IFR Editor-at-large Keith Mullin
I’M PUZZLED. MY May 21 column on block trades – “Equity block trades or how to lose your shirt in a heartbeat” caused a stir in ECM circles; I received some supportive feedback from the Street on my anti-blocks stance. So why am I puzzled? Well, because I wasn’t exactly expecting support; I was expecting some pretty aggressive pushback.
My comments had been intentionally provocative to flush out counterviews but I was at the same time throwing down a challenge to an industry I thought had gone mad. But pretty much everyone agreed with me. “Closer to the truth than to provocation”, said one. “I completely agree with you,” said another. “Keith Mullin’s discussion of block trades is spot on”, said a third.
“Get rid of the blocks business as a primary measuring stick of IB business and it will fade,” said one battle-hardened ECM veteran. “There are firms out there masking ECM franchises and taking risk with house money [in a way] that has no bearing on what ECM professionals were placed on this planet to do.”
My immediate reaction was: “if almost everyone agrees with me, why does the practice continue?”. One suggestion was: “everyone does it; how can you afford not to participate?”. No particular reflection on the individual who proffered that lame pearl of wisdom but it’s certainly a reflection of a cynical approach taken by an industry still focused on speculative profit over across-the-board client service. It’s dreadful governance and suggests the industry is far from being rehabilitated in its thoughts and actions (or, to use a term I hate, in its culture).
FOR THOSE WHO missed it, in summary I’d said that engaging in outright speculation with shareholders’ money – which is essentially what capital-committed overnight blocks bid under auction are – in a regulatory environment designed to promote transparency and tame risk is a travesty if, in order to win auctions, investment banks bid stupid levels that often make it impossible to offload on the other side if the market moves against them or the lack of a proper discount fails to provide sufficient buyside incentive.
Why has the process of trading blocks become synonymous with reckless endangerment? Given the number of complete disasters of late in overnight risk trades, I just don’t get why the process doesn’t change if it risks losing money not only for investment banks but their clients on the other side of the trade too.
Blocks have invariably become a licence to lose money. It’s more akin to proprietary trading than to investment banking. More seriously perhaps, the way it’s done infers clearly bifurcated levels of service provision that favours one set of über-clients (predominantly private equity firms) over those who end up being treated as second-class citizens (stable, long-term, long-only equity holders and the companies themselves whose shares get unnecessarily roiled).
Blocks have invariably become a licence to lose money
That thinking was confirmed amid the one piece of pushback I did receive: “[blocks] provide a valuable service to clients who are the largest fee-payers to Wall Street (private equity pays magnitudes above any corporate)”. There you have it. Other gems from the pro-camp included: “if you’re involved in deal-flow cradle-to-grave and blocks are one iteration of that process, why should it matter if you take a US$3m nick on the occasional block?” Err … it matters because it’s not your money to nick. Would you have that attitude if it were your money on the line?
In the case of unsold blocks, all banks are doing is becoming reluctant shareholders by shifting an overhang from a favoured client who bears no risk and who maximises profit on to their own books at their own expense with full market risk. That’s not what banks exist to do any more.
The more serious point here, though, is that this distorts the process of price formation and price transparency because unsold blocks remain in play for a length of time that’s uncertain anyway because of market moves etc but which is also dependent on how honest investment banks are in their messaging and the extent to which they articulate openly their positions and intentions.
SO OVER TO the buyside. There’s certainly a lot of anger around false messaging around blocks. Banks stand accused, at best, of being purposely misleading; at worst, nakedly lying about what’s really going on. Neil Dwane, CIO for Allianz Global Investors in Europe has become the (very reluctant) poster-child for the cause in this area.
In his by-now infamous email to his top 20 bank counterparties, you’ll recall he’d expressed “profound dissatisfaction” about the way blocks are handled “or more directly, mishandled” due to excessive competition and the “apparent fight for league table honours, which seems to serve neither the company nor its investors”.
At the same time as investment banks need to think carefully about whether they continue to conduct business in this way, I also say it’s time for institutional investors to stand up and be counted. They should refuse to deal with wayward banks that are generous with the truth. One strike and you’re out of all commission allocation for a quarter; two strikes and you’re out for the year. Three strikes and it gets escalated to senior bank management, the board and to the regulator. Time for some direct action.
