Theres a Blacklist in $800 Billion of U.S. Loans and Its Legal

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(Bloomberg) — What do Highland Capital Management, Fortress Investment Group LLC and Cerberus Capital Management have in common? The firms, which manage some $110 billion among them, are on a list that says they can never invest in a $155 million loan thats trading in U.S. markets.

RBS Holding Co., the owner of direct marketer Quadriga Art, banned the three firms and seven others last year from buying parts of the loan, according to two people with knowledge of the matter who asked not to be named because the decision was private. They were deemed, the people said, to be too demanding in debt restructurings, a fate that executives at RBS — which has no relationship to the Scottish bank — considered as Quadrigas business faltered.

Unlike any other market in the U.S., the blacklist rules in leveraged loans. No regulator polices trading in the $800 billion market. Here, borrowers — and the investors who control them — choose who gets into the club. It would be as if Apple Inc. got to decide who could buy its stock.

I really cant think of a good example of another market where you really are selling to a lot of people but you still retain the right to keep some people out, said Elisabeth de Fontenay, a professor at Duke University School of Law in Durham, North Carolina, and a former corporate lawyer.

While banks managing stock and bond deals can pick which investors are allotted securities in public offerings, anyone with enough money can buy the assets once they start trading in the market. Not so with loans. The lists prohibiting investors can last until the debt matures.

Booming Market

The practice poses risks to a market whose size has quadrupled from about $200 billion over the last decade as plunging interest rates fueled investor demand for securities that offer extra yield. Blacklisting reduces the number of potential buyers, which in turn makes the loans difficult to trade, and can exclude the savvier investors who are better able to fight for creditor rights in a default.

These types of limitations are tremendously detrimental to the markets quantity and quality of buyers and sellers, said Greg Margolies, a senior partner at Los Angeles-based Ares Management LP, which manages about $80 billion in assets including speculative-grade debt and real estate. Ares will not invest in a name where secondary liquidity can dry up immediately because an issuer has decided to blacklist a number of market participants.

Blacklist Defined

The Merriam-Webster Dictionary defines blacklist as a list of persons who are disapproved of or are to be punished or boycotted. In the loan market, there are three things that can warrant punishment: having a reputation for being a tough negotiator in debt restructurings, like Highland and the other firms in the RBS deal; having an affiliation with a borrowers competitor; or simply being disliked.

We protect the rights of our investors, Jim Dondero, president of Highland, said in an e-mailed statement. Sometimes we must pursue the bad acts of management teams or sponsors. It stuns us that some managers are passive and never protect their investors.

Mark Schulhof, chief executive officer of RBS, declined to comment. Gordon Runte, a spokesman for Fortress, and Peter Duda, a spokesman for Cerberus at Weber Shandwick, declined to comment.

Illiquid Assets

The lack of liquidity in speculative-grade debt has drawn warnings from regulators, including the Financial Stability Board and the U.S. Securities and Exchange Commission, as individual investors poured money into mutual funds and exchange-traded funds. The concern is that its become too easy to get into a market for people who dont understand how tough it may be to cash out when sentiment sours.

Trading is slow even in a bull market.

It took 20 days on average to complete a loan trade in the three months ending in June, according to data compiled by the New York-based Loan Syndications & Trading Association. Thats almost seven times as long as the three-day average in the corporate bond market.

Yet for all of the concern expressed by U.S. policy makers, none of them oversee the loan market. Its unregulated status traces back to securities laws that were drafted in the 1930s, when company loans were mainly private transactions between one bank and one borrower. These days, though, the debt is mostly sliced into pieces worth several million dollars and distributed to investors.

The SECs authority in this market is limited to loans that meet the legal definition of a security, which requires a case- by-case review, according to John Nester, an SEC spokesman. The SEC is focused on the oversight of liquidity management in mutual funds and ETFs, and will continue to vigorously pursue violations of the securities laws within its jurisdiction, Nester said in an e-mailed statement.

Bad Blood

Blacklisting is rampant. And growing.

Data gathered by Xtract Research show that 77 percent of all loan deals in the third quarter included provisions giving borrowers the ability to block individual lenders, up from 51 percent at the end of last year.

The most common explanation given for excluding potential buyers is that they have an affiliation with rivals of the borrower. Theres private information that lenders get access to — things like financial projections — that the borrower doesnt want them to see.

Robert Blank, head of leveraged-loan research at Xtract in Westport, Connecticut, calls those circumstances the most reasonable for justifying the blacklist.

Apollo-Highland

Jonathan Kitei, head of U.S. loan sales and collateralized- loan obligation origination at Barclays Plc, said, though, that hes seen personal animosity shape lists.

Often times you see a sponsor put an investor on a blacklist because one partner at the firm doesnt like the investor, said Kitei, who is based in New York. There are great inconsistencies in the use of blacklists.

Leon Blacks Apollo Global Management LLC has blocked Highland from buying several loans of its takeover targets, according to a person with direct knowledge of the matter. Theres a history of feuding between the two firms: Highland sought in 2006 to stop a merger between Apollo-backed SkyTerra Communications and Motient Corp., triggering a series of court battles.

Highland, a Dallas-based money manager, was banned from deals including loans taken out by Caesars Entertainment Corp., the casino operator partly owned by Apollo, according to the person, who asked not to be identified because the matter is private.

Charles Zehren, a spokesman for New York-based Apollo at Rubenstein Associates Inc., declined to comment.

Shindlers List

Blacklisting dates back to at least the late 1990s, when Nextel Communications Inc.s then chief financial officer Steve Shindler penalized lenders who didnt participate in the companys new credit facility by banning them from buying the debt in the secondary market, according to industry newsletter Bank Letter.

It became known as Shindlers List, reflecting Wall Streets penchant for tasteless puns that twist history. The phrase is a reference to German businessman Oskar Schindlers list of Jews to be saved from transportation to concentration camp Auschwitz during World War II, the subject of the Oscar- winning film of that name in 1993.

To this day, traders still use the name when talking about blacklists. Shindler, who is now chief executive officer of NII Holdings Inc., the bankrupt mobile-phone company that uses the Nextel brand in Latin America, declined to comment.

Disqualified Institutions

Its anti-American, Lee Shaiman, a senior portfolio manager with Blackstone Group LPs credit unit GSO Capital Partners in New York, told the LSTAs annual conference Oct. 23 when asked about the practice. Its anti-competitive.

Some investors find out that they have been barred when they try to complete a trade and are turned away by broker- dealers. Others never know. Most lists are kept privately by the banks that arrange the deals.

Occasionally, theyre included in public credit agreements, like the blacklist orchestrated this year by a Goldman Sachs Group Inc.-controlled company named Interline Brands Inc. An addendum to a March 19 regulatory filing for the deal listed two names as Disqualified Institutions that couldnt buy the loans: hedge funds Bulldog Investors and QVT Financial.

Andrea Raphael, a spokeswoman for Goldman Sachs, said the bank didnt select the names on the list. Lev Cela, a spokesman for Interline, didnt respond to e-mails and telephone calls seeking comment. A QVT representative declined to comment.

Phil Goldstein, the co-founder of Bulldog in Saddle Brook, New Jersey, was unaware for months that he had been banned. It kind of irks you that theres somebody saying youre not good enough to do this or we dont want you for that, he said.

The whole thing is perplexing to Goldstein.

His fund, he said, doesnt even invest in loans.

–With assistance from Christine Idzelis and Pierre Paulden in New York and Dave Michaels in Washington.

On The Move: SEC Appoint Barnett, Goldsholle to Trading and Markets Div.

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On The Move: SEC Appoint Barnett, Goldsholle to Trading and Markets Div.

Barnett and Goldsholle succeed former deputy directors James Burns and John Ramsay who left the agency earlier this year.

Barnett will have responsibility for the Office of Broker-Dealer Finances and the Office of Derivatives Policy and Trading Practices. Goldsholle will oversee the offices of the Chief Counsel, Clearance and Settlement, and Market Supervision.

The Office of Analytics and Research, headed by Gregg Berman, will report to the Director.

I am pleased to announce these additions to our staff, said Stephen Luparello, director of the Division of Trading and Markets. Each brings a wealth of experience that will help us execute our broad and important policy agenda.

I am delighted to be joining the SEC and to work with its talented staff on behalf of investors, said Barnett, who has served since August 2011 as the director of the Division of Swap Dealer and Intermediary Oversight at the Commodity Futures Trading Commission (CFTC). He helped to establish the division and was active in rulemaking to implement the swaps provisions of the Dodd-Frank Act and enhance customer protection rules for futures commission merchants.

Before joining the CFTC, Barnett was a partner and head of the U.S. derivatives and structured finance group at the law firm Linklaters LLP in New York. Prior to joining Linklaters in 2004, he was a partner and co-head of the securitization and derivatives practice at Sherman & Sterling LLP in New York. A graduate of the University of Tulsa and the University of Tulsa College of Law, Barnett received his LL.M. from New York University School of Law in 1986.

Goldsholle said, I am honored to take on this new role and to help advance the SECs mission. He joins the SEC from the Municipal Securities Rulemaking Board (MSRB), where he has been general counsel since 2012. In that role, he led the development of rules for broker-dealers and a new regulatory regime for municipal advisors. He also was the MSRBs primary representative on policy and enforcement matters with officials at the Financial Industry Regulatory Authority (FINRA), the SEC, and the Treasury Department.

Prior to the MSRB, Goldsholle spent 15 years as vice president and associate general counsel at FINRA. Before that, he was an attorney at the CFTC and in private practice. He graduated with degrees in computer science and economics from Duke University in 1988 and received his law degree from the University of Chicago Law School in 1991.

Security Traders Association of Wisconsin 2014 Gallery – Part 2

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Leave it to the traders and brokers in Wisconsin – while other STA affiliates raffle off golf outings and iPads, the members of the Security Traders Association of Wisconsin raffled off a Harley Davidson. Why weren’t we invited?

Traders is pleased to present a second round of networking photos from the annual conference of the Security Traders Association of Wisconsin.Attendees at the summer event hailed fromCitigroup, RW Baird, Cortina Asset Management, Instinet, 1482 Asset Management, and other high-powered firms.

The event took place on August 7th through the 9th at the Hotel Pfister based indowntown Milwaukee.After hours, attendees from the local brokerage and buyside community gathered at the Harley Davidson Museum for dinner and networking.

To check out the first round of Tradersphotos from the event, pelase visit our Security Traders Association of Wisconsin’s 2014 Annual Conferencegallery.

For otherTradersslideshows of industry conferences, charity fundraisers and networking events, please visit our ever-growingTraders Photo Gallery.

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Do you have an event that you’d like to see in the pages and on the screens of Traders? Drop us a line at philip.albinus@sourcemedia.com. If you have hired a photographer, we can discuss uploading the images and the names and company info of the subjects.

– Phil Albinus

Top 2014 Trends: Waiting for Volatility

Editorial Staff
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For stock market investors, it has been another good year. But for Wall Street, the continued low-volatility, low-interest-rate environment has made profitability a continual challenge.

With the exception of a brief period of volatility in the middle of October − a month that has historically seen some epic shifts − volatility has remained exceptionally low. The CBOE Volatility Index (VIX), a.k.a. the fear gauge of the markets, has so far had an average daily closing level this year of 14.01, and that includes the high-volatility period in October. Thats far below its historical average daily close of 20.0 dating back to 1990.

The prolonged period of low volatility and low interest rates may be taking a toll. In a volatility survey conducted over the summer by agency-focused brokerage ConvergEx, two thirds of respondents said that historically low volatility levels had made investors either too complacent or much too complacent.

When will volatility return? As U.S. stock indexes continue to hit all-time highs in 2014, investment professionals have asked the questions endlessly, commented ConvergEx executive managing director Anthony Saliba, when announcing the results of the survey.

In one sign of complacency, the equity markets investors arent protecting their stock market gains by purchasing options, such as the ones that the VIX measures, according to the ConvergEx survey.

Another sign of complacency might have revealed itself during the high-volatility days in October.

Possibly caught off guard, three of the largest dark pools – those run by Goldman Sachs, Credit Suisse and UBS – temporarily told clients to send orders elsewhere when volatility spiked on Oct. 15, the busiest day for stocks in three years, Bloomberg reported. One unnamed trader who buys and sells shares across different venues said the three firms were not the only dark pool operators to experience issues on that day.

In the bond market, some view the situation as dire. With both volatility and interest rates in the basement, many firms have drastically reduced their corporate bond inventories. While regulations are partly to blame for low dealer inventories, many market observers also blame the lower risk appetites in a market where minimal volatility and low rates mean there isnt much spread to be gained. The double-sided challenge for the corporate bond market is that the low rates have sent huge numbers of investors into corporate bonds and issuance has been high, leaving many to wonder how bond investors will exit when volatility returns.

Several new electronic venues have launched in the corporate bond space this year, from Liquidnet, ITG, Bondcube, CodeStreet and, most recently, Tradeweb, in an attempt to make up for the lost dealer inventory. Still many doubt the inventory from electronic venues will be enough to plug the gap.

Its going to be an ugly exit, Michael Chuang, CEO of iTBconnect, a bond platform that connects bond market participants to multiple ECNs, told Traders. Its going to be a very ugly exit.

Money Manager Profits Exceed Pre-Crisis Levels: McKinsey

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(Bloomberg) — Money managers profits in North America last year surpassed pre-crisis levels, rebounding to $34 billion on asset and revenue growth, according to a study by McKinsey & Co.

Profits were 18 percent above the pre-crisis peak in 2007 after assets reached $30 trillion, the New York-based management-consulting firm said today in a report. Profits at asset managers globally also moved past 2007 levels, increasing 15 percent to $65 billion from 2007. Assets reached a record $64 trillion last year.

Central bank efforts to stimulate economies have driven most of the industrys growth, according to McKinsey, with the MSCI World Index of stocks rising 24 percent last year.

The asset management industrys profitability, enviable as it is, has been propped up by asset and revenue growth, McKinsey said in the report.

The trend has continued this year with Vanguard Group Inc., the largest U.S. mutual-fund firm, attracting more money from investors in the first 10 months of 2014 than it has in its 39- year history. BlackRock Inc., the worlds biggest money manager, has expanded to oversee $4.5 trillion.

Net inflows at North Americas money managers remained at 1 percent of assets under management for the past three years from 2012 to September, which is a third of the organic growth from 2002 to 2007, according to the report.

ETFs, Alternatives

New subscriptions and revenue are concentrated in passive strategies and exchange-traded funds, active specialties, multi- asset class strategies and alternatives. Money that flowed into alternatives, which includes private equity and hedge funds, reached a high of $4 trillion in the U.S. and $7.5 trillion globally last year.

Alternatives could account for 20 percent of assets and 40 percent of the industrys revenue by 2020, according to the study. Blackstone Groups assets, for instance, have grown 35 percent since 2012 to $284 billion, the most among managers of alternative assets such as private equity, real estate, credit and hedge funds.

Costs have increased 29 percent since 2007. McKinsey said it expects costs to increase as the industry needs to improve digital capabilities, strengthen foundational operations and invest in new talent and skills to generate economic growth.

Costs have grown 4 percent faster than revenue since 2007. Expenses for the industry rose 10 percent to $80 billion last year from 2008 with the fastest increases coming from sales and marketing and operations and technology.

The report was based on a survey of more than 300 managers — 100 from North America with more than $18 trillion in assets under management.

To contact the reporter on this story: Sabrina Willmer in Boston at swillmer2@bloomberg.net To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net Mary Romano, Pierre Paulden

Treasuries Hurt When Breaking News Hits: Speed Trader Study

Editorial Staff
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(Bloomberg) — High-frequency trading in the U.S. Treasury market makes it harder for investors to buy and sell bonds when news events cause prices to move, according to the Bank of Canada.

Researchers studied how liquidity changed as algorithmic- trading programs, which are much faster than human beings, reacted to economic indicators including the unemployment rate, home sales and inflation. They examined trades on ICAP Plcs BrokerTec trading system from January 2006 to December 2011, putting their findings in a paper released this month. The $12.3 trillion Treasury market is the worlds largest debt market.

High-frequency trades and orders tend to have a negative impact on liquidity around public-information arrival, researchers George Jiang, Ingrid Lo and Giorgio Valente wrote in the paper. After news is announced, they significantly reduce depth, both at the best quotes and behind the best quotes.

When economic data is not being released, they improve price efficiency, the researchers wrote in a working paper. That means automated trading narrows the difference between prices to buy and sell bonds.

In 2011, Michael Spencer, the CEO of ICAP, said that high- frequency trading, or HFT, accounted for slightly less than 55 percent of the volume on BrokerTec.

Public scrutiny of Treasury trading has intensified since Oct. 15, when a sudden surge in bond prices caused the yield on 10-year notes to drop the most since 2009. The event highlighted the urgency of understanding what is happening in one of the worlds biggest markets.

Lightly Regulated

Light regulation for trading U.S. government debt has created the space for possible market manipulation. Executives at three of the largest market-making firms raised concerns earlier month. They told Bloomberg News that an electronic bait- and-switch tactic known as spoofing — already the focus of alleged manipulation at a futures exchange — needs to be investigated in cash Treasuries.

Spoofers make money by feigning interest in buying or selling at a certain price, creating the illusion of demand in an attempt to make other traders move the market. The spoofer cancels the original order and buys or sells at the new price to make a profit. The practice is sometimes called pull and hit.

The rules and responsibilities governing Treasuries are split between the U.S. Treasury Department, Securities and Exchange Commission, the Federal Reserve Bank of New York and others. Rules first enacted by Congress in 1986 have gone virtually untouched for a decade and a half, creating loopholes that allow algorithmic traders to outmaneuver less-savvy rivals.

Beyond Capacity

The Bank of Canada report didnt examine the subject of market manipulation. The researchers used tick data from BrokerTec for two-year, five-year and 10-year Treasury notes. They defined high-frequency trades as those made, canceled or altered at a speed deemed beyond manual capacity, according to the working paper.

They also used ICAPs i-Cross co-location service, which reduces the time it takes for HFT firms to execute their orders but does not have any other direct impact on market quality to identify the effect of HFT on the market, the researchers wrote.

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net Will Hadfield

On The Move: McCarthy to Head Nasdaq ETP Listing and Services

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Jeff McCarthy has been named vice president, head of ETP Listings & Services at Nasdaq. McCarthy hails from Citigroups Investor Services & Markets group, where he was responsible for Global ETF & North America Fund Services. Prior to his tenure at Citigroup, he served as the Global ETF Product Head and Global Sales & Relationship Manager at Brown Brothers Harriman & Co.

At his new role inside Nasdaq, McCarthy will be responsible for all aspects of Nasdaqs U.S. ETF Marketplace. According to Nasdaq, we will guide issuers through the development, listing, and trading processes. He will also manage the workflows required to list a new ETP (exchange traded product) on The Nasdaq Stock Market, including all aspects of product pricing, packaging, sales and marketing efforts.

McCarthy will work alongside the market makers Index Licensing and U.S. Equity Transactions teams, and will report to Brian Hyndman, senior vice president, Nasdaq Global Information Services.

We are confident that Jeffs extensive ETF background – coupled with more than 16 years of experience building relationships in the ETP space – will make him a tremendous asset to Nasdaq and our many ETP sponsors and issuers, said Hyndman in a press statement.

Security Traders Association of Wisconsin Annual Conference 2014

Editorial Staff
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Security Traders Association of Wisconsin Annual Conference 2014

Top 2014 Trends: Bitcoin Comes of Age – Awkwardly

Editorial Staff
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Sure, your mother may have no idea what a Bitcoin is, and some investors who lost money trading it most likely wish that they had never heard of it, but one thing is certain: 2014 was the year of the Bitcoin, and the buyside is paying attention.

Theres no denying that Bitcoin had quite a year. There were allegations of a Ponzi scheme, new hedge funds and dark pools dedicated to the currency cropped up, and now the ultimate mark that the crypto-currency that started as the tender of drug traffickers and mercenaries has arrived − regulatory oversight.

And hedge funds and brokers are taking the $7.8 billion Bitcoin industry very seriously. “Digital currencies like Bitcoin are not going away,” said Barry Silbert, founder and CEO of SecondMarket, a capital-raising platform for private companies and investment funds. SecondMarket is creating what it hopes will become the largest, best-capitalized and best-run Bitcoin exchange in the U.S., and is enlisting banks and Bitcoin-related firms to be exchange members. “And Wall Street and the regulators know this; they’ve studied how to deal with it, and now they are starting to understand its potential,” Silbert said.

As Bitcoin slowly and steadily gains a foothold with more forward-thinking investors and consumers, financial services firms are looking to make a killing, either in investing in the 12 million Bitcoins currently in circulation or servicing its investors. “We’re betting that the market is going to be there, maybe not next month, but soon,” said Alec Petro, managing partner at Bay Hill Capital Management in Duxbury, Mass. “Institutional players are going to want to be in this space.”

Not to be outdone, SecondMarket has launched the Bitcoin Investment Trust, a $70 million open-ended trust that invests exclusively in Bitcoins, as well as a dedicated desk of 10 traders who buy and sell Bitcoins for the trust and other institutional clients.

Earlier this year, Atlas ATS opened a dark pool dedicated to trading Bitcoin currencies among institutional investors and established Bitcoin exchanges in Canada and Europe, with plans for more in Africa. It also offered a white label trading platform that will allow firms to offer their customers an exchange platform to trade and store Bitcoins. Were leading the charge on this from a technology point of view, said Shawn Sloves, co-founder and CEO of Atlas ATS. Sloves is not some shady anarchist with agoatee and a Guy Fawkes mask; he previously developed trading products and networks at Mantara and SunGard, and is co-founder and CEO of Fundamental Interactions, a virtual trading platform firm.

This year, TeraExchange joined forces with BitGo to provide secure custodial services for USD/Bitcoin swaps executed on its swap execution facility. TeraExchange is registered with the Commodity Futures Trading Commission, and it aims to provide access to Bitcoin swaps, interest rate swaps, credit default swaps and non-deliverable forwards.

All is not rosy in Bitcoin world, however. This summer, a judge fined a Texas man $40.6 million, blocked him from trading the virtual currency and further ruled his case as securities fraud that can be pursued by federal regulators. This was the first case to declare that the SEC has the authority to regulate Bitcoin transactions, and therefore opened the door to greater regulatory oversight. Bitcoin may not be attached to any sovereign nation, but it is subject to laws in the nations where it is traded.

On the Move: Scoria Hires Ex-SAC Manager Orenstein

Editorial Staff
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Ted Orenstein, a former money manager for Steven A. Cohens troubled hedge fund, will join Scoria Capital Partners where he will focus on industrial stocks.

According to Bloomberg, Orenstein is a veteran of SAC Capital Advisors, which suffered a slew of bad headlines, arrests and fines for allegations of insider trading. SAC closed down its hedge fund to manage Cohen’s own money as Point72 Asset Management. Orenstein has worked with Cohen for the past 12 years and most recently ran a portfolio worth an estimated $500 million to $1 billion, according to news reports.

Orenstein starts trading at Scoria, which is based in Greenwich, Conn., on January 5. The fund was founded by Larry Sapanski and reportedly has $235 million in assets under management. Orenstein will be one of six traders inside Scoria.

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