published Jul 27, 2018, 10:12:15 AM, by Matt Levine
(Bloomberg Opinion) —

Bitcoin ETF fail.

Right now if you want to buy Bitcoins, you mostly have to buy Bitcoins. Presumably a lot of people who want to buy Bitcoins want to buy Bitcoins, but a lot of people don’t. A lot of people, that is, want to buy Bitcoins, but they don’t want to set up their own Bitcoin wallet or remember their private key or give their credit card number to some shady foreign crypto exchange or deal with the various other headaches inherent in the actual ownership of Bitcoins. Some of those people can buy Bitcoins without buying Bitcoins by buying Bitcoin futures, which trade on big regulated U.S. exchanges. But Bitcoin futures are expensive—a contract is five Bitcoins at CME Group, one at Cboe, and a Bitcoin is currently trading at almost $8,000—and some people don’t want to be bothered with futures contracts. They just want to buy Bitcoins in their brokerage accounts, their retirement accounts; they want to buy Bitcoins like they’d buy a stock.

I have asked, in the past: Why? I think it remains a good question. If you’re buying Bitcoin like a stock through your broker, it seems to betray a lack of confidence that Bitcoin will displace the traditional financial system. But that is I suppose a pedantic concern, and plenty of people might think that Bitcoin is a good investment (or speculation) without thinking it is actually a good system for storing their wealth.

The natural product for those people would be a Bitcoin exchange-traded fund: A pot buys some Bitcoins, it sells shares in the pot, and the shares trade on a stock exchange with a price that tracks the price of Bitcoin. If more people want to buy shares, arbitrageurs can create those shares by buying Bitcoins and delivering them to the pot in exchange for shares; if more people want to sell, then the arbitrageurs can deliver shares to the pot, get out Bitcoins, and sell them. It works for stocks, and bonds, and abstract concepts like volatility; why not have an ETF for Bitcoins?

The Winklevoss twins have been pushing a Bitcoin ETF, which would trade on the Bats exchange and would be linked to Bitcoin trading on their own Gemini exchange, for a while now. They got turned down by the Securities and Exchange Commission last March, and they tried again, and they got turned down again yesterday.

The SEC’s decision is pretty unedifying. Basically it asked Bats (which would have listed the ETF), what if Bitcoin prices are manipulated? And Bats said, well, it’s pretty hard to manipulate Bitcoin prices. And the SEC said, well, you haven’t really proven that to our satisfaction. It’s not that the SEC has any evidence that Bitcoin prices are manipulated, or even any belief that they would be easy to manipulate. (Though it does mention that recent paper examining Tether and Bitcoin.) It’s just that Bitcoin trades on a lot of unregulated under-policed venues, and the SEC doesn’t really trust them, and Bats and the Winklevosses didn’t do enough to assuage that mistrust.

It is tempting to say: So what? Let’s say Bitcoin prices are manipulated. Then if you buy Bitcoins through the Winkle-ETF, you will get a price that doesn’t reflect fundamental supply and demand for Bitcoin. That’s bad! But if the SEC bans the Winkle-ETF, then you’ll have to buy Bitcoins on some unregulated under-policed venue (or, yes, fine, Gemini, or some other fairly regulated U.S. venue), and you will also get a price that doesn’t reflect fundamental supply and demand—because, the hypothesis is, Bitcoin prices are manipulated—and also you’ll have to worry about the exchange being hacked or generally being unregulated and under-policed. The ETF is better, even if it is not objectively good.

(Also there is a good argument that the ETF will improve the ecosystem and make manipulation less likely: If the ETF is big and popular, then market makers will arbitrage it, and it will drive demand, and Bitcoin will be harder to manipulate just because there will be more volume coming from real economic demand. There is an alternative argument that the ETF will make things worse and make manipulation more likely, since it—and its mechanism of using the Gemini auction to set prices—will be a big target for manipulators to shoot against. Both of these arguments are fairly theoretical, though, as the SEC never claims that any actual manipulation is going on or explains how it would work.)

This is a deep tension in a lot of securities regulation, and you see it play out in debates about whether and how to relax rules for companies that go public. There are areas of the markets that are lit up, public, protected; and then there are vast other areas that are dark and unregulated. If you are the regulator in charge of policing the lit areas, you are constantly facing the question: Is it better to let some things into the lit areas even though they are imperfect and risky and not exactly what we want public investors to buy? Or is it better to keep them in the dark, even though investors are going to find a way to buy them there anyway? Do you want to let some bad stuff into the public markets, where at least you can keep an eye on it and try to improve it, or do you want to leave it on the private markets knowing that it’ll probably be worse?

Elsewhere in ETFs, here is a story about how State Street Corp., which pioneered ETFs and still has some of the most recognizable ones (like SPY for the S&P 500 index and GLD for gold), lost its lead and fell to third in the ETF rankings. Part of the problem is this:

To amp up its brand recognition, State Street consolidated all of its ETFs under the SPDR name in 2007, but there was a downside: The SPDR trademark belongs to S&P. When it expanded its use of the name, State Street also extended until 2031 a contract under which S&P gets one-third of the fees paid by SPY’s investors. S&P’s cut alone—$3 a year for every $10,000 invested—is almost as much as the entire fee BlackRock and Vanguard charge for their comparable funds.

Three basis points—on absolutely zillions of dollars—for the name and a list of stocks! Every time I read stuff like this I feel like I should get into the index business. I’d happily give State Street a list of stocks for two basis points.

Aramco.

Saudi Arabian Oil Co. is a gigantic company that owns gigantic oil reserves and makes gigantic amounts of money every year by pumping and selling that oil. It is also a state-owned company whose fortunes are intertwined with Saudi Arabia’s ruling dynasty, and that has some history of confusing the desires of that dynasty with the business needs of the company. Also it, or rather they—Saudi Aramco and the Saudi rulers, jointly—want to raise something on the order of $100 billion to diversify the Saudi economy. The rough idea is that investors would give Aramco a lot of money, and Aramco would give it to the Saudi state, and the Saudi state would invest the money in its Public Investment Fund. The outside investors would then have an investment in Aramco, and the state would reduce its investment in Aramco and would diversify itself by using the PIF money to buy, like, stakes in tech startups or whatever.

Given that simplified background, here is a question: Should Aramco raise debt or equity? There are, it seems to me, some really good arguments for debt:

Aramco is a giant company with oceans of oil reserves and tons of cash flow, so it can probably pay back any money it borrows. Aramco is deeply intertwined with the Saudi state and its ruling dynasty, and it would be difficult to separate it out as a truly independent public company with clear fiduciary duties to its outside shareholders and the kind of corporate governance that can manage conflicts of interest.

In a sense, this is a perfect case for debt financing. Debt is an essentially contractual, explicit arrangement; equity is a matter of trust and fiduciary duties and co-ownership. When you raise equity, you say to investors: “We’ll take your money, and we can’t promise we’ll pay it back, but we’ll all be in this together and if we do well you’ll do well too.” When you raise debt, you say to investors: “We’ll take your money, and we’ll pay it back with interest, but otherwise leave us alone.” I mean, there are covenants and stuff. But Saudi Aramco is a huge and good enough credit that it can probably pretty easily raise tens of billions of dollars of debt without, like, disentangling itself from the Saudi dynasty, or committing to manage conflicts of interest, or operating with all that much transparency. Just take the money, pay it back, and you’re fine.

Anyway Saudi Arabia has for a while been working on an initial public offering of Aramco, but that IPO has slipped as the state has gotten cold feet about the levels of transparency, legal exposure, shareholder governance rights, etc., that would be required of a public listing in a major overseas financial venue. So instead, debt:

Crown Prince Mohammed bin Salman’s advisers are prodding Saudi Arabian Oil Co., as the oil company is officially known, to raise debt to buy a controlling stake in a petrochemical company from the country’s sovereign-wealth fund, said Saudi officials and executives familiar with the talks.

A potential deal would give the Public Investment Fund between $50 billion and $70 billion for all or part of its stake in Saudi Basic Industries Co., officials and executives said. Controlled by the state, Sabic is the country’s largest publicly listed company, with a market capitalization of about $100 billion.

If Aramco did an IPO, it would just be the state directly selling its shares to investors; if it raises debt, then it will have to give that money to the state in exchange for something, and the something seems to be Sabic. The debt would be a mix of bank loans and international bonds, which “could open its accounts up to scrutiny from investors.” And: “Neither Aramco nor Sabic are enthusiastic about the deal, said the officials and executives, but the companies have acquiesced under pressure from the prince’s advisers.”

There are two main disadvantages to issuing debt, though. One is that it doesn’t diversify you as much as selling equity does: If Saudi Arabia sells an equity stake in Aramco, then it reduces its exposure to the oil industry; if it sells debt, then that debt still needs to be paid back even if Aramco’s business gets worse. But the bigger disadvantage is that all the governance stuff was part of the point of the IPO. You open up Aramco’s books, make it stand on its own, give it real public-company governance structures, and maybe it becomes more valuable than it was as an arm of the Saudi state. Selling debt, and using that debt to do some weird deal that helps the Saudi state even as Aramco opposes it, is a move in the opposite direction.

Poison pizza pill.

John Schnatter, Papa John’s International Inc.’s founder, ousted chairman and chief executive officer, and estranged father, sued the company yesterday in Delaware court, demanding “to inspect documents because of the unexplained and heavy-handed way in which the Company has treated him since the publication of a story that falsely accused him of using a racial slur.” (“News reports attributing the use of inappropriate and hurtful language to me during a media training session regarding race are true,” he previously said.) Schnatter wants to see the communications other board members might have had about pushing him out; the company says it “is providing Schnatter, who remains on the board, with the documents he ‘is entitled to as a director’” but apparently not the communications he wants. My uninformed gut instinct is that the company is probably right not to give Schnatter too much: If you are a corporate director, you are entitled to information about how the business is run, but not to transcripts of the mean things that the other directors say about you when you’re not in the room.

But you can see why Schnatter wants that stuff. In parallel with the lawsuit, he is also looking to rally shareholders to give him back his company, or at least to take it away from the current board:

Schnatter, who resigned as chairman but remains on the board, owns 29 percent of the company’s stock and is planning to speak with other shareholders about installing new leadership at the company in an effort to fix the struggling pizza chain, he told Bloomberg News. …

“The shareholders are going to dictate the board, and I think we have to take a hard look at this board and if the composition of this board is the best thing for Papa John’s,” Schnatter said in a phone interview. “I would suggest we start looking for new leadership immediately.”

But as we discussed earlier this week, he can’t quite do that: The “poison pill” that Papa John’s put in place makes it very risky for Schnatter to talk to other shareholders and get them to agree with his plan. If they do that, then the board can argue that they are “Acting in Concert” with him, and that therefore he has gone over the 31 percent ownership limit in the poison pill, and that therefore the board can trigger the pill and dilute Schnatter’s ownership.

The safe way for Schnatter to mount a shareholder-pressure campaign like this is by first invalidating the pill in court. And the way to do that is by convincing a court that the board wasn’t serious and thoughtful enough in its decision to put the pill in place, that it didn’t have a good enough reason to consider Schnatter a threat to its shareholders. (Delaware courts are still a little suspicious of poison pills, and want boards to at least have a good reason for them, to make a case that the pill is protecting shareholders, not just the board.) And the way to do that is to dig up documents showing that the board acted hastily, or at least, to make a lot of noise about how it acted hastily in the absence of those documents. If Schnatter wants to talk to other shareholders to oust the current board, the first step really is to go to court and demand that that board cough up every mean thing it has said about him.

Darts and monkeys.

I wrote yesterday:

I am always curious, when people talk about making random stock picks by throwing darts, or hiring a monkey, or hiring a monkey to throw darts, if they are talking metaphorically, or if they are actually throwing darts at the stock tables. Where do you even get printed stock tables these days?

That seems to have annoyed some people who work at publications that print stock charts. Sorry! Anyway yes the Wall Street Journal really did throw darts at stock tables to make its random stock picks, and those picks did outperform the best picks of the best hedge-fund managers at this year’s Sohn Conference. There is video. (Of the dart-throwing, not the outperformance.) I don’t know if the Journal ever actually used a monkey, but some Russian jokers did back in 2010. (The monkey did great.)

On the other hand, while this controversy was raging, Facebook Inc.’s stock was plummeting; it closed down 19 percent yesterday. Jeffrey Gundlach’s Sohn idea was shorting Facebook. The monkeys never saw it coming.

Civilization is collapsing.

Apparently it’s warm in London:

“I’ve some men wear loafers with no socks,” says one vice president of J.P. Morgan. “It’s unusual, but it’s happening.”

At Goldman Sachs, where operations staff to get to dress down in jeans and shirts all summer, there are rumours of one intern turning up at a meeting with an MD in a t-shirt and being sent out again.

Things happen.

U.S. GDP Growth Hits 4.1%, Fastest Since 2014, in Win for Trump. Donald Trump keeps leaking economic data. Twitter Shares Plunge 17% as Monthly Users Decline. UBS Is Cutting Dozens of Staff in Wealth-Management Revamp. “If you’ve got an offer from Oxbridge and Love Island, you’re better off going on Love Island.” There’s a shark at Goldman. The SEC and CFTC softball teams are called the Naked Shorts and the Sultans of Swap. “For he hath tasted Paradise, / 5/5, would taste again.” Someone untied Betsy DeVos’s yacht.

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To contact the author of this story: Matt Levine at mlevine51@bloomberg.net
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