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Saturday, 21 October 2017

Musing of a market veteran

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MISTAKES WILL HAPPEN. They always do. However, by and large, the Street has become far more tolerant of human error. Heaven help the trader or investor who committed a trading error in the cut and thrust of the Eurobond market in the 80s when “done” meant “done” and that was it.

If you erroneously hit a bid in too large a size, you’d be looking at buying the over-size back from the dealer in question on his offered side. If you got the wrong bond, it would be even worse. How many hours did we all spend in the basement of the office building listening to tapes in order to prove who it was that had made the mistake?

It is strange to recall how opposed many traders were to having recording equipment installed for fear of their bosses listening to their conversations. They seemed to think that heads of trading had nothing better to do in the evening than sit listening to tapes and it is not until one has actually been “into the tapes” that one realises what a mind-bendingly boring pastime this is. Did he cry “Off!” before or after the counterparty had yelled down the phone “Yours!”? Horrible.

But all parties in the markets have since become a bit more tolerant. Trades are cancelled, issues are changed, sizes adjusted and prices revised on a regular basis and broadly without too much fuss – at least until the loss incurred is substantial.

JUST RECENTLY, WE encountered a case where the dealer buying had priced the wrong issue and bid 1-1/2 points higher than he would have done; not surprisingly he ended up wearing the bonds. The issue was illiquid and, with current volatility, any price might have been right.

After some moaning and a bit of attempted blackmail – you either sell me the bonds on my correct bid or there’s no trade – a compromise was reached in which both sides yielded a bit and agreement was struck. As ever, if both sides are moaning about the outcome, it is probably the right result.

But there are other sources of error that are causing far more consternation. With ever increasing frequency, we are seeing the allocation of bonds in new issues reported in different shapes from different joint lead managers.

The rule is clear in that the word of the billing and delivering house is the one which counts, but that presupposes that all of the leads have seen the original order. It may be, however, that the investor does not have a dealing relationship with one or more of the leads and, even more significantly, no relationship at all with the billing and delivering house.

This has led to a series of worrying situations in the past weeks. We recently placed an order in two tranches of a multi-tranche US dollar deal and sent the order to all three joint leads. The following morning the billing house phones in some confusion to report that we had, for some strange reason, been allocated more bonds than we had subscribed to. The salesman knew it was wrong and so did we.

Alas, as New York opened the salesman duly leapt on the phone and quizzed his syndicate desk, which told him that they had received the instruction for the substantial increase from one of the joint leads. Remarkably, the joint lead in question had failed to pick up our original order and knew nothing.  

Now to the point: instead of apologising, agreeing our allocation and moving on, the New York syndicate manager began to try to find out where the error had occurred. There we sat for three frustrating hours, waiting and at risk, while the joint leads were performing their private post mortem. Who was at fault was not our problem, you’d have to agree, but that was of no consequence to them.

Given the way bonds will be issued with calculations to three decimal places and hedges reported in quarters of a plus, the cavalier manner in which investors’ risk is dealt with leaves much to be desired.

THE REPORTING OF allocations often appears random, with significant time delays and increasingly with different numbers coming from different leads. Mistakes will be made but the habit of many syndicate desks to immediately deny culpability and to leave the risk and uncertainty at the door of the subscriber is not elegant.

The reporting of allocations often appears random, with significant time delays and increasingly with different numbers coming from different leads. Mistakes will be made but the habit of many syndicate desks to immediately deny culpability and to leave the risk and uncertainty at the door of the subscriber is not elegant.

Bankers must remember that although they are answerable to their shareholders, most institutional investors are bound by a statutory duty of care and contractual fiduciary responsibility to those who have placed money under their management.

Syndicate desks appear to be drifting ever further from investors. It used to be that syndicate was powerful because it was the department that understood the needs of both issuers and investors. It underwrote entire issues and hence bore the biggest risk on the floor.

It is not without reason the path to the top job in fixed income used to invariably begin in syndicate. From the buy-side it feels as though the desk has somehow lost its way, lost its authority and lost its appreciation of what risk management means to anyone other than itself.

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