Risk Committees and Bank Fines
Deutsche Bank: The Glory Days.
At the end of 2008, Deutsche Bank AG did a trade with Banca Monte dei Paschi di Siena that magically made 367 million euros of losses disappear from the Italian bank's books. The magic was fairly simple, as magic goes: Deutsche and Monte dei Paschi entered into offsetting swaps, one of which would make a lot of money for Monte dei Paschi, and the other of which would make a lot of money for Deutsche Bank. The profitable one for Monte dei Paschi would be booked up-front, saving its balance sheet for 2008; the profitable one for Deutsche Bank would bleed into Monte dei Paschi's financial statements over time, and they'd worry about that later. "Essentially, the trade had little economic purpose—only an accounting one."
This has turned out poorly for Deutsche Bank (and for Monte dei Paschi for that matter): The bank and several former executives are facing a criminal trial in Milan, German regulators launched an audit, and the reputational effects have been grim. It turns out that bank regulators don't like trades with little economic purpose, only an accounting one. But to be fair, the deal team recognized this possibility, and brought the trade to Deutsche Bank's "global market risks assessment committee, a top-level panel that reviews transactions with legal, regulatory, and reputational considerations." Where this happened:
To at least one member of the committee, the possibilities of Faissola’s trade seemed wondrous. “This is fantastic,” said Jeremy Bailey, Deutsche’s European chairman of global banking, according to testimony of an executive who later recounted the exchange for an internal disciplinary panel. “You can book a [profit] in front and spread losses over time?” Bailey added. “We should do it for Deutsche Bank.”
Ivor Dunbar, the meeting’s chairman, curbed Bailey’s enthusiasm. “We are not discussing [our] balance sheet here,” he said. (Bailey, through a spokesman, denies he made the remarks.)
Well, se non è vero, è ben trovato; that might be the most Deutsche Bank thing I have ever heard. A deal team constructed a spivvy trade for a distressed client, a risk manager worried that the trade might be too aggressive, they brought it to the firmwide reputational-risk committee, and that committee said "never mind your client, let's do this stuff for us!" It's like a cop catching you with cocaine and snorting it all. When your risk committee is asking everyone who walks into the room, "hey you got any more risk for us, we need some more risk around here," you might have a problem.
Deutsche Bank: The Reckoning.
Eight years later:
Deutsche Bank AG scrapped the bonuses of its top executives for a second straight year and slashed variable compensation for other senior employees, as Germany’s largest lender tries to shore up capital that’s been eroded by low interest rates and legal expenses.
"Employees interested in the long-term development of Deutsche Bank will understand the bonus cut and stay," says a compensation consultant, and I have to say, if a global universal bank finds any employees who are interested in its long-term development, it should probably give them a bonus. They are a rare species.
So many fines. Credit Suisse finalized its $5.3 billion mortgage settlement, a day after Deutsche Bank's $7.2 billion deal. "JPMorgan Chase has agreed to pay $55 million to settle an investigation into whether it charged thousands of African-American and Hispanic borrowers higher interest rates on mortgages than white customers." "State Street Corp. has agreed to pay more than $64 million in criminal and civil penalties to resolve US government inquiries into fraudulent secret commissions on trades for major clients." (This is their transition management trouble, which we've discussed before.)
If it feels like an avalanche of fines, it is: "The Obama administration rushed to complete a raft of investigations of big business before relinquishing power, reaching settlements worth around $20 billion in the past week alone with megabanks, auto makers, drug companies and others." I actually ... a little bit ... don't understand why you'd pay billions of dollars to settle a crisis-era mortgage case this week? Like, why not tell the Obama Justice Department that you lost the signature page, and then let their calls go to voicemail for a few days? And then come in next week, call up the Trump Justice Department, and say "look, who among us hasn't exploited the mortgage crisis for profit?" And then you all have a good laugh about it and forget the whole thing. I realize that the Justice Department transition doesn't quite work like that, but could it really hurt to stall a bit, at this point?
Otherwise though things are pretty chill for the big banks. "The historic U.S. election jolted Wall Street trading desks, buoying investor confidence and sparking activity that pushed the five biggest U.S. investment banks to sharply higher fourth-quarter profits." Generally speaking, trading businesses do well in volatile conditions, when stuff is happening and markets are moving, and conditions seem pretty volatile right now. On the other hand, the "Bond-trading bump shows Wall Street banks doing more with less":
Bank executives uniformly attributed the gains to more clients doing more trading. And each of the five banks reported lower metrics for "value at risk," a metric that tries to gauge how much money an institution might lose in trading on a given day.
One possibility here is that the banks have finally gotten themselves together and are now the right size and shape to take on the business of modern markets by doing relatively low-risk, low-balance-sheet, client-intermediation trades. Another possibility is that eight years is about as long as anyone can remember, and the new year and new regulatory climate will mean that, after a long decline, banks' risk appetite will finally start to pick up.
Starting in about 2012, General Motors Co. noticed that a bunch of Chevy Cobalts had defective ignition switches that would sometimes shut off the engine while driving and cause airbags not to deploy in crashes. That's bad. In February 2014, GM recalled hundreds of thousands of Cobalts and Pontiac G5s for this problem; eventually millions more cars were recalled for similar issues. You will notice that 2014 came after 2012. If you were killed in a Chevy Cobalt crash in 2013, you might have a legitimate complaint that GM should have told you about this problem sooner -- when it found out about it in 2012, not when it finally got around to the recall in 2014. The U.S. Department of Justice raised that complaint, and GM paid a $900 million fine for that delay.
The U.S. Securities and Exchange Commission is not tasked with protecting drivers from faulty ignition switches. But in late capitalist America, all law is securities law, or at least, securities law is all law. If a public company did a bad thing -- any bad thing -- then it also committed a securities-law violation. (Because the odds that it did the bad thing, and announced it to shareholders, and properly quantified the likely financial impact of the fines for the bad thing, are very low.) And so here is a $1 million SEC settlement with GM because GM forgot to tell its accountants about the defective ignition switches until late 2013:
GM’s Warranty Group did not learn of the issue until the FPE Director informed them of the likely recall in November 2013, and, as a result, prior to this time the Warranty Group were unable to evaluate the likelihood of a loss related to the potential recall of the Defective Switch to determine if disclosure of the nature of the potential recall or an estimate of the possible loss or range of loss was required.
This is a very meta case: The SEC doesn't even say that GM should have disclosed the potential recall, or quantified its impact; it just fines GM for not properly considering that disclosure. Also, you will notice that, while 2013 came after 2012, 2014 came after 2013. GM told the accountants, who had to quantify the financial impact of the ignition-switch defect, before it told the Cobalt drivers, who were driving -- and dying -- with defective ignition switches. But it's paying the SEC for telling the accountants too late.
Blockchain blockchain blockchain.
Here is the Financial Industry Regulatory Authority's "Report on Distributed Ledger Technology: Implications of Blockchain for the Securities Industry." It's worth a skim; relative to some other reports on the blockchain, it has less breathless utopianism and more grumbling skepticism about whether securities transfers over the blockchain will comply with, like, the broker-dealer net capital and books and records rules. This can feel a little parochial; after all, those rules were written for an earlier time, when keeping accurate books and records was a difficult challenge for broker-dealers. If you are a blockchain utopian, the blockchain is the perfect record, so why should you care about Finra Rule 4511 on books and records? But Finra does. Also I enjoyed this concern:
One of the key stated features of DLT is that it has the potential to reduce settlement times for securities transactions by facilitating the exchange of digitally represented assets contemporaneously with the execution of a trade. However, independent of technological hurdles to reducing settlement times, it is unclear what the ideal settlement time would be for various segments of the securities market. Some market participants have indicated that the ability to net transactions occurring over a period of time (e.g., end-of-day netting) is more advantageous compared to real-time settlement because it limits the frequency with which assets need to be transferred when taking on a temporary position. Any move toward real-time settlement would also influence how and if short sales or trade cancellations take place with respect to transactions in the applicable securities, and thereby may affect the way in which market makers and others trade or hedge positions.
The problem with blockchain is that it might be too efficient, and settlement might be too fast for many dealers. I feel like they are not quite getting into the blockchain spirit here. (To be fair, they also say that "while the adoption of DLT may not necessarily lead to implementation of real-time settlement, it has the potential to make settlement time more a feature of the actual market needs of the parties instead of being based on operational constraints.")
Elsewhere: "The head of Chinese bitcoin exchange BTCC on Thursday denied media reports that the central bank had ruled it was offering margin loans illegally, and he said the platform is operating normally," though it has also stopped offering margin loans, so.
I joked yesterday about how no one ever reads bond documents, and that when every so often someone does, they tend to find surprises. I was talking specifically about the Trust Indenture Act of 1939, which one hedge fund argued -- with temporary success, reversed this week by an appeals court -- prevented companies from doing coercive out-of-court restructurings of their bonds. Shearman & Sterling LLP partner Harald Halbhuber e-mailed:
The reason that (almost) nobody had ever thought to invoke the Trust Indenture Act against debt restructurings that didn’t change legal payment terms (that the statute did forbid) was not that sophisticated investors and their lawyers didn’t read the law. I think it had more to do with the fact that everybody knew what it meant. There is something like an institutional memory of the legal community. In fact, this original understanding of the law was so engrained that it had become difficult to articulate precisely where it came from and why it made sense (it does). So it took some archeology do reconstruct it.
Halbhuber did that archeology in this law review article, which the appeals court cited. I think this supports what I was getting at with my joke. There are three possible levels of understanding the law, or a bond document, or whatever:
- Not reading it.
- Reading it.
- Reading it while also being familiar with the institutional memory of the legal community.
Number 3 is hard and takes years of acculturation in the legal community. Number 1 is easy and leaves your days untroubled by indentures. Number 2 is also pretty easy, in the grand scheme of things. But it feels hard. The documents are long and boring! So if you wade through the documents, and find something that seems to contradict what everyone else thinks, you feel entitled to rely on it. You read that whole boring document and learned something! You should really be able to make money from that, no? But the reason everyone else thinks you're wrong is not that they haven't read the document; it's that they rely on the institutional memory of the legal community to know what the correct reading of the document is. (Many of them also haven't read the document, of course, though their lawyers have.)
Here, from the New York Times, is the most amusing college ranking, one that orders colleges by how rich their students' parents are. The top five are Washington University in St. Louis, Colorado College, Washington and Lee, Colby and Trinity. There are some other statistics too.
"This Is What a $250 Million House Looks Like."
It looks pretty dumb, to be honest.
People are worried about non-GAAP accounting.
Here's a $1.5 million SEC settlement with a company called MDC Partners for improper use of financial measures that do not comply with U.S. generally accepted accounting principles:
According to the SEC’s order, MDC Partners presented a metric called “organic revenue growth” that represented the company’s growth in revenue excluding the effects of two reconciling items: acquisitions and foreign exchange impacts. But from the second quarter of 2012 to year end 2013, MDC Partners incorporated a third reconciling item into its calculation without informing investors of the change, which resulted in higher “organic revenue growth” results. MDC Partners also failed to give GAAP metrics equal or greater prominence to non-GAAP metrics in its earnings releases.
Also it "failed to disclose additional personal benefits the company paid on the CEO’s behalf such as private aircraft usage, club memberships, cosmetic surgery, yacht and sports car expenses, jewelry, charitable donations, pet care, and personal travel expenses." Sure the undisclosed CEO cosmetic surgery and pet care is the salacious stuff, but it's the failing to give GAAP metrics equal or greater prominence to non-GAAP metrics that will really get you.
People are worried about unicorns.
There are two main gateways that lead out of the Enchanted Forest, the NYSE Gate and the Nasdaq Gate, and people congregate around them waiting to see what beautiful unicorns will emerge. The unicorns get to choose which gate they come out of, and the more beautiful unicorns choose one gate, the more people will congregate at that gate, and the more prestige and money will flow to the owners of that gate. So they compete:
This past November, Nasdaq Inc hired a helicopter to film Manhattan's skyline using Snapchat's new video-camera sunglasses and sent the aerial footage to its social media followers.
The New York Stock Exchange - its arch-rival - on the same day tweeted a video shot from the floor of its exchange, showing that it too was using the social media giant's gadget.
The scramble to promote Snapchat's "spectacles" is revealing the fierce competition between the two exchanges to host initial public offerings (IPOs) of prominent technology startups.
I have to say that hiring a helicopter shows a little more commitment than tweeting, but neither of these things seems particularly relevant to Snap Inc.'s decision on where to list its stock when it goes public this year. But, you know, the unicorn ecosystem isn't about practical considerations; it's about magic. And tweeting.
People are worried about bond market liquidity.
Here is the New York Fed's Liberty Street Economics blog on the "Advent of Trade Reporting for U.S. Treasury Securities."
On the one hand, the Treasury market is more transparent than the corporate market was in 2002 in some respects, with institutional investors having access to real-time transactions data from the interdealer market. This suggests that the benefits of greater transparency may be more modest in the Treasury market. On the other hand, given the Treasury market’s widespread role as a benchmark, even slight improvements in efficiency and liquidity could produce sizeable positive liquidity externalities for related markets. Moreover, the benefits of transparency could be greater with respect to dealer-to-client transactions, for which there is little widespread price information available today.
By the way, remember when I tried to soft-retire this recurring section before my paternity leave? That didn't take, huh?
ECB Leaves Bond-Buying Program Unchanged as Inflation Picks Up. Bankers at Davos discuss plans to move jobs out of UK. Goldman could move up to 1,000 London staff to Frankfurt. The $15 Billion Fight Over What Funds Hartford Annuities Holders Can Invest In. Toshiba shares plunge on fears of full-blown crisis. Outgoing Canadian Pacific CEO and Activist Investor to Target CSX. New York Attorney General Investigating Reverse Mortgages at Firm Steven Mnuchin Ran. Mary Jo White: “The SEC after the Financial Crisis: Protecting Investors, Preserving Markets.” Dealpolitik: SEC Tilts Playing Field Against Targets of Hostile Bids. Cleary Gottlieb: 2016 Developments in Securities and M&A Litigation. "We find that banks with stricter shareholder liability targeted a lower level of default risk and experienced smaller liquidity shocks." Complaint from Martin Shkreli leads to FTC drug price suit. Barack Obama almost minted the trillion-dollar coin. Trump’s Army Secretary Pick Was Once Accused of Punching Auction Worker. 'Love Actually' director Richard Curtis is using Pokémon Go at Davos to tackle poverty — and Jamie Oliver is playing. "Until now, the smell of U.S. dollars hadn’t been inventoried." Beer poptimism. Fake News for Dogs.
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