Reserve Currencies and Due Diligence

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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Happy SDR day!

Today is the day that the International Monetary Fund will announce its decision "to grant China’s yuan status as a reserve currency by adding it to the fund’s Special Drawing Rights basket." (Or it won't, I mean, but it will.) This decision is sort of controversial:

The staff’s findings hinged on the renminbi meeting two criteria. The first is that China and the renminbi have a significant role in global trade, a bar which Beijing passed years ago. But the second — that the renminbi be both widely used and “freely usable” internationally — has proved more contentious.

In a number of the measures that ascertain how widely it is used — such as its use in central bank foreign exchange reserves and in international debt markets — the renminbi fell below the Australian and Canadian dollars, neither of which is a member of the SDR basket. 

Operational and free-usability issues remain, but on the other hand I suppose nothing will encourage Chinese currency liberalization like SDR inclusion. That is the theory, anyway:

The inclusion puts new pressure on Beijing to change everything from how it manages the yuan, also known as renminbi, to how it communicates with investors and the world. China’s pledges to loosen its tight grip on the currency’s value and open its financial system will come under new scrutiny.

Also here is a possibly relevant paragraph from Bloomberg News (citing the Wall Street Journal):

A working group that includes former Treasury secretaries Henry Paulson and Timothy Geithner hopes to build a framework for the trading and clearing of the Chinese currency in the U.S., the Wall Street Journal reported Monday, citing a statement from Michael Bloomberg, who will chair the group. Michael Bloomberg is the founder and majority owner of Bloomberg LP, the parent of Bloomberg News.

Diligence.

Last week Barclays got in a bit of trouble for not doing much due diligence on "a multi-billion-dollar deal for people with high-profile political ties in 2011," and was fined 72.1 million pounds by the U.K. Financial Conduct Authority. I have to say the FCA order is a little nitpicky; a lot of the red flags that the FCA thinks called for enhanced due diligence don't seem all that glaring. Like, the transaction was big and complicated, and Barclays signed a confidentiality agreement, and "the extension of credit to clients who use their own assets as collateral poses a money laundering risk." Surely the extension of credit to clients who use other people's assets as collateral is worse? If secured borrowing against your own assets is probably money laundering, then what isn't?

Still there are some legit worries:

At one point while arranging the Transaction, the Clients requested that Barclays make a payment of several tens of millions of US dollars to a third party. When Barclays questioned the rationale for that payment, the request for the payment to be made to the third party was withdrawn. 

The two most suspicious words in the world are "never mind." Despite the red, or reddish, flags, Barclays's diligence seems to have been conducted mainly on Google:

Barclays obtained one explanation about the Clients’ sources of wealth, which described them as “landholdings, real estate and business and commercial activities”. This was wholly inadequate and virtually meaningless in the context of the due diligence that Barclays was required to undertake in connection with the Business Relationship.

Barclays also relied on printouts from publicly available internet pages to verify the Clients’ sources of wealth. However, while internet research can be a useful source of information for firms carrying out EDD, the articles used by Barclays did not provide sufficiently detailed, meaningful or reliable information as to the size and source of the Clients’ wealth. 

On the one hand ... how else would you research anything? It's not like investment banks have some special magic super-Google to find out where people got their money from. On the other hand, they kind of do ("It was relatively common practice for Barclays to commission third party intelligence reports on clients classified as Sensitive PEPs or where a client’s source of wealth was not easy to corroborate with independently verifiable evidence"), and anyway you could always just ask the clients. I mean, you could ask them and then demand a specific answer, which seems not to have been a priority here.

Insider trading.

This is old news, but I would be remiss not to mention the former Goldman Sachs employee sued by the Securities and Exchange Commission last week for insider trading. Here are the SEC press release and complaint. Here's the scorecard:

  • Bad work: He allegedly got inside information about upcoming mergers and acquisitions as part of his work at Goldman, and then bought out-of-the-money call options on the targets, which, as I may have mentioned a few dozen times, the SEC tends to notice. ("The SEC’s case stems from its Market Abuse Unit’s Analysis and Detection Center, which uses data analysis tools to detect suspicious patterns such as improbably successful trading across different securities over time," says the SEC, and I promise you that buying a lot of short-dated out-of-the-money call options on not-yet-announced merger targets is the most suspicious of all patterns.)
  • Good work: He is a Chinese national, is currently in China, and allegedly left for Shanghai the day after he closed his last options position. That's the right time to leave! The SEC will catch your short-dated out-of-the-money call options trading, but it will take a while; the trick is to leave first.
  • Amusing twist: He worked in compliance, specifically in the "Surveillance Analytics Group," where he "was tasked with helping to develop surveillance analytics to assist Goldman Sachs in detecting improper conduct, including potential insider trading." Honestly that can't be that big a surprise. Quis custodiet ipsos etc.

The financial sector.

I don't necessarily agree with Adam Levitin that "Glass-Steagall is a political imperative for American democracy," but surely he is right that the only real argument to bring back Glass-Steagall is a one of political power: As he puts it, "by splitting up the financial services industry into squabbling factions, the result will be a substantial reduction in the influence of any particular section of the industry." I have argued before that "Wall Street" is not as monolithic as politicians sometimes think, but it is doubtless more monolithic than it would be if commercial banking and investment banking were kept separate.

Elsewhere, here (via Tyler Cowen) is a pithy Dan Davies comment on the causes of the financialization of the economy:

Surely the answer is “risk transfer”. The biggest economic policy decision of the last thirty years has been the decision to de-socialise a lot of previously socially insured risks and transfer them back to the household sector (in their various capacities as workers, homeowners and consumers of healthcare). The financial sector was obviously the conduit for this policy decision. Their role is to provide insurance to the rest of society and this is what they did – in fact, they provided too much of it, with too little capital which is why they went bust, and why their bankruptcy was so disastrous (there’s nothing worse than an insurer bankruptcy, because it hits you with a big loss at exactly the worst time).

And here is the New York Fed's Liberty Street Economics blog on "U.S. Banks’ Changing Footprint at Home and Abroad." 

People are worried about unicorns.

One worry about unicorns is that the market for initial public offerings may be souring, which will make it tough for late-stage private investors to get out of unicorns at acceptable valuations. But of course there are other exit options:

Many IPO candidates are getting better offers from potential acquirers, including strategic rivals and financial firms.

All told, the dollar volume of U.S. IPOs this year has dropped 63% from the total in 2014 to $36 billion. At the same time, more than $2.3 trillion worth of merger and acquisition deals have been announced this year, a record pace that is up 46% from the total volume of 2014.

That story is about IPO candidates in general, though, not tech unicorns, and I suppose it's easier to pivot from IPO to M&A if you are a private equity re-IPO than if you're a disruptive world-changing social whatever. 

Meanwhile, here's a BuzzFeed story about employee-benefits unicorn Zenefits, whose employees apparently sometimes sold insurance (to companies) without being licensed as insurance brokers in the relevant states. When I read about pushy libertarian startups flouting the law, the law usually turns out to be dumb. I'm sure there are some good reasons for occupational licensing for corporate insurance brokers, but this is pure barbarism:

Under Washington law, anyone who knowingly sells, solicits, or negotiates insurance without the proper state license is guilty of a Class B felony, which can carry a prison sentence of up to 10 years, as well as a civil penalty of up to $25,000 for each violation.

Ten years in prison! I understand the desire for the state to protect us from the coercive power of financial capitalism, but the state hasn't always covered itself in glory in its use of its own coercive powers. Elsewhere, here is a sad story about criminal justice reform.

People are worried about bond market liquidity.

They aren't really, this morning, as far as I can tell, but let's just use this section as a general catchall for technical fixed-income-market worries. For instance: "There's a Big Drop in U.S. Treasury Debt Supply Coming in 2016," which probably won't be good for liquidity. (But what will it do for swap spreads?) Here is Izabella Kaminska on Credit Suisse on Libor, repo and dealer balance sheet regulation. And here is a Thanksgiving poem by Bloomberg's Tracy Alloway about repo. Stay tuned for my sonnet cycle about bond market liquidity. ("Much have I traded in new-issue deals / And many goodly bonds and CUSIPs seen" etc.)

Things happen.

BTG Pactual Drops as Firm Separates From Jailed Founder Esteves. Behind Puerto Rico’s Woes, a Broadly Powerful Development Bank. Private equity looks to tap hedge fund growth. Hayes Poised to Challenge 14-Year Libor Sentence, Conviction. The Silk Road Affair: Power, Pop and a Bunch of Billionaires. Divergent Paths for U.S., European Central Banks. Deutsche Bank created complex tax avoidance strategies. AIB Seeks $872 Million From Citigroup in Rogue Trader Clash. Jessica Pressler on "The Big Short" ("The giddy get-rich-quick plotline, which most likely reminded Pitt of his Ocean’s Eleven heyday, loses some of its magic when you realize the party on the losing side is not a predatory corporate casino but the U.S. economy"), and Christian Bale on the people he met while researching "American Psycho" ("I went on the trading floor, and to offices, and then we went out for the evenings, and I have no idea where we went, I couldn't tell you, but it was disturbing"). Robot balls. Finland bear map. Cannabis coffee. Mary-Kate Olsen and Olivier Sarkozy’s Wedding Featured "Bowls Filled With Cigarettes." A lot of the stuff here is bad.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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

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