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Friday, 15 December 2017

SEC barks up a dead tree

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Bond allocations aren’t fair? Tell me something I don’t know, says Anthony Peters.

I CAN’T TELL you how many people were on to me last week as to whether I had seen the news that the SEC is launching a probe into the new-issue allocation process in the US corporate bond market.

It is hardly a secret that I spend a significant part of my professional life trying to procure allocations in new issues for my own clients, most of which is time wasted on an exercise in futility. I have kicked and screamed and moaned about the inequality in the distribution of new bonds and pleaded with syndicate desks – I think they must dislike me as much as I dislike them – to consider lesser players such as my own SwissInvest when doling out the goodies.

Now we are met with news that the SEC has approached Citigroup and Goldman Sachs to ask for supplementary information as to the process involved in allocating bonds from new issues.

Interest seems to be focused on events surrounding allocations of the mega deals for Verizon and Apple (although Goldman was involved only in the Apple but not the Verizon trade and Citi served merely as a junior partner in the latter). I commented at length on the Verizon deal at the time, but I was more concerned with the rather cavalier pricing than with the distribution process.

Nevertheless, the apparent fact that even in a deal of US$49bn there was not enough paper to filter down to guys like us – especially as it broke syndicate offering eye-watering profits – was enough to get me just a little hot under the collar.

SINCE THE AUTHORITIES began an effort to turn the credit market into something it is not – namely, a transparent and liquid equity market lookalike – things have gone from bad to worse.

Pre Dodd-Frank and Basel III, bank-held bond inventories – what truly constitutes a trading or a proprietary position is a moot point – were said to be around US$256bn. These are now estimated to be closer to US$37bn, around a seventh of the original size. This is clearly not enough to guarantee a normally functioning secondary market, irrespective of how many electronic platforms and trade reporting systems are mandated and installed.

Regulators’ repeated but rather ham-fisted attempts to control debt markets smack a bit of trying to reduce pollution by fitting cars with smaller fuel tanks, only to find the countryside being concreted over as more gas stations are built. Most large institutions have frankly given up on secondary markets as a usable source of paper and investment dollars are focused on the new-issue supply. It’s not complicated.

Based on what I have read and heard so far, it would appear that the SEC understands the basics of business in the real world even less than I had expected. No law appears to have been broken and in a rules-based environment there would appear to be nothing that can be done. One cannot legislate either for or against business relationships and there is no rule that prohibits using third parties as conduits in order to come by paper.

This is not John Meriwether’s trading desk at Salomon trying to corner the two-year Treasury note market in 1991 with false bids. What it is is a 3D Technicolor example of the law of unintended consequences.

The new-issue allocation process is unfair because life isn’t fair – smaller clients have always drawn the short straw

Syndicate desks used to do the right thing simply because it was the right thing to do. Now, where everything is measured in cost of capital employed and where fees have shrunk to a level at which taking balance-sheet risk at the point of underwriting is no longer viable, the temptation – nay, the key strategy – has to be to get the stuff out of the door as fast and as painlessly as possible.

Forget those old chestnuts of broad distribution and the involvement of new investors. Forget future liquidity. Book the fees and move on. And if you can find a way of knocking out US$16.25bn of a US$49bn Verizon issue to five investors, give me one compelling reason not to do so.

IT WAS THE late Sir James Goldsmith’s wife, Lady Annabel (the one after whom the London nightclub is named) who coined the phrase that if a man marries his mistress, she creates a vacancy. In the markets, it would appear that every time a new regulation is implemented, a new set of loopholes comes as part of the package.

The new-issue allocation process is unfair because life isn’t fair. Smaller clients have always drawn the short straw and equality cannot and will not ever become legally enforceable. If they try, we might as well all pack up and go home.

Perhaps the SEC showing the big stick will be enough to prompt lead managers to share the love a bit more equally, but I doubt that everybody will ever be pleased. Unless the collective of investors, large and small, were to boycott a new issue or a lead manager, nothing can be expected to change and the odds on that happening would make a snowball feel tempted to bet on its chances of surviving a protracted sojourn in hell.

If in the investigation the SEC is able to pin legal culpability on somebody, anybody, pretty much irrespective of what for, please don’t expect me to be dancing on their grave. I might be a dinosaur but that does not stop me from applauding Darwin.

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