The cancer at the heart of capital markets

Last week, Martin Wheatley at the FSA was asked to make a pretty rushed judgement on the British Bankers Association ‘s(BBA) setting of the LIBOR rate. As we all know, this is a key rate, less important than it used to be sure, but still key to setting long-term mortgages and bond prices as well as many bank loans.

With the various Global banks involved in the Libor scandal seemingly bang to rights in terms of their guilt for trying to fix LIBOR, it comes as no surprise to learn the Government will now strip the BBA of the right to set it (tactfully the BBA had thrown in the towel earlier) and this will now go to an independent body. Plus, banks will have to quote real trades and not their ‘averages’ and so they will be less able to fudge the numbers going forward. A welcome victory for the market then, with ‘real’ market forces and an independent body be put in charge. As a consequence of the Libor rate rigging scandal, the setting of the Gold rate in London and now various other commodity ‘fixes’ are also under question.

What is also clear  to me throughout this whole process is just how much the FSA now distrusts the capital markets, bankers and traders en bloc. If this is to be their new default setting then I can see many more targets for investigations coming. So many in fact the that their action is more likely limited solely due to the FSA’s staffing capacity rather than by the number of potential cases.

Take for example market making in smaller shares in illiquid markets – a real bone of contention for many smaller private investors. The capacity for ‘co-petition’ (as opposed to competition) and for brokers to help each other is huge. Plus, even the FSA admit that around 25% of all trades before major RNS announcements are ‘suspicious’ – in fact they are pleased that this number is actually lower than a few years ago but still substantial and symptomatic of the ‘insider’ riven environment that is the UK markets and that many private investors are sacrificed at the altar of greed due to the information deficiency they suffer. Ask yourself this question – last week Bumi shares fell 20%on the Friday before the announcement of a probe into the company – plainly obvious those “in the know” were stepping aside. What did the company’s broker say? “Nothing suspicious in our book Guv” – despicable!

Then there are the real challenges around ETF’s and so called ‘Delta One’ trades – where synthetic structures do not really hold the underlying assets that buyers think that they do. ETF’s in fact managed to get suspended in 2008 and I personally have not touched them since given the small print they come with that ‘lightly’ informs you that there is no real relationship between the synthetic instrument and the market!

And then the bid daddy of all problems, the one that is technically holding markets back the most – IPO’s. Banks setting the wrong IPO pricing due to vested interests has tarnished the equity markets of late with again Bumi and Facebook being prime examples where billions of pounds of misvaluation occurs… With so few genuine companies willing to risk going public presently, our main indices have become full of foreign natural resources plays and not necessarily for the greater good. We only have to look once more at Bumi this week to see the dangers here of the lack of information and control that concentrated shareholder lists have…

Currently, investment and retails banks are so stuffed with regulatory issues such that they are not focused at all on lending new money – with all the above still on the ‘to do’ list of the regulators, that won’t change any time soon in my opinion.

Cityunslicker