Wednesday, 22 November 2017

IFR DCM Milestones Roundtable: Part 3

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IFR: Robert, you took something which wasn’t yours …

Robert Gray: What became self-evident during this period that Gene is describing is that if you didn’t have a good swap team, you were
at a huge disadvantage. I was blessed as Morgan Guaranty’s syndicate manager to have the best swap team on the street. I think it
made a huge difference.

One of my memories is when we did the first zero-coupon swaps. We took a zero-coupon bond for a US industrial and swapped it into floating dollars. The competition was somewhat distressed, because no-one else had worked out how to do it. It’s a vivid memory of mine as a syndicate manager being able to take advantage of such an outstanding swap group. They had the technology that was ahead of the rest.

IFR: As we move towards our conclusion, I wanted to ask each of you for a couple of short anecdotes describing the high points and low points of your careers, in as much detail as you care to indulge.

Michael Dobbs-Higginson: My low point was when the Japanese equity market was collapsing and we had five mandates (to the chagrin of the Japanese securities companies) but we pulled them all. I went to a dinner with one of our Japanese clients, attended by 25 Japanese and myself.

I took along a pair of Japanese 15th century swords (I have a black belt in Kendo) and I said: “this is a Japanese situation. I’m willing to commit seppuku [a form of Japanese ritual suicide] if one of you would act as my second”. [The second is the man who stands behind one with the long sword and cuts off one’s head as one cuts open one’s belly with the short sword].

There was a shocked gasp and, not-suprisingly, no one offered to do so. Accordingly, I was relieved of any obligation to do the honourable thing because I had offered and they hadn’t got the guts to take me up on it - obviously a somewhat over-the-top play with no real risk, but it faced them down re their criticism that the honourable thing would have been for us to have done the deals even if we and the investors would have lost their shirts!

IFR: Is that a low point or the high point?

Michael Dobbs-Higginson: That was a low point in the sense that we lost lots of deals that I had sweated blood and tears to get, and we got lots of opprobrium from the market. I recall people like Salomon Brothers and Morgan Stanley trying to take advantage of our pulling all these deals by saying that we couldn’t be trusted. The high point was, as I mentioned earlier, was when I pulled an Australian billion-dollar deal for Holmes a Court. He was known for his ability to say nothing while waiting for his counterparty step in and make some asinine comment and dig himself into a hole.

I was in the boardroom at CSFB on a speakerphone at 11am on the deadline day with about three lawyers from Linklaters and a number of colleagues. Holmes a Court was on the other end of the line, and he was trying at the same time to call my chairman, William Schreyer, in New York, who was calling me on his line saying, “What do I do? What do I do”? I said: “Bill, for God’s sake, just don’t do anything. Say you’ve “gone fishing; or whatever”.

So Holmes a Court had to deal with me. At 12 o’clock, the breakpoint came. I said: “Robert, I’m sorry, we’ve offered you a compromise deal and you’ve turned it down, so the deal is now officially pulled. Thank you very much.” That was a high point, because we probably saved ourselves and the market some A$400m-$500m.

Iain Baillie: My high point was a transaction we did at Luthy Baillie Dowsett Pethick shortly after sterling left the ERM, so I guess that would have been late 1992. The Gilt yield curve went very positive, and it was relatively early days of interest-rate swaps and the effect of high coupons and a positive yield curve is you short duration and that makes them look very cheap, whereas everybody thought high coupons were horrible and were busy selling them.

We were able to swap a high-coupon Gilt into floating-rate sterling at Libor+50bp. We then went round to see the Bank of England, to explain that we thought there were some pricing discrepancies in the Gilt market at that point of time, which was quite good fun.

Robert Gray: I suppose both my high and low point relate to experiences with European sovereign governments. In the area we’ve been reminiscing about, I think my high point was being summoned to Stockholm by the Swedish central bank during the 1992 currency crisis initially saying: “We need US$1bn in loan assistance”. I went up there with Hugh Paton, sadly no longer with us, who was my head of syndications. During the conversation, it became apparent that this was an operation that should be somewhat larger and should be handled by officials from the Debt Management Office, who were summoned across to the central bank.

Before the end of the day we’d got a mandate for I think a Ecu15bn loan. What was memorable for me was we took exactly the amount of money from the syndicated loan market that was available; there wasn’t a penny left out there but we did it. Ecu15bn was a lot of money in 1992.

My low point was another European sovereign, when I was heading the syndicate desk, when we did a US$1bn 15-year FRN. At the end of the first day we found we had US$1.3bn of this US$1bn deal on our books, which caused us inevitably to implement a squeeze on the syndicate members who had shorted the issue. Of course, they came in individually to explain that they hadn’t, that they’d genuinely sold the issue and should be allotted in full. That was not a particularly good experience.

Cyrus Ardalan: My high point is probably something which actually involves Rene very much. That is doing the first euro denominated transaction for anybody in the public market prior to the euro being created. We were sitting around in Paribas discussing what we were going to do with the European Investment Bank, and the proposal was to go to them with a traditional Ecu transaction but I said: “why don’t we just call it a ‘euro’?”

People looked at me and said: “you can’t call it a euro, we don’t have a euro, it’s not going to come for another four or five years”. I said: “so what? Let’s just call it a euro, and if it doesn’t happen it just converts back into an Ecu”. It was as simple as that. We went to Rene, and he thought it was a good idea because first it avoided re-denomination from Ecu into euros, and secondly it sent a very, very strong signal in official circles that the euro was a reality and was going to happen.

Rene had the courage to do the transaction, and following that we did three or four, one after the other, including for Italy, Finland; and I think Spain. We led all those deals, because we were the pioneers in that area, although it really didn’t require a huge amount of expertise.
Michael Dobbs-Higginson: You had the brilliant idea.

Cyrus Ardalan: It was such a simple idea but it actually worked. My low point was again very much in a sovereign area, when I was structuring a silver-linked bond issue for a European sovereign. Fortunately it was a small bond issue, but it really did not go well …

Rene Karsenti: Cyrus, I was exactly thinking about that euro transaction; that’s one of the high points of our career. Indeed, launching the very first euro transaction almost two years before it became the official currency of Europe was really a big risk. It was also a show of confidence even if we were far from being sure that it would work, As well as that transaction, we did a global euro transaction - also before the euro came into being. I remember we were trying to sell the deal at roadshows in the US. I recall being interviewed on a very early morning show on CNN. They asked me: “Which currency are you issuing, Mr Karsenti? This euro; do you really believe that the euro will exist?”

The other high point of my career was very early on in my time at the World Bank. Thanks to Gene, I was one of the most junior members of his team working on the first swap with IBM in 1981. I remember after the transaction was put together Gene sent me to Japan to explain the transaction to the Japanese bankers and officials, with strict instructions not to give the name of our swap counterparty. When I arrived in Tokyo, the first question I heard from the bankers was: “what is this transaction you just did with IBM, Mr Karsenti”?

What could have been the lowest point of my career came when we were doing a global transaction for the World Bank in October 1987 in the middle of the stock market crash. We thought our transaction could become a real disaster. I remember a call to our lead manager - and this will give you an indication of the culture at that time - and I said I was concerned about the transaction and the way it was going.

The answer of this lead manager was: “Rene, absent a nuclear war, we will stand by your deal” and he saved it. That could have been the lowest point of my career, but it was a success. That bank was Deutsche Bank and the banker was Rainer Stephan, who was covering us. This was the relationship between underwriters and regular issuers at that time. That deal could have been a real disaster.

Gene Rotberg: To me it’s not so much a transaction that has given me the most pleasure; it’s very frankly the people I work with who have enhanced my life in terms of their awareness of the ethical necessity to act in the markets, their innovation, their risk awareness, and just ways that they have handled themselves in their career. People like Cyrus and Rene, Antoine van Agtmael, Jessica Einhorn, Ken Lay, Afsaneh Masheyekhi Beschloss; all of them worked with me. They all have those characteristics of which I’m very proud, as well as the people on the outside. I can’t name them all, people like Patrick Stevenson and Roberto Mendoza. When I look back, it’s given me a great deal of pleasure to see how much they accomplished.

The great downside is a disappointment or frustration that started 40 years ago, I have written and talked about the great risks of financial structures - such as securitisation and derivatives - and the lack of knowledge of regulatory agencies as to what really goes on in the market. I have been singularly unsuccessful in getting the regulatory agencies to fully understand that risk, decades before the collapse five years ago. That still bothers me. Much of it could have been avoided. We will have events in the future of a similar magnitude and they can be avoided but there is simply not any expertise in those who are responsible.

IFR: Gene’s comments are in some respects a good segue into our final topic: the issue of where we go from here. That’s a symposium in itself so let’s frame it this way: based on your own experiences over the last few decades and based on where we are today in regulatory discourse and internal changes taking place within banks and so on, can you give some thoughts about what the future might hold for the capital markets?

Michael Dobbs-Higginson: I can’t possibly give you a definitive answer, but I have some thoughts on the subject. Asia generates a great deal of the world’s trade flows and has a great deal of the world’s reserves and its past history is of virtually no sovereign default (unless we go back to the 19th century and China). I think there’s an interesting observation to be made in cultural terms: there is considerable shame in the Asian context of not paying your debts, and I think that that is an interesting driver of how they’ve behaved.

That leads into the future. Given the region’s economic strength, which is growing, and given that attitude, it’s going to be interesting to see whether the Asians will develop an Asian version of the Eurobond market based around the RMB. We’ve tried in the past with Asian currencies with the Euroyen market, for example, but nothing has really taken off because none of the currencies were sufficiently big and dispersed enough to become an alternative to the US dollar at the time the Eurobond market started.

Will we move to an Asian currency like the RMB? Will the Asians take much more of a role in funding themselves through an Asian version of the Eurobond market, as opposed to coming to the Eurobond market? That’s my question.

Iain Baillie: I guess as an ex-trader, my concern is that through the first 20 or 30 years of the Eurobond market, liquidity grew hand-in-hand with the growth of the number of issues, issuers, and the investor base. Leading from the late 1990s through to the credit crunch, liquidity grew through leverage rather than through any great necessity. That’s reversed itself since the credit crunch, because the intermediaries don’t have the capital they had before to provide that liquidity.

I think it’s led to a dislocation, which might well have a little bit further to go to get back to a steady state if it had grown based off investor demand, which really at the end of the day is the only true provision of liquidity.

Robert Gray: I think Iain raises an extremely good point about the importance of liquidity, sustaining liquidity in the interests of a healthy long-term primary market. I’m just remembering that the Financial Services Action Plan introduced in 1999 was due to be completed by 2004, and yet we’re still saying we don’t have a fully harmonised European capital market.

If you look at it, it doesn’t seem to me that we’re distributing bonds any differently than we were the best part of 30 years ago. I think we have to take stock of where this financial services plan has taken us in terms of it clearly not having succeeded in harmonising markets in the way its architects intended in 1999.

I would just like the regulators to be highly conscious of what Iain said, in terms of doing what they can to protect liquidity, because so far the evidence is that they’re not attuned to it at all. The attempts to impose greater transparency pre and post-trade and the other measures they’ve taken, including the desire to shift things onto regulated markets are all a major threat to the over-the-counter market, which we’re all talking about here and which we’ve been living with for the last 40 years. It would be a shame to see it put to the sword through ill-conceived regulation and supervision.

Rene Karsenti: I believe the bond market will continue to be a tremendous engine for financing the global economy, particularly in Europe, where we’re seeing major bank deleveraging. I believe that the bond market will become more and more important in particular for the development of corporate bond issuance. That is good news in Europe - and in emerging markets where I think the bond market will continue to develop.

I also believe there will be increasing investor appetite for socially-responsible investment. Investors are increasingly interested in gravitating towards issuers that demonstrate compatibility with their own values. I believe that “impact bonds” like the vaccine bonds issued by IFFIm (which Cyrus and I are in charge of) will become more and more important.

Gene Rotberg: Talking about the future, I guess there are two different things. I have a slightly different tilt to some of my colleagues here on the issue of the financial condition of the intermediaries. I think right now there’s still too much leverage; I think there’s too much securitisation, and I think that there’s even too much liquidity.

I just don’t know if we need it, because if you can get rid of everything very fast I think it diminishes attention to prudence. I also think there’s still a huge possibility for contagion. In terms of what I think is likely to happen, I think that Asian savings in future years will account for an enormous percentage of the financing of the global economy. I think that will have tremendous geo-political implications. Second, I think that changes in energy and particularly the cost of energy will shift, and that’s also going to affect the geo-politics.

Finally, as for the intermediaries ie the investment bankers that put buyers and sellers, borrowers and lenders together, I think we will continue to have plenty of them and I think they’re going to be reasonably profitable. But I think we sometimes overstate our importance; we’re just middlemen. As long as we don’t think that we are the creators of wealth, but merely the intermediaries between wealth, I think we’ll be OK. What I’m concerned about is that sometimes we think that we are the ultimate savers or investors. We’re not, we’re the middlemen. I think if we can just have that modesty our financial system will be much better off.

IFR: That’s a fairly sober point but a well made one. Cyrus, let me come to you, particularly with your public policy focus. Where we are in this debate is fascinating …

Cyrus Ardalan: If we look at the last three or four years, the defining characteristic has been the complete re-regulation of the financial services industry from top to bottom. The future is going to be driven by what consequences this re-regulation is going to have for this industry. That’s the big question, and I’m not sure that people really necessarily have the answer to it.

One of the consequences of re-regulation will be a shift away from banking to the capital markets, or at least the acceleration of that process, particularly in Europe - which is lagging a long way behind the United States - but also for the emerging world and Asia. The success of this transition from banking to the capital markets is going to be a critical driver of future growth and prosperity globally. That’s where I think we have to really focus, and there I think there are a number of issues that need to be thought through.

One is that there’s a real risk of unintended consequences coming out of all the different strands of regulation that are being introduced, each of which has a small impact, but cumulatively can have a significant impact on the capital markets. Liquidity is one example, which is impacted by CRD IV, by MiFID and the financial transaction tax. It’s impacted by so many different legislations, each of which has its own small impact, but collectively they could have a very big impact. That is one thing.

The second element is that for the capital markets to prosper they need to prosper on a global basis. That takes you into the world of extraterritoriality. There we’ve already seen huge issues between the United States and Europe, and also between Europe and Asia. Unless that gets resolved then it will not fulfil its potential.

The third, which is also linked to that but distinct, is the balkanisation of markets, because if we get extraterritoriality coming in, if we don’t create a mechanism which works effectively because of its unintended consequences, the natural reflex will be to balkanise. That will simply make the situation even worse.

Michael Dobbs-Higginson: Excellent point.

IFR: On that note, I’d like to close our session. Thank you so much for some fascinating comments and insights.

To continue reading this roundtable, click the relevant section. Introduction - Participants - Part 1 - Part 2 - Part 3


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