Death Of The Salesmen - Mifid II Strikes Again

Now they tell us…

The imminent prospect – January 2018 - of Mifid II, with the unbundling of research costs, was bad enough in terms of complexity and lower profitability for both the buy and sell sides...never mind disastrous for the analysts who are likely lose their jobs. Now the regulatory powers that be in London are ensuring that collective hatred of them is about to reach a new all-time high. The definition of “research” is to be expanded from the tsunami of analyst reports to the even bigger tsunami of email and Bloomberg messages swapped between sellside salesmen and sales traders and buyside portfolio managers and dealers. According to the FT.

The UK financial watchdog has alarmed some City brokers by saying new rules on payment for investment research could extend to wider sales and trading roles. From January - under European legislation known as Mifid II - asset managers will have to pay financial institutions directly for research instead of combining the cost with trading commissions. To date, the debate has focused on price negotiations for research between banks and asset managers, with the former offering packages that include written reports and direct access to analysts. But some brokers have been caught off guard after the Financial Conduct Authority (FCA) said that content produced by sales traders who take orders on trades and typically advise clients by highlighting trends and “market colour” — would also count as research.

 

“Whilst this is logically consistent with everything the FCA has said on (research) unbundling, it will still come as a bombshell,” said Richard Balarkas, director of Quendon Consulting and former chief executive of Instinet, an agency broker.

 

“Most firms will have hoped to sidestep the question of how to charge for all those client-facing employees whose role is neither research nor pure trading.”

With most firms acknowledging that they are less than fully prepared for Mifid II, it’s likely that the FCA’s latest “gem” has led to a widespread muttering of expletives in scores of offices, including in “execution only” firms who thought they had no explicit research relationship with their clients. However, presumably wise to regulatory incompetence, some firms had already assumed the widest possible assumption of “research”, where the key term is “substantive”. The FT continues.

An FCA official told an industry conference this month that if a sales trader provided an idea with “substantive” analysis or insight, that would need to be paid for by an asset manager to avoid being classed as an inducement, according to multiple sources who attended the event.

 

“Research departments give a structured output that you can price, but this will be extremely hard to monitor and police,” said the chief executive of one City broking house, who did not wish to be named.

 

The rules could make it more difficult for a broker to interact with an institution with which it traded but had no research deal, he added. Nevertheless, some larger banks and brokers said they had already interpreted the rules in this way and were taking precautions to ensure staff would not breach them. One said that in drawing up Mifid II agreements with asset managers, it was pricing “research and sales” as a combined package.

Some firms are pursuing an alternative solution…if saying something “substantive” is going to attract more regulatory scrutiny, don’t say anything “substantive”. What this means the FT doesn’t explain. Our suspicion is that saying nothing substantive means not giving a recommendation in terms of Buy, Sell or Hold. Having said that there is a hundred ways of getting across your view on a security without specifically characterising it in terms of a recommendation. However, the FCA is already trying to head this off.

By contrast, another bulge bracket bank said that it was reviewing its sales communication policies and had given training to traders to ensure they would not write or say anything that could be deemed “substantive”. Neil Robson, a regulatory law partner at Katten Muchin Rosenman in London, said the FCA had likely spoken out as a warning to any investment banks who planned to blanket label certain content as “non-substantive” or “not research material’ — where it might not always be the case.

 

“Simply because it’s coming out of the front office doesn’t mean it’s immediately out of scope,” he said. “Asset managers will have to look at everything in context, on a case-by-case basis, to determine if something is research covered by Mifid II rules or not.”

If the Mifid ii implementation has led to the “discovery” that formal research has, in many cases, little or no value, it’s amusing to speculate on the likely value of much of the gossip, hunches and “guestimates” peddled by salesmen and sales traders when they (frequently) diverge from marketing their firms published research. The FT speculates in catastrophic terms that it could signal the beginning of the end for salesmen and their service.

Others have raised concerns about what the changes might mean for the future of sales traders, whose numbers have already fallen with the move towards automated trading. “It makes the job of the salesman ever more redundant because he’s not allowed to have a view on anything,” said a senior executive at a London stockbroker.

 

Mr Balarkas said: “Brokers will either have to cease supplying some services, or price them on a discrete basis — or ensure that the service has little or no value, which rather defeats the point of supplying it.”

UK PMs Push Back As Regulators "Bend The Rules" To Accommodate Saudi Aramco IPO

All IPO’d up and no place to go? UK portfolio managers with $6.9 trillion resist rule bending by regulator to achieve Aramco London listing

Another potential problem for the world’s biggest ever (potential) IPO…

A lobby group representing UK portfolio managers with $6.9 trillion AUM has warned the UK financial regulator that bending the rules to accommodate Aramco’s IPO will damage London’s status as a global financial centre.

In a letter to the head of the Financial Conduct Authority (FCA), the embattled Andrew Bailey, the Investment Association (IA) argued that it threatened the “high standards” of London’s listing regime.

In “Funds fire broadside over Saudi oil float”, the Sunday Times noted that “Britain’s largest investors have turned up the heat on the City watchdog over its controversial plans to allow Saudi Arabia’s oil giant to float in London.”

Besides the tricky issue of its oil and gas reserves (especially the Ghawar field), the IA argued in the letter that “For the premium segment of the UK main market, investors must have confidence that a company is run for all shareholders, not just the major or controlling shareholder.”  

Selling only 5% of the share capital, rather than the prescribed 25%, is one of the major stumbling blocks in terms of the listing regulations.

According to the London Stock Exchange, a premium listing meets “the UK’s highest standards of regulatory and corporate governance.”

However, regulations are made to be broken…not just by banks and funds…but (when it suits) by the regulator itself, it seems. The FCA’s Bailey has proposed a new category of premium listing which would be tailor-made for government-controlled companies, like Aramco.

According to Bailey, investor safeguards would not be “weakened.”

It turns out that Bailey proposed the new category of premium listing after meeting and having conversations with Aramco and its advisers. As the Sunday Times reports, Bailey “emphasised during those conversations that we (FCA) were reviewing the listing regime.”

Perfect timing.

Clicking on the “About Us” tab on the FCA’s website, the regulator champions its wish that “consumers can place their trust in transparent and open markets” under the heading “Enhancing Market Integrity”.

Having said that, there is an option to click “No” after the question “Was this page helpful?”

In Bailey’s defence, it is possible that he’s being lent on by the British government to find a way to accommodate the high-profile Aramco IPO.

After all, Theresa May travelled to Saudi Arabia in April with the CEO of the London Stock Exchange, Xavier Rolet.

Here is Mrs May making the introductions in Riyadh on 5 May 2017.

Given the stringent anti-trust laws in the US and Aramco’s pivotal role in the Opec cartel, a US listing is also looking problematic. So, it’s no wonder that chatter about delays to the IPO or a private sale to China, or a consortium of sovereign wealth funds, has gathered pace.

Aramco denied such reports on Twitter over the weekend “All listing venues under review for optimal decision, IPO process is on track for 2018.”

If three denials are forthcoming, maybe we’ll know what’s really happening.

In the meantime, it’s embarrassing to the Saudi regime and not good news for improving its short/medium term cash flow problem.

With LIBOR Dead, $400 Trillion In Assets Are Stuck In Limbo

In an unexpected announcement, earlier this week the U.K."s top regulator, the Financial Conduct Authority which is tasked with overseeing Libor, announced that the world"s most important, and manipulated, benchmark rate will be phased out by 2021, catching countless FX, credit, derivative, and other traders by surprise because while much attention had been given to possible LIBOR alternatives across the globe (in a time when the credibility of the Libor was non-existent) this was the first time an end date had been suggested for the global benchmark, which as we explained on Thursday, had died from disuse over the past 5 years.

Commenting on the decision, NatWest Markets" Blake Gwinn told Bloomberg that the decision was largely inevitable: “There had never been an answer as to how you get market participants to adopt a new benchmark. It was clear at some point authorities were going to force them. The FCA can compel people to participate in Libor. What can ICE do if they’ve lost the ability to get banks to submit Libor rates?”

And while the rationale for replacing Libor is well understood (for those unfamiliar, read David Enrich"s comprehensive account of Libor rigging "The Spider Network"), there are still no clear alternatives. Ultimately, as Bank of America calculates, "moving an existing $9.6 trillion retail mortgage market, $3.5 trillion commercial real estate market, $3.4 trillion loan market and a $350 trillion derivatives market is a herculean task." A partial breakdown of the roughly $400 trillion in global Libor-referencing assets is shown in the table below.

And with nearly half a quadrillion dollar in securities referncing a benchmark that is set to expire in under 5 years, the biggest problem is one of continuity: as Bloomberg calculated last week, in addition to the hundreds of trillion in referencing securities,  there is also currently an open interest of 170,000 eurodollar futures contracts expiring in 2022 and beyond - contracts that settle into a benchmark that will no longer exist. "What are existing contract holders and market makers supposed to do?"

Then there is the question of succession: with over $300 trillion in derivative trades, and countless billions in floating debt contracts, referening Libor, the pressing question is what will replace it, and how will the transition be implemented seamlessly?

According to Bank of America, one possible option to achieve the transition could be to move to a "fixed-spread" Libor benchmark. In this scenario, regulators and market participants could agree for Libor to be hardcoded as a fixed spread over the underlying benchmark of their choice (BTFR-broad Treasury financing rate in the US, SONIA in UK etc). This could help to ensure that contracts that rely on Libor could continue to have a reference rate while the rate itself would move based on the regulator"s preferred benchmark.

The option obviously would raise some concerns around what spread to be chosen, the term structure of the fixed spread (for 1m vs. 3m libor for example) - but these, BofA believes, would be easier challenges to address than renegotiating and re-hedging existing contracts.

There is a third problem: while the above scenario could be one option for a short term solution, the longer term concern continues to be the lack of a clear alternative for new contracts. Acccoring to BofA"s Mark Cabana, the FCA announcement likely increases activity in the OIS market (both receive and pay flows) - but ultimately, the OIS market (overnight indexed swaps) is based on a fed funds rate whose own future is unclear in a system of non-zero excess reserves dwindling underlying volumes (chart below).

Another option is the BTFR rate (broad Treasury financing rate) which was selected by the Alternative Reference Rates Committee or ARCC (which is having its inaugural meeting on August 1) - but the market has gone down this route before with little success in the GC futures market given declining GCF volumes.

In the end, BofA warns that the most likely emerging scenario is one "involving a fractured derivatives market with multiple underlying benchmarks across different countries developing."Worse, note that the FCA suggests that the IBA and panel banks could continue to produce Libor but the FCA would no longer persuade panel banks to stay.

Finally, what makes the above especially problematic, is that 2021 is when the Fed"s balance sheet shrinkage is expected to conclude (according to NY Fed estimates), and when short term rates are to be at their tightening peaks according to sellside estimates. That this will come at a time when there is no effective way to trade, or hedge, unsecured short-term rates - which will by then be roughly 2% higher than where they are now according to the Fed"s dot plot...

... will make the Fed"s normalization, from a market standpoint, especially "interesting", if not impossible.