Chinese Markets and Saudi Oil

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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China.

I have joked about a "meta-circuit-breaker" in the Chinese stock market that would shut the market down for the year, but I used the term all wrong. A "meta-circuit-breaker" would really be, not just a big circuit breaker, but rather a rule that says: If the circuit breakers do enough damage, then you shut down the circuit breakers. And yesterday China's regulators went ahead and invoked the meta-circuit-breaker, shutting down the circuit breakers, or at least suspending them. It seems to have worked: "The Shanghai Composite Index closed 2 percent higher, after falling as much as 2.2 percent earlier," and I suppose with the circuit breakers in place that earlier drop might have spiraled into a down-7-percent drop, an early close, and no chance for a rebound.

Still you could get even more meta. For instance, if China's constant readjustment of market rules always seems to make things worse, you could have a meta-meta-circuit-breaker in which if things get bad enough, you stop adjusting the market rules. The most general meta-rule might be: If something is making things worse, stop doing that thing. You just have to find the right level at which to stop doing things. One concern about the circuit breakers is that retail investors were rushing to dump shares before the market shut for the day, but one concern about another intervention -- the one banning major shareholders from selling stock for some indefinite period -- is that retail investors will rush to dump shares before the major shareholders can sell, and that no one will be there to buy. ("It would be hard to conceive of a better plan for scaring money away," says the Economist.)

Circuit breakers seem to me to be a technical solution to a technical problem: If there is an irrational panic, ideally a machine-driven panic, you pause the market for a while to allow investors to recognize value and start buying. It is not a priori obvious that that is the right diagnosis for China's stock market, or that any of this week's pauses have actually attracted any value investors. "There’s a lot of confusion about how much of [the sharp moves in Chinese markets] is tied to real changes in economic activity, versus volatile noise," says a guy. So former U.S. Treasury Secretary Nicholas Brady, who sort of invented circuit breakers, says that China's regulators are "on the wrong track" and should "widen their band," which is probably right but which also might overestimate the power of any circuit breakers to help. And other technical aspects of China's markets -- like the fact that "Hedge funds in China generally have agreements with investors spelling out mandatory liquidation levels if their holdings drop below a certain value" -- might counteract any good that a circuit breaker could otherwise do.

Elsewhere: "Be Scared of China's Debt, Not Its Stocks," says my Bloomberg View colleague Noah Smith. And: "Global Circuit Breaker Guide."

Saudi Aramco.

One weird thing about the prospect of Saudi Arabia selling shares in Saudi Aramco is that the Economist seems to have just casually asked deputy crown prince Muhammad bin Salman, "Can you imagine selling shares in Saudi Aramco?" and he just casually answered:

This is something that is being reviewed, and we believe a decision will be made over the next few months. Personally I’m enthusiastic about this step. I believe it is in the interest of the Saudi market, and it is in the interest of Aramco, and it is for the interest of more transparency, and to counter corruption, if any, that may be circling around Aramco.

But it's a listing of Saudi Aramco! It's a big deal! If the whole business was listed (and "options under preliminary consideration range from listing some of its petrochemical and other 'downstream' firms, to selling shares in the parent company"), it would be easily the most valuable company in the world. "An initial public offering of the entire enterprise had only ever been discussed as a joke," and while I do not myself quite get the humor in that joke, Bloomberg does report that "When one financial adviser heard about Saudi Arabia’s plans to list a company larger than the economies of most nations, he had to pull over his car because he was laughing so hard."

So the media and the bankers are incredulous. But "diplomats say investors are already being sounded out," and "the prince has held two high-level meetings recently on the possibility of floating Saudi Aramco shares," all of which makes this sound a lot more real than just a casual chat. If nothing else, it is strange that Saudi Arabia could have had investor meetings about the biggest initial public offering in history without it leaking.

The other strange thing is that oil prices are below $30 a barrel, making this a world-historically inopportune time to sell shares in an oil company. "It’s hard not to see talk of floating Aramco as a defensive move forced on a kingdom that is under pressure on the financial, political and military fronts," says Bloomberg Gadfly's Liam Denning.

Lycalopex.

The most interesting subject in the world is, of course, tax arbitrage, and so I admired this Wall Street Journal article about Bank of America's tax structuring group for its imperturbable focus on tax arbitrage, despite touching on subjects that in lesser hands might prove distracting. For instance, one of BofA's counterparties in tax arbitrage was "a Dubai investment firm called Lycalopex," which was "named after a jackal-like animal," and whose "partners in Dubai no longer pursue the investment strategy and instead sell packaged, halal-certified meals to refugee-aid organizations and supermarkets." That is a fascinating pivot! Are the packaged meals also somehow a tax trade? We never learn; it is just left there so we can get back to the tax arbitrage.

Or there is a section of the article about some deals involving a Bank of America trader named Rurik Jutting. If that name sounds familiar to you, it may be because he was arrested in Hong Kong for allegedly murdering two women and stuffing one of them in a suitcase. The Journal article gets around to that fact 11 paragraphs after Jutting is introduced, and even then just to explain why "Mr. Jutting couldn't be reached for comment." The previous 10 paragraphs about Jutting keep the focus squarely where it belongs, on the tax stuff.

That said, honestly this tax stuff is not the sexiest of tax stuff? The Bank of America group, called Structured Equity Finance and Trading, seems to have done a lot of dividend-arbitrage trades, a fairly vanilla sort of tax avoidance where a hedge fund that would otherwise be subject to withholding tax on dividends on its share holdings instead sells those shares to the bank, which puts them in a jurisdiction without withholding tax, collects the dividends, and then passes the economics on to the hedge fund in the form of a swap or repurchase agreement, splitting the tax savings. (We have discussed this previously here and here.) A lot of tax authorities don't like this sort of thing -- it was shut down in the U.S. starting in 2008 -- but it still works, or worked, or arguably worked, in enough European and Asian jurisdictions that SEFT had a good run:

In a sign of the group’s importance, some employees pocketed bonuses of $1 million to $3 million apiece in certain years, spawning envy from nearby colleagues who mostly saw SEFT as a bunch of nerds who milked other employees’ client relationships for additional profits.

I may be a bit sensitive on this subject since, when I worked at an investment bank, it was in a group with "Structured Equity" in the name and nerds in the seats, but I have to say that if you work at an investment bank and criticize people for being "a bunch of nerds who milked other employees' client relationships for additional profits," you are doing it all wrong. Milking relationships for additional profits is the whole point of an investment bank, and oh what, you're not a nerd? Elsewhere in taxes, "Viacom Accused of Hiding Mutant Ninja Revenue in Netherlands."

Martin Shkreli.

"Martin Shkreli put up his $45 million E*Trade account to secure $5 million bail" in his federal securities fraud case, which you can take as evidence that:

  1. Martin Shkreli has at least $45 million (the New York Times says that this "is the first public accounting of just how much money Mr. Shkreli" has made); and
  2. he keeps it in an E*Trade account.

I don't know what's in his E*Trade account, but I will point out three other facts:

  1. As of his most recent disclosure, Shkreli owns 2,075,200 shares of KaloBios Pharmaceuticals;
  2. KaloBios most recently closed at $23.59, making those shares worth about $49 million; and
  3. That was in mid-December, just before Shkreli's arrest, and since then KaloBios's trading has been halted and it has filed for bankruptcy.

What I don't know is whether Shkreli's KaloBios shares were or are in his E*Trade account, or how E*Trade would value those shares if they were. I assume that if he has put up those shares for bail, he'd need to disclose it: Item 6 of Schedule 13D requires major shareholders to disclose pledges of shares, though I don't know how often that is used for pledges to secure bail.

IEX.

Here's another Securities and Exchange Commission comment letter from Hudson River Trading about IEX's application to become a stock exchange, which we talked about at enormous length a couple of weeks ago. Here's the basic argument:

  1. IEX protects its pegged orders against "latency arbitrage" by changing them in response to new information before they can be swept by other traders.
  2. IEX protects its routable orders against "latency arbitrage" by sweeping other traders before those other traders can change their orders in response to new information.
  3. Those are the opposite.

As Hudson River writes, "when IEX protects its users from Definition 1 of latency arbitrage, it does so by committing Definition 2 and when it protects its users from Definition 2, it does so by committing Definition 1."

This is absolutely right, and it can seem unfair or hypocritical, especially if you are a high-frequency trader. On the other hand, if you are an IEX customer, it is exactly what you want: You want your orders to be updated before they can be picked off, but you want to pick off other people's orders before they can be updated. I think the core of IEX's position is that, in both cases of "latency arbitrage," it is more or less on the side of real investors against flighty high-frequency traders, and so we should not get too hung up on the formalism of fairness. As I put it last time: "The question for the SEC is, roughly speaking, does fairness require being fair to high-frequency traders (who lots of people think are themselves unfair)?" 

The candidates and the shadow banks.

Mike Konczal takes Hillary Clinton's and Bernie Sanders's financial-regulation proposals way more seriously than I would have, and the results are very interesting:

Here’s a useful way to think about it: Bernie Sanders sees the problem of shadow banking primarily as a problem of major institutions. Tackle the biggest banks, weakening their political power and their ability to engage in questionable financial practices by breaking them up, and that largely solves the problem. Hillary Clinton, however, sees the problem of shadow banking as primarily one of activities. In this case, you need to cast a wider regulatory net, aiming at the specific types of actions financial people are taking rather than the size and strength of specific institutions.

And here is Felix Salmon with "15 things Bernie Sanders said about Wall Street, and whether they make any sense."

People are worried about swap spreads.

Swaps should trade wide to Treasuries, the theory goes, because swaps have counterparty credit risk and Treasuries have only U.S. government credit risk. But if China is going to dump a lot of Treasuries to prop up its own markets, then that will push Treasuries down relative to swaps.

People are worried about unicorns.

Gilt Groupe announced yesterday that it was being acquired by Hudson's Bay for $250 million, making it a mere quadranticorn, or quadranticorne, though it reached unicorne status all the way back in 2011. Katie Benner notes that the $250 million sale price is around what Gilt raised from investors (or even less), and that, since investors usually have preferences on any sale proceeds, that doesn't leave much for employees. It's possible, though, that if you take investor money at a $1 billion valuation and then destroy $750 million worth of value, maybe you shouldn't get paid any more than your salary. There's a reason employees tend to get common-equity claims. Elsewhere: "Venture capital funding fell by 30% between the third and fourth quarters of 2015."

People are worried about stock buybacks.

For a while, the stocks of companies with large buyback programs outperformed the S&P 500. Recently, they haven't. The competing mechanisms here are, on the one hand, a buyback boosts demand for shares and increases earnings per share; on the other hand, corporate buybacks are notoriously ill-timed, and negative-net-present-value investments should reduce the value of the company.

People are worried about bond market liquidity.

There is a popular theory that bond market liquidity has been harmed by increased regulation, but here Neil Collins at the Financial Times rather bravely extends that argument to suggest that liquidity might also be harmed by investigations of market manipulation. The easy response is that manipulated liquidity is the kind that you don't want. Still, I agree with him that the investigation into Lloyds possibly manipulating the gilt market sounds pretty weird: It's hard to see how any one trader or bank could manipulate a market that big on its own, and crackdowns on what were previously normal trading tactics might indeed make it harder for banks to trade bonds, with bad results for markets. Some dishonesty might be required to grease the wheels of bond commerce. Elsewhere: "Tensions mount in repo market."

Things happen.

How the Long Recession Is Changing Puerto Rican Migration. Ousted Fannie Mae CFO Tells His Side of the Story. Swiss Central Bank Racks Up Massive Losses in Curbing Strong Franc. How Central Banks Gained More Control Over the World's Major Currencies. Making sense of negative yielding convertible bonds. Is Blockchain Evidence Inadmissible Hearsay? The Flextrade FTSef rulebook looks a lot like the Thomson Reuters SEF rulebook. Why Banks Want to Be Complex. Investors cry foul over bank bail-ins. Activist Hedge Funds, Golden Leashes, and Advance Notice Bylaws. CEO pay in private military companies in the condottieri era. A bankruptcy court is auctioning a lottery prize of $1,000 a month as long as the debtor lives. We Are Living in the Golden Age of the Goatee. Offspring monetization. Hoverboard raid. The Year of Reading Wokely. Bread face. Super black pudding. Militia erotica. Hoax rats. Virtual-reality puppies

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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