BlackRock Borrows Against Diversity – Bloomberg


Nice BlackRock

The basic idea of green bonds is that some investors want to finance environmentally friendly projects, for reasons of their own, and they are willing to pay more to do so. So if a company can issue bonds at a 4% yield to finance its regular business, perhaps it can issue green bonds at a 3.9% yield to finance its green projects. There is extra demand for sustainable finance — demand from individual investors who care about sustainability, or from institutional investors with sustainability goals in their mandates — and so issuers of green bonds can get a “greenium,” that is, get more money at lower interest rates than they could by issuing regular bonds.

In principle you could do the same thing with any other environmental or social goal that people care about. If investors care about diversity, for instance, you could issue a bond saying “we will use this money to create a more diverse workforce,” and investors would charge you a lower interest rate for it. Or, since that doesn’t exactly make sense — it’s easier to earmark specific money for green projects than it is for diverse hiring and promotion — you could issue a bond saying, like, “we will use this money for regular stuff, but we will also create a more diverse workforce.” One way to do that would be to have a contingent interest rate: “We’ll pay you 3.9% interest if we hit a set of diversity goals, or 4.1% if we don’t.” That way investors who care about diversity will get what they want (diversity) at the cost of giving up some economic return; also, the issuer will be incentivized to do what those investors want (become more diverse) in order to save money. 

That is the point of all socially responsible investing, really; the idea is that socially responsible investors provide cheaper capital to companies in exchange for those companies promising to do socially responsible things. This makes it more economically appealing for otherwise self-interested companies to be socially responsible. It uses the forces of capitalism to encourage good behavior; it translates investors’ social and environmental goals into financial rewards for companies.

The implicit theory here is that investors have social and environmental goals and issuers don’t. Companies, in this model, simply maximize shareholder value; they wouldn’t do socially or environmentally responsible things unless they had a financial incentive to do so. Investors, meanwhile, do not simply maximize financial returns; they will explicitly accept a lower return in exchange for getting what they want environmentally or socially.

But what is going on with this BlackRock loan?

Investment giant BlackRock Inc. will need to hit its staff-diversity targets and other sustainable-business goals to keep its corporate borrowing costs down.

The firm struck a financing deal with a group of banks that links its lending costs for a $4.4 billion credit facility to its ability to achieve certain goals, like meeting targets for women in senior leadership and Black and Latino employees in its workforce. …

BlackRock’s progress on growing assets in funds focused on companies with high environmental, social and governance ratings will also impact its lending costs. …

The loan is a five-year credit facility that gives BlackRock a ready pool to draw on in emergencies. The clauses were among other changes BlackRock negotiated recently with its banks that included a $400 million increase to the size of the facility. 

Here’s the loan amendment.

 The relevant provisions are in the new section 4.17, “Sustainability Adjustments.” Basically BlackRock’s interest rate can go up or down by 0.05%, and its commitment fee can go up or down by 0.01%, depending on how it performs on the sustainability metrics.

If you told me that BlackRock was selling sustainability-and-diversity-linked bonds to a group of socially responsible investment funds, I’d be like, sure, fine, makes sense. There is a lot of demand —  from BlackRock, as it happens, but also from other big investment firms — for green and socially responsible investments, and there’d be nothing surprising about BlackRock taking advantage of that demand by issuing bonds with interest rates tied to sustainability and diversity goals.

But in fact BlackRock is selling a sustainability-and-diversity-linked revolving credit agreement to a group of big banks. Socially responsible investment funds are not really in the business of doing unfunded revolvers; the lenders here are just regular old banks. Wells Fargo & Co. is the administrative agent, Citigroup Inc. is the syndication agent, and the list of lenders is a pretty standard assortment of giant global banks. In fact, in this amendment, BlackRock has added two banks to its list of joint lead arrangers, Industrial and Commercial Bank of China Ltd. and China Construction Bank Corp. It seems unlikely that they came into this loan on the condition that BlackRock improve its diversity practices.

In general, it seems unlikely that the big banks in BlackRock’s revolver wanted any of this. There might be some public-relations or investor-relations benefit to a big bank doing environmental or socially responsible things (though probably not for ICBC or CCB?), but that means things like stopping lending to coal companies or pushing IPO issuers to have diverse boards, not, like, charging BlackRock one basis point less on a revolver in exchange for being more diverse. I doubt this loan would check any boxes for any of these banks, that it would make any of their shareholders any happier, that it would solve any non-financial problem for them. Presumably they agreed to it not because they care about BlackRock’s diversity or sustainability, and not even because they are making some sort of economic bet against BlackRock achieving its diversity goals; they agreed to it because BlackRock is a giant global asset manager that does a ton of business with banks, so they can’t really say no to its weird whims.

Obviously BlackRock wanted it, though. In addition to being a borrower on this credit agreement, BlackRock is a gigantic investor with a lot of environmental and social-responsibility mandates, and with a general inclination toward this sort of thing. Its chief executive officer, Larry Fink, writes annual letters to other CEOs scolding them about being more socially responsible; it has announced plans to push clients into more sustainable investments; it has agreed with a shareholder proposal to do a racial diversity audit. It fits with BlackRock’s image, to make binding (well, binding-ish: one basis point!) promises to improve its diversity and sustainability.

Still it’s a weird place for it. BlackRock could have announced “we have some diversity and sustainability goals, and we will publish a report in a year about whether we meet them, and if we do we’ll have a party, and if we don’t we’ll donate $440,000 to charity.”

 That would be about as good an economic incentive as this weird revolver, and would leave the banks out of it.

But the goal here is presumably not (just) to bind BlackRock to its commitments; the goal is to create a precedent, to show other companies that it can be done, and to force banks to deal with this sort of thing. Banks will grudgingly agree to this weird deal because it’s BlackRock; they’ll get approvals and legal documentation and so forth in place to make loans with interest rates that vary based on sustainability goals. And then some other company can (try to) use the same template, and sustainability-goal-based financing can become more mainstream.

It does invert the usual theory, though. This is not a case of investors pushing companies to be more sustainable and diverse; this is a company (albeit a big investing company) pushing its investors to push it to be more sustainable and diverse. And why not? There’s no real reason to believe that most actual companies — most actual executives at companies, that is — are motivated solely by maximizing financial returns to shareholders. Some CEOs care about diversity and sustainability as goals in themselves. Why not get investors to pay for them, too?

Archegos timing

As of, let’s say, Monday, March 22, Bill Hwang’s family office Archegos Capital Management had total return swaps in place with a half-dozen banks that gave it economic ownership of giant gobs of ViacomCBS Inc., Discovery Inc., Baidu Inc., GSX Techedu Inc. and a half-dozen other stocks. As the week went by, those stocks went down, and Archegos’s swap counterparties sent it margin calls demanding that it post more cash to maintain the swaps. Archegos more or less declined to do that, and by, let’s say, the following Monday, March 29, it did not have those swaps anymore.

 

The banks that served as Archegos’s counterparties on the swaps hedged those swaps by owning the underlying giant gobs of stock. So for instance Goldman Sachs Group Inc. and Morgan Stanley are listed, on Bloomberg, as the top two holders of GSX Techedu, with a combined 32% of the American depositary receipts as of January, not because they are big GSX bulls but because they are (well, were) swaps counterparties for big GSX bulls like Archegos. When Archegos defaulted on its margin calls, the banks terminated its swaps, which means that they were no longer economically short enormous amounts of stock to Archegos. One result of this is that they were economically long enormous amounts of stock, unhedged: The huge quantities of stock that they had owned as hedges for their huge swaps were now just naked long positions; the banks were economically exposed to whatever happened to the stocks. Roughly speaking, they bought the stocks at the price of their financing to Archegos: If a stock peaked at $100 and a bank required 15% margin, then the bank got to seize Archegos’s $15 of cash and effectively owned the stock at $85.

This is bad. Mainly it is bad because banks do not want to be in the business of owning large unhedged blocks of stock. Owning $10 billion of one company’s stock to hedge a $10 billion swap is just good customer service and usually (not always!) does not expose you to much market risk. Owning $10 billion of one company’s stock outright is a weird proprietary position and exposes you to $10 billion of market risk.

But it is also bad because the stocks are going to go down. For one thing, the stocks already went down; the whole problem started because Archegos’s stocks went down, leading to the margin calls that blew it up. For another thing, the fact that all of Archegos’s banks suddenly owned big unhedged chunks of stocks, and didn’t want to, means that they were all going to sell those stocks as rapidly as possible. Something like $50 or $100 billion of stock moved instantly from the hands of a long-ish-term fundamental investor (Archegos) into the hands of short-term uncomfortable dealers (the banks) who wanted to sell immediately. If the biggest holders of a stock need to sell a ton of it all at once, the stock will go down.

This is all obvious stuff and if you are one of Archegos’s banks there are basically two ways of dealing with it. One is to wait. You say, look, we have terminated these swaps and now we are unhedged outright owners of giant blocks of Viacom and Baidu and GSX and other companies that we don’t particularly care about. Our job now is to be smart owners of those stocks. The stocks are going to go down a lot this week, because every other swap counterparty is going to be selling, but if we wait that selling pressure will subside and maybe the stocks will recover and we can sell them at less of a loss, or even at a profit.

That’s a hard thing to do. Again, if you work in prime brokerage or equity swaps at a big bank, you are just not in the business of holding billions of dollars of stock, unhedged, for long periods through huge mark-to-market losses. You have $10 billion of stock, it goes to $5 billion, you have a $5 billion mark-to-market loss, the chief executive officer calls you up and asks what on earth you think you’re doing, you say “oh it’s fine, I just found myself long $10 billion of stock and decided to hang onto it, we gotta wait for it to recover,” and the CEO instantly and publicly fires you.

 Your replacement is no dummy; she knows that if she sells the stock now she’ll have a huge loss and no one will blame her — this situation is all your fault — but if she hangs onto it and it keeps going down she’ll get fired too. So she will dump the stock. 

Also, separately, waiting might just be a dumb move from a fundamental perspective, if the stocks were overvalued in the first place. Presumably if you are the swaps trader who gave Archegos exposure to those stocks, you have only limited insight into the fundamentals of the stocks. You weren’t betting on those stocks; you were just facilitating Archegos’s bets. Maybe they’ll go up when the margin-call selling pressure subsides, but maybe they won’t.

Still, there is an obvious temptation to wait. Bloomberg News reported that when Archegos’s banks got together to discuss the situation, Credit Suisse raised the idea:

Underscoring the chaos of an escalating situation, representatives from Credit Suisse Group AG floated a suggestion as they met … to confront the reality of such an exceptional margin call and consider ways to mitigate the damage: Maybe wait to see if his stocks recover? Viacom, some noted, seemed artificially low after its run-up past $100 just two days earlier.

Not only that, but it seems like Credit Suisse did wait:

The bank’s latest trades came more than a week after several rivals dumped their shares to skirt losses. Credit Suisse hit the market with block trades tied to ViacomCBS Inc., Vipshop Holdings Ltd. and Farfetch Ltd., a person with knowledge of the matter said. The stocks traded substantially below where they were last month before Bill Hwang’s family office imploded.

And it “could see further impact from the Archegos Capital Management blowup this quarter as it winds down residual positions.” This did not go great for Credit Suisse, which has taken $4.7 billion of losses, but I’m not sure that waiting a week went terribly either; Vipshop and Farfetch both closed a little higher this Monday than they did last Monday, when many of the faster banks were blowing out their positions. (ViacomCBS closed lower.) And the Archegos portfolio has recovered, a little, this week. It wasn’t a terrible plan, to wait until some of the other sellers got out of the way. It does seem to have resulted in everyone involved being fired, though, which you have to expect in this situation. 

The other approach, of course, is to sell first, before everyone else sells and the stock drops. Morgan Stanley knows:

The night before the Archegos Capital story burst into public view late last month, the fund’s biggest prime broker quietly unloaded some of its risky positions to hedge funds, people with knowledge of the trades told CNBC.

Morgan Stanley sold about $5 billion in shares from Archegos’ doomed bets on U.S. media and Chinese tech names to a small group of hedge funds late Thursday, March 25, according to the people, who requested anonymity to speak frankly about the transaction. …

Morgan Stanley had the consent of Archegos, run by former Tiger Management analyst Bill Hwang, to shop around its stock late Thursday, these people said. The bank offered the shares at a discount, telling the hedge funds that they were part of a margin call that could prevent the collapse of an unnamed client.

But the investment bank had information it didn’t share with the stock buyers: The basket of shares it was selling, comprised of eight or so names including Baidu and Tencent Music, was merely the opening salvo of an unprecedented wave of tens of billions of dollars in sales by Morgan Stanley and other investment banks starting the very next day.

Some of the clients felt betrayed by Morgan Stanley because they didn’t receive that crucial context, according to one of the people familiar with the trades. The hedge funds learned later in press reports that Hwang and his prime brokers convened Thursday night to attempt an orderly unwind of his positions, a difficult task considering the risk that word would get out.

That means that at least some bankers at Morgan Stanley knew the extent of the selling that was likely and that Hwang’s firm was unlikely to be saved, these people contend. 

Yeah, well. If you know you are going to need to sell $50 billion of stock, and you start by selling $5 billion of stock, you will naturally not want to tell the buyers that there’s $45 billion more coming. Then, when the $45 billion more comes, the price will go down more, and your original buyers will feel betrayed. They were betrayed! That’s life as an arm’s-length counterparty: Sometimes you dump a lot of stock on a bank without telling it that you’ll be selling more; other times, the bank dumps a lot of stock on you without telling you that it’ll be selling more.

It was unsporting for Morgan Stanley to do this to those hedge funds, and those funds should be mad at Morgan Stanley and maybe refuse to trade with it for a little while, but also it was totally the right call for Morgan Stanley to do this, and they’d do it again if they had to. If you are looking at billions of dollars of potential losses, and you can avoid them by burning some clients, you burn the clients. And then they are justifiably mad at you, and they say mean things to the press and you lose some prospective business, but you save the billions of dollars. Seems better than the alternative.

Greensill

Well I look forward to this lawsuit:

Credit Suisse Group AG is leaning toward letting clients foot the bill for eventual losses in funds that the bank ran with former billionaire Lex Greensill’s company, according to a person familiar with the matter.

The bank considers that the risks around Greensill were known and the funds were only marketed to investors able to assess such risks, the person said, declining to be identified discussing private matters. The Zurich-based lender didn’t take any substantial loss due to Greensill in the first quarter.

The bank’s stance runs counter to reports last month suggesting executives were considering compensating investors hit by the collapse of the funds. Credit Suisse marketed its popular supply-chain finance funds as among the safest investments it offered, because the loans they held were backed by invoices usually paid in a matter of weeks.

But as the funds grew into a $10 billion strategy, they strayed from that pitch and much of the money was lent through Greensill Capital against expected future invoices, for sales that were merely predicted. Now, investors in the frozen funds are left facing the potential for steep losses as the assets are liquidated.

I wrote yesterday that “one problem with ‘prospective receivables finance’ is that it is easy to confuse with fraud.” The popular perception of Greensill, the one that was regularly reported in the press and that Credit Suisse relied on in marketing, is that it was a supply-chain financing firm that made short-term loans secured by invoices. The fact that it was actually making long-term speculative loans secured by “expected future invoices” is … uh … maybe it’s fine … but it surprised a lot of people.

Did it surprise investors in those Credit Suisse funds? I don’t know, but I bet they’ll find some lawyers who’ll say it did! It is just hard to defend, you know? You go to trial, and the investors’ lawyer shows you loans against imaginary invoices and asks “did you know, when you marketed this safe supply-chain financing fund to investors, that these invoices were fake?” If you say “yes,” then you were in on a fraud; if you say “no,” then you failed in your due diligence. The correct answer is “well of course they’re fake, that’s how prospective receivables finance works, don’t be naive,” but that will not play well with a jury.

Speaking of that defense, here’s a letter from Greensill client Sanjeev Gupta to the Financial Times:

We note the allegation in the story written by Robert Smith and Cynthia O’Murchu (“Questions raised over Gupta invoices”, Report, April 3). Before the story was published you contacted us about an allegedly outstanding invoice to RPS Siegen GmbH. When we asked for that outstanding invoice to be produced, so that we could investigate, it was not provided. As has already been reported in the press, many of Greensill’s financing arrangements with its clients, including with some of the companies in the GFG Alliance, were “prospective receivables” programmes, sometimes described as future receivables.

As part of those programmes, Greensill selected and approved companies with whom its counterparties could potentially do business in the future. Greensill then determined, at its discretion, the amount of each prospective receivables purchase and its maturity. Therefore, although RPS Siegen GmbH was a company identified as a potential customer of Liberty Commodities, it is not one currently. 

“Of course it’s fake, that’s how prospective receivables finance works, don’t be naive.”

WSB DD alpha

If someone on Reddit’s Wallstreetbets forum tells you to buy a stock, should you buy that stock? I want to be clear that I do not give investing advice around here, and that I personally have never bought a stock based on a Reddit recommendation and probably never will. However, in my journalistic capacity, I must tell you that the answer might be yes?

We examine the market consequences of due diligence (DD) reports on Reddit’s Wallstreetbets (WSB) platform. We find average ‘buy’ recommendations result in two-day announcement returns of 1.1%. Further, the returns drift upwards by 2% over the subsequent month and nearly 5% over the subsequent quarter. Retail trading increases sharply in the intraday window following publication, and retail investors are more likely to be net buyers following reports that earn larger returns. Thus, in sharp contrast to regulators concerns that WSB investment advice is harming retail traders, our findings suggest that both WSB posters and users are skilled.

That is the abstract of “Place Your Bets? The Market Consequences of Investment Advice on Reddit’s Wallstreetbets,” by Daniel Bradley, Jan Hanousek Jr., Russell Jame and Zicheng Xiao. Wallstreetbets seems to be more influential than Seeking Alpha, though less so than professional analysts:

Our focus is exclusively on single firm ‘Due Diligence” (DD) reports, which are reports identified by the poster (and verified by moderators) as containing some type of analysis and a clear buy or sell signal. Our sample includes 2,340 DD reports issued between 2018 and 2020. The number of DD reports increase exponentially through time coinciding with the exponential growth in the WSB user base. Consistent with the view that WSB emphasize speculative investments, we find that DD reports tilt towards unprofitable, volatile stocks with low institutional ownership.

After examining the determinants of WSB reports, we turn to the investment value of DD recommendations. We find ‘buy’ DD recommendations (~80% of all DD reports) earn two-day abnormal returns of roughly 1.12% percent. These returns are statistically significant and economically large, albeit smaller than the average returns to sell-side analyst recommendations (Womack 1996; Crane and Crotty, 2020), but substantially larger than the returns to Seeking Alpha recommendations (Farrell, Jame, and Qiu, 2020). We do not however, find significant abnormal returns to ‘sell’ recommendations.

Incidentally one thing that people like to complain about is that something like three-quarters of all sell-side analyst recommendations are “buy” or “strong buy.” People take this to be proof that Wall Street research is biased by the need to maintain good relationships with issuers, and that is probably true, but it’s worth noting that pure hobbyist due diligence on Wallstreetbets skews even more toward “buys.”

 Being nice and enthusiastic is just more appealing than being negative!

Anyway in addition to being influential, Wallstreetbets research seems to be … good?

We next examine if this price movement is transitory (e.g., due to short-term uninformed price pressure) or permanent. We fail to find any evidence of reversals. In fact, the returns continue to drift in the same direction over the next month. For instance, we find Day (2,21) returns of 1.45%, which are highly statistically and economically significant. Further, the cumulative one-quarter return following buy DD recommendations exceeds 6%. …

Collectively, our evidence suggests that 1) WSB DD posters have skill and 2) retail investors may have some ability to discern report quality. Our evidence is in sharp contrast to the conventional view that WSB only attracts uninformed investors and to regulators fears that following the advice of user reports on WSB results in significantly less informative retail trading. 

“Guys these people are saying we’re smart,” is the headline on the r/Wallstreetbets thread about the paper. It is early, though: The paper’s evidence runs from 2018 to 2020 and misses the whole GameStop/meme-stock situation. 

Elsewhere, here’s a fun story about generational disagreements between old people who invest based on fundamentals and young people who invest based on memes:

“I’m on Reddit every single day and I’m constantly analyzing all social media posts and people on Twitter, so I’m seeing this data way faster than my dad is able to,” Kevin Aldrian said.

He persuaded his dad to buy into AMC Entertainment Holdings Inc., a “meme stock” that also benefitted during the Reddit-driven GameStop frenzy. Both made big gains, they say, after buying in at around $2 and selling at $17.

Things happen

Non-Existent Cattle Cost Tyson $200 Million at Bankrupt Ranch. Topps Is Going Public in $1.16 Billion SPAC Deal With an Eye on NFTs. How Ken Griffin rebuilt Citadel’s ramparts. Clubhouse Discusses Funding at About $4 Billion Value. Flying-Taxi SPAC Accused of Stealing Aircraft Technology. Singapore’s Grab set to list in New York in biggest Spac merger. DoorDash Drivers Game Algorithm to Increase Pay. “The CEO of a Michigan-based telecommunications company … was quietly designing an underwater drone meant to shuttle large amounts of cocaine to Europe as part of a massive drug trafficking organization that [prosecutors] say he was financing.” Ice Cube Says Robinhood’s ‘Terrible’ Products Sullied His Image.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at [email protected]

To contact the editor responsible for this story:
Tracy Walsh at [email protected]


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