The Depository Trust & Clearing Corp. is a financial-market utility that is owned by the big banks, brokers and mutual-fund companies and that helps them keep track of what they own and what they've sold to each other. They own lots of things, and are constantly selling those things to each other, so this is a hard job! DTCC can't just write the things down on index cards; it needs lots of computers to keep track of all the things. Sometimes outside companies write good programs to help computers keep track of things, and then DTCC buys those programs so that its computers can be good at remembering where all the things are. Yesterday DTCC announced that it will be using a new program to keep track of one class of things -- repurchase agreements -- that banks trade with each other.
But the new program is the blockchain, and the company selling it to DTCC is Blythe Masters's Digital Asset Holdings, so this was an event. DTCC held its "first ever single-issue public symposium, on blockchain," yesterday, and it seems to have been well attended:
Matt Harris, of Bain Capital Ventures, said he had never seen such high-powered talent drawn to back end of bank technology in his 20 years in the space.
That, to me, is the great magic of the blockchain. There have been back-office mechanisms for clearing and settling financial transactions for about as long as there have been financial transactions, and those mechanisms have been computerized for about as long as there have been computers. But they're called "back office," because no one really wants to look at them. The blockchain, with its romantic back story, techno-libertarian bitcoin associations, high-end marketing by the likes of Blythe Masters, and, sure, why not, technology that is superior to conventional databases for many financial uses, has made the back office the cool place to be.
By the way, that is not at all a trivial accomplishment. A lot of settlement processes are dumb and bad, and it is perfectly plausible that, if high-level executives and brilliant technologists had devoted themselves to, say, getting syndicated loan trades to settle in fewer than 20 days, they would have accomplished that a long time ago. The blockchain may well be a technological improvement, but just keeping track of loans in an Excel spreadsheet would be a technological improvement over 20-day settlement. The blockchain's real force comes in the fact that it is a sociological improvement over previous settlement technologies: It has managed to make people care about back-end technology.
Like, care a whole lot. Here is a speech that Commodity Futures Trading Commissioner J. Christopher Giancarlo gave at that DTCC symposium ("DLT" is "distributed ledger technology," i.e., blockchains):
DLT may be able to provide regulators with visibility into the trading portfolios of swaps counterparties that they lacked during the financial crisis and that Dodd-Frank mandated. It may make possible new “smart” securities and derivatives that can value themselves in real time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.
On this point, a dramatic example of the potential benefits to regulators of blockchain technology is in the collapse of Lehman Brothers. If an accurate DLT record of all of Lehman’s transactions had been available in 2008, then Lehman’s prudential regulators could have used data mining tools, smart contracts and other analytical applications to recognize anomalies in trade activity, divergence in counterparty exposure (specifically those willing to trade with Lehman), widening credit spreads and disruptions in short term funding activity. Regulators could have reacted sooner to Lehman’s deteriorating creditworthiness.
Felix Salmon called the notion that the blockchain could have prevented Lehman "bonkers," which strikes me as mostly right, but, I don't know, why begrudge Giancarlo this dream? I am skeptical that giving regulators piles of easily accessible real-time data will do all that much to solve problems in the financial markets, but it can't hurt (oh, fine, it probably can), and it does seem a little weird not to give them that data if we can. Now we can! Why not try it?
Though I have to say that the idea of blockchain as regulatory panopticon does seem pretty far from its techno-libertarian bitcoin roots. I am old enough to remember when the blockchain powered Silk Road.
Elsewhere in market structure, "Igor Oystacher’s former business partner alleged that top executives at the world’s largest futures exchanges condoned Oystacher’s trading practices," which regulators have said were spoofing. Bats Global Markets is buying ETF.com. And "The Federal Reserve on Tuesday announced the selection of McKinsey & Company to support Faster Payments Task Force efforts this year to assess faster payments solution proposals from various providers across the United States payments industry."
The collapse of Valeant has been such an entertaining mess that it is perhaps too easy for outside observers to root for more mess. So many shoes have dropped that it is tempting to assume that the shoe supply is unlimited, and to think that the company's problems might be fatal. But here is a column by Steven Davidoff Solomon arguing that Valeant is probably more or less fine. Sure, it got some accounting wrong, aggressively cut research and development, aggressively raised prices beyond what insurers were willing to pay, and was overbought by hedge funds who encouraged it in its financial engineering. But it's not Enron; it's "a real operating business that by all accounts is profitable," and its accounting and debt-covenant issues are more technical than fundamental.
On the other hand, Valeant's $30 billion of debt is real enough, and this Financial Times "Big Read" on Valeant is rather more skeptical:
Mr Maris says many of the tricks in Mr Pearson’s playbook no longer work. The company, already groaning under its debt, will be unable to embark on another deals spree, while price hikes of the size it used to rely on are now politically impossible. Having refrained from investing in its in-house research, it has no blockbuster drugs in its pipeline.
And an investor argues that "It’s not just about avoiding a technical default — they’re going to have to start selling things that are dilutive to earnings just to meet their debt requirements."
Elsewhere in fallen hedge-fund hotels, SunEdison is not having a good ... year, I guess? Spencer Jakab summarizes:
TerraForm Global said in a Securities and Exchange Commission filing that its controlling shareholder faces a “substantial risk” of bankruptcy. SunEdison’s stock, already down by about 95% since last summer, plunged in premarket trading, but not just for that reason. It emerged Monday that the SEC’s enforcement unit is investigating SunEdison’s disclosures about its cash position last fall.
TerraForm Global is a majority-owned SunEdison subsidiary, a "yieldco" formed to buy solar projects from SunEdison; awkwardly its chief executive officer is also the chief financial officer of SunEdison. (That's after an earlier coup at TerraForm Global and its sister yieldco TerraForm Power, when the yieldcos' conflicts committees refused to approve a transaction with SunEdison, and were replaced along with the CEOs.) The SunEdison story has some similarities with the Valeant one: The financial engineering, the "hyper-growth," and the loyalty of some big hedge fund names. One might uncharitably conclude that shareholder-value-focused hedge fund managers with concentrated portfolios and a commitment to active involvement in their portfolio companies do not always produce good results.
Here is an entertaining profile of Tim Leissner, the former Goldman Sachs partner who, according to a colleague, "could hop in a canoe, paddle upstream and come back with a fee." One particularly lucrative canoe that he piloted was a series of three bond deals for 1MDB, a state-affiliated investment fund in Malaysia; 1MDB raised $6.5 billion of bonds and paid Goldman an astonishing $593 million. ("The bank said last year that fees and commissions 'reflected the underwriting risks assumed by Goldman Sachs,'" and why not. Disclosure: I used to work at Goldman, though no imaginable conveyance could have brought me to a $593 million fee.) That was controversial, though "anger about the Wall Street bank’s profit was overshadowed by controversy over whether the money 1MDB raised was spent as intended on local projects including a Kuala Lumpur financial center or siphoned off" by Malaysia's prime minister.
Leissner's personal life includes one marriage where "the wedding feast included suckling pigs with electric lights flashing in their eye sockets," and another -- to Kimora Lee Simmons -- that began "in business class on a flight from Hong Kong to Kuala Lumpur, with an argument in the beginning and a marriage proposal by the end." I feel like there are important productivity tips in this story, mainly about using travel time productively. If you find yourself in a canoe, try to close a deal. If you find yourself traveling business class on a flight for work, on the other hand, maybe use the time to propose marriage.
Elsewhere in Asia, "Businessman Denies Planning Bangladesh Central-Bank Heist." And here is a fascinating post from Cleary Gottlieb on "How M&A Agreements Handle the Risks and Challenges of PRC Acquirors," including often requiring Chinese acquirers to escrow reverse break-up fees in case the deal falls apart. We talked a little yesterday about the intriguing ownership of Anbang Insurance Group, and its long delay in being specific about the financing of its proposal to buy Starwood. You can see why the lawyers might want to keep a close eye on that one.
I don't really know how accurate is the stereotype that lawyers don't understand computers, but I mean, if I were looking to hack into a computer system to illegally obtain inside information to trade on, I would be mighty tempted by law firms. (Also newswires!) The big law firms advise on almost as many mergers as the big investment banks, but with fewer people and, I might assume, less technological sophistication. Law firms aren't exactly keeping track of their billable hours on the blockchain. Anyway here is a story about how hackers may or may not have stolen inside information from big law firms including Cravath and Weil Gotshal. "Law firms are being deluged with attempts to crack their systems," says a guy.
Elsewhere, here is the wonderful story of how CNBC tried to teach readers about password security by asking them to enter their passwords on an unsecured website, uploading the passwords to a Google spreadsheet, and sharing them "with more than 30 third parties, such as advertisers and analytics providers who pull data from CNBC.com." That is some sort of lesson in password security, yes.
Here is a ValueWalk article about Jacob Wohl, "the teenage 'hedge fund trader' dubbed 'The Wohl of Wall Street' and profiled by many outlets," who -- at age 18 -- has switched strategies from "a value, stock picking approach" to "a managed futures strategy." The article is a very niche kind of comedy that not everyone will appreciate; I laughed uproariously but also became angry and uncomfortable, sort of like how I get watching "Curb Your Enthusiasm." But the odd thing about this particular form of comedy is that, if you don't have the right context, none of the sentences read like jokes. "Our strategy is based on pricing options more effectively than current liquidity providers" -- hilarious! "Wohl claims to have taken the MS GARCH Volatility Projection model and created his own version, the NX GARCH model upon which the volatility trading method is based" -- dying! "Wohl has moved from his parents 'Inland Empire' suburban house in the far west suburbs of Los Angeles to the Hollywood Hills and has added former 'Desperate Housewives' actress and derivatives trader Rachel Fox to his line-up" -- umm, okay, you lost me there a bit? Anyway, it is, in its way, very good stuff.
Elsewhere in, I don't know, investment advising and the media, here is a Securities and Exchange Commission settlement with Tobin Smith, a Fox News and Fox Business contributor who was allegedly paid to promote a pump-and-dump scheme on his website. "By Dumb LUCK I Just Discovered the PERFECT Tech Stock. . . In My Backyard!," he wrote, and do people believe that sort of stuff? I guess they must. After all, he's on TV. Smith "neither admitted nor denied the allegations in the settlement."
We have talked a little before about the Vanguard tax thing, which I have called "the faked moon landing of financial news stories, except that it might be true." Basically a former Vanguard tax lawyer, David Danon, thinks that Vanguard should have been charging investors higher fees and paying taxes on those higher fees, and he wants the Internal Revenue Service to collect those (billions of dollars) in back taxes and give him a chunk of them. It sounds crazy when you say it like that, and it is crazy, but it might also be right as a matter of tax law. Anyway, in addition to trying to get those billions of dollars out of Vanguard, Danon is also somehow suing Vanguard for wrongful termination? Because he ... wants his job back? That also sounds crazy, but the Securities and Exchange Commission is supporting him in that suit (though not, as far as I know, the tax one) because it thinks he deserves whistleblower protection. Sure, why not.
People are worried about unicorns.
And yet "U.S. venture funds have collected about $13 billion" this quarter, "which would be the largest total since the dot-com boom in 2000." That is despite worries about valuations, and this rather colorfully-named malady:
Chris Douvos, managing director at Venture Investment Associates, which invests in venture firms, said the lack of IPOs and acquisitions of startups is leading to “capital constipation.” Money is going out the door faster to startups than is coming back to limited partners, forcing some investors to make choices about which funds to back.
People seem to be a bit worried about the terms of a $1 billion convertible debt deal that Spotify AB just raised from "private-equity firm TPG, hedge fund Dragoneer Investment Group and clients of Goldman Sachs Group Inc." Those terms include the right to convert into common stock at a 20 percent discount to the initial public offering price, stepping up by 2.5 percentage points every six months after the first year; a 5 percent pay-in-kind coupon that steps up by 1 percentage point every six months until the IPO; and a 90-day lockup on share sales after the IPO, instead of the 180 days for other pre-IPO shareholders. "By raising debt instead of equity, Spotify adds to its war chest without the possibility of setting a lower price for its stock, which can sap momentum and hamper recruiting," but that is sort of a technicality: Spotify has sold a lot of stock, at a discount; it just hasn't set a price.
The way a convertible bond normally works at a public company is that you can convert $1,000 worth of bonds into, say, 11 shares of stock, or whatever -- the number of shares is fixed. The Spotify convertible, as is more typical of pre-IPO convertible debt, doesn't have a fixed conversion ratio: At the IPO, you convert $1,000 worth of bonds into $1,250 worth of stock (that's the 20 percent discount), or more if you have to wait more than a year for the IPO. Plus there is the pay-in-kind interest. So the math is something like, if there's an IPO in a year, your $1,000 investment has turned into $1,050 worth of bonds, which convert into $1,313 worth of stock -- or 31.3 percent interest in a year. (If there's an IPO in two years, you get like $1,487 worth of stock, give or take, because of the coupon and conversion-discount step-ups, though I am probably not doing the compounding right.) The "convertible" investors, in other words, don't really have any equity exposure to Spotify, except in the 90 days between IPO and lockup expiry: Because they are just getting stock at a discount to whatever the IPO price is, they don't care what that price is; they are just getting their money back with (a lot of) interest.
Elsewhere, I was going to say "Betterment, the Robot Unicorn, raised a $100 million funding round," but Betterment is actually only a .7icorn, oh well. And Dan Lyons wrote about working at a startup called HubSpot:
HubSpotters talk about being “superstars with superpowers” whose mission is to “inspire people” and “be leaders.” They talk about engaging in “delightion,” which is a made-up word, invented by Dharmesh, that means delighting our customers.
People are worried about bond market liquidity.
One thing that I think about bond market liquidity is that everyone is worried about it, so there is not really much risk of a "liquidity illusion" where bond investors are too sanguine about liquidity. I could be persuaded that that view is wrong about, say, retail investors in bond mutual funds. But mutual fund directors? I don't know:
SEC Chairman Mary Jo White, speaking Tuesday to a conference of independent directors of mutual funds in Washington, admonished the audience to take steps to avoid the fate of the Third Avenue Focused Credit Fund, a high-yield bond fund that collapsed last year after building concentrated positions that it couldn’t liquidate without selling at fire-sale prices. Ms. White implored the directors, who oversee fund managers, to probe “whether these events could happen at your fund.”
If you are a director of a bond mutual fund and you haven't asked that question, what are you doing? Anyway here is White's speech. Elsewhere, "Europe's Bond Shortage Means Draghi Is About to Shock the Market." And here is a graphic of "media-inflamed fears" that somehow doesn't include bond market liquidity.
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