| Here are two equity derivatives trades that you might do if you wanted to be a big shareholder of a public company. First, you might want to buy shares on swap. You might decide one day that you'd like to own 11.5% of some public company. But you can't just go out and buy 11.5% of the company, for some regulatory reason. In the US, for instance, you might need to get antitrust approvals, or you might want to avoid filing a Schedule 13D disclosing your position. Or in Europe, there are European Central Bank regulatory restrictions on owning more than 10% of a bank, so if you want to buy 11.5% of a European bank you need to get ECB approval first. But if you go and get the approvals, that will tip off the company and the market, and then the stock will go up ("ooh there's a big buyer") and/or the company will scramble to fight you off ("ooh there's a big hostile buyer"). So what you want to do is to buy the stock without buying the stock: to get economic exposure to the stock without actually owning it. So you go to a bank (or several banks) and ask them to sell you the stock on swap. You enter into a total return swap with the bank, in which the bank effectively gives you economic ownership of the stock. Say the stock is at $100 now and you want to own a million shares. You do a one-year million-share total return swap in which the bank agrees to pay you $1 per share for every dollar the stock goes up, and you agree to pay the bank $1 per share for every dollar the stock goes down. If the stock ends up at $117, the bank pays you $17 million; if the stock ends at $88, you pay the bank $12 million. The bank hedges this derivative in a fairly straightforward way: It buys a million shares of the stock. That way, if the stock goes up to $117, it has a $17 million profit on the stock, which it uses to pay you the $17 million it owes you on the swap. If the stock goes down to $88, it has a $12 million loss on the stock, but it gets back $12 million from you on the swap. The stock and swap hedge each other. And then you file for whatever approvals you need, and get them, and then buy the stock for real. If the stock is at $117 at the time, you pay $117 million for your million shares, and you get back $17 million from your swap, and you end up paying exactly $100 million for the stock. By doing the swap, you lock in the $100 price today, even if you have to wait months to actually buy the stock. And in fact you'd probably do something even simpler: When you get your approvals, instead of going out and buying $117 million of stock for yourself and getting $17 million back from the bank, what you'd probably do is "physically settle" the swap: You pay the bank $100 million, and the bank tears up the swap gives you the 1 million shares that it bought for $100 million and held as a hedge. (I am ignoring the financing cost and fees that the bank charges you for doing this.) Okay, that's the first trade, buying a stake on swap. It's pretty common: There are various people who want a big economic exposure to a public company but can't buy a big chunk of stock immediately, and this is a normal way to solve that problem. The second trade is: If you already own shares of a public company, you might want to hedge. So for instance you might own 1 million shares of some public company, but you don't want to lose money if the stock goes down. The stock is at $100 per share now, and you want to floor your downside. You go to a bank and ask it for help, and it says "well are you willing to give up some upside?" "Sure," you say. "Okay," says the bank, "I can make you a derivative. I'll give you a one-year collar, guaranteeing that you won't get less than $90 or more than $110 for your stock." The bank sells you a put option: If the stock is below $90 in a year, it will buy the stock from you at $90 (or, equivalently, you can keep the stock and the bank will pay you cash for the difference between the final price and $90). In return, instead of paying cash, you sell the bank a call option: If the stock ends up above $110, you will sell the bank the stock at $110 (or, equivalently, keep the stock and pay the bank cash for the difference between the final price and $110). The bank gets upside in exchange for protecting you from downside. If the stock ends up at $94, or $103, you keep the stock and no money changes hands. When you enter into this trade today, you cap your upside (at $110) and floor your downside (at $90), so you have less economic exposure to the stock. But you still own the stock; you still have the million shares today. In a year, when the collar expires, you might sell the stake to settle the collar, but you might not. Probably you'll have the option to "cash settle": Instead of delivering the stock, you can pay cash to terminate the collar and keep the stock. So if the stock ends up at $140 but you want to keep holding it, you can just pay your bank $30 million (to settle the call option) and keep the stock. This is a pretty classic way for big stake holders to hedge, and you do it for reasons that are sort of the opposite to why you'd do the first trade (buying a stake on swap). You buy a stake on swap if you want economic ownership without actual ownership: You want to have exposure to the stock price, but actually owning the shares triggers some sort of regulatory or other problem, so you buy economic ownership on swap. You do a collar if you want actual ownership without (as much) economic ownership: You have some reason to own the stock (you want to keep the votes to control the company, you are a big shareholder and don't want to freak out the market by selling, etc.), but you want to reduce your economic exposure, so you keep the stock and take risk off with the collar. I should say that my numbers — the stock is at $100, you buy a put at $90 and sell a call at $110 — are fake and designed for ease of use. The width of that collar — the collar covers a 10% stock move in either direction — is pretty normal, but there is no magic to it. You could imagine a wider or tighter collar. In particular you could imagine a $100/$100 collar: If the stock goes below $100, the bank buys the stock from you at $100 (or pays you the difference), and if the stock goes above $100, the bank also buys it from you at $100 (or you pay it the difference). No matter what, you get $100 per share; you have completely gotten rid of your stock price risk. Effectively, you own one million shares, and you have sold short one million shares, so net you have no economic exposure at all. That's just a total return swap: It's the same as our first trade, except you're on the other side of it. Instead of buying the stock on swap, here you own the stock in real life and sell it on swap. This is much less common than doing a collar, for various reasons. I mention it only as a clarifying limit case of the collar: Hedging your stock price risk with a collar is like selling all of your stock on swap, but less so. Selling your stock on swap is economically equivalent to selling 100% of your stock. Doing a normal collar is economically roughly like selling, you know, 75% or 80% of your stock. What I mean by that, in particular, is: If you sold all your stock on swap, the bank would go out and hedge by selling the million underlying shares short. And then if the stock went up, the bank would make money on the swap and lose money on its short, and vice versa. Whereas if you do a collar with the bank, it will go out and hedge by selling, like, 800,000 shares short. And then if the stock goes up, the bank will make money on the collar (it is more likely to profitably buy the stock at $110 and less likely to lose money buying it at $90) and lose money on its short, and vice versa. The rough result of the collar is "the bank probably ends up owning these shares, but maybe not," so the bank hedges the collar by selling many, but not all, of the underlying shares. Here is the synthesis of those trades: Consistent with its statement on 11 September 2024, UniCredit submitted the required regulatory filing for acquiring a stake in Commerzbank in excess of 10% up to 29.9%. Meanwhile, UniCredit has today entered into financial instruments relating to ca. 11.5% Commerzbank shares. Physical settlement under the new financial instruments may only occur after the required approvals have been obtained. Together with the position of ca. 9% communicated previously, UniCredit's overall position now totals ca. 21%. The majority of UniCredit's economic exposure has been hedged to provide it with full flexibility and optionality to either retain its shareholding, sell its participation with a floored downside, or increase the stake further. This will depend on the outcome of engagement with Commerzbank, its management and supervisory boards as well as its wider stakeholders in Germany.
UniCredit SpA has been taking a run at buying Commerzbank AG. It is now in a weird position: - It wants to buy more stock.
- It has to get ECB regulatory approvals first, so it can't.
- It can buy more stock on swap, sure.
- But that is complicated too: If it buys 11.5% of the stock on swap, that requires its banks (its counterparties on the swaps seem to include Barclays Plc and Bank of America) to buy all that stock as a hedge, which might be costly and time-consuming. That 11.5% of Commerzbank is something like 136 million shares; Commerzbank has traded an average of under 7 million shares per day this year. It could take UniCredit's banks weeks to buy all that stock, and they'd push up the price. And they'd be unlikely to agree to a swap on 11.5% of the stock at a fixed price today, if they still have to go out and hedge it.
So my best guess is that its trade today is, roughly: - UniCredit buys 11.5% of the stock on swap, today, from its banks.
- It sells most of the stock back to them, today, presumably in the form of a collar: "The majority of UniCredit's economic exposure has been hedged," so that (1) UniCredit doesn't have that much economic exposure to Commerzbank's stock price and (2) its banks don't have to go out and buy a bunch of stock to hedge their swaps.
UniCredit's derivatives counterparties have to buy Commerzbank stock to help UniCredit accumulate its position (on swap), and they have to sell Commerzbank stock to help UniCredit hedge its position (via collar), and the net result is that they don't have to do much trading. So UniCredit can say "we signed swaps today to get 11.5% of Commerzbank, and it's all hedged," and the whole transaction happens at once. Because it's not much of a transaction! You buy stock on swap because you want economic exposure to a stock without owning it. You hedge a stock with a collar because you want to own the stock without much economic exposure. When you combine those transactions you get not owning the stock and not having much economic exposure to it. (In particular, if Commerzbank's stock doubled, would UniCredit have to pay more than today's price to acquire that 11.5% stake? It would if it has collared the stake.) Why would you do that? What is the point of owning the stock on swap and hedging it? Well. This is the most efficient way to accurately tell everyone that you have bought 11.5% of the stock. Actually buying the stock would take time: You'd need to wait for ECB approval, and then go out in the market and buy stock. Buying the stock on swap, unhedged, would take time: Your banks might need weeks to hedge all that exposure. Doing this lets you announce a 11.5% stake whenever you feel like it, which is nice if you are, for instance, trying to build public pressure to acquire the company. Bloomberg reports: UniCredit SpA Chief Executive Officer Andrea Orcel moved to more than double the lender's stake in Commerzbank AG, in a dramatic development that's likely to escalate tensions with the German government. … The step effectively makes UniCredit the largest shareholder ahead of the German government and puts it on course for a takeover. The move is almost certain to exacerbate tensions between Orcel, one of Europe's most prolific dealmakers who surprised markets this month by saying he's considering a full takeover of Commerzbank, and the German government, which has indicated it opposes a deal. Late Friday, Berlin announced that it will pause a planned disposal of its stake in Commerzbank, with some officials apparently blindsided by Orcel's approach. … The additional 11.5% stake UniCredit disclosed on Monday is linked to derivatives, which means that the Italian bank has the right to take ownership of the shares in the future. UniCredit, which currently doesn't have regulatory clearance to raise its stake beyond 10%, has submitted a request to increase its stake to as much as 29.9%. It's a strategy Orcel also used to buy around 4.5% in Commerzbank ahead of the government share sale this month. UniCredit purchased derivatives known as total return swaps for an 1.7% stake, a filing shows. That helped the Italian lender stay below 3% in physical holdings and avoid triggering a shareholder notification that would have tipped off Berlin and the competition to Orcel's intentions.
Announcing a big stake all at once gives you the element of surprise, which seems to be helpful in Orcel's game. Actually buying the stake can wait. Apparently the way Citi Bike works is: - Lyft Inc. runs Citi Bike, the New York bike-share program.
- If you use Citi Bike, it is inconvenient for you to encounter an empty bike station (no bikes for you) or a full one (nowhere to return a bike).
- Therefore Lyft incentivizes users (called "Bike Angels") to move bikes from full stations to empty ones. It pays them in "points," which are apparently worth $0.20 each, and you can earn up to 24 points for moving a bike from a completely full station to a completely empty one. (You can also earn points for moving a bike from a somewhat full station to a somewhat empty one, but fewer.)
- There is an arbitrage.
- Assume there are two stations, two blocks away from each other, each with 40 slots for bikes, each half full (20 bikes). You and 19 friends get on the 20 bikes at Station 1 and move them to Station 2, where you dock them. Now Station 2 is totally full and Station 1 is totally empty. You wait 15 minutes, then take the 20 bikes out and bring them back to dock at Station 1, earning $4.80 per bike for moving them from a full station to an empty one. You do this every 15 minutes (when the algorithm resets), earning up to, uh, I calculate $19.20 per hour for each of you? "One legendary Bike Angel, known to other riders only as Tommy, was rumored to have earned $60,000 last year," reports the New York Times, which presumably means either that he did this trade over and over again for 60 hours a week or that I am slightly misunderstanding the mechanics or math here.
- I … okay?
That Times article is very entertaining, in that (1) this really is a rigorous and amusing gamification of Lyft's Bike Angel algorithm and (2) it makes the ordinary customer experience worse, since a Bike Angel doing this arbitrage is having the opposite of the intended effect. (Instead of redistributing bikes around the system, he's intentionally creating shortages and surpluses in order to maximize rewards for fixing them.) And people give very good quotes: "How are we cheating?" said one Angel in a baggy gray T-shirt, black athletic shorts and sneakers, who declined to give his name. "If Lyft wants something else, they can change the algorithm."
And: "People run scams across the city every day," someone wrote under the username Nomotho. "There's not really a large societal cost to this behavior."
But also … just … it's not a very good arbitrage, is it? We talked a couple of weeks ago about a Spotify arbitrage, which is basically that if you pay $12 a month for Spotify and listen to your own songs 24 hours a day, seven days a week, Spotify will pay you on the order of $100 per month as your cut of its streaming revenue. That is a good percentage return on investment, but it is not a very large number. I argued that there is another crucial step in making it a good trade: You need to scale it up. With Spotify listening, that is doable, and someone did it. (And was then arrested so, you know, not legal advice.) The way he did it was he set up like 10,000 bot accounts, all streaming his music 24/7 on cloud computers, so that he could turn this gameable feature of Spotify's algorithm into something like $10 million of profits. And, again, he was arrested, so I suppose that's bad, but other than its arguable illegality it's a nice trade. He put a lot of work into it — it's not just like "set up the bots and they generate profits automatically forever" — but the work was scalable and the money was good. But with the bikes you have to ride the bikes? Back and forth? Yourself? Someone in the article calls these Bike Angel arbitrageurs "real life bots," which is very apt, but does sort of point to the essential problem here, which is that you can program lots of bots to run in parallel but you can only pedal one bike at a time. If you optimize it perfectly and work at it a lot, you can apparently make $60,000 a year and get a lot of cardio, but that seems like the cap. This is not the arbitrage for me, is I guess what I am saying. Also, when we talked about the Spotify thing, I wrote: Basically much of modern economics, and life, has the following characteristics: Everything is intermediated through some depersonalized automated electronic exchange. The automated electronic exchange has a mechanism — how it actually works, what the exchange's software allows you to do — and also rules, the terms of service regulating how you can use the mechanism, which are fuzzier than the mechanism and written in small print, things like "don't do fraud" or "you have to be a human" or whatever. The mechanism is much more legible and salient than the rules, and in a depersonalized electronic world people treat the mechanism as the rules: They don't believe that the rules exist, because the rules seem to contradict how the service works. The basic description of Spotify's mechanics suggests Smith's alleged arbitrage; if he didn't do it surely someone else would.
And … right? Like even real life is like this now? "If Lyft wants something else, they can change the algorithm," says a guy, as he pointlessly rides bikes back and forth to earn points from Lyft's algorithm. "Code is law," he pants as he rides away. Okay! In the US, at least, there is no official definition of ESG (environmental, social and governance) investing. If you advertise that you are an ESG fund and put all your money in coal stocks, the US Securities and Exchange Commission can't stop you. Who is the SEC to say what is good for the environment, or for society, or how to weigh trade-offs between the environment and society? "ESG" is a matter for you and your investors. Still the SEC, like everyone else, worries about "greenwashing," where a firm says it cares about ESG factors but really doesn't. And the SEC has fined investment firms for greenwashing. But it can't make substantive objections; it can't say "your supposedly ESG investment process produces results that are bad for the environment." It can just object to process. If you say to your investors "we carefully consider five ESG factors and write a memo about them before buying any stock," and in fact sometimes you didn't write the memo, the SEC will fine you. If you always wrote the memos, but they all say "actually coal is good for the environment," there is not much the SEC can do. (Not legal advice!) Similarly: If you advertise that you invest using biblical principles, the SEC just obviously cannot come in and say "actually you've got the Bible all wrong." But if you don't always apply the biblical processes that you say you apply, sure: The Securities and Exchange Commission today charged Idaho-based investment adviser Inspire Investing LLC with making misleading statements and for compliance failures related to the execution of its "biblically responsible investing" strategy. According to the SEC's order, Inspire Investing represented that it used a data-driven methodology to evaluate companies and that it would not invest in companies that had "any degree of participation" in certain enumerated business practices that Inspire determined did not align with biblical values. However, the SEC's order finds, from at least 2019 to March 2024, Inspire Investing in fact relied on a manual research process and did not typically perform research on individual companies to evaluate them for eligibility under its investing criteria. According to the SEC's order, Inspire Investing also lacked written policies and procedures setting forth a process for evaluating companies' activities as part of its investment process, which at times resulted in inconsistent application of its investment criteria. As a result, Inspire Investing invested in companies engaged in activities that did not align with Inspire Investing's own stated criteria and in which the advisory firm represented that it would not invest.
They settled for $300,000. Basically they advertised a rigorous process: Inspire elaborated on its methodology and touted its reliability in a white paper published on its website. According to the white paper, by relying on data science and analysis of faith-based screening data, the Inspire Impact Score "reflects a rules-based, scientifically rigorous methodology of faith-based ESG analysis which creates a level of consistency and reliability of results necessary for making well-informed, quantitatively sound, biblically responsible investment decisions."
But mostly they just checked donor lists of abortion rights groups? Inspire employees' research was primarily limited to cross-referencing company names with donor and sponsor lists of well-known national organizations that it determined were associated with Prohibited Activities.
So the SEC checked donor lists too and caught them in a contradiction: For example, certain companies were excluded from Inspire's investment universe for donating to certain advocacy organizations or sponsoring certain events that Inspire considered to be Prohibited Activities. At the same time, multiple companies held within the Inspire ETF portfolios donated to organizations or sponsored events that were the same or similar.
That is about all the biblical regulation that the SEC can do. We talk a lot around here about the US Securities and Exchange Commission's crackdown on financial industry employees who text about work on their personal phones, and I have become sort of a clearinghouse for the absurdities of this crackdown. Last week I mentioned a woman who allegedly texted her building manager about water pouring through the ceiling and got in trouble for texting about work. Because any use of personal phones to discuss anything business-related is, in the SEC's view, a problem, no matter how innocent the actual message is. One thing that this suggests — not legal or compliance advice! — is that you shouldn't even give your personal phone number to a client, because what if they text you? That's off-channel communications, and thus bad. It gets worse. A reader who works in compliance in Asia at a global financial firm writes: "The irony is that because of common standards, we and other global banks tried lobbying numerous local regulators to stop messaging our staff on WhatsApp, WeChat etc. One guess as to their response!" Intel Gets Multibillion-Dollar Apollo Offer as Qualcomm Circles. How Intel Fell From Global Chip Champion to Takeover Target. BGC's Howard Lutnick takes on CME with interest rate futures debut. BofA returns to margin loans after seven years. Chip Giants TSMC and Samsung Discuss Building Middle Eastern Megafactories. World's biggest banks pledge support for nuclear power. Johnson & Johnson Files Third Bankruptcy Case Seeking to End Talc Lawsuits. Goldman's Old Headquarters Turned Into $4,000-a-Month Apartments. Hedge fund mogul who helped topple Marissa Mayer sued by own mom for $13M: 'World's worst son.' Zoo admits that their pandas are 'painted dogs' after backlash from visitors. Cards Against Humanity Sues Elon Musk's SpaceX for Trespassing. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
No comments:
Post a Comment