds from the three brokerages before the details were made public and the cabinet’s involvement in decisions on the fate of Quaestor with respect to political rivalries within Fidesz.
“Such issues are likely to go nowhere in terms of resolution," Attard Montalto said, reminding that the central bank, which is also the financial markets regulator, said there are no charges to answer in regard to insider trading and Parliament has dismissed similar inquiries with the exception of an investigation into the ‘failings’ of previous administrations before 2010 on the brokerages.
Troubling issues
Attard Montalto has pointed to some serious and still unanswered questions:
Why the whole scandal suddenly came out at the end of February and start of March?
What were the activities or reports that prompted an investigation by the MNB? Were there liquidity problems in the brokerages at that time that forced the MNB to open up the brokerages’ books with the lack of a real asset base?
How were customers allowed to buy unregulated bonds?
Why have there been no discussions on reforming brokerages to prevent the issuance of unregulated bonds?
What actually brought the brokerages down? Was it the removal of government deposits for political reasons?
“These issues have risk premia issues at best for markets and with no momentum on them locally the ECB QE etc is likely to wash over them. Leaving this to one side - we focus on any other potential implications," he said.
Attard Monatlto noted how odd this situation where Buda-Cash and Hungaria Securities victims will only get HUF 6 m in compensation, while Quaestor clients will receive HUF 30 m. (There is also a 10% own contribution at BEVA on investments over HUF 1 m.)
“[...] it is fair that all the figures and costs are multiplied by a factor of 1.5. As we shall see however there is still much uncertainty about the costs and the timelines," he said.
“The total costs of Quaestor compensation have not been made available, but there are some HUF 200 bn of assets, while around HUF 160 bn of asset recovery has been projected from Quaestor by the state, the liquid portion of this may well be quite small because many of the assets are real estate or similar. BEVA is likely to take control in some form of the proceeds to fund itself overtime," he added.
Attard Montalto said the key remains BEVA borrowing, funded by cash-stream payments from the banking system.
“This leads to some very difficult questions for the banking system. Although it is standard practice that the rest of the banking system backstops protection funds, it is unclear why any payments should be due from, say, OTP, to BEVA to compensate for losses of non-deposit investments for richer households, where there were clearly regulatory failures and a complex mesh of political involvement."
He has reiterated an earlier comment he made when the scandal first broke out, saying he would not surprised “if the government uses the scandal as a stick to beat the financial sector with and indeed use higher payments to BEVA to offset planned lower corporation tax or as an eventual bargaining tool to get higher lending rates."
“For now there seems to be an additional drag on the banking sector that will consume a significant chunk of the banking tax reduction to cover the full HUF 30 m compensation limit. In some senses this will not affect bank profitability vs last year, but means the weight of demands on banking sector profits are not decreasing," he added.
Hence Attard Montalto’s concern remains that “the banking system is not available as a real driver of growth, particularly for corporates (ex-FGS), especially as the compensation bill grows."
In his view, the scandal “looks set to have no impact on fiscal or gross debt levels, though will likely increase contingent liabilities, if there is a guarantee given to BEVA for market issuance or MNB credit lines."
The initial concern about mass bond liquidation holdings seems to have passed, though no announcement on asset liquidation has been made yet, Attard Montalto noted.
“Parliamentary proceedings have suggested that Quaestor liquid client assets will still be transferred to other banks (ie clients government bond and equity holdings), while BEVA will then step in with its cash (from issuance/MNB) to compensate clients directly in the future (with no timeline set). This money will likely find its way into other brokerage accounts or deposits and into government debt holdings."
Hence, the strategist still believes excessive risk premia is not justified on the brokerage scandal on the HGBs.
Fidesz takes a beating, Jobbik should be watched
Attard Montalto said that although the political connections involved in Quaestor are unlikely to concern investors immediately, the political choices on compensation and the scandal reflect increasing pressure on Fidesz.
“This should be a reminder to markets of the long-run political issues and shift in the landscape in Hungary," he has warned.
Unlike in the past when the loss in Fidesz support went into undecided voters with no pick up in the other parties, this time there has been an increase in undecided voters, but far-right radical party Jobbik has taken a fair chunk of the loss in Fidesz support.
“Indeed this has solidified in the first by-election win by Jobbik against Fidesz last weekend and both parties are now coming into contention for being poll leader in the coming months. Hence the political sphere through which Fidesz has dealt with Quaestor and the surprise at the lack of compensation extension to the other brokerages," he concluded.
“Just as the increase in support for other radical parties in Europe has sparked increased concerns, in Hungary, even though an election is a long way off, so the potential for more extreme policy in the interim rears its head.
“Until now we have always said that Fidesz had little to concern itself with Jobbik and that it would not be a serious influence on policy - maybe with any effects confined at the margins to social policy. However, we think that is not the case anymore, and Jobbik’s support in the electorate and its actions within parliament (as already the third largest party with 23 seats out of 199) need to be more closely watched, together with Fidesz’s reaction to its rise."
The number of controversies in the statements Hungarian government officials have made about the still unfolding brokerage scandal almost matches the number of mysteries surrounding the frauds themselves. See the table below for details.
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