Off message: Communicating in the shadows

by John Anderson

For this month’s column, the editor kindly suggested I take a look at issues related to the steady incursion of shadow banking. He wanted to know if private equity and hedge funds are having a tough time facing off to clients, now that they are becoming more and more like banks. Those funds would once have taken great pains to set out their non-bank credentials to those same clients.

After talking to practitioners on each side of the divide I can report back conclusively that the answers to the editor’s contention are: maybe, kind of, once in a while, and who the devil knows?

Here’s what I do know. Investment banking has always been an incredibly competitive business. Up until the repeal of Glass-Steagall, the bulge bracket banks and a tight coterie of subalterns fought it out in banking’s equivalent of football’s Premier League. Post Glass-Steagall, the competition was expanded to include teams that were only just learning out how to play the game in real stadiums.

Now, however it looks like someone has populated the top table with a handful of Aussie Rules football clubs and a dollop of English county cricket teams.

Consider the following:

• a recent report cites the rise of hedge funds making markets in FX;

• a credible financial website recently listed its top 25 global banks and five of them were either funds or non-regulated banks;

• trawl the websites of the biggest players on each side of Fund Street and you will see as much commentary about the lack of liquidity in the bond market as you will about asset allocation or investment returns;

• more pointedly, the number of chunky deals led by funds or non-regulated banks is rising.

How does all this play out in the trenches with the people who are actually talking to the issuer clients and doing the deals?

On the banking side, there might be a consensus that there is an issue at hand but there is no consensus on how it affects the face-off to the client.

One banker offered up the nugget that he does remind clients that ultimately the alternatives will be regulated and life will change.

That same banker’s colleague observed that ultimately all a client wants is good pricing, crisp execution and support he can count on.

Then came the interesting remark that at the moment banks regard funds as participants not competitors. That’s a lovely thought I suppose, but in my mind it conjured up images of a mongoose and a cobra taking a nap in opposite corners of a steel cage – there might not be a lot of action at the moment, but just wait.

The financial sponsor desks at investment banks would appear to be caught in the vortex of this all, but one head of a desk seemed rather calm about things, content in the fact that some of her bigger clients were focused on making hay in the world of distressed debt. That could change, however, if the global economy improves any time before we all retire and those same funds may start looking for yield in more conventional deals.

I promised myself I wouldn’t get into regulatory matters in this column – I simply don’t have enough neural synapses left for that kind of analysis. Unfortunately, this phenomenon turns on the future actions of the regulators.

At some point, they have to figure out a way to level the playing field and that’s when we should all hold our breath. I’m convinced that history isn’t going to be kind to the regulatory/political response to the Great Global Fire of ‘08.  

Admittedly, we may have blown up the world, but whether or not you like it, the world now needs us and the knee-jerk, heavy-booted response from regulators has not been particularly brilliant. Dare I say it has demonstrated that the regulators simply don’t understand the intricacies of our industry?

So now we wait while those same regulators consider how to sort this situation out. No investment banker I’ve talked to is optimistic about how that will work out. And it might surprise you that it’s not in the best interest of the banks for those alternatives to get hobbled by the wizards in London, New York or Basle. Something about detonating a hand grenade in your own foxhole comes to mind.