The first year of Covid-19 has caused havoc for many industries, but specialist firms whose business is correlated with capital-markets issuance have seen buoyant conditions as volumes have soared.
For ConvEx Advisors, a calculation agent that has been helping European issuers manage their obligations to convertible bond investors since 2012, the time has come for the next step in its growth: making it in the US.
This is the single biggest step we have taken since we started hiring
Mark Dalton, an ex-UBS banker who is ConvEx’s founder, thinks that pushing into the US is a logical move for the firm, after a period of success that has seen it emerge as the dominant calculation agent for European convertible bonds.
Since 2012, the company has worked with more than 300 issuers on public and private deals totalling $200 billion.
“This is the single biggest step we have taken since we started hiring people in 2015,” he tells Euromoney.
On Thursday, Dalton announced that ConvEx was launching in New York with two staff on the ground. Strategic equity veteran Alan Rifkin is heading the desk, after a career that included 15 years at Citigroup. He was most recently head of strategic equity solutions at UBS.
He will be joined by Justin Veltre, who used to head the global convertibles team at Thomson Reuters. In time, if the business takes off as it has in Europe, ConvEx’s US team could expand to half a dozen people.
Right time
As a calculation agent, ConvEx spends most of its time looking after the mathematics of conversion ratios and other dull but essential aspects of convertible bond issuance. In Europe, where the role is by now a routinely accepted one by issuers and their advisory banks, ConvEx has grown to be the main player by far.
The US, where such things have traditionally been handled by the banks themselves, poses more of a challenge. It’s why ConvEx has shied away from embarking on a move there in the past. The higher equity capital market fees that are routinely paid in the US make it easier for banks to help issuers out – and for issuers to expect them to do so.
Doing the maths: Why bother with a calculation agent?
For a calculation agent such as ConvEx, potential clients usually come knocking after things have gone wrong. And in convertible bonds, there is plenty to go wrong.
“It’s usually forgetting to do something or doing it incorrectly,” says Mark Dalton, founder of ConvEx. “A company might announce a dividend, the stock goes ex-dividend and investors start to look for the conversion ratio adjustment notice for the bonds. They can’t find it.
“Two or three weeks might go by and then eventually someone will call you and say, ‘Hey, I think you’re in breach of your terms and conditions’.”
At that point there can be panic, which might go all the way up to an issuer’s chief financial officer. A typical response would be to fire out a plea for help to a deal’s underwriting banks.
“The problem is that you might ask four banks and get four answers,” says Dalton. “And then the issuer is thinking, how can anyone expect us to get it right?”
Forgetting to do things is one aspect. Another is not picking up on the precise definitions laid out in an issue’s documentation.
‘Current market price’ looks simple enough, but often means something more nuanced. It might refer to a five-day historic volume-weighted average price, for instance, but a desk junior unfamiliar with the niceties of a deal’s language might look instead at whatever is showing on their screen at that time.
Adjusted prices are another trap for the unwary. It wouldn’t be unusual for your Bloomberg to be set up to adjust historic stock prices to account for them going ex-dividend. But if a calculation is asking for pre-dividend prices, you’ll be in trouble – and you might not hear about it until it’s much too late.
“You might make what appears to be a small error in favour of investors to the tune of thousands or even millions of dollars,” says Dalton. “And believe me, no one calls to tell you about that.”
What has changed? A very busy market certainly helps. So far this year, there has been about $80 billion of convertible bond issuance in the US. In the second quarter alone there was about $50 billion, roughly the same as in the whole of 2019. Europe stands on $25 billion this year, compared with $17 billion in 2019.
However, high activity levels help not because they mean more deals for ConvEx to be involved with but because banks are much busier, meaning they may have less time to devote to ancillary services.
Market participants also say fees are starting to fall a little, which may in time see banks rethink the scope of their desks. And for all the talk of bankers returning to work in their offices, the Covid-19 pandemic is still causing severe disruption to teams.
There are US-specific reasons, too. Dalton has been spending the past few years sounding out where the requirements of US-based issuers might differ from those elsewhere, and whether those differences add complexity that could increase the scope for business. His conclusion is that they do.
“We have learned a lot about the way in which people put in place derivatives related to convertible bonds, whether to fully hedge issues – like the European non-dilutive CBs – or whether related to call spread overlays, which are a big part of that market,” he says.
A call spread overlay is used by a convertible bond issuer to effectively increase the conversion price of an issue and thereby manage dilution.
There are a few ways to do it, but the most common is for an issuer to buy from its banks a call with a strike price set at the bonds’ conversion price, which offsets the short call position that the issuer has through selling the convertible bonds. At the same time, it sells those banks another call with a higher strike.
Arrangements such as these are handy for issuers, but increase the number and complexity of calculations and adjustments that are needed throughout the life of a convertible bond.
Opportunity
Dalton thinks all these factors add up to an opportunity, but there are still a few challenges to navigate. For ConvEx to be formally designated as the calculation agent on a particular issue, its role will have to be written into the deal documentation.
“People will have to change the way they document transactions, but we have done a few issues structured as US deals but for European clients, and this was not hard to do,” he says.
Meanwhile, ConvEx’s European business added another head in November 2018, when Nick Sibbering, the last trader standing on UBS’s European convertible bonds desk, joined after a 20-year career in trading and structuring converts.
The company is continuing to branch out into other areas that demand the same number-crunching and attention to detail. That includes capital securities and make-whole calls, but also stretches to benchmark rate transition.
“We are talking to banks and corporates on existing instruments, particularly issuance since 2018, where issuers and law firms ask us to check the fall-back language in the documentation,” adds Dalton.
