Wednesday, 19 September 2018

UPFRONT: Time for change

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Institutional investors have begun to realise that it is not enough simply to criticise banks for the state of the European IPO market in 2010 and 2011. For 2012 to be any better they need to accept they are a fundamental part of the market and stop acting like passive onlookers.

BlackRock’s decision to hire a head of ECM is a significant moment in this process. Last year, a public letter from the firm blamed everyone else for the extraordinarily high rate of failed IPOs and poor returns from those that made it to market.

Now, BlackRock will engage with banks to help with structuring, will meet companies earlier in the listing process and may even invest before an IPO and then top up through the float – an approach that has been a large, but under-appreciated, component in the (relative) vibrancy of the US IPO market.

Other major funds are expected to follow BlackRock’s lead, perhaps creating some hope for banks desperate after two years of such low volumes that some are struggling to generate returns.

ECM might be one of the least capital-intensive areas of operation, but it is far from a sure-fire money-spinner for many firms. RBS, for example, is about to shut its ECM unit because it is unprofitable.

But banks have cause to worry about changes in the fundamentals of the ECM market. They are, after all, simply intermediaries and as end-investors develop in-house expertise banks could find their role redundant. When a sponsor is looking to sell, ECM bankers might find their phones don’t ring.

The industry’s Rolodex is sufficiently extensive to protect their position for some time, but they have to change. ECM teams are designed around a very narrow range of products in public markets. Their future depends on wider application of those skills to seed financing, pre-IPO rounds and more – essentially any point where equity financing is needed and investor relationships are valuable.

Too much of a bad thing

The sorry state of India’s domestic bond market is forcing the country’s issuers to some extreme – and potentially dangerous – measures.

The move by India’s Rural Electrification Corp to add an element of currency risk to its latest rupee fundraising will save it about 170bp in annual interest costs. However, it adds an additional layer of risk at a time when the country’s regulators are already raising the alarm over foreign currency exposure in India’s corporate sector.

REC is planning a Rs15bn (US$304m) bond issue that will be sold at a fixed rate and then swapped into a spread over yen Libor. While the rupee is appreciating and the yen is depreciating, that will be fine, but a recent missive from India’s heavy-handed central bank appears to have also made it impossible for REC to hedge against a reversal in that trend.

REC may only be swapping the coupons, reducing the amount of currency exposure. Still, systemic risk will magnify as more issuers take the same path.

The moot question is whether REC fully understands what it is getting into. Assuming it does, why is it taking potentially unhedged foreign currency exposure?

Rather than ringing alarm bells over corporate risk, REC’s move should be seen as a failure by India’s regulators to address the fundamental failings of the domestic debt market.

Protectionist policies may have insulated India from the fallout of the 2008 credit crisis, but they are now choking liquidity. With rates uncertain, a narrow base of participants and an investor base that is already full up on public sector exposure, issuers are backed into a corner.

Most probably such moves by REC and others will trigger more regulation. The RBI has been against such practice in the past when banks were taking the same route to pare costs on their Tier 2 debt and is probably also unhappy now companies are doing the same.

But, as is so often the case in India, plugging one hole may just pierce another.

As long as India’s top issuers struggle to access competitive funding in the rupee market, the search for alternatives will continue.

Some 21 years after it first introduced market-opening reforms, the lack of belief in risk management policies among banks and issuers is discouraging.

India has left few onshore or offshore funding options open to Indian companies as they look at refinancing a mountain of debt. And as borrowers seek creative ways of getting money a bit cheaper, they only prompt more roadblocks.

Savings under scrutiny

As the SEC considers a complete overhaul of the money-market fund industry, another supposedly safe-haven investment has come under close scrutiny.

With yields on certificates of deposit below 2%, banks have had to do something to entice investors – even if it means linking CDs to a form of derivative instrument.

Savings instruments were never really meant to be spoken of in the same breath as derivatives and the US retail regulator, FDIC, would still prefer to keep them apart.

Slicing and dicing baskets of funds is par for the course in derivatives but only recently has it become a common structure in CDs. Structured CDs have been tied to the movement of gold, CPI, Euro Stoxx, the list goes on.

The idea is troubling regulators and FINRA is now keeping a watchful eye on the products. That is wise. After all, investors don’t always read the fine print. Principal may be protected, but not the gains from the underlying indices. And not all CDs are backed by the FDIC.

Take a look at some of the latest offenders when it comes to retail-oriented discrepancies and it reads like a banking awards list. Bank of America Merrill Lynch and Citigroup were fined by FINRA early this year for violating retail investor rights, and that followed earlier action taken against Credit Suisse, Barclays and Wells Fargo in December.

It is not surprising, then, that non-US bank branches in the US have become some of the heaviest pushers of the products lately.

For some, derivatives are still the ultimate symbol of toxic risk in financial markets, but banks may not have learned that lesson well enough.

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