Are Crypto-Currencies more Democratic?

The internet, as I’m sure you know, is formed of millions of connections between nodes, or access points for all its users.

Concurrent with, or alongside, this network a new network has sprung up, consisting of the Bitcoin miners and its payment system. This is supposedly money at its most ‘democratic’ because supposedly no one entity can gain control of a majority of the miners on which this consensus rests.

(for an explanation of the Bitcoin creation mechanism, see https://jessking1311.wordpress.com/2015/10/01/what-is-the-real-problem-with-bitcoin/  )

A fintech explosion

Goldman Sachs’ widely read ‘Future of Finance’ report cited three trends which two of its authors, Heath Terry and Ryan Nash on the Global Investment Research team, expanded on further in a podcast. These were: regulation, technology, and changing consumer habits.

The financial crash and ensuing regulation “effectively created a greenfield opportunity during the recovery… following Facebook’s IPO in 2012, a lot of opportunists asked themselves, ‘What sectors don’t have a Facebook, a Google, an Amazon yet. And financial services was the only one of those.”

A friendly credit environment also contributed to the exponential growth in ‘shadow banking’, – here defined more narrowly than the Fed which has tracked a recorded $15 trillion in liabilities by non-bank lenders like private debt funds – as so-called P2P or marketplace lenders.

The Goldman Sachs analysts predict $10-12 billion could move out of the traditional sector and into shadow banking. Marketplace lenders have been quick to adopt innovations like risk pricing algorithms, and analytics to predict consumer demand for loans. Thus they benefit from ‘lower cost of customer acquisition’ and ‘efficient delivery channels’, where banks are hampered by due diligence restrictions which give loans applicants offputting mountains of paperwork.

The third factor cited is regulation. Where Basel III imposed rigid capital adequacy ratios, the Dodd-Frank stress test limits made bank lending even more restricted, because they needed to consider also the value at risk of certain assets under stress scenarios. This severely limits the type of assets they can hold on balance-sheet.

Finally, the Credit Card Accountability Responsibility and Disclosure Act of 2009, or Credit CARD Act of 2009, created a unified pricing standard which also meant credit providers’ losses were absorbed to some extent. And profits in the industry as a whole became more attractive, spurring innovation and start-ups to capitalise on the benign regulatory environment.

Crypto-currencies are more ‘democratic’ than fiat currencies

Bitcoin is a new currency but unlike sterling or the dollar it is not controlled by a national government, which can intervene to buy and sell the currency to preserve its value. And which are traded on mass by foreign exchange funds.

This means Bitcoin’s value depends almost entirely on how much it can be exchanged for in terms of goods and services on the internet. Or, to be more accurate, what people believe these items to be worth in Bitcoin at any given time. Which depends on the amount of Bitcoin in circulation.

For an explanation of the historic issue of the ‘capacity crunch’ and the competing plans to increase the size of transactions and transfers to scale up the payment system, again see my previous post on the issue.

But more important in revolutionising the way money is lent in the modern world is the Distributed Ledger Technology used to record Bitcoin transactions. Everyone in the Bitcoin network has access to this record, and its only alterable by mutual consensus or agreement.

So no one can fraudulently claim they have made or recorded a transaction, because the online ledger called the blockchain shows exactly who had made and received the transaction. Many companies and governments, like that of Estonia, are adapting this technology because it is a secure way of record-keeping for other purposes, such as health records, marriage and birth certificates, taxes and property.

The new distributed ledgers would have different rules. For example, there would likely be an administrator who would have overall control over access and permission to transact. Each system would also have its own encoded rules of conduct.

Some Real-life Examples

Some payment systems like Coinify already use the blockchain to enable consumers to make guaranteed payments, via small businesses which act as merchants.  Within some payment networks, such as Lending DApp (see https://jessking1311.wordpress.com/2016/01/13/back-to-the-future-bitcoin-blockchain-and-how-marketplace-lenders-are-using-technology-to-overtake-banks-in-the-race-to-attract-new-lenders/), ordinary people can act as intermediaries to guarantee that the terms of a contract have been fulfilled. Or the computer programme can be designed such that it recognises e.g. when a certain number of hours have clocked on a timesheet.

It occurs to me that this could be the solution to many of the problems in the banking system. Processing payments by the big banks like HSBC, RBS, Barclays et al. can take several days, even need, your money right away. Because they have to comply with so many regulations, banks have to do a lot of checks to make sure the payment is for legitimate activity and by a legitimate entity.

Alternative, more immediate providers like Paypal charge a transaction fee for every payment they process. But a pretty insignificant one. And Paypal seems to be cornering the market in micropayments. What does blockchain and DLT have that existing providers don’t?

It struck me the other day that the systems in place to connect us with the money we have earned or need to conduct our life and business are grossly inefficient.

I was waiting for a sum of money I had collected from a crowdfunding platform, Indiegogo. But when I tried calling HSBC, I had to wait on hold for 20 mins. When I finally got through to someone, he did not speak enough English to process my request. Three times I told him I was waiting for a transfer to my account and if he could put me through to whoever was responsible for bank checks, that maybe the depositor was concerned it was an individual not a business account.

Three times he asked me ‘If I would like to make a transaction’? When I tried to contact Indiegogo to ask the same question, initially I couldn’t find the contact form. Eventually I got a response, and my money, after I Twitter-bombed the crowd-funder. But the point is that I couldn’t access my money when I needed it. I had to pay it out of my own pocket and then be tardily reimbursed.

Now I’m not saying we need to overhaul the entire financial system, but if the service is flawed it would make sense to encourage competing providers, like those using the blockchain network, to let individuals like you or me moderate payments for a fee that corresponds with their efficiency and success rate at doing so.

And I’m not the only one this thought has occurred to.

Capital Markets Union – Breakdown of EU Roadmap (Part 2)

Share Offerings Will be Made Easier by Reducing Prospectus Requirements

As it stands, the threshold for share offers which must issue a prospectus stands at €5million; though the European regulation leaves leeway for individual states to legislate a lower threshold. The EU proposal is for a higher and universal threshold. This, it is hoped, would reduce onerous requirements for companies to shell out for a professional marketing sheen to give to their business plans and earnings forecasts.

The EC asks stakeholders if it would free smaller companies of some onerous obligations to remove the mandate for a prospectus for follow-on offerings. Instead it would allow them to point to existing info in the public domain, provided they were “released pursuant to the transparency and disclosure requirements to allow sufficient investor disclosure.”

A slightly less drastic solution would be to just raise the threshold required for follow-on prospectuses, from the existing level of 10%, to 20% of existing issued share capital.

Law firm Latham and Watkins makes the still more radical proposal that only “secondary offerings of, for example, up to 50 percent of the issued share capital of the company” would necessitate a prospectus being published.

This would not, however, require regulatory approval before permission was granted to list on Multilateral Trading Facilities (MTFs). As a mitigating measure, the firm posits that the threshold be raised for fully exempt offerings.

This last caveat links us on to the proposal that standard share prospectuses should be approved before trading on MTFs. There is some concern that these marketplaces do not provide the necessary due diligence on all of the securities listed, and an objective assessment is required by a regulator who, unlike the exchange operators, has no vested interest in securing transaction fees.

Some industry commentators, however, feel that increasing the barriers to listing new securities could check growth of the vibrant MTF market in Europe.

The Pan-European Corporate Private Placement Market Guide

This set of guidelines to the process of negotiating contract terms between borrowers and professional investors in large, unlisted bond and note issuances, has already been issued and should be starting to take effect.

Noteworthy considerations to observe from a legal perspective are, firstly, the possibility of a conflict of interests between private loan and note subscription, and trading in listed securities. The mandatory disclosures of non-public information, that full knowledge of the borrower’s debt burden requires, could leave the investor open to accusations of insider dealing, if they then trade in associated listed securities.

Institutional investors in unlisted debt placements should demand loans on equal terms with borrowers’ other debts, which is why disclosure of all information concerning the borrower’s existing debt is essential.

Details of, for example, the hierarchy of priority of repayment; actions in case of a breach in covenant or non-payment of an instalment; any assets that have already been pledged as securities; these are all necessary to ensure the comparability of loan contracts, and to ensure the borrower can meet any new obligations.

The guide provides four model documents by which best practice in this area can be followed:

As regards the ‘term sheet’, the list of terms each side agrees to include in the final contract, – subject to local law, – it is advised firstly that the borrower makes a ‘negative pledge’. This restricts the borrower’s ability to create security over its assets, and thereby enshrines the ranking of the new private placement.

It should also be requested that they disclose any restrictions on disposal of assets. Financial covenants with relevant ratios form another, obvious, clause. It might also be desirable to place restrictions on mergers and corporate restructuring and change of business.

In the event of a change in control, an option should be provided for early redemption or repayment, or even prepayment, of the interest and principal due on the loan. This measure is also advised to guard against a change in the borrower’s tax characteristics.

Finally, as insurance against the future, investors should consider a “more favourable terms” clause, such that if the Borrower grants more favourable financing terms to another creditor, it must also offer the same terms to the Investors.

Banks are tightening their belts on high-risk assets.

Are Europe’s corporate debt and equity markets really in dire straits?

The ECB Statistics Bulletin for 2015 does show some cause for concern, in that holdings of debt securities issued by euro area residents (non-government securities), fell from €1,360.9 billion in 2013 to €1,275.9 billion in 2014. That is on the listed assets side. As regards liabilities, debt securities issued fell also, from €2,586.50 billion in 2013 to €2,476.3 billion in 2014.

Equity and non-money market investment fund shares fell too, partly as a result of, and due to anticipation of, the ECB’s €1.1trillion QE programme which substantially increased the demand for government securities. Between 2013 and 2014, equity holdings fell from €792.1 billion to €768.4 billion.

At the same time, banks and other financials’ deleveraging is very much in evidence, as the level of capital and reserves rose during the same period, from €2,340 billion in 2013 to €2,466.9 billion in 2014.

This is perhaps reflected in the downward trend in loans to non-financial corporations (seasonally adjusted), a metric which includes loans issued by non-MFIs (monetary financial institutions). The total value fell from 2013 to 2014, from €4,354.1 to €4,282.1billion, slightly recovering in the first two months of 2015 to an average of €2,177.5 billion. This pattern of recovery is mirrored when you break down the loan total into 1-5 year loans, and for loans over five years.

The only increase was in short-term loans (up to 1 year), showing some appetite for low-risk corporate debt.

Evolution and Survival in the European Bond Market

The European market for high risk premium, subordinated debt ballooned last year by 56 percent compared to 2012, with a net value of $123billion. Dealogic reported the impressive figures in December of last year.

Additionally, the capital raised by 32 new issuers was $14.7billion, 18 per cent higher than the value for 2012, which constituted the offerings of 30 new issuers. Part of this increase must be down to the improved and extended facilities offered to bond traders.

One is the BondMatch secondary trading forum initiated by Euronext, which has tight rules governing trading processes and matches bids and offers with a proprietary algorithm. Another is the Open Trading forum of MarketAxess, whose request for quote system connects an international chain of brokers, displaying all offers on one screen, and was credited with a record quarterly increase in trading volume.

The safeguards in place within BondMatch are not just requirements for Members to ensure the creditworthiness of their clients – and sustainability of their positions. They system itself prevents orders being carried out which are “clearly disproportionate in comparison to the liquidity of the Admitted Debt Security, evaluated on the basis of the market’s normal absorption capacity,” according to the Bondmatch trading manual.

It also bars block or distortionary trades, defined as “orders with a price which differs significantly from prevailing market prices”, or “which is obviously likely to trigger an excessive price swing or a reservation.”

Euronext claimed, in a mission statement, June 2010, ‘Euronext Paris SA’s response to the Expression of Needs expressed by the CASSIOPEE Committee’, that its pioneering platform was “designed to improve the liquidity of the secondary corporate bond market by being the first electronic corporate bond trading platform to offer international investors the possibility of trading firm orders with transparency obligations similar to those for regulated markets.”

Its proprietary algorithm ensures maximum continuity in pricing, as well as ensuring that the highest buy offers, and the lowest sell offers, take priority in order queues. This ‘execution priority principle’ is another factor lowering the risk of market manipulation, biased in the least likely direction of price distortion: traders are more likely to make bids that are too low than too generous.

There is a set formula, too, for the prices at the auctions at the opening and close of the trading day, which maximises efficiency of trades. Bids are placed in advance in the Central Order Book, and the auction price is that with the highest executable volume for each limit. If there is more than one limit with the top executable volume, the bid entailing the highest surplus volume is taken as the auction price.

Watch out for icebergs, though! Reserve orders, nicknamed ‘iceberg orders’, allow traders to conceal the true amount of bonds being released onto the market. Although the fake figure they give must not be greater than ten times the trading unit, this distinction will mean precisely peanuts to large institutional traders who have licence to dump over 100 corporate bonds onto the market. Some protection is given to buyers, in that reserve or iceberg orders cannot be stipulated to sell “at opening price”, or in an “all-or-none” order. And once the first package of, say, ten bond certificates out of 100 is sold, the remaining 90 (which is labelled as 10) goes to the bottom of the order queue.

The success of this approach is difficult to quantify, as Euronext releases its quarterly reports with aggregated figures from across its equity, debt and derivatives ventures. And its reporting has also been interrupted by the necessity of merging many of its operations with the InterContinental Exchange, as part of an acquisition deal finalised end of 2013.

For the third quarter of 2013, Euronext reported its European cash market share (value traded) in NYSE Euronext’s four core markets was 66% in quarter three, 2013; this was slightly reduced from 68% in quarter three of 2012; and also lower than the 67% it gained in the second quarter of 2013.

MarketAxess’ closest equivalent is the Open Trading forum for corporate; although it has considerable flexibility in type of additional bonds offered – ranging from emerging market, to domestic credit, to supras and covered bonds – all this must be conducted through what it claims, admittedly, is the “industry’s broadest, most robust network of global broker-dealers. In total its list comprises over 85 global, regional and specialist dealers, and in excess of 1,000 institutional investor firms.

As of April 2013, Open Trading entered a strategic partnership with BlackRock’s gargantuan, all-seeing risk management system Aladdin, which gives investors access to the global repository of information about the impact of extreme weather, financial or political events on securities’ risk profiles.

MarketAxess chairman and CEO Rick McKey attributed in large part the group’s 24.4% leap in fourth-quarter revenue to its Open Trading facility, citing “increased engagement from investors and dealers in our all-to-all trading protocols.”

Of course, the firm also offers structured products, credit default and other types of swap, which can offer a lucrative commission for the issuer and the exchange hosting the trade. But pricing is more obtuse, and the swap derivatives require clearing by central counterparties, who approve the trade and can monitor collateral and margin posted.

However, the 14.9% increase in trading volume is that significant, its one-screen, instantaneous request-for-quote screen for high-grade, high-yield and emerging market bonds is no doubt to thank for its grabbing such a large slice of additional market share.

The Moscow Exchange announces decision to float… on its own platform

The Moscow Exchange’s decision to float on its own platform could provide a novel opportunity to gauge the worth of the country’s financial sector. But with the process only open to institutional investors, further information about the offering could be limited.

While it is restricting disclosure of information on the public offering within the US, shares will be available to institutional and qualified investors there; as long as they are “offshore transactions” as defined in, and in reliance on Regulation S of the US Securities Act. Such transactions will be exempt from requirements to register with the SEC, under Rule 144A of the Securities Act or “pursuant to another exemption,” it said in a public statement.

The company, OJSC Moscow Exchange MICEX-RTS, hopes by becoming listed publicly it will enhance its profile and reputation. Alexander Afanasiev, Chief Executive Officer of Moscow Exchange, said: “Today’s announcement… marks a crucial step on our path to greater transparency and openness as a company, as well as bringing governance fully in line with best international practices. We are confident that this will become a key factor in strengthening Moscow’s position as an international financial centre and make Russia’s financial market more attractive for both Russian and international investors.”

Among the 694 issuers who acknowledged trading on the securities exchange, at the end of 2012, are some of Russia’s largest companies by market capitalisation: LUKOIL, Rosneft, Sberbank, VTB and Gazprom. The Exchange’s operating income for the first nine months of 2012 was equal to £330 986 000. Its net income, with an adjusted EBITDA margin of c.66%, was £133 226 000. Over the same period, it ranked tenth in the world for bond trading by volume (by value), ninth for derivatives (by number of contracts traded) and eighteenth for equities (by market capitalisation).

Furthermore, it has a consistent track record of growth, with a compound annual growth rate in consolidated operating income of 23% from 2009 to 2011. These statistics it claims are compatible with figures from RTS Group, realtime financial systems provider, starting on 29 June 2011.

Credit Suisse, J.P. Morgan, Sberbank CIB and VTB Capital are acting as both global coordinators and bookrunners for the offering. Other financial giants Deutsche Bank, Goldman Sachs International, Morgan Stanley, Renaissance Capital and UBS Investment Bank are solely acting as joint bookrunners.