Opportunism Well this is no fun: "The continued pursuit of various opportunistic strategies in the credit derivatives markets, including but not limited to those that have been referred to as 'manufactured credit events,' may adversely affect the integrity, confidence and reputation of the credit derivatives markets, as well as markets more generally. These opportunistic strategies raise various issues under securities, derivatives, conduct and antifraud laws, as well as public policy concerns." That is a joint statement from the heads of the U.S. Securities and Exchange Commission, the U.S. Commodity Futures Trading Commission and the U.K. Financial Conduct Authority, who have all taken notice of "various opportunistic strategies in the credit derivatives markets" and have announced that they "will make collaborative efforts to prioritize the exploration of avenues" to do something about it, which is quite a bit less definitive than just doing something about it. If these opportunistic strategies were, for instance, market manipulation, then presumably one of the regulators would have brought a case by now. But they haven't. Instead, they've announced plans to collaborate to prioritize exploring avenues. We talk a lot around here about "various opportunistic strategies in the credit derivatives markets." It is an appropriately vague term. Sometimes it means what is traditionally called a "manufactured credit event": buying credit default swaps that pay off if a company defaults, and then paying the company to default. (There are variations, like paying the company extra to issue new bonds that will increase the CDS payoff. You can do that part without a manufactured default, or even without a default at all.) Other times it means selling credit default swaps that pay off if a company defaults, and then paying the company not to default. (There are variations, like paying a company to shift all of its debt to a new subsidiary to eliminate the possibility of defaulting on the old CDS.) Sometimes it means cornering the market in specific bonds to reduce the CDS payoff on default. Hunting through a company's bond documents to find a default, buying CDS on that company, and then suing it for the default also probably counts as an "opportunistic strategy in the credit derivatives markets," why not. Is "opportunistic" bad? I feel like, for a certain kind of trader or hedge-fund analyst, there is no higher compliment. Opportunism—seeing profit opportunities that others miss and ruthlessly exploiting them—is what makes markets efficient; it's the foundation of the financial-industry tournament of cleverness that demands the long hours and justifies the high salaries. It is a very broad-ranging tournament of cleverness. You may do a lot of credit analysis and conclude that a company has enough money to avoid default, and I may do a lot of credit analysis and conclude that it doesn't, and your credit analysis may be better than mine, but if I also analyze the wording of the derivatives documents and the psychology of the company's executives and find a way to get it to default anyway, I win. And you will say "wait no we were just competing on credit-analysis cleverness, no fair," and I will say "no we were competing on unconstrained overall cleverness, totally fair." But of course it is not true that we are competing on totally unconstrained cleverness: If I cleverly lie to you, that's probably fraud and not allowed. There are some constraints set out by law, but there are also some retroactive constraints on stuff that just looks unfair. Regulators have a general tendency to want to constrain the cleverness competition, to say "this thing was built for a certain purpose and you can't do stuff that undermines that purpose, however clever it is." Hedge funds have a general tendency to seek unconstrained cleverness competitions, to try to outthink their competitors laterally, to seek "unfair advantage" and "edge," to use tools for purposes for which they were not intended in order to gain the advantage of surprise. Sometimes this looks like financial innovation; other times it looks like cheating; often it depends on who is looking. One thing that would be interesting to study is: Over the entire universe of "various opportunistic strategies in the credit derivatives markets," have companies generally been made better off or worse off?[1] Credit derivatives are essentially zero-sum bets; if Hedge Fund A makes a lot of money on an opportunistic CDS strategy, then Hedge Fund B (or Bank C, etc.) loses an equal amount of money; there may be knock-on effects on integrity, confidence, etc., of the market, but the actual financial gains and losses offset each other. But all of the high-profile opportunistic strategies in the past few years have involved doing things to or with the companies that the hedge funds are betting on: giving them money to accelerate or delay default or to issue or restructure bonds, suing them for earlier defaults, etc. Probably the most notable case is that of Windstream Holdings Inc., which was forced into bankruptcy over a previous debt default due to a lawsuit from a hedge fund that everyone assumes was "net short" due to CDS holdings. But probably the, like, five next-most notable cases are companies that benefitted from CDS opportunism: They got cheap financing from CDS-market participants in exchange for helping with CDS opportunism. Sometimes the financing came from CDS buyers ("manufactured defaults"), sometimes it came from CDS sellers ("orphaning"), and occasionally it came from the companies pitting buyers and sellers against each other and helping out the highest bidder. Seen in the best light, "opportunistic CDS strategies" means just "hedge funds extracting money from other hedge funds and, for a fee, giving it to troubled companies to keep them alive." Maybe it's cheating and financial innovation. Greater fools Remember Long Island Iced Tea Corp.? It made iced tea. Not the cocktail, actual iced tea. On Long Island, one assumes, I don't know. Then in late December 2017, a couple of days after Bitcoin hit its all-time high, it changed its name to Long Blockchain Corp. Now it does blockchain things. I absolutely refuse to learn what those blockchain things are, but I hope they are long. Meanwhile it is selling its iced-tea business, to focus on the blockchains, lengthening them I suppose. The day before its pivot from iced tea to blockchain, Long Confusing Story's stock was worth about $20 million. The day after, it shot up to about $70 million. Now it's about $13 million. Also there is a Securities and Exchange Commission investigation. If you bought Long Iced Block Tea at a $70 million valuation, expecting that its pivot to blockchain would make it the global leader in blockchain length and thus a $10-billion company, you were … "deceived" is not a nice way of putting it, but something seems to have gone at least temporarily wrong. On the other hand if you bought the stock at a $40 million valuation right after the announcement, on a cynical theory of "stocks that add 'blockchain' to their name go up," you were basically right, and you could have turned around and sold the stock to someone else for a quick profit. Maybe that someone else was a true believer in the long-term underlying value of the blockchain pivot, but you don't have to assume that. Maybe the buyer also had the pure cynical theory of "stocks that add 'blockchain' to their name go up," and was hoping to sell to someone else who also had that theory, etc. It is not clear that you need anyone who actually believes in the blockchain story to buy the stock. The whole thing could just be a game of hot potato, sustained by pure cynicism, everyone just hoping to be able to sell the stock one more time rather than making any real bet on fundamentals. Eventually it collapses and the last buyers are left holding the bag, but that might just be because their timing was off, not because they believed in the story any more than anyone else. If this is a game that you play—and it is clearly a game that some people play!—then you will be interested not in questions like "what is the total addressable market for long blockchains" or "how long is their blockchain anyway" or "is blockchain length actually a meaningful characteristic or am I just stretching out a joke here," but rather in questions like "how long does it take things like this to collapse, usually?" Stock investing always has an element of psychology, of the Keynesian beauty contest, but if you don't care about fundamentals at all then that is all that's left. All you care about is: How long will it take people to get bored of the "blockchain" in the name? Here are Archana Jain and Chinmay Jain in Economics Letters: Using a list of companies that changed their names to add "blockchain" or "bitcoin" to their names, we find that after changing the names, these firms have a significant abnormal positive return that lasts for 2 months. The abnormal return turns negative 5 months after the change. This suggests that these firms changed their names to take advantage of the hysteria surrounding the price rise of bitcoin. Helpful! It's just an average, though; what you'd ideally want is sort of a time series: Companies that went blockchain in June 2017 took ____ months for the effect to wear off; in December 2017 it was ____ months; in June 2018 it was ____ months; now it … you don't see a lot of it now, but if I had to guess I'd assume a blockchain name change now would be an immediate negative? Perhaps I am wrong. Anyway the sample is amusing but small—10 name changes—so you may not be able to learn all that much from the trends. Really what you'd ideally want is sort of a time series across different trendy name changes: How much does a stock go up, and for how long, from adding "-tronics" in the 1960s, or ".com" in the late 1990s, or "blockchain" in the late 2010s, or all of the other mini naming trends over the years? Winton Capital actually did an anecdotal version of this study last year, and we talked about it here, but there is more work to be done. Is the half-life increasing or decreasing over time? Is the size of the effect getting bigger or smaller? Are markets getting more efficient at reacting to trendy name changes? Less efficient? As this effect becomes better understood, are people less willing to bet on it, or more? Revolving doors A lot of financial regulation has these characteristics: - It is complicated.
- It involves choosing winners and losers from a fairly small and defined set: If the regulation goes one way, one group of market participants will be better off; if it goes the other way, another group will be better off.
- Everyone who understands anything about it works for one group or the other.
I mean, number 3 might not be literally true. There will be some professors with some academic understanding of the issues, and there will be some people at the regulatory agency itself with a decent grasp on them. And of course these characteristics don't describe every sort of financial regulation, and, say, taxing financial transactions to pay for free college will stir up opinions from a broad group of people. But for a lot of bits of regulatory plumbing, the only people who will bother to understand the nuances will be the people who work for companies who have a lot to gain or lose from them. This is actually fine; it's a standard aspect of the regulatory state, and what typically happens is that the regulator puts out proposed rules and ask for comments on them, and the people who would gain or lose from them write long careful public comment letters to the regulators advocating for their position, and the regulators review those comment letters and come up with a final rule and publish it, typically along with a long explanation of what comments they got and what consideration they gave to them. It's a process meant to incorporate and evaluate the expertise of the market participants, and to filter their (biased) expertise through the neutral regulator. But this situation can make it hard to hire senior regulators. You can promote from within, giving career regulators bigger and bigger jobs. But it's helpful sometimes to hire outsiders who have a more practical on-the-ground understanding of the issues from having worked in the actual markets. But: having worked for which side? If you're making rules that will choose winners and losers, and if the regulator in charge of the rules once worked for the winners, the losers are going to complain. This is a much uglier problem than the general one of choosing the right regulations, though I think you mostly solve it in the same sort of way: You meet the people who work for one side, and you meet the people who work for the other side, and you try to hire the people who seem like they'd do the best job and hold the most intellectually honest opinions. Ideally those people would then sometimes side against their former team, when their former team is wrong. But maybe not that often; maybe their former team mostly had the better arguments, and that's part of why you hired them—and not the people from the other side—in the first place. Anyway: The New York Stock Exchange and Nasdaq Inc. on Monday accused a senior regulator who supervises them of having ethical conflicts, raising the ante in a battle with Washington over how the companies sell market data. ... The SEC official involved in the debate, Brett Redfearn, has overseen efforts to scrutinize whether fee increases imposed by exchanges for the data are justified. In a Monday court filing, the exchanges said "the SEC's misconduct here so infected its process" by allowing Mr. Redfearn to work on the matter. ... Mr. Redfearn, director of the SEC's division of trading and markets, criticized exchanges for ratcheting up market-data fees before he joined the SEC in 2017. His employer at the time, JPMorgan Chase & Co., bought the data as part of its business handling and executing customer orders. … In 2016, while still at JPMorgan, Mr. Redfearn told an SEC advisory committee that the richest market-data products are "characterized by unconstrained and increasing fees," according to a written statement he submitted for the meeting. We have talked a couple of times about the SEC's decision to reject some NYSE and Nasdaq fee increases. Exchanges charge fees for market data. Some trading firms—big banks like JPMorgan, high-frequency trading firms—have essentially no choice but to pay those fees. The exchanges want to charge as much as they can. The banks and HFT firms want to pay as little as they can. There is no particular market constraint on any of this. There is a regulatory constraint, which is that the exchanges can't raise the fees without the SEC's permission. So the exchanges go to the SEC and ask to raise fees, and they submit some rationales for raising the fees that boil down to "we would like to make more money," and the banks and HFT firms object and submit some rationales that boil down to "no we would like to make more money." No one involved is especially sympathetic; there are no widows or orphans; it is just big banks and HFT firms fighting against big stock exchanges. No matter who wins, the money won't go to fund free college for everyone. Also while this issue isn't all that technical—you could just flip a coin to decide who wins, and either way the world would pretty much be fine—the actual job of running the SEC's division of trading and markets is pretty technical, and it's useful to have someone who understands trading and markets. That's basically going to mean someone who worked at a trading firm—a bank or high-frequency trading firm—or someone who worked at a stock exchange. (Or, of course, someone who was an outside lawyer for one or the other or both.) And if, as is the case here, he used to work for a bank, and the SEC's decision comes down on the side of the banks, then the exchanges are going to complain. I myself am pretty sympathetic to the SEC's decision: The exchanges strike me as monopolists facing no competitive constraints, and the data seems super profitable. (It helps that IEX, a competitor exchange, effectively trolls the big exchanges over their data fees.) But I should disclose that I used to work at a big bank, and also that Bloomberg L.P., where I work now, runs a financial data business that has opposed the exchanges' fee increases. It is possible that, if I had never worked at a bank or at Bloomberg, I would have come to the same conclusion about the SEC's decision. But it is unlikely, not because I would have come to the other conclusion, but because most likely you couldn't have paid me enough to care about any of this either way. There are only so many people who care about market structure, and if you care about it long enough you will probably end up on one side or another. Insider trading Well this is a new one, to me anyway: IT consultant Steven Oakes, 42, sat in his car outside the St Kilda offices of Port Phillip Publishing and read its "buy" recommendations before they were published between January 2012 and February 2016. "Financial service companies need to have adequate cyber resilience. Whether it's small firms or banks, this case highlights the need to have sufficient safeguards to protect theirs and their clients' confidential information," said Australian Securities and Investments Commission senior investigator Anthony Flynn. Mr Oakes targeted Port Phillip Publishing by using a wi-fi scanner to find computer networks that were vulnerable to hacking before skimming usernames and passwords from its system, according to Mr Flynn. He then reconfigured Port Phillip Publishing's email system so that any draft reports emailed to its editors were also sent to him. … Mr Oakes used the insider information to make 70 trades in 52 different small cap ASX-listed companies before the "buy" recommendations were released, and made more than $220,000 when he sold the shares shortly after the "buy" recommendations were published. Now he'll spend 18 months in prison. It seems to me that if you are going to hack into a trove of inside information, it's a lot better to hack into a trove of actual inside information—say, a company's financial data, or a law firm's list of merger clients, or a newswire's collection of draft press releases—rather than just a research firm's buy recommendations on small-cap stocks. But maybe the buy recommendations are easier to get, and they seem to have worked well enough. Things happen AbbVie Strikes $63 Billion Deal for Botox-Maker Allergan. After Stephen Moore's failed Fed bid, he's creating a crypto central bank. Natixis's H2O Lost $3.4 Billion in Three Days of Carnage. Tweets, Trade and the Fed Now Have Markets Moving in Packs. Robots Can Now Decode the Cryptic Language of Central Bankers. Nissan Overhauls Board Following Raucous Shareholder Meeting. A Leader of America's Fracking Boom Has Second Thoughts. Assessing Contagion Risk in a Financial Network. The Double Standard of Antitrust Law. Howey, Ralston Purina and the SEC's Digital Asset Framework. Should you cry at work? Squirrel census. 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] If you were studying this you'd probably want to define what it means for a company to be better or worse off. Its stock price going up or down? Its creditors (on an unhedged basis) getting back more or less money? More of its workers keeping their jobs longer? And the counterfactual is in many cases hard to know: If a company that took money for a manufactured default *hadn't* taken that money, would it have eventually run out of money and had an even worse default? |
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