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Same As It Ever Was - The Talking Head

Tuesday 4th April 2023

The LatAm sovereign debt crisis of 1982 was provoked by an inability of Latin American countries, mostly Mexico, Argentina and Brazil, to repay the cheap foreign debt secured when their economies were booming; as the World economy went into recession rates on borrowing ballooned, currencies collapsed and these countries could not pay their bills. It took the IMF and major bond debt restructuring (Brady Bonds) to restore a vestige of trust in the following years...familiar?

The S&L crisis of the 1980s dragged on to the 1990s as over 700 savings and loan associations in the USA were bankrupted. In a less complicated fashion S&L lent long and borrowed short, higher rates meant poorly managed bond balance sheets provoked insolvency.... SVB?

The Junk Bond crash of 1989 is more complex and can be attributed to pivotal events such as the failure of the UAL $6.75bn buyout and the Ohio Mattress ( the burning bed fiasco) , this and other public "missteps" caused of subsequent collapse of the 5th largest investment bank in the US, Drexel Burnham. In fact, a failure to manage bond balance sheets, and a fundamental collapse in trust over hard numbers ...SVB and Credit Suisse?

The Tequila Crisis of 1994 was a rate crisis and a resulting bond sell-off. Following a reversal of Mexican economic policy to ease currency controls, to alleviate pressure on the government finances peso devalued almost 50% in a week ensuring a bond rout as investors fled the market. The Fed was in aggressive tightening mode to counter inflation, market activity fell away dramatically, liquidity dissipated, and we experienced real strain in the bond markets.... 2022?

Asian Crisis 1997/98 was triggered as Thailand floated the baht, could not meet obligations to pay dollar debt and a similar effect spread crisis to Indonesia, South Korea, Malaysia, and Hong Kong amongst others. A year later Russia was in the foresights….Sri Lanka and others?

Dotcom bubble 1999/2000 was a hysterical flush of FOMO investment in tech and internet related stocks (eBay and Amazon!) with little, or no profitability, these collapsed in value as the economy slowed and rate hikes halted the flow of easy money that had been supporting these companies... deja vu?

The GFC Crisis was the culmination of myriad factors, however, many point to a slowing global economy and failures in the European sovereign debt arena as a major provocation; however, one prime reason for this was the collapse in the US housing market...possibly uncorrelated now; but hauntingly prescient.

Moving to more recent events, what can we glean from the above? Sovereign failures as Sri Lanka, Lebanon, Russia, Zambia and Suriname resulted in default. Other sovereigns are on the brink as borrowing costs soar, inflation bites and failing economies seem imminent, Argentina, Ecuador and Egypt lead Tunisia, Ghana, Kenya, Ethiopia, El Salvador, and Pakistan amongst other candidates. The IMF is under assault...

Banks are folding as SVB heads the US and Credit Suisse, Europe. A lack of trust has brought peers into analysis and distress. It is said one print of USD5mm in CDS helped provoke a sell-off on Deutsche Bank two weeks ago. Bond and debt structure both play a central part in the examples above. It has been a debt consideration that has precipitated and provoked most often, the market with a reason to sell off and "de-risk".

How can we allow this to occur especially when we have more access to real-time data than ever?

The global fixed income markets in 2021 comprised USD 126.9 TRN according to SIFMA. Moreover, global issuance in fixed income over equities paints a stark picture:

In 2020 we saw historic highs as global debt experienced the largest in 50 years as per the IMF:

How do we accurately gauge this and manage expectations? For decades the market has been attempting to place fixed income securities into a convenient investment bucket alongside equities, foreign exchange and commodities, exchange-traded, centrally cleared asset classes. The nirvana of securing fixed income as an investment class outside the broker-dealer network onto a centralised exchange has been the aim of legislators, central banks, regulators and dealers alike. This is not happening soon.

In the 1980s, dealer boards at fixed income desks offered upwards of 50 direct market makers through which a player could offload risk. If your name was in the book and you picked up the phone you were obliged to make a market (place a bet). In the 21st Century we abandoned direct dealing in favour of more even handed inter-dealer broking of negotiated prices; more skewed to credit and value considerations than an ability to squeeze a bond higher over borrowing constraints or push lower owing to purported false supply. In today’s market dealers cannot sell short, paint the screens offer the liquidity and in distress will avoid picking up the phone; the risk rewards are asymmetric.

In response Legislators and Regulators have moved to protect the “end investor" from the practices described and a repetition of the crises we highlight above; through increasingly expensive restrictive practices in the fixed income arena and to help “prevent another Drexel, Bear Stearns or Lehman” event.

But as we play through to 2023, we have seen round after round of consolidation and capitulation by market participants reminiscent in response to "Big Bang" in 1986, Basel III from 2004+++, Dodd-Frank 2010, to EMIR in 2019 amongst others. The rollup of CS into UBS is a time-honoured occurrence. Many such alliances have been brought about by a mutual desire to higher achievement and profitability, the ones we tend to recall are those fashioned to avoid dissolution and eradication.

In their altruism these regulatory bodies have indeed, in the short term, helped calm storms and ease concerns, however, we now face a market of monstrous proportions and a handful of brave players looking to continue the game. The rules are better defined, the wagers more restricted but the oversight is heavy handed. An unfortunate consequence is that the risks for those at the table are unexpectedly commensurately greater as it becomes increasingly difficult to offload risk.

To be clear at the table, private banks do not offer "trading desks". Their "traders' on sell liquidity with a margin by reverting to these same market makers through RFQ, they do not take positions, or offer liquidity. Platforms do not "make prices" they rely on input from traders (and increasingly holders of assets) and often will supply static data that maybe both dated and erroneous. Platforms purporting to offer democratisation in fixed income trading are all ultimately reverting to these hardy few market makers.

Many have attempted to commoditise fixed income. There have been successes with homogeneous bond classes. Government securities and associated government related bonds, generally one credit, balance sheet and defined by maturity and coupon structure. The rules surrounding investment in these are mostly pro forma and readily accepted. This is not the case for corporate bonds They are defined by a singular prospectus across multiple borrowing vehicles in different jurisdictions and currencies. (ref AT!s and the continued debacle). Static data (generally not fully studied, or understood) is in place at Bloomberg as a source of truth, indeed prices are calculated through Bloomberg, however, Bloomberg and its competition will not be offering liquidity, or making you a price anytime soon.

To be open…we like exchange traded markets. Regulators feel in control; they can see who does what, how much is in play, and they can choose to halt the game if the odds are too great to support. We feel comforted when the house intervenes and cool things off, resets the game and allow players to re-engage. This is clearly not the game played out in fixed income. The game takes place behind closed doors; trades are not reported (mostly) to an exchange, the house struggles to either see, or control, the bets being waged and, more often than not, the game can very rapidly become one of forced calls and a plethora of bluffs. What could go wrong?

Ultimately, the "investor" has been the one to suffer as liquidity evaporates and venues for price discovery fall away. The regulators will push on to fine tune the blunt instruments hurriedly put in place to remediate the unconscionable; but the cost of compliance and equally, non-compliance, has discouraged many former players from any longer playing the game.

How can we help improve on these odds?

Our clients are not prioritised by size or demand, we are fully open architecture and institutional in levels of service and cost. To afford our clients a more reasonable opportunity to discover liquidity and provide a full customer interface we have secured over 60 relationships in fixed income. These comprise global relationships offering expertise in home markets and a depth of liquidity that is hard to replicate. Reliance on a bulge bracket company to serve your needs many be compromised by nationality, geography or an ability to play the game as it once did. We continue to expand these relationships and rotate through as incumbents leave the table and others ante up. We offer real-time liquidity, regardless of the size of inquiry and pass on pricing sourced through institutional market access.

We at Conduit are a few of the survivors to have witnessed and survived most of the carnage caused through the crises we described above. Perhaps we revert again to our favourite new wave artist of the 80’s as we may well have seen “Burning down the house” on more than one occasion, nevertheless we strive to ensure that for our clients it is the “Same as it ever was”.

Paul Durrant


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