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Wednesday, 26 September 2018

Equity block trades or how to lose your shirt in a heartbeat

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Ever since politicians and the media invented the ‘casino banking’ moniker to describe what investment banks do, I’ve reacted vigorously to the term, finding it offensive and wide of the mark.

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

But having disconcertingly watched equity block trades come to the fore in ECM this year, I’m making an exception.

Using your own capital to bid for large lines of stock in auction situations – typically put in play by private equity firms looking to cash out – is nothing but an outright gamble. I don’t care what dealers tell me about the strength of the stock market rally (the rally that no-one really believes in); that they’re familiar with the sector; they follow the company; or know who the current owners are etc. It counts for nothing. Private equity firms stiffed the banks in the pre-crisis LBO bonanza; they’re at it again in the blocks business – with other canny sellers such as governments also in on the act.

The kamikaze discounts you have to bid to own stock, the risk (occasionally realised) of additional holders offloading concurrently and flooding the market; having dealers bet against you to screw your deal; or the tiniest market correction that can put you on the wrong side make this a treacherous business. The margin for error is tiny. For sure, some firms have the distribution network to withstand the dynamics of blocks; many don’t, though, and use them as a way of pretending they’ve got an ECM business when they in reality don’t.

Is this what banks employ experienced and (still) highly paid investment bankers for? Don’t think so. I reckon a team of trained chimpanzees with a bag of cash, an address book, a battery-operated calculator and a red baseball cap (so you can recognise the head of ECM) could run a blocks business.

Global ECM proceeds year-to-date are not far off US$300bn world-wide. Of that around a third is accounted for by accelerated bookbuilds and close to half ABB volumes are accounted for by block trades. (By way of definition, Thomson Reuters lists blocks as a sub-set of ABBs; the distinction being whether the business is conducted as an agency trade or on-risk.)

While it’s not always clear whether it’s one or the other, Thomson Reuters data shows that business to-date that is principalled, owned, backstopped or whatever else you want to call it is around the US$50bn mark. I reckon it’s more than that. Whatever the case, it’s more than the total volume of IPOs. Average deal size is nothing to be sneezed at, either, at around US$375m, with many blocks closer to or beyond the US$1bn mark. We’re running at an average pace of US$2.5bn in blocks per week so far this year, which if maintained could see this business ending up somewhere in the region of US$125bn for the full year.

To be fair, a lot of blocks pass by almost unnoticed; some are actually very profitable. But things don’t always go to plan and that’s why I think the business should be expunged from the investment banking toolkit in the way it’s currently conducted. The number of uncleared trades in just Europe – Ziggo, EADS, ProSieben Sat.1 Media, Edenred, Safran, EDP – tells you all you need to know about risk in the blocks business, and we best not forget Amadeus where HSBC sold barely a share last November.

Shining a light on the other regions reveals a business just as grubby. A US$1.2bn block in Singapore’s Global Logistic Properties ended with JP Morgan still nursing 38% of the deal – but at least it boosted the bank from 13th to fifth in the first quarter, eh?

Regulator-enforced transparency means purchase and sale prices are disclosed in the US, but unsold deals are no less prevalent. As newcomers to the deal structure ECM pros are still getting to grips with the more unusual dynamics, as Barclays and Citigroup (the US block kings) found last week. Their sale in SS&C Technologies suddenly found competition as other shareholders took the opportunity to sell and the stock tanked.

The sorry sight of dealers on failed trades having no more imagination than to tell you that they’re happy to be shareholders because they love the company, wanted to capture some of the punchy dividend yield, or that their distribution strategy was always to maintain a position with a view of trickling it out over time is not just a load of cobblers; it’s embarrassing not to mention an affront to good and proper governance.

Market abuse?

The attempted cover-ups are a disgrace. Going out with half-baked or unclear cover messages – or no messaging at all – can veer close to market manipulation.

Who remembers the infamous Blue Arrow rights issue of 1989? Bankers on that trade were generous with the truth on the take-up of rights, having loaded up themselves to give the impression that the trade was something other than the failure it was. Four bankers ended up in the dock as defendants in a fraud trial and were handed suspended prison sentences (later quashed on appeal).

Yet the market today is rife with tales of half-believed covered messages; talk of warehousing arrangements-cum-repos, account stuffing etc. Regulators need to be aware of and get involved in how block trading is originated and conducted.

Those whipping the investment banks’ competitive spirits into a frenzy of low-balling and puerile bravado – I’m talking here about the advisory firms that have no skin in the game – bear some responsibility here. And frankly so do the sellers who should have an interest in making sure business is conducted in an orderly fashion.

The way it’s done today resembles a dangerous race to the bottom that leaves dealers with no room for manoeuvre; no time for banks or investors to prepare and every opportunity to lose your shirt on both sides of the trade.

Whatever you want to call it; a derivative form of proprietary trading or some such, investment banking it isn’t.

I say exclude block trades from ECM league tables; the market doesn’t need pretend ECM shops whose deal flow is block-driven and this is no way to conduct business..

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