Catastrophe In 2017 the World Bank issued some pandemic bonds. Investors who bought these bonds got a high interest rate, but they could lose all their money if there was a pandemic: The bonds would "trigger" if a pandemic occurred, and then instead of paying back the bondholders, the money would go to the World Bank to fund relief efforts. The bonds "were originally conceived as a sort of public-private partnership to get insurance investors to assume some of the risk of the Ebola epidemic." Obviously the current coronavirus outbreak is of interest to pandemic-bond investors, and John Dizard has a fascinating column in the Financial Times about the virus and the bonds. There are a lot of classic financial-engineering lessons in these bonds. For instance, I just said that the bonds trigger if a pandemic occurs, but what exactly does that mean? Well, there's a long document with specific provisions describing what does and doesn't qualify as a pandemic, and—as is so often the case in financial-contract triggers—there is room for debate and gamesmanship. So it's not a pandemic unless there are deaths in multiple countries—a devastating epidemic in one country would not trigger the bonds—and so you get this gruesome speculation: As one London underwriter comments: "They only needed 20 bodies on the other side of the Congo border to get to the trigger. What if someone loaded up a truck and dumped those in Rwanda?" To be fair I asked much the same question—"Do you think that anyone at the World Bank was a little tempted to smuggle one Ebola patient over an international border to trigger the Ebola cat bonds?"—last year. So that is sort of standard financial thinking applied to global pandemics. But then there is this: Insurance people, though, are remarkably chipper about the future of pandemic deals. After all, as that London underwriter says: "Nothing is uninsurable; you just need more data. And life risk gives you more data than earthquakes." The real problem with underwriting pandemic risk, he thinks, is that it tends to be correlated with financial markets. "You don't get the diversification offered by hurricanes and quakes." See, the problem with a global pandemic, for financial investors, is not that it's bad, it's that it's correlated. If there's a global pandemic then all the stocks and bonds will go down; if you own pandemic bonds, you will lose money on the pandemic bonds at the exact same time you are losing money on your other stocks and bonds. Hurricanes and earthquakes, meanwhile—yes of course you can invest in hurricanes and earthquakes, those are called "catastrophe bonds"—tend to be less correlated to global financial assets. If you buy a catastrophe bond and there are a lot of hurricanes, your cat bonds will trigger and you'll lose money, but you might be making money on all your other stocks and bonds because the global economy is not primarily determined by the frequency of hurricanes. Conversely, if there's a recession and you're losing money on all your other assets, the cat bonds might still perform well, because the frequency of hurricanes certainly isn't determined by the global economy. If you are an investor, the hurricane profile is desirable; it gives you a diversification benefit. As with every financial asset, you do well in some states of the world (no hurricanes) and poorly in other states of the world (lots of hurricanes), but the states of the world are different from the ones that determine the performance of other financial assets (recession vs. no recession, etc.). You can improve your risk-adjusted return by combining uncorrelated assets. Giving investors an uncorrelated asset, one whose performance has nothing to do with the performance of normal financial assets, makes them better off. I think often about issuing a bond that pays a high interest rate if I flip a coin and it lands on heads, and defaults if it lands on tails. "Ooh uncorrelated risk," people will say, and rush to buy it. One way to read the pandemic bond story is that the risk of an Ebola outbreak spreading from Congo to Rwanda does not seem likely to be highly correlated with global financial markets, but the risk of a deadly coronavirus spreading from China to the rest of the world probably is pretty correlated with global financial markets: The actual coronavirus is shutting down factories, disrupting trade, and generally causing large economic impacts even as it is also risking triggering the bonds. People may have bought these bonds with the wrong disease, and the wrong correlation model, in mind. Ensign Peak But really once you start thinking about important global events in terms of how correlated they are to traditional financial assets, it is hard to stop. For instance: Will the second coming of Jesus Christ be correlated with financial asset prices? Here is Roger Clarke of Ensign Peak Advisors, the Mormon Church's $100 billion investment fund: A former employee and the whistleblower in his report said they heard Mr. Clarke refer to the second coming of Jesus Christ as part of the reason for Ensign Peak's existence. Mormons believe before Jesus returns, there will be a period of war and hardship. Mr. Clarke said the employees must have misunderstood his meaning. "We believe at some point the savior will return. Nobody knows when," he said. When the second coming happens, "we don't have any idea whether financial assets will have any value at all," he added. "The issue is what happens before that, not at the second coming." I confess that I don't quite know how to read this, but I think it means something like "the second coming will probably be highly negatively correlated with financial asset prices, so stockpiling financial assets is a bad way to prepare for the second coming," which, as a financial if not a theological matter, strikes me as pretty reasonable. (You could read "we don't have any idea" as suggesting that the second coming is an uncorrelated risk, which, given the lack of statistical data, is also possible, but I think my reading is a little better.) At the highest level of generality, amassing financial assets is a way to hedge against the expense of having to continue to live in the sublunary world; once the world ends you probably don't have much use for the assets. (This also largely explains retirement savings, annuities, etc.) A further question is "well then what does Ensign Peak need $100 billion for," and for that I will refer you to the article. It seems to be a matter of some controversy. ESG If you are an investor focused on environmental, social and governance issues, should you buy Facebook Inc.? On the one hand, it definitely does not drill or refine fossil fuels. On the other hand, it's Facebook: MSCI gave Facebook and Amazon poor ratings on privacy and data security and on labor management, respectively. The two stocks are held by a number of large sustainable funds anyway since they satisfy other criteria. For instance, Brown Advisory's Sustainable Growth Fund excludes companies that conduct animal testing for nonmedical purposes, own fossil-fuel reserves, derive revenue from "controversial weapons," or defy the United Nations Global Compact Principles—but doesn't have in its prospectus any language that disqualifies companies with controversies related to user privacy or labor rights. "What's considered a good ESG stock is in the eyes of the index provider," said Todd Rosenbluth, head of ETF and mutual-fund research at investment research firm CFRA. And see if I were trying to make the case that Facebook is socially irresponsible I am not even sure that "privacy and data security" would be in my top five arguments! One way to think about this is that "ESG" is not quite the same thing as "investing in companies that you subjectively think are good for the world." ESG involves weighting some factors and following some indexes and excluding some categorical things, but there is not necessarily a step where you say "yes but is this a good thing or what?" What this can mean is that if a company finds a new way to make the world worse, it will probably be included in a lot of ESG funds, because they are focused on excluding old, traditional ways of making the world worse. Elsewhere, if you are an ESG-focused investor, should you be happy about a board of directors with a strong and long-serving lead independent director who might have the ability to stand up to and supervise the chief executive officer, or should you be sad that he's an oil guy? Lee R. Raymond, 81, holds the top position on JPMorgan's 11-member board after Dimon. He has occupied his seat for 33 years, making him both the longest-serving and oldest director among Wall Street's biggest banks. He helped guide JPMorgan through mega-mergers after mastering them at Exxon, backed Dimon during his rise and has stood by him. ... A nonprofit group called Majority Action is beginning a fight this week to use shareholder voting to remove Raymond from JPMorgan. The group argues that Raymond's role as the lead independent director and his coziness to Big Oil compromises JPMorgan's capacity to react to the climate crisis. … The oil veteran's relationship with Dimon gives him special status inside the bank, and makes the campaign against him a longshot. Raymond is described in public filings as the chief executive's sounding board, adviser on long-term strategy and guide for annual performance reviews, as well as a key voice in who will one day succeed him. He oversees the board's agenda, has the discretion to call members together whenever he wants, and runs meetings in Dimon's absence. Still elsewhere, oil companies are internalizing some externalities: Even before the deadly virus struck, another menace confronted the global energy industry: the warmest winter anyone can remember. ... For global energy markets it's a disaster—and as the world continues to get hotter it's something producers, traders and government treasuries will have to live with long after the acute dislocation of the coronavirus has passed. The industry relies on cold weather across the northern hemisphere to drive demand for oil and gas to heat homes and workplaces in the world's most advanced economies. Climate activists might find a certain poetic justice in energy markets suffering from the global warming caused by fossil fuels. Burning natural gas, oil and other fuels to heat homes and businesses accounts for as much as 12% of the greenhouse-gas emissions blamed for raising the world's temperatures. "In the long run, we are all dead," which is of course bad for business; an appropriately long-term-oriented energy-company CEO would try to delay that as long as possible. Tokens There are basically three reasons why a cryptocurrency project might get in trouble with the U.S. Securities and Exchange Commission: - It's a huge fraud, and the SEC goes after it for fraud.
- It's a huge fraud, and the SEC goes after it for being an unregistered offering of securities.
- It's an interesting and ambitious way to launch a new sort of marketplace that will not be owned by anyone but will instead be governed by code and blockchain and the economics of crypto, and the SEC goes after it for being an unregistered offering of securities.
Case 1 is easy. Case 2 is even easier, though: Proving fraud is hard and requires looking into the minds of the promoters (were they intentionally trying to deceive people?) and investors (were they deceived?), while proving that an initial coin offering is an unregistered securities offering is pretty easy. And the way the securities laws work, even an upstanding good-faith non-fraudulent unregistered non-exempt offering of securities is illegal, and the SEC can shut it down without doing the hard work of proving fraud. Case 3 is hard, though. I mean it's easy to prove, mostly, but it's a hard regulatory decision. There is I think a pretty broad consensus that some crypto tokens are not securities. Things that you can use, "utility tokens" that can make things happen on some well-developed blockchain platform, Bitcoins, Ether—those are not securities. And there is a widespread view among crypto people that the right way to build those platforms is by pre-selling those tokens to potential users. This is not just a matter of raising money from the most enthusiastic and credulous investors. It's also a matter of philosophy: If you want to create new un-owned platforms, new ways of organizing human activity other than through shareholder capitalism, then the way to do it is by tapping the future users of the platforms to fund their development and participate in their governance. Unfortunately the SEC mostly won't let you do that: If you sell tokens to fund the development of the platform where those tokens will be useful, that's a securities offering, and even some of the standard attempts to comply with the securities rules (by selling sort of pre-tokens as exempt securities that will one day flip into useful tokens) have met with SEC disapproval. I can understand where the SEC is coming from. The modal initial coin offering is probably a huge fraud. "Cryptocurrency Scams Took in More Than $4 Billion in 2019." Most ICOs don't seem to actually result in useful products. Many were launched as more or less explicit ways to raise money from investors without complying with the securities laws. A regulatory attitude of "they're all frauds so let's use an easy technicality to shut them all down" will only snare a few false positives. Still, though: a few. Here is a "Token Safe Harbor Proposal" from SEC Commissioner Hester Peirce, which would allow people to sell tokens to raise money for crypto projects without complying with the securities laws: The safe harbor would provide network developers with a three-year grace period within which they could facilitate participation in and the development of a functional or decentralized network, exempted from the registration provisions of the federal securities laws, so long as the conditions are met. This objective is accomplished by exempting (1) the offer and sale of tokens from the provisions of the Securities Act of 1933, other than the antifraud provisions, (2) the tokens from registration under the Securities Exchange Act of 1934, and (3) persons engaged in certain token transactions from the definitions of "exchange," "broker," and "dealer" under the 1934 Act. The initial development team would have to meet certain conditions, which I will lay out briefly before addressing several in more depth. First, the team must intend for the network on which the token functions to reach network maturity—defined as either decentralization or token functionality—within three years of the date of the first token sale and undertake good faith and reasonable efforts to achieve that goal. Second, the team would have to disclose key information on a freely accessible public website. Third, the token must be offered and sold for the purpose of facilitating access to, participation on, or the development of the network. Fourth, the team would have to undertake good faith and reasonable efforts to create liquidity for users. Finally, the team would have to file a notice of reliance. Peirce is one of five SEC commissioners and I am not sure there is much appetite for this to actually happen, but it's a fun proposal. One way to think about this is not so much in terms of a "safe harbor" as an "alternate registration regime." That is, if you are selling securities, you have to file certain documents with the SEC and provide certain disclosures to investors. If you are selling tokens, under Peirce's plan, you have to file different documents with the SEC and provide different disclosures to investors. (For instance her proposal would require you to publish the source code of your blockchain network.) If you do all those filings you would be exempt from SEC regulation covering securities offerings (though you'd still be subject to securities fraud rules), but of course by doing the filings you'd be complying with the SEC regulation (this one) covering token offerings. There'd be two SEC regimes, one for companies issuing securities (and sending investors audited financial statements and narrative descriptions of the business), another for decentralized blockchain projects issuing tokens (and sending investors source code and narrative descriptions of their mining process). Peirce's safe harbor only gives a minimal sketch of that second regime, but you could imagine a longer one. You could imagine an SEC registration system for tokens that is as complex and codified as the registration system for securities, but focused on different things. It might be meaningless to ask a decentralized blockchain project for audited financial statements; it might be meaningless (or overly invasive) to ask a regular old company for its source code; these are different ways of organizing economic activity, and they call for different disclosure regimes. It is not obvious that the Securities and Exchange Commission—which regulates company securities—is the best agency to put in charge of the crypto disclosure regime, but it's not obvious that it isn't. In any case the SEC's default view of "every token is a security" means that, in practice, the rules it writes to exempt tokens from securities rules will be the rules that token projects have to follow. Elsewhere, poor Warren Buffett finally had dinner with that crypto guy who paid $4.57 million for lunch with him: "Mr. Buffett shared a lot of his wisdom in business, investment and life in general," according to Ryan Dennis, a spokesman for Tron, a network and digital token that Sun founded. "And of course there were a lot of conversations around blockchain and crypto. Crypto and blockchain are still at their infant stage, and Mr. Buffett said blockchain has its value. There are a lot of incredible companies in the payment realm, and it has huge demands. He believes blockchain technology will have a disruptive effect on the future of payment." Buffett's assistant, Debbie Bosanek, said the pair had an "interesting and enjoyable discussion" at the dinner. I can't believe Warren Buffett is a "Bitcoin bad blockchain good" guy now but I guess he had to say something at this dinner. Private markets are the new public markets Here you go: Until last March, Henry Ellenbogen ... managed T Rowe Price's celebrated $29bn New Horizons fund. The fund focuses on the stocks of smaller companies, and notched up one of the best track records in the industry. Mr Ellenbogen has now founded Durable Capital, an investment boutique that will invest in both public and private businesses. Durable's inaugural fund raised $6bn despite asking investors to lock up their money for at least three years, according to people familiar with the matter. Mr Ellenbogen declined to comment specifically on the fund, but in an interview said the structure reflected both the dwindling number of companies going public and the ascendancy of systematic, automated investment strategies in recent years. "I can see how artificial intelligence is impacting a lot of the businesses I invest in, but I believe it is also impacting financial markets," he says. "We're increasingly competing against machines. So identifying areas where humans still have an advantage is really important." This is two trends meeting each other. On the one hand there is the trend of stock pickers in public markets noticing that those markets have gotten really efficient and that it's hard to outperform the index. On the other hand there is the trend of private markets becoming the new public markets, with large global companies that would once have gone public instead raising billions of dollars from private investors. If you're a certain sort of stock picker—one focused on smaller, more tech-y companies—then (1) the companies you like to buy are now often staying private, but (2) they're often the sort of private companies that will take money from public investors, but (3) they won't take money from index funds. (Or, rather, normal public index funds won't give money to private companies.) Starting a public/private fund allows you to both keep investing in the sorts of companies you know well, and avoid competition from index funds. By the way, we talk sometimes around here about the criteria for inclusion in the big stock-market indexes, and the sort of unexamined first criterion for inclusion in almost any index is that you have to be a public company. It is not obvious that this is a necessary criterion. You could build a Super Broad Market Index (or a Special Tech Sector Index) that includes both public and private companies. It would be complicated to make that index investable (or to get prices for it for that matter), but there are at least a few private companies whose shares trade pretty frequently among accredited investors. If you structured the index right (and probably make it mostly public) you could maybe make something investable, something that an index fund could track. I'm not saying that this is a super-near-term thing, but if private markets keep becoming the new public markets, and if public-market investors keep migrating into private companies, eventually the index funds are going to follow them. Don't put it in "Bag Full of Drugs" I wrote on Friday: A key theme of this column over the years is something like: Don't do crimes over permanently preserved, easily searchable, electronic, written communications networks, or at least, if you must, don't type stuff like "here is the part where we do the crimes." If you are using a chat room to run an illegal price-fixing cartel, don't call the chatroom "the Cartel." This is not that, but it is … better? As the police in Florida's Panhandle began examining the inside of the Kia sedan, they came across two bags helpfully marked "Bag Full of Drugs." It's not exactly probable cause, but it's a lead. And police say it led to a jackpot: 75 grams (2.6 ounces) of methamphetamine, more than a kilogram (2.2 pounds) of the date-rape drug GHB, 3.6 grams (0.12 ounces) of fentanyl, plus ecstasy, cocaine and assorted paraphernalia. The driver and passenger were both booked on multiple felony drug charges …. "They don't always make it that easy for us," Lt. W. Robert Cannon of the Florida Highway Patrol said of the clearly marked drug bags. Now my first reaction was, well, if you have several bags, you might naturally mark the ones that are full of drugs "Bag Full of Drugs," to distinguish them from your other bags that are not full of drugs. It is risky, sure, but on the days when the cops don't stop you it is more efficient for you to know where your drugs are without having to open all the bags. But in fact this is a commercial product: A brief review of the Internet finds that a "Bag Full of Drugs" is available in both accessory pouch and tote sizes. "There's nothing more fun than walking around town with your ironic bag full of drugs," one vendor notes. See, if everyone is carrying "Bag Full of Drugs" bags ironically, then maybe the police will not search your "Bag Full of Drugs" bag because they do not want to look like the sort of rubes who take jokes literally. It is a reverse-psychology hiding place. Maybe you should name your illegal cartel chatroom "The Cartel"; your compliance officers will just assume "they can't be doing a cartel in 'The Cartel,' this can only be a joke." (Actually I suspect that the "Cartel" guys thought that they were being ironic, but never mind that.) Anyway it didn't work, with the cartel, or with the bags full of drugs. Things happen In the Eternal Quest to Decode Fedspeak, Here Come the Computers. People are worried about ETFs. Investors Who Tried to Save Credit Suisse's CEO Hastened His Demise. Moore Capital 'Didn't Try That Hard' at Succession. EU regulator calls for clearer rules on rescuing banks. Chinese Military Personnel Charged with Computer Fraud, Economic Espionage and Wire Fraud for Hacking into Credit Reporting Agency Equifax. Stocks Surge to Record Highs, but Few CEOs Cash Out. Unexplained Trading in Pound Last Month Wasn't a First. The Demand for Interns. Meghan and Harry 'earn £400k speaking at exclusive JP Morgan banking summit.' "I think witchcraft and crypto are deeply involved with each other." Man comes down from pole after 78 days in a barrel. "He began drinking a can of White Claw hard seltzer — which may have been just another taunt." 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! | 
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