Yield Curves and Market Color
"Control the yield curve, control the future."
Ben Walsh has an amazing story at the Intercept about "a plan for the United Arab Emirates to wage financial war against its Gulf rival Qatar" by manipulating the market for Qatar's bonds and credit-default swaps, though it is perhaps less a story about Middle Eastern states conducting economic warfare and more a story about, like, if you work at a bank and want to pretend you're a spy, you can cook up some pretty dumb fun stuff. The plan -- which was apparently never implemented, but which "was found in the task folder of an email account belonging to UAE Ambassador to the United States Yousef al-Otaiba" -- was devised "by Banque Havilland, a private Luxembourg-based bank owned by the family of controversial British financier David Rowland," and it is ... nuts?
The plan the document presents is far-fetched and appeared to have been put together by someone with little or no experience trading in credit and currency markets, two industry veterans who reviewed the plan for the Intercept said. Both were granted anonymity because speaking to the press could jeopardize their employment. “I can’t believe they put this on paper,” one of the credit veterans added. “They are talking about colluding to manipulate markets.”
Stage 1 of the plan is "to preserve the integrity of existing Qatari bond holdings, an in-situ transfer will be arranged into a protected cell company," which, sure, all of those are definitely words. Stage 2 is "Gear Up to Control the Yield Curve," which starts by buying "medium- and long-term Qatar paper." Then you buy Qatar CDS. Then magic happens, I guess; I don't know, there are more stages, but none of them make much sense. The gist of it is that you ostentatiously paint the tape (including with "a crossing transaction arrangement whereby another affiliated party sells the same bond holdings back to the original seller") to put downward pressure on Qatari bond prices, damaging Qatar's finances and also causing you to lose money on the bonds that you inexplicably bought at the beginning of Stage 2, as well as on the bonds that you held already and inexplicably put into a "protected cell company" in Stage 1. (Why didn't you just sell those bonds?)
Rather than outline specifics, the document speaks in a vague, somewhat harebrained tone: It doesn’t contain any analysis of Qatari bond, derivative, or currency markets or an estimate of the total economic firepower the UAE can put behind the plan, nor does it address how much of Qatar’s $68 billion in outstanding debt the UAE and it allies already own; how to respond when, as is likely to happen relatively quickly in these lightly traded markets, the Qataris see strange trades and apply pressure to markets in the opposite direction by buying their bonds, stabilizing their currency, and selling credit default swaps; or whether a successful attack on a pegged currency in the region will whip back and lead to pressure on the UAE dirham, the Saudi riyal, and the pegged currencies of their allies.
Honestly, it's great, I love it. The payoff is that Qatar's CDS will be so wide, or whatever, that it will lose the right to host the 2022 World Cup, because FIFA -- which has kept the World Cup in Qatar despite evidence of corruption in the bidding, evidence of slave labor in the construction of stadiums, and the fact that it will have to be held in the winter because Qatar is too hot in the summer -- will be swayed by Qatar's bond prices.
"Control the yield curve, control the future," the presentation says in all caps on its "Mission Statement" slide. "This belongs in a James Bond movie but probably wouldn’t work very well in practice," says law and finance professor Frank Partnoy. I am not sure it would even work in a Bond movie, and that is not an especially high bar. Perhaps at some later stage you irradiate the bonds?
When I was a derivatives structurer at a bank, people would sometimes come to me hoping to do some dumb difficult thing -- usually raising money for a hard-to-finance company, not overthrowing a sovereign state or causing it to lose the World Cup, but whatever -- and would ask "couldn't we use ... some sort of ... derivative?" "No, come on," I would usually say. But if I were made up slightly differently, I might have instead said "well, maybe; of course the first step would be to arrange an in-situ transfer into a protected cell company to preserve the integrity of our existing holdings," and we'd be off to the races. A ridiculous presentation would get written, we'd show up at the client, and everyone would have a good time discussing an idea that, deep down, we'd all know wasn't going anywhere. I don't exactly understand what the payoff for the bank could be from pitching a scheme as silly as this one, but it must have been fun to write.
A useful way to think about modern electronic market structure is that in the olden days humans traded stocks and options, making markets based on gut instinct, and then those humans were replaced by computers that used algorithms that largely replicated the humans' gut instincts but more efficiently. But also, in the olden days, those humans did various shady things, and over time the computers have started to replicate the humans' shady-thing-doing abilities, because, you know, the shady-thing-doing tradition runs deep.
And so the way human markets work is that Pension Fund X will buy a lot of Microsoft Corp. stock through Dealer Y, and Hedge Fund Z will call up Dealer Y and say "hey who is buying all this Microsoft stock," and the dealer won't say "oh it's Pension Fund X" -- that would be a hideous violation of client confidentiality -- but she might give the hedge fund some "market color." The exact flavor of market color will depend on her relationships with Pension Fund X and Hedge Fund Z, and on the norms of the particular market they trade in, but she might say something like "we're seeing long-term real-money flows into Microsoft" or whatever. And Hedge Fund Z will conclude that there's more Microsoft buying to come, and so will buy Microsoft itself to profit by selling into those additional long-term real-money flows. And Pension Fund X will have to pay a little more to complete its Microsoft buying, and will feel aggrieved that its trading strategy leaked out into the market and that it was "front-run" by Hedge Fund Z.
This story is a little fanciful because no one trades stock over the phone anymore, but you can computerize the whole thing. Here's a story about the "Intellicator Analytic Tool," a tool that Nasdaq Inc. has proposed to give option-market color to its customers:
Every minute, it would spit out numbers corresponding to a part of the options market and show whether investors in that market segment were bullish or bearish.
While it wouldn’t reveal the identities of investors, the Intellicator could reveal the “customer type” of buyers or sellers in thinly traded markets. For instance, it could show whether a trade was initiated by a small investor or big money manager, by identifying certain traders as “professional customers” who place larger volumes of orders each day.
This is useful color, for the recipient of the color, which means that it will make the subject of the color feel aggrieved:
But if the Intellicator reveals a small order was initiated by a big investor, others could infer that the investor is about to buy or sell many options, potentially affecting the price of the underlying stock. An algo trader could quickly buy or sell that stock, resulting in a worse price for the investor on the options.
It all just feels so much more naked when the computers do it. When the humans do it, it is all a vague mosaic of intuition and inference and "color." When the computers do it it is all there in black and white, specifically quantified, plugged into trading models that can make decisions based directly on these signals. It is also less dependent on relationships: Hedge Fund Z, in my fanciful story, needed to know to call up Dealer Y, and she needed to take its call. But Nasdaq will sell its Intellicator, with no clubbability restriction on who gets what market color. "If this data is made publicly available, customer trades could be adversely impacted if bad actors attempt to utilize this data to manipulate the market," said Sifma in a comment letter. Electronic trading has in many ways democratized Wall Street, but it can also democratize the shadiness.
Here is a story about how McKinsey & Co. has grown its consulting business in Saudi Arabia while also hiring "at least eight relatives of high-ranking Saudi officials," raising a whiff of quid pro quo hiring, which if true might violate the U.S. Foreign Corrupt Practices Act. McKinsey's defense is basically that these people were all super-qualified and had top grades at fancy schools. ("McKinsey added they had an average grade point average of 'A.'") This is a perfectly fine and very McKinsey ("how dare you question a 4.0 at Harvard?") defense, but I always kind of want companies in this position to go further.
McKinsey is not in the business of performing some discrete task whose success can be measured objectively. It is not building bridges or even investing in stocks. It is in the business of giving advice. Having a 4.0 at Harvard might make you good at giving advice. (I mean, I don't know, but that does seem to be a McKinsey belief.) But there are other considerations. Having a firm handshake, sharp cheekbones and a booming voice might improve your ability to give advice, or at least to get people to listen to it. And if McKinsey's core business is to convince powerful people to do stuff, who better to convince them than their sons and daughters? "Dad, I've put together a 50-slide Powerpoint about how you should modernize your state-owned oil company." "This is amazing, I love it, I will put it on the refrigerator, and also do everything you recommend."
Some lines are pretty clear. Getting a government official to hire your consulting firm by handing him a sack of cash is bad. Getting a government official to hire your consulting firm by gushing over how insightful his questions are is fine, even if his questions are not insightful. But almost everything in the middle -- almost all of the actual work of building relationships -- is fraught and controversial. If you buy him dinner, is that okay? What if the dinner is very expensive?
The essential problem of institutional sales is one of agency costs: A big company (McKinsey) is selling a big-ticket item (consulting) to a big institution (Saudi Aramco), but the way that that actually happens is that individual humans at McKinsey interact with individual humans at Aramco. These interactions can never be focused solely on the interests of the principals (McKinsey, Aramco). Even the most business-focused interactions will have something in them for the agents: A good consultant won't tell her client contact simply "this will be good for your company" when she can instead tell him "if you do this it will be good for your company and make you look good so you can get promoted." And probably she'll do it over dinner and compliment his kids first. And if those kids are looking for a job, well, they are great kids, aren't they? It is rather fortuitous that they have 4.0s at Harvard.
Elsewhere in bribery.
Here is a Bloomberg Businessweek story about "The Brothers Who Bought South Africa," the Gupta family, whom you may remember from the story of the guy who drew a middle finger in a stock price chart to protest against their dealings. It contains this impressive anecdote about an alleged attempt by the Guptas to bribe a government official named Mcebisi Jonas:
Jonas would later tell investigators, Gupta said his family could put 600 million rand, or about $43 million, into an account of Jonas’s choice. And if Jonas happened to have a bag with him, he could have 600,000 rand in cash right away. (The Gupta family denies the meeting occurred.)
What? Is the lesson here, if you are a government official going to a meeting with rich businessmen, always bring a bag for bribes, just in case? Or is it, if you are a rich businessman setting up a meeting to bribe a government official with a bag full of cash, maybe you should supply the bag? Honestly it seems like poor planning on their part, expecting him to bring the bag.
Here is a story about how some of the bankers on Snap Inc.'s initial public offering had misgivings about the company, its marketing, and the structure of the offering, but bit their tongues because they didn't want to miss out on the deal. Hey that's not great!
It should not be all that surprising though. There is an old-fashioned notion that underwriters of initial public offerings are gatekeepers who are supposed to vouch for the quality of the offering, and to refuse to underwrite companies they don't believe in. But this notion comes from a time when IPOs were small and obscure, and the main thing that investors knew about a company was that it was being taken public by Morgan Stanley or whoever. In that world, Morgan Stanley's stamp of approval really mattered, and needed to be bestowed carefully. But Snap is Snap. Snap was going to go public no matter who underwrote it, because it was a big buzzy social-media company going public at a big buzzy time for social media. Nobody bought Snap because of Morgan Stanley's imprimatur. In this world, the underwriters are mostly just service providers. Certainly they have due-diligence obligations -- they really aren't supposed to take companies public if their financials are fraudulent -- but they don't have much leverage to insist on things like voting stock or forward-looking earnings guidance. The market decides stuff like that, not the underwriters. The underwriters just shut up and execute.
On the other hand it's also a story about how some of the investors in Snap's IPO had misgivings and bought anyway. They're not service providers; they're the ones whose stamp of approval actually matters. If you buy an IPO that you think is bad because you don't want to miss out -- what is it that you don't want to miss out on?
Blockchain blockchain blockchain.
I wish I could do this:
During a recent briefing at a storied Silicon Valley venture-capital firm, the young analysts in the room nodded along to his words in excitement, [cryptocurrency evangelist Bart] Stephens says. But not everyone was sold. In the middle of his presentation, a gray-haired senior partner stood up, yelled “PONZI SCHEME!” and stormed out.
Just, like, storm out of the whole crypto thing. That's from a story about how venture capitalists are considering how enthusiastically to jump into cryptocurrency and initial coin offerings:
Even some longtime cheerleaders for the sector lament today’s hyped-up gold rush mentality. “You know how you feel when that band that you saw in a 20-seat club and fell in love with plays Madison Square Garden?” asks Fred Wilson, a partner at Union Square Ventures, who was an early believer in cryptocurrency. Still, Union Square’s partners believe the hype will fade and the tech will persist. “That’s what we all experienced with the internet from 1990 to 2000,” he says.
Depressingly, I am sure Wilson is right. There's some nub of real innovation in the crypto/ICO space; blockchains and distributed tokenized systems will probably end up being important in the long term. But the probability that any individual crypto/ICO/blockchain project is a dumb scam is quite high. It is enough to make you want to yell "PONZI SCHEME!" and storm out.
Elsewhere: "SEC Chairman Jay Clayton said so-called initial coin offerings in many cases looked like securities, raising the prospect the agency will take a more aggressive stance to this red-hot fundraising method." I mean, yes? Really it is shocking that the Securities and Exchange Commission hasn't gone after any ICOs for being unregistered securities offerings.
People are worried about unicorns.
Uber Technologies Inc. Chief Executive Officer Dara Khosrowshahi spoke at the DealBook conference yesterday, saying a lot of what you'd expect him to say, including that "the culture went wrong" at Uber under his predecessor Travis Kalanick, and that he "is trying to put his own imprimatur on the company in what he calls 'Uber 2.0.'" I have to say that using decimal version numbers as the public brand names of actual software products seems to have gone out of style when I was in high school. Really it should be Uber Ice Cream Sandwich or Uber Snow Leopard or something.
Anyway Khosrowshahi also said that Uber will go public by 2019:
"We have all of the disadvantages of being a public company, as far as the spotlight on us, without any of the advantages," he said in his first high-profile appearance since he became CEO. "So Travis [Kalanick] and the whole board now agree we should just go public. The numbers support it."
I've been saying something like that forever, though in my version Uber also has most of the advantages (name recognition, ability to raise limitless funds, secondary liquidity) of being public. And to be fair, when Uber does go public, it will have a few new disadvantages: frequent public disclosure of audited financials, for one thing, and a mark-to-market stock price that will incorporate scandals and setbacks instantly and publicly, rather than a static most-recent-private-valuation number that can be propped up with gimmickry. But basically Khosrowshahi is right. It would be a bit silly to worry about going public and being subjected to the short-term whims of activist shareholders, given that Khosrowshahi is already a CEO who was installed by activist shareholders after the previous CEO was deposed.
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