It’s a common piece of received wisdom that the City is a less gentlemanly place that it used to be. Philip Augar, a former Schroders merchant banker and regular Financial Times commentator, has even written a book called The Death of Gentlemanly Capitalism. Innumerable others have pined for the return of a market ruled by culture and honour.
Regulators, too, have tried their best. The FCA, this week, published a thick report full of essays on the importance of culture, with contributions from UBS Investment Bank boss Andrea Orcel and Credit Suisse CFO David Mathers, among a host of academics, regulators and other bankers.
Culture, in terms of “tone from the top” is the focus of the UK’s Senior Managers’ Regime, supposed to make bank management personally culpable for the actions of their underlings, while other UK initiatives, such as the Banking Standards Board and the FICC Markets Standards board have also delved into the business of nudging market culture in a particular direction.
But actually, the culture never went away — though the standards expected in certain markets have certainly shifted.
In the high yield markets, private equity firms are the main borrowers, and are notorious for what might be considered sharp practice in documentation. Structures such as the 'J. Crew trap door', which allows an owner to pull assets from a bond guarantor, have featured more regularly on deals, as have evermore elaborate interpretations of “adjustments” to Ebitda.
While this might have appalled the blue blooded merchant bankers of the 1980s (then again, perhaps not; remember Guinness-Distillers?), a bit of fun with covenants is a distinct feature of modern leveraged finance market practice. It might be an irritant for investors, but finding and disclosing aggressive terms in deal documents is an ordinary part of the market.
Pointing out flaws in the press or through specialist covenant review firms like DebtXplained or Covenant Review, is part of how investors in the market push back. When demand is hot, this has little effect but when the market turns, resisting covenants is one way of achieving supply and demand equilibrium.
What’s not acceptable, though, is a failure to fulfill contractual obligations, however manipulated the contract may be. When Vieo, the owner of telecoms company Lebara, simply didn’t report its financial results, the market was rightly appalled.
This will be followed by potential financial sanction, in the form of a covenant breach, should Vieo fail to disclose, but it’s not like high yield issuers are going around regularly trying to avoid reporting results. There is a culture of respectability in high yield, and for the most part, it functions. People judge the behaviour of their counterparties by implicit moral standards that go beyond the bald legal limits in the documentation.
In other markets, though, even quite mild covenant chicanery would horrify everyone involved. Inserting a term on page 200 of a covered bond prospectus allowing conditional removal of guarantee assets might easily be missed by investors, who are used to buying deals during a two hour bookbuild, in a market which is mostly characterised by clean documentation.
The covered bond market has its own problems — how to disclose book size adequately, or what the value of a “market making obligation” might be in practice — but it’s not part of the game to push the bounds on bond terms as it is in high yield.
No school like the old school
In the market for financial debt, old forms of honour have been eroded by the crisis, and by regulatory action.
The presumption that bank capital trades would be called was left in tatters by Deutsche Bank’s 2008 economic non-call, while, more recently, Standard Chartered’s non-call of legacy tier one in 2016 cemented the impression that investors couldn’t rely on nods and winks from issuers.
On the other hand, Aviva’s announcement last week that it could redeem its preference shares at par sent the notes spiralling downwards and provoked a howl of outrage. Investors argue that it would be a grotesque misuse of contractual provisions supposed to be activated only when an issuer is in distress.
In no bond market, meanwhile, is it considered acceptable to deliberately fail to settle trades for momentary advantage. That came up recently in a tender for an old securitization called Fairhold. Hayfin and Avenue Capital disclosed that a buyer for more than 25% of the deal had refused to settle a trade, on the day payment was due.
The fund involved in the Fairhold tender, Clifden IOM Holdings, has also been blacklisted by a number of counterparties for behaviour that include attempted sale of assets it did not own and an attempt to purchase assets as principal when they did not, in fact, have the money in place to pay for it.
This kind of market culture is a world away from the kind discussed in the FCA paper.
Crucially, it spans markets, not institutions. The culture in high yield, or money markets, or M&A is different, but it is created by all of the participants, not simply those in regulated firms. Swaps traders or private equity treasurers at different firms have much more common with each other than with their colleagues under the same roof but involved in different businesses.
Private equity, hedge funds, traders on both sides, law firms, and even the press help create and maintain a sense of what sort of behaviour is acceptable when jostling for competitive advantage, and what sort of behaviour is beyond the pale. “360 reviews” or “balanced scorecards”, meticulously designed e-learning modules or ponderous speeches from senior management might nudge culture inside an institution in a particular direction, but markets are where people spend their time.
As such, it’s the judgement of counterparties and the whisper of information around a market which carries the really important cultural messages about what is acceptable. Many sub-markets are small enough that many of the principal participants know each other personally, and deal with each over decades, working together or against each other. Personal reputation matters — not just following the law, but following the implicit cultural rules of the game, whatever they may be. It always has.
That is what makes it hard for regulators to tweak it in the way they think they can.