Levine on Wall Street: Draghi and Dark Pools

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Draghi's big day.

"At about 2:30 p.m. in Frankfurt, the European Central Bank president will probably commit to a quantitative-easing program that may exceed 1 trillion euros," so get your bets in. "At stake here ...," begins a guy, and you get the idea. It's a big deal. The ECB's executive board has proposed "proposed spending 50 billion euros a month through December 2016," larger than previous proposals, "but markets largely shrugged as investors pondered whether the ECB will do enough to stoke Europe’s fragile economy." Here are some predictions from Deutsche Bank, Credit Agricole, Bank of America and Soc Gen.

Elsewhere in central bank news, Canada cut its overnight rate yesterday. And that "first too little volatility, now too much" problem that bond traders were having is spreading to currencies, with normally placid Canadians yelling on trading floors after yesterday's rate cut, sandwiched as it is between last week's Swiss National Bank move and today's ECB announcement. Speaking of the SNB, Credit Suisse yesterday said that its "currency sensitivities have remained broadly unchanged since the end of 3Q 2014"; those sensitivities were "that a 10 percent move in the euro to the franc would have potentially reduced its profit for the first nine months of 2014 by 180 million francs, or $205 million," and the actual move was 20 percent. And January 15 -- the Swiss franc un-pegging day -- seems to have set a record for foreign-exchange trading volume, with the continuous link settlement system settling 2.26 million transactions for $9.2 trillion.

Again with the Barclays dark pool.

A cynic might look at last week's Securities and Exchange Commission action against UBS's dark pool as the agency's attempt to regain the dark-pool, um, spotlight from New York Attorney General Eric Schneiderman. That cynic might then view Schneiderman's amended complaint against Barclays's dark pool, filed yesterday, as another round in a regulatory turf battle. The new complaint isn't exactly full of new wrongdoing -- Barclays says: "The amended complaint merely repackages the same flawed arguments that were in the original complaint" -- but it is full of names. A bunch of Barclays executives are named, and connected with specific alleged misdeeds, with William White, the head of electronic equities trading, coming in for particular attention. And a bunch of high-frequency trading firms are also named (besides Tradebot, which we already knew about, though supposedly Barclays's clients didn't), with GTS Securities singled out in an anecdote about how it traded too much volume and Barclays asked it to cut it out and it didn't.

The problem -- and it's sort of shared by Barclays and Schneiderman -- is that nobody knows what "toxic" high-frequency trading is. Barclays promised -- or, I mean, hinted, whatever -- to keep its dark pool free of toxic HFT. (Also called "aggressive," or "predatory.") Schneiderman claims it didn't. Did it? Well, there was a lot of HFT in that dark pool -- more, Schneiderman hints, than the non-HFT clients were led to expect. But neither Schneiderman nor Barclays offers much in the way of a definition of what "toxic" might mean. (Just ... making money? Doing a lot of trades? Doing a lot of trades that make money?) But this doesn't look great for Barclays:

For example, on January 16, 2014, senior leaders in the Equities Electronic Trading Division were provided an analysis identifying over a dozen major high frequency trading firms engaged in significant trading activity in Barclays' dark pool. That analysis described those firms' history of sending "toxic" order flow. One high frequency trading firm, Hudson River Trading, was described in the analysis as "historically ... very toxic." Another firm, Sun Trading LLC, was described as having "[trading activity that] is very toxic, and the client is up-front about this." Another firm, Getco, "is in [the most toxic] bucket 0 every week and will likely stay there for a long time." GTS Securities LLC was described as having "[k]nown latency arbitrage flow" in the pool (emphases added). Barclays never denied any of those firms (or any others) access to its dark pool.

If you were a high-frequency trading firm, would you want to be on that list? "Toxic," presumably, means that you made a lot of money trading with Barclays's dark pool, which is probably why Sun Trading was "up-front about this." Anyway the life lesson here is that, whatever you mean by it, you probably shouldn't call any of your clients "toxic," at least not in writing.

Elsewhere the European Securities and Markets Authority "will look at whether automated trading adds fake, or ghost, liquidity to markets," and I bet that "ghost liquidity" is going to be about as hard to define as "toxic HFT."

Venture capital and private equity.

Uber seems to have succeeded in raising "$1.6 billion in convertible debt from Goldman Sachs Group Inc.’s wealth management clients." The security is sort of interesting (we've talked about it before): It's a six-year bond with a coupon that ratchets up over time if there's no initial public offering; if there is an IPO, the bond "will convert into equity at a 20 percent to 30 percent discount to Uber’s valuation at the time of an initial public offering." So you're not buying in at a fixed valuation in the hope of getting back a multiple of your money at the IPO. You're getting a fixed-income-type return -- that ratcheting coupon, plus you amortize that IPO discount over however long you hold the bond -- plus you get to capture any IPO pop. The institutional investors who bought in at a $40 billion valuation probably aren't expecting a huge multiple by the IPO either. The financings "underline Uber’s endless appetite for cash as the company moves its operations into new cities worldwide, a task that requires plenty of capital" but not, so far, an IPO. Uber's previous $2.8 billion in equity funding -- before this convertible! -- is "the most on record for any private company backed by venture capital." Uber is a good laboratory for economic reasoning, and Uber's balance sheet is a good laboratory for financial reasoning. 

Elsewhere, "online tuxedo rental start-up" The Black Tux raised $10 million in venture funding, K.K.R. is buying Thetrainonline.com, "a booking website for train travel in Britain," and Ship Your Enemies Glitter sold for $85,000 "on Flippa, an online marketplace where entrepreneurs can trade in start-ups, domains or toolkits for building a business from scratch."

Oops!

"My only hope is that you understand that I acted in an attempt -- however misguided -- to generate higher returns for the fund and its investors," says Owen Li, the hedge fund manager who lost 99.8 percent of his investors' money, and he is quite right: If they don't understand that -- if they suspect that he couldn't really have lost 99.8 percent of their money entirely in good faith -- then he will be in big trouble. As it is, he is "truly sorry," and honestly imagine sitting down to write a letter to the effect of "sorry I lost your $100 million!" Words seem so inadequate. Li's fund is (was?) called Canarsie Capital, perhaps a surprising neighborhood for a hedge fund name, and he used to work at Galleon Group, so he's seen trouble up close.

Elsewhere, "Inside trader Michael Lucarelli admits struggles with impotence, cocaine at sentencing" pretty much sums it up. And Daniel Gordon has quite a story: After getting out of prison for stealing $43 million from Merrill Lynch, he "reinvented himself as a businessman whose projects included lending money to professional athletes at steep interest rate," and then filed for bankruptcy to discharge the taxes he owed to the IRS on the money he stole from Merrill. This did not work, is the latest news, which is probably not that surprising.

Some bond news.

Too little volatility may be bad for trading, but too much is definitely bad for issuance. So far this year there's only been $9.7 billion of U.S. junk bond issuance, "making 2015 the slowest start in six years," though I feel like 21 days is a pretty small sample? This is bad for bank fees, but also for investors, who complain constantly about illiquidity; the customary complaint is that the only bond sellers are issuers, and without that there's just no liquidity at all. In perhaps liquidity-related news, BlackRock is increasing its funds' credit lines to allow them to pay out redemptions without immediately selling securities. And Russia's first bond sale of the year did not go well.

State of the Union follow-up.

Look, the State of the Union address is for saying a bunch of nice-sounding things that won't happen, for a whole variety of reasons, one of them being that Congress won't pass any of them. Here is a claim that one of President Obama's proposals with particular relevance to finance -- a 7 basis point tax on borrowing by banks with over $50 billion of assets -- could be implemented without Congress, despite the Constitution's allocation of the taxing power to Congress, because the Fed might do it. The Fed, an independent body, might implement a tax that the President called for in a speech. If you're a big bank, you should feel pretty good about your chances here.

Stuff happens.

Nobody goes out to lunch. John Hempton has some very interesting musings on "Herbalife after option expiry," noting that a lot of Bill Ackman's puts seem to have been assigned. An independent PayPal will have "good governance," i.e., no staggered board and serious restrictions on poison pills. Succession at Tootsie Roll. The Rewards of an Ethical Culture. How to seed the Champions League. "The sportswriters present shamefully failed to ask about monetary policy." Cardinal Marx: We must think beyond capitalism. Opposite Opening Lines to Famous Novels.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net