Tag Archives: shadow finance

Barclays Toxic Landfill

barclays

The lawsuit filed by New York’s top securities regulator against Barclays, alleges that it favoured high-speed traders using its “dark pool” trading venue, while misleading other investors.The 30-page complaint gives examples of what Eric Schneiderman, the state attorney-general, claims were the bank’s practices.

The lawsuit claims that Barclays took advantage of its institutional investor clients, known as “the buy side.”  The complaint quotes a former director as saying: “[T]he way the deal would work is [Barclays] would invite the high frequency firms in. They would trade with the buy side. The buy side would pay the commissions. The high frequency firms would pay basically nothing. They would make their money off of manipulating the price.“Barclays would make their money off the buy side. And the buy side would totally be taken advantage of because they got stuck with the bad trade . . . this happened over and over again.”

It also quotes a former Barclays director as saying: “There was a lot going on in the dark pool that was not in the best interests of clients. The practice of almost ensuring that every counterparty would be a high frequency firm, it seems to me that that wouldn’t be in the best interest of their clients . . . It’s almost like they are building a car and saying it has an airbag and there is no airbag or brakes.”…

The same day Barclays’ then-head of equities sales noted in reference to the analysis that some in the industry viewed Barclays’ dark pool as a “toxic landfill” and so “[i]f we can help ourselves we should[;] it’s in our control”.

The attorney-general alleges the bank’s “Liquidity Profiling” surveillance system failed to protect clients from predatory high-speed trading tactics…“Barclays has never prohibited a single firm from participating in its dark pool, no matter how toxic or predatory its activity was determined to be.”

Excerpts from John Aglionby, Lawsuit alleges Barclays misled dark pool clients, Financial Times, June 26, 2014

Regulating Capital: the information challenge

stock market

During the financial crisis regulators discovered the hard way how little they knew about the risky derivatives portfolios built up by large financial institutions. Lehman Brothers, for example, was thought to have been a counterparty to about $5 trillion of credit default swaps. When they turned sour in 2008, it brought the financial system to its knees. In response leaders of the world’s main economies demanded in 2009 that derivatives deals should all be reported to “trade repositories”—vast central databases—to make it easier to identify and then reduce systemic risks.

On February 12th, 2014 European rules came into force requiring the reporting of all derivatives to one of six approved repositories. Similar rules have already been in place in America for about a year. But the effort, although concerted, is not consistent: the American and European reforms differ, making awkward transactions spanning the two jurisdictions. Moreover, even if these data can be reconciled, it is not clear what regulators will do with it.

The American regulations allow the reporting to be taken care of by one party to the trade. Yet Europe requires both parties to report. That means every fund manager or corporate treasurer trading derivatives has had to follow cumbersome rules, not just the banks that peddle most deals.  Getting both sides to report was originally seen as a means to ensure that every entity’s exposure could be rigorously monitored. But the complexities of obliging both parties to report trades, which then have to be reconciled with one another, have led many to question whether the additional burden is really worthwhile. “Dual reporting was required to avoid omissions in the data,” says Stewart Macbeth of the Depository Trust & Clearing Corporation, one of the approved repositories. But it “captures a lot of companies in the real economy that probably do not pose a systemic risk”.

The European rules differ from the American ones in other ways too. America staggered implementation of its rules over the course of several months as different sorts of contracts and counterparties were gradually brought within their scope. European regulators chose instead to have everyone start reporting everything on a single day. That created a bottleneck as participants rushed to put the necessary procedures and agreements in place.

Now that the deadline has passed, responsibility shifts to regulators, whose duty it will be to make sense of the torrents of data that are now flooding in. In America the Commodity Futures Trading Commission has openly acknowledged the problems it has already encountered coping with the deluge, with one commissioner blaming “inconsistencies and errors” in the rules. In Europe the problems are likely to be even worse as so many more counterparties are reporting data to multiple repositories. That will create an unfortunate opportunity for both omissions and duplications of data. In time the new reporting rules should reduce risks, but much work still needs to be done.

A paper published on February 4th by the Financial Stability Board (FSB) offers a solution. It proposes aggregating data from multiple repositories into one central one. That may iron out inconsistencies in the data—but it will not necessarily make it any more digestible.

Derivatives:  Data dump, Economist, Feb. 22, 2013, at 65

Why Chinese Banks Love the United Kingdom

Yuan. Image from wikipedia

Britain’s banks, heirs to empire, have long coveted the riches of China. On October 15, 2013 their hopes of reaping them rose greatly when the chancellor of the exchequer, George Osborne, announced a deal with China that is intended to make Britain the main offshore hub for trading in China’s currency and bonds and for foreign institutions investing in China’s fast-growing economy.But there was a price. Mr Osborne conceded that British regulators would “consider” (which tends to mean “approve”) applications from Chinese banks wanting to enter Britain as branches of their parent banks rather than as subsidiaries. The difference may seem arcane but in the world of banking regulation it is hugely important. Branches are overseen by their parents’ bank supervisors at home. They are not required to have thick cushions of capital to absorb losses or large chunks of cash to see them through hard times. Instead they are expected to call on their parents for help if they run into difficulties. This makes branches much cheaper and more attractive for banks than subsidiaries.

It also explains why regulators generally dislike them. The laxer rules on branches leave them more vulnerable if they or their parent banks get into difficulties. In allowing Chinese banks to use branches, British authorities are in effect betting that if anything goes wrong the Chinese government will bail them out, says Simon Gleeson of Clifford Chance, a law firm.

The chancellor’s decision has raised eyebrows in London’s financial district. Some worry that a supposedly independent regulator has been subjected to political interference and has been forced to lower its standards. Yet critics of the deal overlook two important points. The first is that there is an inevitable tension between a bank regulator’s mission of maintaining financial stability and the wider aim of promoting economic growth. Tension between a regulator and elected officials is not just inevitable but healthy.

Just as important is the tricky balance regulators must find between protecting their own banking systems and encouraging the smooth functioning of global capital markets. Letting banks use branches allows capital to flow more easily around the world. Forcing them into subsidiaries can lead to the creation of stagnant pools of cash and capital.  Although Britain has cast a more sceptical eye over branches of foreign banks since the crisis—particularly after its taxpayers were left out of pocket by the collapse of Icelandic banks and their British branches—it has generally stood on the side of financial globalisation. In this it is increasingly lonely. American regulators are likely soon to force foreign banks to establish fully-capitalised units. EU officials are threatening to do the same. Given this trend, Britain’s stance looks less like an opportunistic grab for Chinese business and more like a last, probably hopeless, stab at keeping alive the dream of a seamless global financial market.

Chinese banks: Open for business, Economist, Oct. 19, 2013, at 62

Tax Evaders and Whistleblowers

HSBC Private Bank n London, image from wikipedia

What  Edward Snowden is to mass surveillance, Hervé Falciani is becoming to private banking. In 2008 the now 41-year-old native of Monaco walked out of the Geneva branch of HSBC, where he had worked for three years, clutching five CD-ROMs containing data on thousands of account holders. The theft lobbed a bomb into Europe’s private-banking market, spawning raids and tax-evasion investigations continentwide. In the latest, this week, Belgian agents swooped on the homes of 20 HSBC clients, including some with ties to Antwerp diamond dealers.

Mr Falciani went on the run when the Swiss charged him with data theft. After moving to Spain he was imprisoned, but freed when a judge denied a Swiss extradition request. At one point, he claims, he was kidnapped by Mossad agents who wanted a peek at the clients’ names. He has now taken refuge in France, where the government has offered him protection in return for helping it hunt for tax dodgers.

Several countries have used the data to bring cases against suspected evaders. Revelations that dozens of Greek public figures hid money offshore have magnified the tumult in that country’s politics. Spain and France have fingered hundreds of high-level cheats and retrieved €350m ($610m) in back taxes. Mr Falciani maintains that his CDs provided support for an American probe into weak money-laundering controls at HSBC, which led to a $1.9 billion settlement. HSBC disputes this.

Mr Falciani has said he still fears for his safety, despite round-the-clock protection from three armed guards provided by the French. At least he is not short of work. He has been helping France’s tax authorities develop long-term anti-tax-evasion measures. And he recently became an adviser to a new Spanish political party, Partido X (which, ironically, tries to keep its members anonymous).

He insists his motives have always been pure: to repel Switzerland’s “attack” on other countries’ tax laws and exchequers. HSBC says he is no high-minded whistle-blower. He tried to sell the data at first, the bank contends, and started to work with prosecutors only when he was jailed in Spain. It claims he has data on only 15,000 clients (Mr Falciani says it is eight times that) and that the stolen files contain errors.

Either way, many more tax-shy Europeans have reason to sleep fitfully. Other countries are said to want a look at the data, some of which are yet to be decrypted. When Mr Falciani first made the rounds with his discs, there was little interest. The fiscal strains produced by the euro crisis have changed all that.

Banks and tax evasion: Hervé lifting, Economist, Oct. 19, 2013, at 79

Multinationals and their Stateless Income

Cross-border corporate taxation is fiendishly complex, the lobbying around it furious. Several recent academic studies show just how pervasive tax avoidance is.  The ability to shift profits to low-tax countries by locating intellectual property in them, which is then licensed to related businesses in high-tax countries, is often assumed to be the preserve of high-tech companies. Yet in “Through a Latte, Darkly”, a new study of how Starbucks has largely avoided paying tax in Britain, Edward Kleinbard of the University of Southern California shows that current tax rules make it easy for all sorts of firms to generate what he calls “stateless income”: profit subject to tax in a jurisdiction that is neither the location of the factors of production that generate the income nor where the parent firm is domiciled. In Starbucks’s case, the firm has in effect turned the process of making an expensive cup of coffee into intellectual property.

In another new paper Harry Grubert of America’s Treasury and Rosanne Altshuler of Rutgers University delve into tax returns by American multinationals in 2006. They examine all the foreign profits held abroad by these firms (because bringing the money home would incur tax). A remarkable 36.8% of these profits were recorded in countries taxing them at a rate of 0-5%, and a further 9.1% were in countries taxing at 5-10%. Given how much more aggressive their tax-avoidance strategies are believed to have become since, it seems likely that the proportion of foreign profits held by American firms in low-tax countries is now well over half. It will take more than fine words in a communiqué to change behaviour when so much is at stake,

Excerpt, The G8 summit: T time, Economist, June 22, 2013, at 72

Geological Scandal: Why Mining Companies Like Least Developed Countries

Iron ore. Image from enrc.com

An expert panel led by Kofi Annan, a former UN secretary-general, looked at five deals struck between 2010 and 2012, and compared the sums for which government-owned mines were sold with independent assessments of their value. It found a gap of $1.36 billion, double the state’s annual budget for health and education. And these deals are just a small subset of all the bargains struck, says the report, which Mr Annan presented in Cape Town, South Africa, on May 10th.

The report highlights some puzzling details. For instance ENRC, a London-listed Kazakh mining firm, waived its rights to buy out a stake in a mining enterprise owned by Gécamines, Congo’s state miner, only to acquire it for $75m from a company owned by Dan Gertler, an Israeli businessman, which had paid $15m for it just months earlier. Mr Gertler is close to Joseph Kabila, Congo’s president. ENRC, which is being investigated by the Serious Fraud Office in Britain, was Congo’s third-largest copper producer last year. Both ENRC and Mr Gertler deny wrongdoing.

African countries often fail to collect reasonable taxes on mining, says Mr Annan’s panel. For example, Zambia’s copper exports were worth $10 billion in 2011, but its tax receipts from mining were a meagre $240m. The widespread use by mining firms of offshore investment vehicles as conduits for profits creates scope for tax avoidance. Their use is not restricted to rich-world companies. Much of the oil that Angola ships to China is via a company called the China International Fund. Its trading prices are not made public…

Congo’s prime minister, Matata Ponyo Mapon, promises change. In January 2013… Mr Ponyo said he would rein in the state-owned mining companies and increase transparency in the industry. “We must avoid situations where we’re not publishing our mining contracts, where our state assets are undervalued, and where the government doesn’t know what its state mining companies are doing,” he told miners and officials at a conference in January….

Last year miners in Congo, which include Freeport-McMoRan and Glencore Xstrata, shipped $6.7 billion-worth of copper and cobalt from the country.

Business in the Democratic Republic of Congo: Murky minerals, Economist, May 18, 2013, at 74

See also Who is Looting Congo?

Not Dead Yet: the Fate of Micro-states in Europe

european microstates map

Armed with a cache of more than 2m documents, leaked from two offshore service providers, a group of investigative journalists has spent the past week publishing articles that lift the lid on thousands of companies and trusts set up in the British Virgin Islands and Cook Islands. The vast client list ranges from Asian politicians to Canadian lawyers—and no fewer than 4,000 Americans. For an industry that peddles secrecy and likes to operate in the shadows it is all rather embarrassing.

Opinions vary on the impact of the leaks. Tax campaigners have cheered it as a “game changer”. Offshore operators counter that most of the activity uncovered is legal. So what if President François Hollande’s former campaign treasurer has a Cayman Islands company? So do thousands of banks and hedge funds. Nevertheless, the affair will add to international scrutiny of tax havens. The pressure on them has grown as governments scramble to plug fiscal holes and push for the systematic exchange of tax information across borders. Germany’s finance minister welcomed the leak, hopeful that it would provide leverage to force more co-operation from “those who have been more reticent” to rein in the havens.

Faced with an end to the days of easy money, offshore jurisdictions are being forced to rethink their strategies. One of the more proactive has been Liechtenstein, nestled between Switzerland and Austria. The principality has long been popular with European tax dodgers, but growth accelerated when Swiss banks hawked Liechtenstein foundations to clients worldwide. This lucrative niche was damaged in 2008 when the former head of Germany’s postal service and many others were caught hiding money in the principality.

Under pressure from Germany and America, Liechtenstein buckled, agreeing to dilute bank secrecy and to exchange tax information. It has since signed many bilateral tax agreements and clamped down on money-laundering. The local financial industry has paid a high price for this. Liechtenstein banks’ client assets declined by almost 30% in the five years to 2011, to SFr110 billion ($118 billion)…

Other offshore centres must also attempt to square this circle. Next may be Luxembourg, a leader in offshore banking and tax avoidance. Bowing to greatly intensified pressure from its neighbours since the Cyprus debacle, the Grand Duchy has dropped its long-held opposition to swapping information about non-resident depositors with other EU countries. Jean-Claude Juncker, the prime minister, said the policy shift was about “following a global movement”, not caving in to German demands. Whether automatic information exchange can be introduced “without great damage”, as he confidently declared, remains to be seen.

Offshore finance: Leaky devils, Economist, April 13, 2013, at 71

Bank Secrecy: Wegelin

image from wikipedia

Wegelin & Co, the oldest Swiss private bank, said on Thursday it would shut its doors permanently after more than 2 1/2 centuries, following its guilty plea to charges of helping wealthy Americans evade taxes through secret accounts.  The plea, in U.S. District Court in Manhattan, marks the death knell for one of Switzerland’s most storied banks, whose original European clients pre-date the American Revolution. It is also potentially a major turning point in a battle by U.S. authorities against Swiss bank secrecy.  A major question was left hanging by the plea: Has the bank turned over, or does it plan to disclose, names of American clients to U.S. authorities?.. Wegelin admitted to charges of conspiracy in helping Americans evade taxes on at least $1.2 billion for nearly a decade. Wegelin agreed to pay $57.8 million to the United States in restitution and fines. Otto Bruderer, a managing partner at the bank, said in court that “Wegelin was aware that this conduct was wrong.”  He said that “from about 2002 through about 2010, Wegelin agreed with certain U.S. taxpayers to evade the U.S. tax obligations of these U.S. taxpayer clients, who filed false tax returns with the IRS.”..

The surprise plea effectively ended the U.S. case against Wegelin, one of the most aggressive bank crackdowns in U.S. history.  “Once the matter is finally concluded, Wegelin will cease to operate as a bank,” Wegelin said in a statement on Thursday from its headquarters in the remote, small town of St. Gallen next to the Appenzell Alps near the German-Austrian border.  But the fate of three Wegelin bankers, indicted in January 2012 on charges later modified to include the bank, remains up in the air. Under criminal procedural rules, the cases of the three bankers – Michael Berlinka, Urs Frei and Roger Keller – are still pending.,

Although Wegelin had about a dozen branches, all in Switzerland, at the time of its indictment, it moved quickly to wind down its business, partly through a sale of its non-U.S. assets to regional Swiss bank Raiffeisen Gruppe.….Wegelin, a partnership of Swiss private bankers, was already a shadow of its former self – it effectively broke itself up following the indictment last year by selling the non-U.S. portion of its business.

Dozens of Swiss bankers and their clients have been indicted in recent years, following a 2009 agreement by UBS AG (UBSN.VX), the largest Swiss bank, to enter into a deferred-prosecution agreement, turn over 4,450 client names and pay a $780 million fine after admitting to criminal wrongdoing in selling tax-evasion services to wealthy Americans…Banks under U.S. criminal investigation in the wider probe include Credit Suisse, which disclosed last July it had received a target letter saying it was under a grand jury investigation…Zurich-based Julius Baer and some cantonal, or regional, banks are also under scrutiny, sources familiar with the probes previously told Reuters. So are UK-based HSBC Holdings (HSBA.L) and three Israeli banks, Hapoalim, Mizrahi-Tefahot Bank Ltd and Bank Leumi (LUMI.TA), sources also said previously.

Under its plea, Wegelin agreed to pay the $20 million in restitution to the IRS as well a civil forfeiture of $15.8 million, the Justice Department said.  Wegelin also agreed to pay an additional $22.05 million fine, the Justice Department said. U.S. District Judge Jed Rakoff, who must approve the monetary penalties, set a hearing in the case for March 4 for sentencing.  Last year, the U.S. government separately seized more than $16 million of Wegelin funds in a UBS AG account in Stamford, Connecticut, via a civil forfeiture complaint.  Since Wegelin has no branches outside Switzerland, it used UBS for correspondent banking services, a standard industry practice, to handle money for U.S.-based clients.  n court papers, Bruderer said that Wegelin “believed it would not be prosecuted in the United States for this conduct because it had no branches or offices in the United States and because of its understanding that it acted in accordance with, and not in violation of, Swiss law and that such conduct was common in the Swiss banking industry.”

The case is U.S. v. Wegelin & Co et al, U.S. District Court, Southern District of New York, No. 12-cr-00002.

Excerpts, Nate Raymond and Lynnley Browning, Swiss bank Wegelin to close after guilty plea, Reuters, Jan. 4, 2013

How Insiders do Insider Trading: the case of SAC Capital


American authorities increasingly believe they have a more prosaic explanation for SAC’s success: this week they accused a former SAC trader of conducting what may be the biggest-ever insider-trading job, illicitly netting $276m.

Simple bribery is at the core of the case. The Securities and Exchange Commission (SEC) says that between 2006 and 2008 Mathew Martoma, a trader working for an SAC subsidiary, paid $108,000 to a doctor overseeing medical trials for a promising drug used in the treatment of Alzheimer’s. The insider’s tip about adverse side-effects helped SAC avoid losses by selling its shares in the two pharmaceutical companies backing the drug, and then profit by betting their shares would tumble. The US Attorney’s office in New York is issuing criminal charges.

Mr Martoma’s arrest is part of a wider, five-year snare on insider traders. From a trickle, 69 people have been convicted in the past two years, most prominently Raj Rajaratnam, the boss of Galleon Group, once a $6.5 billion hedge fund, who was jailed for 11 years. Many of the SEC’s targets used “expert networks” that pair up industry specialists (such as the doctor in question) with hedge funds wanting insights. All too often the insights given were inside information that should have remained confidential, prosecutors say.

It is the sixth time a current or former employee of SAC has been linked to insider trading while working there; one of its subsidiaries is targeted in the latest probe. Mr Cohen himself has not been named as a defendant now or before, but the complaint places him at the heart of the action in the pharmaceutical imbroglio. Many of the lucrative trades in question were approved by an unnamed “Portfolio Manager A”, described by the SEC as the owner and founder of a hedge fund affiliated with Mr Martoma. It was on the orders of the same “Portfolio Manager A”, who was himself trading in the same shares, that SAC’s position in the soon-to-crash pharma stocks was speedily liquidated.

What the authorities have not proved is that Mr Martoma’s bosses knew he was dealing in privileged information. SAC and Mr Cohen say they acted appropriately and are co-operating with the authorities. Mr Martoma’s lawyer says he is confident his client will be let off.  Mr Cohen has cultivated an aura of secrecy, despite managing $14 billion, one of the biggest hedge-fund piles in the world. Much of that is from his own fortune, estimated at $9.5 billion. His returns since inception in 1992 are among the ten best in the history of the industry. It is a safe bet the SEC and others are not done probing how those profits were generated.

Insider trading: Ever sharper questions, Economist, Nov. 24, 2012, at 80

The Manipulation of Energy Markets by Wall Street

The U.S. Federal Energy Regulatory Commission (FERC) is taking on big banks for their questionable energy trade.  The Federal Energy Regulatory Commission has slammed Barclays (pdf) with a demand to pay $470 million in fines for allegedly manipulating electricity markets in the western US to benefit the bank’s financial swap positions from 2006 to 2008.  Messages and email exchanges between Barclays energy traders released earlier this month reflect their efforts to manipulate and cheat their way to profits. What’s more disturbing is the glee the Barclay’s traders took in manipulating the energy markets with a total disregard for the costs to consumers.

The Barclays traders’ own words are damning:

“I totally f**kked with the Palo mrkt today. . . . Was fun. Need to do that more often.”

The attitude expressed doesn’t get much clearer than that.

In another instant message, the same Barclays trader wrote, “I’m gonna try to crap on the NP light and it should drive the SP light lower.”

The response from his colleague: “That is fine.”

Enron’s energy traders could have written the Barclays’ traders’ scripts. Remember Enron traders gloating, “He just f—s California,” and “He steals money from California to the tune of about a million” a day?  Only the traders’ attitudes are more obscene than their language. So saturated in arrogance, the traders had no concern they might get caught — which makes it even better that they did.

Though FERC hasn’t historically had much to do with regulating Wall Street, that is changing. FERC now also is going after JPMorgan Chase (pdf) and Deutsche Bank  (pdf) on similar charges.  The Los Angeles Times reports that JP Morgan’s questionable trades in the power market in 2010 and 2011 may have cost California residents and businesses more than $200 million. The no-holds-barred pursuit of profiteering no matter what laws and regulations are violated or what the cost is to the public has become a hallmark of Wall Street from Enron to Barclays.

While Wall Street may not have gotten the message that Enron-esque conduct is wrong, it’s gratifying to see FERC step up to hold banks accountable using the power from a post-Enron law. The 2005 Energy Policy Act gave FERC the authority to prevent market manipulation in the energy markets.  Not only does FERC have the power to fine companies as much as $1 million a day per violation, but it also has the ultimate weapon: the ability to suspend authorization to sell. JP Morgan knows that FERC is not afraid to flex this muscle.

Just last week, FERC suspended the authorization for a JPMorgan unit, J.P. Morgan Ventures Energy Corp., to sell electricity at market-based rates for six months beginning next April. FERC took this step because it found that JPMorgan had filed “factual misrepresentations” and omitted material information in filing with FERC and in communications with the California Independent System Operator. JPMorgan will be able to offer electricity for sale only at prices based on specified factors, so that utilities can continue to be able to meet demand.  FERC is relatively new to dealing with Wall Street, but it is quickly learning that a strong jolt is necessary to get banks to comply.

The Commodity Futures Trading Commission, which often works side-by-side with FERC, is expected to see similar cases of energy market manipulation as a result of whistleblower information provided to the CFTC’s new whistleblower reward program created under Dodd-Frank. The outcome of the FERC cases against Wall Street could provide a useful roadmap for future whistleblowers.

Excerpt from, Erika Kelton, Barclays’ Traders Show How Much Fun Wall Street Has Manipulating Markets, Forbes, Nov. 20, 2012