FX Conduct and Disappearing Bonds

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.
Read More.
a | A

FX conduct.

The job of a financial market intermediary is to acquire and manage information. If you are a broker or dealer or trader or M&A adviser, you have to know who's buying so you can help sellers sell, and you have to know who's selling so you can help buyers buy. So you will always have conflicts of interest. You'll talk to a buyer who'll say "boy I really would like to buy," and then you'll talk to a seller who'll say "man I am just desperate to sell," and there will be some gains from trade available there, and your decisions about what to tell whom when will help shape who -- the buyer, the seller, or you -- benefits most from them.

The conflicts are unavoidable, but they make everyone uneasy, so every market has evolved norms about how to deal with them. "Front-running" -- using a client order to trade ahead of the client -- is generally frowned upon. Brokers in some markets have fiduciary duties to customers on one side of the trade; the seller's bankers in a merger sometimes get sued for being too cozy with the buyer. And the foreign exchange market, which has always been relatively unregulated, and in which banks have recently gotten in trouble for price manipulation and sharing of customer information and taking of "last looks," has a shiny new Global Code of Conduct for the Foreign Exchange Market, sponsored by the Foreign Exchange Working Group of the Bank for International Settlements. 

Obviously the fun in the Code of Conduct comes in the gray areas. For instance, in the "Information Sharing" section, Principle 4 says that "Market Participants should communicate Market Colour appropriately and without compromising Confidential Information." There is a charming Annex with examples of good and bad market color. Good:

Bank salesperson to hedge fund: We saw large USD/KRW demand from Real Money names this morning.


Bank salesperson to hedge fund: We've just seen large USD/KRW demand from XYZ (where 'XYZ' is a code name for a specific Client).


Corporate to bank market maker: What is liquidity like in EUR/USD at the moment in terms of market depth for EUR 50m, 100m or 200m?


Corporate to bank market maker: If you sold 500m EUR/USD for me now, how much do you think you could move the rate?

Obviously the punch line is that these are near-synonyms. If you are XYZ, what you are worried about is that people will be front-running your efforts to trade dollars for won. Of course you don't want your broker to tell everyone that you're buying won, but as you're buying won, you don't want your broker talking up won demand at all. With or without a name, it's unhelpful for your broker to push up the price. On the other hand! You want to know if anyone else is buying won. Market color is useful for clients who receive it, and harmful to clients whom it's about, and there is some general vague sense that it's a worthwhile trade-off as long as no names are used, but it is all a bit gray. There are other gray areas; don't miss the discussion of "Pre-Hedging," which was controversial in the last big round of FX fines but which was always basically allowed, and still is.

Anyway all of this is moot because soon everything will be electronic and no one will talk to each other about anything. Here is Bloomberg Gadfly's Lionel Laurent on that prospect. And Saudi Arabia's central bank has asked Saudi banks "to explain why they are offering dollar-riyal forward structured products to customers less than four months after the regulator banned options contracts that let speculators place wagers on a currency devaluation." Of course some central banks think that fair FX dealing requires not only safeguarding client information, but also not betting against those central banks' currencies.


This is something that doesn't happen much, and is crazy:

Gogo, the in-flight internet provider has pulled a bond it issued three days ago, taking the debt out of the hands of investors who had already begun trading it, report Mary Childs and Joe Rennison in New York.

After issuing $525m of senior secured notes due 2022, Gogo said on Thursday that a major airline had proposed it provide services on a “meaningful portion of the airline’s domestic fleet.”

Once you sell bonds, you're supposed to sell the bonds! Especially if they've gone up. "The bonds, which had a 12 per cent coupon, had rallied 1.75 cents to 101.75 cents on the dollar" before disappearing. If you, in good faith, agreed to pay Gogo $100 for a bond, and a few days later it was worth $101.75, and Gogo called you up and said "never mind, turns out things are great here and we don't need the money," you'd be a bit aggrieved, no? And if you were Gogo's investment banks, and had a signed purchase agreement with Gogo, and then learned that you not only would be losing your underwriting fees but would also have to call up all your investor clients and tell them they weren't getting the hot bonds they had ordered (and started trading), you'd also be pretty aggrieved, no? I kind of don't understand how the banks let Gogo do this.

Also, like, there aren't that many major airlines? I feel like issuing a bond at 12 percent interest is a fairly serious step; maybe Gogo could have called around first to see if any of the big airlines was looking to do a huge deal before selling the bonds? Rather than immediately afterwards? The bond offering was supposed to close yesterday; if Gogo had taken one more day to find this airline deal, it'd be stuck with $525 million of 12 percent first-lien bonds for the next six years. Anyway here are the press releases where Gogo launched the deal, and priced it, and pulled it.

This sort of thing is so weird that records of it seem to be kept mostly in the memories, and the cocktail-hour war stories, of market participants; the article cites one guy's memory that the last bond deal pulled like this was in 2007. An initial public offering of stock was pulled in 2014, and we talked about it here; in some ways that was an even stranger story, but at least there the stock had gone down. So if you bought the stock in that deal, you weren't too upset that you didn't end up having to pay. 

Goldman will be nicer or less nice.

On the one hand, there is a growing and irrefutable consensus that annual performance reviews are terrible. On the other hand, when I worked at Goldman Sachs, there was like a week when everyone was filling out performance reviews that had a strange end-of-semester feel to it; people took the reviews so seriously that real work slowed down noticeably so that people could sit around rating each other. I guess that's not really an "on the other hand." It was also terrible.

Anyway Goldman will be cutting back on its annual-review fetish: "Starting next month, the Wall Street bank will no longer rate staff each on a scale of one to nine," "the firm also is paring the maximum number of designated reviewers per employee from 10 to six to decrease demands on colleagues’ time," and the reviews "will focus on giving employees specific directives on improving their work rather than grading performance for the previous year." It all sounds relatively humane, though the reviews will still be considered in deciding bonuses, just not in a quantified way I guess.

In less humane news, "the firm will experiment with an online system through which employees can give and receive continuous feedback on their performance." I gather that the idea is that Goldman's millennial employees need constant validation, but I am going to throw out a wild guess that not all of the continuous online feedback that Goldman employees give each other will count as validation. Is there a generation whose career goals include finding a job where they can be criticized constantly? Is it my generation?

How's Bill Ackman?

This article about Bill Ackman's increasingly direct involvement with Valeant builds subtly to the magnificent punch line that Ackman sees a ... skin psychiatrist?

The board had wanted a doctor who could help with relationships in its core dermatology segment. Mr. Ackman suggested Amy Wechsler, a Valeant consultant, dermatologist and psychiatrist focused on the connection between skin and stress.

She has been an adviser to beauty-products giant Chanel, has appeared on the “Today” show and the “Dr. Oz Show,” and is author of the book: “The Mind-Beauty Connection: 9 Days to Less Stress, Gorgeous Skin, and a Whole New You.” Mr. Ackman has been a patient.

You can't deny the results. If I had put billions of dollars of client money into Valeant and lost 90 percent of it, my skin would not look nearly as good as Ackman's does. It doesn't now, even, but if I lost all that money my skin would fall off entirely and I'd dissolve into primordial ooze. So kudos to him on his skin-care/de-stressing regimen.

Also honestly kudos to him on running toward the fire? This is a hair-raising (skin-loosening?) passage:

He passed on a rumor that Valeant’s largest investor, investment firm Ruane, Cunniff & Goldfarb Inc., was selling its position. (That turned out not to be true, though the firm did sell some shares.) If that news came out on Monday morning, Mr. Ackman said, the stock would plunge to the single digits. The bonds would start trading at 60 cents on the dollar, and Valeant would need to negotiate with investor funds known to be tough. They’ll send us into bankruptcy, he warned.

The board agreed to make him a director, starting that Monday.

Obviously he had a lot of his and his clients' money invested in Valeant, and a bankruptcy would be bad. But jumping on to a board of directors if you're worried about bankruptcy is a bold move; being a director of a bankrupt company is even more unpleasant than being a shareholder. I joked a while back, about Valeant's strange ability to attract directors (and its strange inability to get rid of them), that "the rats are fleeing toward the ship," but Ackman's energetic and whole-hearted efforts to save his investment are kind of impressive. Not that they've especially worked yet.

Elsewhere here is a story about Ackman, a rapping geneticist, improv for scientists, "Hamilton," and Alan Alda. Read the whole thing -- much of it rhymes! -- but especially don't miss Ackman saying, "Actually, I know Lin-Manuel."


The U.S. Office of Financial Research released a working paper yesterday with "A Map of Collateral Uses and Flows"; the map is delightfully three-dimensional:

Here, meanwhile, is a story about cows:

"It’s not very common to use cows as collateral," said Robin Yuen, an analyst at RHB OSK Securities Hong Kong Ltd. "The value of a cow would fluctuate depending on milk prices and other factors, so it’s a risky asset for lenders. It would be hard to do forced selling -- there’s no liquid market for a large number of cows."

That is how collateral works! That's what it is! My bank lends money against my apartment not because my apartment's price is stable and easy to ascertain, and not because the bank could sell my apartment in a heartbeat if it needed to, but because those things aren't true. We have banks to finance illiquid risky opaque assets. Sometimes things go wrong and the banks own cows.

This is more widespread than just a thing someone said about cows. There are illiquid things whose price is not transparent and fluctuates based on a variety of factors. We call those things almost all the things in the world. Sometimes financial claims are issued against those things, and those financial claims are more liquid than the underlying things. (For instance: Sometimes companies, whose underlying business activities are hard to trade or price, issue stock, which is easy to trade and price.) There is a persistent temptation for people to see that as a potential crisis. It is a potential crisis! Always! Sometimes when you finance things, those things lose value, and it is a mess. But don't give in too easily to the temptation to tut-tut that the financial system is financing illiquid assets. That's what it's there for.

Enjoy your weekend.

It's Memorial Day weekend! You know what that means, right? It means news reports about taking helicopters to the Hamptons. But don't get on the chopper just yet

At 1:15 p.m. New York time, just 45 minutes before the world’s biggest bond market is set to go dark for three days, Federal Reserve Chair Janet Yellen is due to speak at an event in Massachusetts that may turn into a crucial moment for investors handicapping the path of interest rates.

"'It’s unusual and potentially dangerous for the Fed chair to speak on a day when markets are expected to be so quiet and thinly traded,' said Larry Weiss, head of U.S. trading in New York at brokerage Instinet LLC"; the danger he is referring to is wild market swings due to limited liquidity, but also I feel like if all the helicopters leave Manhattan in a hurry at the same time, that can't be safe either?


This is sort of a parochial internet-journalism thing, but if you care, here are Nick DentonHenry Farrell, Ezra Klein, David Streitfeld and Katie Benner, Timothy B. Lee, Ben Thompson, more Ben Thompson, Shane FerroPaul Ford, Alex Balk and John Gruber on Peter Thiel and Gawker. Also Gawker might be for sale, if you know anyone.

People are worried about non-GAAP accounting.

"Indeed, an examination of the most recent proxy statements from companies in the Dow Jones Industrial Average shows about a dozen of the index’s 30 constituents had annual pro forma earnings well in excess of GAAP ones and used the pro forma ones in annual bonus calculations." As a believer in efficient markets and accounting relativism, I am not generally worried that shareholders are deceived by companies that report pro forma financial results as well as results under U.S. generally accepted accounting principles. And as someone who sort of believes that managers should be paid for stuff that is in their control, I am not that worried that some big companies pay their executives for results after stripping out currency effects. Still, as a believer in incentives, I cannot really disagree with the conclusion that "using pro forma to set bonuses provides executives with an incentive to exclude items not because they should, but to hit performance bogeys."

People are worried about unicorns.

Nobody seems to be worried about Snapchat, the Vanishing Unicorn (Elasmotherium invisibile), which raised a $1.8 billion Series F round from investors including General Atlantic, Sequoia Capital, T. Rowe Price and Fidelity, at a valuation of about $18 billion. It also grew daily active users by 50 percent in 2015 while remaining entirely inscrutable to me.

Meanwhile: "Theranos hit with second class action lawsuit, one day after the first," is the headline here, and can you believe that the first class action lawsuits against Theranos were filed this week? The Wall Street Journal raised doubts about the accuracy of its tests months ago. I am unimpressed by the plaintiffs' lawyers here.

People are worried about bond market liquidity.

"A borrowing binge by companies globally is poised to make May one of the the busiest months ever, thanks to investors who continue to devour the relatively juicy yields on corporate debt in a negative-rate world," so they're not that worried. But I guess tri-party repo plumbing is a form of bond market liquidity, and people are (permanently) worried about it. Oh and Bill Gross is bearish on credit.

Things happen.

North Korea Linked to Digital Attacks on Global Banks. Google Beats Oracle on Copyright, Defeating $9 Billion Claim. The New Oil Traders: Moms and Millennials. Philips Lighting Valued at $3.3 Billion in I.P.O. IMF economists put ‘neoliberalism’ under the spotlight. Debt may be up, but debt servicing expenses are down. LendingClub Talking With Citigroup About Loan Purchases. Malaysia’s Probe Into 1MDB Fund Was Flawed. Court Rules Companies Cannot Impose Illegal Arbitration Clauses . "If you are a developer who is paying tax, you have to be pretty dumb." Seadrill Drops as CEO Says Drillship Firesale Was Overpriced. "Cannabiz initially claimed to be in the business of mineral exploration in Brazil and, later, servicing businesses in the medical marijuana industry." What's John Hinckley up to? Pigs not micro.

If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks!

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