Monday 29 October 2007

Is the City dirty?

Amongst all the interesting news today, Oil heading for $100 a barrel and gold heading for $800 a snippet slipped out today.

This article shows that our regulator, recently shown by the Northern Rock scandal to not perhaps be the heroic organisation it once claimed, has some fairly serious reservations about Hedge Funds.

In this case it has reviewed them and found that many lack any serious controls to prevent market abuse. Given the huge power of these funds to short-sell shares and decide on the success or failure of merger and acquisitions this is a serious accusation.

More than that it adds to the study already done that showed up to 25% of M&A deals had some dodgy looking share deals associated with them in the past few years.

All this leaves a rather nasty taste in the mouth (this phrase always reminds me of rhubarb crumble, but I digress). how are the small retail investors to prosper when the big boys are keen on large stitch ups and how are we to judge funds success when they may have been cheating the market rather than playing fair?

All in all a difficult situation and deserving of more headlines and action than many of the other stories of the day. Certainly more important than the Government interfering in the workings of the mortgage market.


Steven_L said...

I'm glad you ventured into the topic of hedge fund regulation.

I tried to read more about this on the FSA website after the Telegraph reported that 1/2 of Northern Rock's shares had been 'borrowed' (I presume they mean shorted). The relevant page of the site was dow so I emailed them this:


I'm trying to read annex 5 of Chapter 3 of the 'Conduct of Business' sourcebook so that I can persuade hedge fund managers to let me look at their websites.

Unfortunately this page of your website is down.

Can you help me?



They never replied. The regulation is set up so that unless you testify you are worth $1,000,000 or something along those lines you are not allowed to see what is happening to the funds.

A kitchen salesman I know used to work as a graduate in Morgan Stanley running a FTSE tracker product. I asked him about it and all I got was nonsense that sounded like it had come straight out of the Morgan Stanley graduate training course.

He tried to make out I didn't have a clue what I was talking about and was gravely mistaken. At the end of the day I'm just as entitled to my opinion regardless of whether or not I have $1,000,000 or have worked in an investment bank.

My opinion is that the regulation of hedge funds protects hedge fund secrecy, not the consumer.

This is the same government that has made it easier for me to play roulette. No one stops me buying £5,000 worth of shares or shoving £5k in a long fund. Many asset managers involved in hedge funds run long funds that allow minimum £5k investments whilst their hedge fund products are a minimum 1m Euros in and they are not allowed to let you see how they have been doing.

Add to this that shorting is illegal in the UK and USa but no t in UK and US operated tax havens, and that the shorting is actually controlled from the US and UK and it looks dodgier.

Then you have to ask the question about the big US investment banks that lend the shares to be shorted. How is it in the long fund investors interests to lend their assets to short sellers?

There are a lot of questions that the UK consumer is perfectly entitled to answer seen as we are denied a slice of the action.

Nick Drew said...

A really, really important topic, allied to the Comment of the Week from your Sunday business roundup.

it's hard to make a strong case for free-market capitalism if in fact markets are perennially shown to be distorted and disfunctional

I never met a businessman who didn't secretly lust after a monopoly; and you probably never meet a hedge-fund manager who doesn't dream of being able to move the market himself. OK, that's human nature - so that's what has to be guarded against.

(BTW, Steven, "shorting is illegal in the UK and USa" - I don't think that is correct)

Whispering Walls said...

Yeah, yeah. What about Crispin Odey who wasn't allowed to short Northern Rock because he was on the Board?

Anonymous said...

Is the city dirty?

Well insider dealing is not permitted, which means people that KNOW what the share price should be are not allowed to trade. Eh?

A small private investor can book a flight to Australia in real time on Expedia but to sell his shares on-line he will need to wait 1 day to find out what they actually traded for. He will then be told at what time the shares were apparently traded, but will be given no proof that they were actually traded at that precise time, thus giving the broker the latitude to claim they were sold at the lowest price of the day when in fact they were traded at the highest price.

The dealers of different companies all go to the same pubs in the square mile.

If you are "advised" by your broker to buy shares in company X they will charge you 1%. If you are advised a day later that it was a bad investment and you should sell them - they will charge you 1% again. That's nice of them.

You may be advised that "the value of stocks and shares can fall as well as rise and you should only invest money you can afford to lose". You are never advised "If the stock market suffers a serious reverse your job may be at risk as well as your life savings - so you might want to consider putting your life savings into something more secure".

The small investor is invariably advised to enter a market just as it tops and then is forced to get out just as it bottoms, because the small investor can't afford to lose all his money. Borkers love getting their hands on the money of those that are too far from the market to know what is likely to happen to stock prices. It is like betting on a horse race where you are told "There is a race, there are some horses. I suggest you put your money on a horse called Fred, but I don't care if Fred wins or loses because I have no money on Fred - I just take 1% off you because you were daft enough to place a bet, and if Fred loses I'll take another 1% off you".

Anonymous said...

It makes me glad I have no money already - if I did I soon wouldn't have would I?

On your Post Office post.. did you notice they have quietly abolished Sunday and Ban Holiday collections from Post Boxes? That must be saving some double time pay?

Liz Hinds said...

I nearly bought a rhubarb crumble scented candle today.

CityUnslicker said...

Steven - thanks for this, I think the evidence is clear for all to see and htis comes from the FSA.

Winchester - Well stricly speaking that is not a hedge fund issue and would be insider trading for sure.

Anon - It is cler that as a retail investor you are going to work in a market not rigged in your favour. A good capitalist government would always at least try and ensure the market is kept as clean as possible. I am not sure that is the case at the moment.

Mutley - re the post office, all sorts of things are being done to try and cut costs. It is a very complex story but basically the management and unions are going to break the company between them...

Liz- Rhubarb, I just can't stand the stuff!

Bill Quango MP said...

The cost saving to Royal Mail of no sunday collections is 3 hours pay at time and a half x the number of sorting offices in the UK.
{ plus associated fuel and vehicle costs }

Not a big saving, but not a major loss to service either so probably worthwhile scrapping it.

Let us have your view on the Scotland / England question please.

Steven_L said...

"BTW, Steven, "shorting is illegal in the UK and USa" - I don't think that is correct" (ND)

It's probably not, this isn't really my area of expertise. I think I read something on wikipedia about share trading rules allowing shorting in the Cyamen Islands, Republic of Ireland and Bermuda.

What is the situation then, why are all the unregulated funds based outside of the UK but managed from the mainland?

Anonymous said...

I know anonymous's 'borkers' was a typo but it sounds like a word that really should exist. Definitions, please, in a city context...

Nick Drew said...

Peter - a Borker is a particularly unattractive and greedy type of capitalist pig, as in

that fat borker has his snout firmly in the trough

Steven - don't know, but I am fairly sure it's not for reason of shorting being illegal, I myself have *ahem* shorted a number of stocks in my time, quite openly

not that I'm a borker, you understand ...

Steven_L said...

Shorted or bought these putt option thingies?

Anyway, it's not me not being able to short I'm upset about, it's not being able to have a professional do my dirty work for me, just because I'm not rich.

Nick Drew said...

Not put-options: outright shorts, i.e. selling stocks I didn't own

(thus notionally needing to borrow certificates for delivery to the buyer from another client of the broker who has a long position in the stock - and also needing to pay the dividend when it falls due: everything is in mirror-image)

Anonymous said...

Ah, thanks Nick, I think you have given me the missing bit of information re. shorting stocks that I didn't get. I couldn't understand why a share-holder would lend shares to someone intending to short them, because that would imply the party shorting the stocks expected the fall in value to be far greater than the cost of borrowing the shares. In which case the shareholder would simply take the approach as a hint to sell before the price dropped. But from what you are saying the shares are borrowed neither from the seller or the buyer but from the broker IN TRANSIT. Is that correct?

Nick Drew said...


- Yes. The holder of the borrowed shares will (in theory) be another client of the broker's. (In practice I think brokers borrow off other brokers if necessary: someone holds the shares !)

- the holder of the shares is not told their certificates are being borrowed. So long as they get the dividend, and full value if they wanted to sell them at any time, they neither know nor care, such is the virtual world of finance. (If they did want to sell them, the broker would simply find some different shares to borrow)

- so, they don't directly get 'tipped off' that someone else thinks the price is about to fall. In all likelihood they are some widow/orphan who doesn't much trade their stocks anyway. But anyone wishing to be 'tipped off' can easily find out the total amount of shorting going on, because 'total short interest' is a published statistic

- this system is fine in principle (damn' fine, thank you very much !) but evidently open to abuse, because sometimes you will read that more shares have been shorted than actually exist - which is where the virtual becomes the pure fantasy ...

- just to complete the picture: because the 'short seller' - who has been credited with £££ from the sale at the outset - may need to buy shares in a hurry (if the price starts rising. e.g.) the broker needs to be certain they have the wherewithal to do so. They will therefore demand collateral equivalent to the current value of the shorted shares. Since this changes daily, 'marginning' and daily margin-calls may be involved, just like with derivatives and other 'virtual' securities.

Here endeth the lesson. Note, this is not financial advice, just a punter sharing his understanding: you must seek qualified advice & do your own research with all due diligence etc etc)

Anonymous said...

Ah yes, that was the missing piece I didn't get very well explained - thanks Nick. Reminds me a bit of this story on Morgan Stanley that came out in the summer:-

Apparently MS was taking cash for silver and its storage - but wasn't actually buying silver or paying for storage but was "borrowing" the cash to do other things instead, unbeknown to the silver investors. Thus the silver investment could be said to be purely "notional" but with very real costs involved and little of the security!

I guess if you are buying precious metals for financial security during times of gross instability - keep it at home under the floorboards!

Nick Drew said...

yes, or buy it on an 'allocated' basis, not (as one must infer) 'unallocated' per the MS case you mentioned

actually, it sounds as though the MS clients (whether they were told this or not) were buying what is called a 'total return swap' (TRS). This can be almost as good as holding the physical commodity for many purposes, provided the financial security offered by the swap-provider is satisfactory, as you indicate: and a TRS has some features that might even be thought superior to the real thing.

But ultimately there is 'utility value' in the commodity which means a TRS should command a slight discount to the real thing.

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