CDS Fights and Golden Parachutes

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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Credit derivatives.

"Everybody loves a good credit derivatives story," I am reliably informed, but the story of Banco Espírito Santo and Novo Banco is really just a mediocre credit derivatives story? The story, according to the International Swaps and Derivatives Association, is that BES had issued some bonds, but "the central bank of Portugal, in its capacity as a resolution authority, transferred various assets and liabilities from BES (which was in difficulty) to Novo Banco (a so-called good bank)." This made bondholders happy, as holding bonds in a good bank is better than holding bonds in a bad bank; it's right there in the names. But then "sixteen months later, the central bank took the decision to re-transfer five senior bonds back from Novo Banco to BES," which made the holders of those five bonds unhappy, for reasons that ought by now to be obvious. They argued that this should trigger credit default swaps on BES or Novo Banco or whatever the issuer was at this point; ISDA, which is in charge of deciding these things, ultimately disagreed. Of course if BES actually defaults on the re-transferred bonds, one would hope that the CDS would trigger. The lesson here is that CDS is supposed to trigger on a default; again, it is right there in the name. As bad things happen that increase the probability of default, the CDS should go up in value, but it shouldn't necessarily trigger. Not all bad things count as defaulting.

Meanwhile the fight over Norwegian paper company Norske Skogindustrier ASA is a pretty classic credit derivatives story. Here, unsecured bondholders including "Blackstone’s credit arm, GSO Capital Partners, and Cyrus Capital Partners" have agreed to a maturity-extending debt exchange, which "senior-secured bondholders including BlueCrest, New York-based Marathon Asset Management and Finnish insurer Sampo Oyj" are opposing. Each side claims that the other is motivated by credit default swaps: GSO has allegedly sold swaps and is trying to keep "the company afloat long enough to avoid paying out on credit insurance it sold," while the company claims "that the bondholders suing to block the exchange wanted to drive the paper company into bankruptcy to collect payouts on the derivatives." It is all a bit reminiscent of RadioShack, in which CDS sellers also agreed to a debt exchange that delayed default and kept them from paying out on their CDS, while CDS buyers and secured creditors complained. This seems to have become a standard move in the distressed arsenal, though my dream of a distressed company running an auction between CDS buyers and writers to see who would give the company the most favorable terms (to default, or to not default) has yet to be realized.

Yahoo!?

Here is Yahoo's press release announcing its strategic alternatives process, and you can almost feel the gust of cold air between the third paragraph (Chairman Maynard Webb's quote about the independent committee that is exploring strategic alternatives) and the fourth (Chief Executive Officer Marissa Mayer's quote about how "as both shareholders and employees, all of us here at Yahoo want to return this iconic company to greatness"). The board and the CEO do not seem to be quite on the same page about whether they'd rather sell Yahoo or keep it. A few months ago Mayer got some press for her potentially nine-digit severance package, which, given Yahoo's recent performance, might seem a bit generous. But it's important to remember that the severance package is not really about rewarding the CEO for wisely guiding the company into a sale. The severance package is about lulling the CEO into accepting a sale: If Yahoo's board decides that selling Yahoo for scrap is in the best interests of shareholders, then it doesn't want Mayer undermining that decision just to keep her job and -- more important than the paycheck for a millionaire overachiever -- continue her quest to "return this iconic company to greatness." Given the value potentially at stake, paying $100 million to neutralize Mayer might seem cheap.

Anyway:

Companies such as Verizon Communications Inc., Comcast Corp. and AT&T Inc. are among interested parties, as well as buyout firms including Bain Capital Partners, KKR & Co. and TPG, the people said, asking not to be identified as the situation isn’t public. The potential first-round bids for the business are unlikely to come in for at least a month, they said. 

I've never quite understood Yahoo's core business but apparently it is basically a phone and/or cable company? Presumably the bids will be for more than zero dollars, although that might not be strictly necessary to create value.

Chinese markets.

"The new head of China’s securities regulator has been tasked with restoring confidence after policy missteps by his predecessor rattled investors and helped deepen a $5 trillion rout," and what sort of confidence, exactly, is a market regulator supposed to restore? The obvious answer is "confidence in the market" -- in its structural integrity, the fairness of its processes, the free movement of its prices, its accounting and governance standards, whatever. In the long run, the theory goes, confidence in those institutions creates value, because it leads to higher stock prices for a given level of underlying economic performance.

But of course after a "$5 trillion rout" the confidence that the regulator is really supposed to restore is probably in, you know, the prices of those stocks, and not so much in the long run. That argues for a different approach. If you want your institutions to be trusted, you push for transparency and market discipline and rigorous accounting standards. If you want your stocks to go up, market discipline loses some of its appeal. In any case I do not envy Liu Shiyu, the new chairman of the China Securities Regulatory Commission, who has a delicate balance to strike:

“The situation is not very stable," said Linus Yip, a Hong Kong-based strategist at First Shanghai Securities Ltd. “The CSRC must regulate without overly protecting the market."

One of Liu’s most important tasks will be to oversee the introduction of a more market-based registration system for initial public offerings, expected to be unveiled later this year. The new regime would leave the questions of IPO supply and timing to companies and the market, rather than the CSRC, and give firms more power to determine pricing.

Meanwhile in China's mergers-and-acquisitions market, "in a year that has already produced $81.5 billion of foreign acquisitions by Chinese companies—blowing away the pace in any prior year—not a single big Wall Street bank is among the top three buy-side advisers." Local knowledge helps:

Deal makers say Chinese banks can better gauge shifting political tides and connect more easily with less-sophisticated local buyers. They benefit from deep local corporate ties as well as an ability to tap vast reserves of cash for loans at a time when many Western banks are retrenching.

They also "tend to have better relationships with Chinese regulators." In other news, "HSBC said it was being investigated by US authorities over its hiring of people linked to Asian governments." It also "posted an unexpected fourth-quarter loss, its first since at least 2009, as revenue dropped and loans to oil and gas companies drove a jump in impairment charges."

Market structure.

The latest news out of the IEX war is that IEX "is tired of waiting for regulators to approve its application to become a full-fledged stock exchange" and is demanding that the Securities and Exchange Commission make a decision soon. It seems to be a hard decision! The main issue is IEX's 350-microsecond "speed bump," not so much the bare fact that it exists (lots of exchanges have delays that are longer than are strictly required by the laws of physics), but the fact that IEX allows some orders to skip it for some purposes. The point of this is to solve "latency arbitrage," but IEX does that by doing some latency arbitrage itself. (In market-structure debates, you can call just about anything "latency arbitrage.") So IEX's router races ahead of other traders to pick off liquidity on other exchanges based on stale information, much like latency arbitrageurs supposedly do, while IEX's pegged orders offer a sort of last-look functionality, trading only after they've checked that the market hasn't moved against them in the succeeding 350 microseconds. These are arguably fairly benign latency arbitrages, and IEX is run by nice guys, and it's helping long-term nice investors, etc. But, the argument goes, if the SEC approves IEX's application to do its own latency arbitrage, then other, less nice exchanges will do the same thing (as Nasdaq has hinted it will), and the market will descend into a chaotic war of latency one-upmanship. 

One counter-argument is more or less that the market is already there, so you might as well let IEX protect some long-term investors from the ravages of latency arbitrage. Another is that IEX's particular kind of latency arbitrage is the good kind, "because helping investors quickly access all displayed liquidity at order submission time across our many distributed markets has been an explicit Congressional and SEC goal since the 1970s."

Elsewhere in market structure, the New York Stock Exchange "is moving its markets on to a single software platform called Pillar, a move that its owner Intercontinental Exchange Inc. hopes will allow it to shed its image of having clunky, out-of-date technology." (Remember that IEX has argued to the SEC that trading on NYSE is slower than trading on IEX, even after taking into account IEX's 350-microsecond speed bump.) And in other NYSE-retro news, a former BuzzFeed president is launching a business-news-for-millennials startup called Cheddar that "will stream one to two hours of live content every day, primarily from the New York Stock Exchange trading floor," because I guess that is what the kids are into these days, God love 'em. 

Commodity ETFs.

The commodity exchange-traded-fund business is a little weird. Intuitively people want a commodity ETF to be a simple bet on the price of a commodity. But the ETF structure is, you give the fund money, and then it invests it in something. In a perfect world that something might be a perpetual swap on the price of oil (or gold or whatever), but that swap doesn't particularly exist. So the ETF either buys the physical commodity and stores it (which is expensive, and arguably distorts real-world supply and demand), or it buys relatively short-dated futures contracts and then loses a lot of money on roll costs. That's happening to oil funds now, which are "one of the few assets performing worse than oil." It vaguely seems like there ought to be a more straightforward continuous-bet-on-spot-oil-prices ETF structure; to be fair, some people have tried to find one

People are worried about unicorns.

The unicorn worries now seem pretty real, as IPO markets dry up, private funding is harder to find and general confidence in tech startups is waning. How are the startups reacting? Well, Practice Fusion "cut free meals to three times a week." Glassdoor "took away a dessert table." TangoMe and Zoosk have cut employees. Foursquare, DoorDash and Janrain have sold shares below the prices of previous fundraising rounds. ("Foursquare founder Dennis Crowley called its down round 'great for employees.'") It is a humbled and chastened industry.

Sort of. Here is the other side:

“The narrative of start-up comeuppance is in the air, but we haven’t seen a statistically significant change in food budgets,” said Arram Sabeti, the chief executive of ZeroCater, which serves meals to tech companies.

"Many entrepreneurs seem to maintain a blithe disregard," and even "emphasize that any downturn will be good for them," because, you know, they will be the survivors:

“It’s always the other guy who will suffer,” said Venky Ganesan, a managing director at the venture capital firm Menlo Ventures, which has invested in the ride-hailing company Uber and the food-delivery start-up Munchery. “I’m no psychologist, but all the people we’ve backed have never been average. They never think the things that happen to average people will happen to them.”

Meanwhile in horrifying unicorn-adjacent news, "the man suspected of shooting eight people in the Kalamazoo area, killing six, was an Uber driver who was apparently taking fares in between opening fire at various locations." Here's a fake virtual-reality startup that addresses "a unique need among some of San Francisco’s residents: The need to not see homeless people." Here's a real startup that "Wants to Use Eye Tracking to Detect If Syrian Refugees Are Terrorists." Here's a funny picture of Mark Zuckerberg surrounded by people wearing virtual reality headsets. 

People are worried about stock buybacks.

This is the opposite of the usual stock-buyback worry, but the Fed's stress tests for U.S. banks are getting tougher, which just means that capital requirements will be higher and there will be fewer buybacks:

As a result, banks are likely to be wary when asking the Fed for permission to return capital through dividends and buybacks, said analysts. The “more challenging” test means that “capital requirements will continue to drift higher for the banking system,” said Richard Ramsden, analyst at Goldman Sachs.

People are worried about bond market liquidity.

Remember how declining dealer inventories are a sign of trouble in the bond market? Well, "Wall Street’s biggest banks boosted their Treasury holdings to the highest level in more than two years, and one of them says that’s a warning sign for the market." The reason this is a daily section is that every imaginable data point gives someone somewhere an excuse to worry about bond market liquidity. 

Elsewhere in bond markets, Toys "R" Us "is trying to replace $1.6 billion in junk-rated bonds coming due through 2018," which may be a bit of an adventure given the current state of the high-yield markets. "In a sign of the pressure, a Toys 'R' Us bond coming due in August 2017 recently changed hands at 83 cents on the dollar."

Things happen.

British Pound Falls After London Mayor Boris Johnson Backs Campaign to Leave the EU. Sovereign Wealth Funds May Sell $404 Billion of Equities. Africa Bruised by Investor Exodus. Smart beta 'could go horribly wrong.' Use of Fed’s Foreign Repo Program Grows. Bank of America’s Newest Mortgage: 3% Down and No FHA. The worrying signal from US online lending. Commodity Slump Puts Dry-Bulk Shipping on Hold. Florida utilities’ $6bn hedging loss spurs public backlash. Has Apple made iPhones illegal in the financial industry? Banks Keep Cutting Currency Traders as Volatility No Job Saver. Welsh Town Leads a British Revolt Against the Tax System and Corporations. Fun with charts. 50 Cent Learns Valuable Lesson About Posing Atop Bed Of Cash, Posting Pics To Instagram While Claiming Bankruptcy. "Real weed for my Tumblr friends." Dwayne 'The Rock' Johnson admits he 'hates' cod after eating 800 pounds of it in a year.

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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:
James Greiff at jgreiff@bloomberg.net