Efficient markets We talk sometimes around here about the risk of accidentally buying the wrong stock: You want to buy Zoom Video Communications because it is in the news, but instead you buy Zoom Technologies Inc. because its ticker is ZOOM and who has time to read the whole name. This is generally considered to be a problem for ill-informed retail traders and jumpy algorithms, but I suspect that professionals occasionally fall prey to it too. But how much harder it must be in futures markets! You don't just have to pick the right thing—oil or copper or wheat or electricity—but you also have to pick the right date, and location, and often other specifications for the contract. In electric power futures, for instance, there are various different regional electricity markets, each with its own futures contracts. There are different contracts for different expiration dates. There are different contracts for different times of day: There's a contract for peak power, and another for off-peak power. (Peak power is obviously more expensive.) You have to pick all the right specifications, and you have to do it all quickly, many times a day, while constantly being distracted by a stream of other information. Of course people will mess up sometimes, and buy (say) the ERCOT North 345 KV Real-Time Off-Peak Daily Fixed Price Future when they want to buy the ERCOT North 345 KV Real-Time Peak Daily Future. So many of the words in those names are the same! Actually it's usually not that hard to tell the peak from the off-peak contract, though. The off-peak contract is much cheaper. Bloomberg shows me a price of 73.15 for the July ERCOT North 345KV peak contract and 29.2 for the July off-peak contract,[1] so peak electricity costs more than twice as much as off-peak. An experienced power trader can easily tell the peak from the off-peak contracts even without reading all the words in the contract name: You can just look at the prices. If you want to buy a peak contract and the price is 29, you know you are looking at the wrong contract. This is a useful heuristic—if the price of the thing is too low, it's not the thing you want—but it opens up the possibility of a truly incredible trade. If you offer to sell the off-peak contract at a price close to, but below, the actual price of the peak contract, someone might get confused and buy it.[2] Like if people know the peak contract costs 73 and you offer the off-peak for 31, they will know it's not what they want, and they'll keep going down the list of contracts until they find the one they do want. But if they know the peak contract costs 73 and you offer the off-peak for, like, 70, they will be like "wow this is a cheap price for a peak contract" and maybe they'll buy it. Maybe they won't—maybe they'll see the words "off peak" in the name of the contract and keep looking for the one they want—but if they are moving quickly and using price as a way to identify what they want, they might slip up. And then you've sold $29 worth of electricity for $70, taking advantage of the fact that in a large fast-moving market sometimes people will just buy the wrong thing by accident. Maybe you don't believe me that this is a thing? Here is a short but exceedingly beautiful Intercontinental Exchange Inc. ICE Futures disciplinary notice against former Macquarie Energy LLC trader Jonathan Alexander: Specifically, Alexander entered offers in the ERCOT North 345 KV Real-Time Off-Peak Daily Fixed Price Future market ("Off-Peak Future") at prices that fell close to the historical prices of the ERCOT North 345 KV Real-Time Peak Daily Future market ("Peak Future"). The manner in which Alexander entered these Off-Peak Future offers made it seem to other market participants that an advantageous buying opportunity was available in the Peak Future. As a result, in some instances, Alexander caused participants to believe they were transacting in the Peak Future, when in reality, they transacted in the Off-Peak Future, and subsequently to report the trades as an error, which resulted in significant price adjustments from the price at which they originally traded. Alexander initiated this conduct after he unknowingly fell victim to the same circumstances he then caused to occur. Alexander intended to prove the point that he was dissatisfied with the price adjustment provided by ICE Operations in accordance with the Exchange's Error Policy after executing a series of trades in a wrong market. So, first of all: This is a thing that happens. It happened to Alexander, and then he apparently did it to others, and it worked, several times. Second: It's a thing that happens often enough that ICE Futures has a procedure to report trades like this as errors and adjust their prices. A normal part of electricity futures markets is people buying the wrong contract because they didn't read the name all the way through, and then going to the exchange and saying "whoops wrong contract," and the exchange fixing the trade. Third: It's not really a good trading strategy. You can't get rich doing this, not because people don't fall for it—they do—but because people are expected to fall for it and so there are procedures to fix it. You can't go out and make a lot of risk-free profit by offering off-peak futures at peak prices and waiting for suckers. Alexander is not accused of doing this to defraud anyone or get rich.[3] Instead he's accused of doing it basically as a form of … protest art, I guess? It happened to him, he was mad, so he did it to other people "to prove the point that" … that … that you'd be mad too if it happened to you? He was driven by that most universal of human motivations, the desire to annoy other people with the thing that was annoying him. Really it's the most relatable kind of market manipulation. Direct listings When a company does an initial public offering, it hires a bunch of banks to underwrite that offering. Usually it hires one bank—called the "lead left bookrunner"—to actually manage the offering, to advise on pricing and marketing and strategy, to help write the prospectus and hone the sales pitch and price the stock and allocate it to investors and manage trading in the aftermarket. Often it hires one or two or three more banks—often called "joint bookrunners"—to do some light version of what the lead-left does, providing second opinions on pricing and strategy and being ready to step in if the lead-left banker messes up. And then it hires like … 20 more banks? To do nothing? (They're often called "co-managers.") Uber Technologies Inc. had 29 underwriters on its initial public offering, and it seems likely that most of them were just there to cash a check. Morgan Stanley, the lead-left bookrunner, got paid about $40.5 million for what turned out to be the rather grueling job of managing Uber's IPO; Goldman Sachs, the number-two bank, got about $21 million for its trouble. An assortment of other, less familiar names got $180,000 checks. It seems unlikely that they weighed in on pricing decisions. Sometimes these junior underwriters will be retail brokerages and will help out the IPO by selling some shares to their customers, and there are various theoretical-legal explanations of how they are taking on underwriting and legal risk, but for the most part they aren't doing anything too critical to getting the IPO done. So why are they there? There are different reasons, but I will tell you one form of general answer, which is: - The total fees for an IPO are relatively fixed. They are not entirely fixed, and in fact for really big IPOs they are highly negotiable, but the big banks care a lot about "fee discipline" and will fight hard for a relatively high level of total IPO fees, measured as a percentage of the amount raised in the IPO. (For small IPOs, the level is notoriously 7%, though we almost never talk about 7%-fee IPOs around here; Uber paid about 1.3%.)
- The split of the fees is much less fixed: The lead bookrunner might get 100%, or 50%, or 30% or less of the total fees. (JPMorgan got about 38% of the Uber fees.)
- This is weird. A bank might happily accept 35% of a $7 million fee to lead a $100 million IPO, but would flatly refuse 100% of a $6 million fee. The latter is more money, but the banks are more adamant about the long-term precedent of keeping total fees high than they are about getting a bigger share of any particular deal.
- If you are the issuer, what this means is that you pay a certain number of dollars for an IPO, but you get a lot of leeway in deciding who gets the dollars.
- Some of those dollars need to go to the banks that are leading your IPO: They are providing an assortment of valuable services, which cost money, and you need to pay for them.
- But some dollars are left over, and you can send them to whomever you want, provided that they are a licensed broker-dealer. You want to reward one of your relationship banks for lending to you? You want to start a relationship with a potential lender bank by giving them a little gift? You want to reward a small boutique investment bank for giving you financial advice over the years? You have a private-equity sponsor with an affiliated broker-dealer that would like to receive a check? Sure, whatever, cut them checks. It is not your money. It's gone—you're paying out some fixed amount—but the lead underwriters will let you have some of it back to allocate to any bank you want.
I don't want to pretend that this is a particularly great or sensible system. It is just, you know, the equity offering business is kind of old and encrusted with tradition, and one tradition is that when you do an IPO you cut a lot of checks to a lot of banks not because they had much to do with the IPO but just because it's a good time to cut a lot of checks. If you are going public by way of a direct listing, that's not a traditional IPO. That doesn't mean you don't need to hire investment bankers: A direct listing is, at this point, probably more complicated than a traditional IPO, and there's only been one big direct listing in modern U.S. markets. So you will need to hire some clever and knowledgeable investment banks to advise you on how to do it. And it's hard complicated work, so you will have to pay them a fair (large) fee. But you are just paying them a fee for their work. The random flurry of check-writing that accompanies an IPO does not occur here: Wall Street can still make money on a direct listing, but most of the spoils are divided by a smaller group of firms. The biggest IPOs may have as many as 20 investment banks as underwriters. For Slack, three banks—Goldman Sachs Group Inc., Morgan Stanley, and Allen & Co.—are splitting about 90% of the $22 million in fees earmarked for all 10 advisers, according to people familiar with the figures, who asked not to be identified discussing private information. Bloomberg Beta, the venture capital arm of Bloomberg Businessweek parent Bloomberg LP, is an investor in Slack. The problem is that IPO fees are partly fees for service, but they're largely rewards for relationships. (For the junior underwriters they might be entirely relationship rewards; for the bookrunners, who after all won their roles by building good relationships, the fees will be an undistinguished soup of relationship-rewarding and payment for services.) That is partially true of merger fees, too, and you sometimes see banks get added as merger advisers without doing any merger advice, just as a way to pay them a fee. Traditional big-ticket investment-banking mandates are not just exchanges of payment for services; they are communal feasts in a complex gift economy. On the other hand, complicated new investment-banking services tend to get paid for à la carte. If a bank dreams up a novel tax trade and pitches it to a client, it will charge a fee, and it won't expect or tolerate the client paying half of that fee to a big lender bank that had nothing to do with the trade. And if a client needs a few expert banks to walk it through a direct listing, it will tend to pay them for their advice, and not pay others for unrelated purposes. Of course we are talking here about the second big direct listing in the U.S. What about the fiftieth? One possibility is that as direct listings are normalized, they will become like IPOs, big-ticket transactions that feed lots of mouths. Another possibility is that as direct listings are normalized, they will just become … cheap? Like eventually the cost and value of the advice will go down; maybe the total fees will too. Elsewhere in direct listings, here is a paper by Benjamin Nickerson, a student at the University of Chicago Law School, arguing that the investment banks who advise companies on direct listings "qualify as statutory underwriters" for securities-law purposes, "notwithstanding language in the registration statement to the contrary." (I suspect that the banks think so too, though they'd argue otherwise in court. I also suspect that this might change if direct listings become standard and the adviser's role becomes smaller.) Mainly what this means is that if a company goes public in a direct listing and turns out to be a fraud, people might be able to sue the financial advisers, just like they can sue the underwriters if an IPO company turns out to be a fraud. And so the financial advisers on a direct listing will have to do due diligence and review the prospectus and generally satisfy themselves that they can vouch for the company they're taking public. Which is after all a good chunk of what companies pay for when they pay for an IPO—and which suggests that direct-listing fees might not come down all that much. Truism What is the value of a bank's brand name? Hahaha ask Wells Fargo & Co. about that one. Ask Goldman Sachs Group Inc., for that matter. Goldman has a long proud history and a prestigious name (I hope; disclosure, I used to work there), but it launched its consumer bank under the brand name Marcus in part, perhaps, because the Goldman Sachs name now has unfortunate associations with images of the financial crisis and vampire squids. We do not live in an era of widespread love for banks. And so I read this story about how BB&T Corp. and SunTrust Banks Inc. are merging and rebranding the combined company as "Truist," and I thought, yeah, sure, fine, whatever: The reception online, said Dontá Wilson, Truist's incoming chief digital and client experience officer, has been "overwhelmingly neutral." Well but that's great, for a bank! If you hear the name of a bank and you're like "meh, whatever," that's pretty much the best they can hope for. Wells Fargo would kill for "overwhelmingly neutral." I mean, to be fair, surely almost anyone who hears the name "BB&T" or "SunTrust" also says "meh, whatever," so they were starting from a good—well, meh—place. Still I think it is probably wise practice in 2019 for a big bank to discard all of its consumer branding every six months; what are the odds that customers are becoming fonder of you over time? And obviously if Goldman ever buys Wells Fargo they will have to rename the whole thing Honest Dollar. Or Muni, by the way: When Goldman Sachs Group Inc. was looking for a name for its new consumer bank in 2016, a consulting firm suggested Muni, a play on "money" that embraces Silicon Valley's occasional flexibility with spelling. Bank executives awkwardly pointed out that they already had a bustling "muni" department—selling municipal bonds on behalf of local governments. Goldman chose the name Marcus. Good choice. Don't put it in email A thing that happens sometimes in the financial industry, and lots of other places too but we mostly talk about the financial industry around here, is that people do a crime, and they send each other emails or electronic chat messages saying things like "boy we are really doing a crime" and "I love doing crime" and "hope we don't go to jail for doing this crime," and they are caught, and prosecutors get hold of their emails and chats and introduce them as evidence at their trial, and even if there is conflicting evidence and the underlying criminality of their behavior is actually ambiguous, those emails are going to look real real real real bad to a jury. Here is an all-timer of a New York Post story about a man accused of trying to kill a Rabbi Jonathan Max, and the man has a tattoo reading "Never let go of the HATRED – KILL Rabbi Max." Which, yes, I see the point; he wanted to set a reminder never to let go of his hatred, and tattooing it permanently on his arm is a good way of accomplishing that. On the other hand, if there's a suspicious fire at Rabbi Max's house, the police are pretty naturally going to take an interest in the guy walking around with "KILL Rabbi Max" tattooed on his arm. Or as the guy put it: "I do hate him. Doesn't mean I torched his house," the suspect wrote in a text-message exchange with a reporter. "Of course the police will think it is me." Of course, yes, right. Look, you know all of this; I guess my point is just that if you sent your buddy a bunch of chat messages saying "hey let's manipulate Libor" and then you manipulated Libor and now you are in prison feeling pretty bad about yourself, maybe this will cheer you up a bit. At least you didn't get "don't forget to manipulate Libor" tattooed on your arm. Things happen Goldman Sachs Wants to Look More Like Blackstone. Deutsche Bank Considers Closing U.S. Equities Trading in Revamp. Deutsche Bank to set up €50bn 'bad bank' as part of overhaul. Calpers' Dilemma: Save the World or Make Money? Chinese Regulators Try to Calm Fears of a Funding Squeeze. UBS Loses China Bond Deal After Economist's Pig Remark. Cult Economist Jailed for Hiding Rare Coins Says They're His Now. British business travellers to US haunted by old offences. Chinese Bitcoin miner arrested for stealing electricity from oil well. "It's like: 'Come on, what could you possibly be doing in the first 10 days of your kid's life? You're not the mom.'" Lena Dunham is making an HBO show "about the cutthroat world of international finance." Elon Musk Changes Twitter Name to 'Daddy Dotcom' and Says He Deleted Account—And People Are Confused. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] Bloomberg tickers FN3PM1 and FN3OM1, respectively. Don't worry much about the units of those prices; Bloomberg tells me it's dollars per megawatt-hour. [2] At an exchange with a central limit order book, this only works if there are no offers for the off-peak contract at the "right" price. But the beauty of having so many different contracts is that there might not be too many bids or offers on every one. [3] If there were no adjustment procedures and he did get rich doing this, would it be fraud? I think no—he was just openly offering a price for a contract! He wasn't lying to anyone!—but I bet some people would disagree. Anyway the disciplinary notice accuses him of violating rules relating to price manipulation, entering bids or offers that do "not reflect the true state of the market," and engaging "in conduct or practices inconsistent with just and equitable principles of trade." It's all a little fuzzy and I am sure I have some readers who think that all of this was fine. Alexander settled the case without admitting or denying the violations; he'll pay $85,000 and be suspended from ICE futures trading for nine months. |
Post a Comment