Greensill

The basic way that Greensill Capital worked is that it would help companies finance their payables and receivables. A client would sell products to customers on credit, and Greensill would pay the client early at a discount and then collect the money later from the customers (“receivables finance” or “factoring”). Or the client would buy products from suppliers on credit, and Greensill would pay the suppliers early at a discount and then collect the money later from the client (“supply-chain finance” or “reverse factoring”).

The more advanced way that Greensill Capital worked is that sometimes it would sit down with a client and imagine who might one day become a customer of that client, and then imagine how much of the client’s product that hypothetical customer might buy from the client, and then Greensill would pay the client early for those entirely hypothetical receivables, and then Greensill would collect the money later from the customer, if the customer actually became a customer and bought things from the client. If not, Greensill and the client would keep rolling the loans over and hope that one day the customer would show up. 

This is called “prospective receivables finance” and is … uh … well, it’s weird? It is very different from traditional receivables financing. Normal receivables financing is safe and short-term lending: You give the client money for products it has already sold, and then you collect the money a few weeks later from real creditworthy buyers who have to pay you to keep getting supplies and operating their businesses. Prospective receivables financing is necessarily speculative, long-term, unsecured lending: You give the client money today in the hopes that it will build its business and attract new customers and sell them new products and bill them for the products and eventually, one day, you will collect on those bills.

We talked about this a few weeks ago, when Bluestone Resources Inc. sued Greensill. Bluestone is a coal company that sells coal to steel companies, and it got a lot of “receivables financing” from Greensill against prospective receivables from steel companies it never met. When Greensill became insolvent, Bluestone sued, arguing that obviously this was meant to be long-term financing and that it shouldn’t have to pay it off until it turns the prospective customers into real ones.

One problem with “prospective receivables finance” is that it is easy to confuse with fraud. Greensill was very much in the business of taking clients’ real customer receivables, giving the clients money, and collecting the money later from the customers; it was also very much in the business of taking clients’ entirely imaginary customer receivables, giving the clients money, and hanging out waiting to see if the customers ever materialized. This was all disclosed and understood and negotiated[1]; Greensill knew which receivables were real and which were fake, and presumably it advanced money on different terms for the real and fake receivables. But as I type it, it all seems absurd, and if you were not deeply involved in the day-to-day relationship between Greensill and its clients, you might be shocked to learn that Greensill would lend a client money against “receivables” from “customers” who had never even heard of the client.

Here is a funny Financial Times story about Greensill’s insolvency administrator, who showed up late to this party and was understandably shocked:

Greensill Capital’s administrator has been unable to verify invoices underpinning loans to Sanjeev Gupta, after companies listed on the documents denied that they had ever done business with the metals magnate. …

Grant Thornton, which is looking to recoup money owed to Greensill in its role as administrator to the collapsed firm, last month approached companies that were listed as debtors to Gupta’s Liberty Commodities trading firm, which borrowed hundreds of millions of pounds backed by invoices.

Greensill had extended a receivables financing facility to Liberty Commodities that allowed it to exchange bills from customers for cash upfront. This process, also known as factoring, meant that Greensill would get repaid when the customer settled the invoice, by paying for goods it purchased from Liberty.

However, several of these companies have disputed the veracity of the invoices from the metals magnate’s commodities trading firm, according to people familiar with the matter and correspondence seen by the Financial Times. 

RPS Siegen GmbH, a German scrap metals business, confirmed to the FT that it had been approached about an outstanding invoice and said that it had not traded with Liberty Commodities.

“We know them, but a trading relationship between us does not exist,” said Winfried Winterhager, manager at RPS Siegen.

Well that sounds terrible! Except that that really was (sometimes) how Greensill operated, so you can’t tell from this story whether (1) Liberty was doing a fraud on Greensill by submitting fake invoices to borrow against fake receivables from fake customers or instead (2) Liberty and Greensill agreed, with full disclosure and understanding, that Greensill would give Liberty long-term unsecured financing but document it as receivables financing involving hypothetical customers. Option (2) sounds bizarre, but it was definitely a big part of Greensill’s business. And in fact, in a follow-up article, the Financial Times reports that Gupta gave exactly that explanation:

Gupta later told the FT that the company named on Friday, RPS Siegen GmbH, had only been “identified as a potential customer” and financing was provided on that basis.

I don’t know if that’s true, for RPS Siegen GmbH or for the other disputed invoices that Grant Thornton discovered. (That follow-up article also reports that “commodities trading houses have launched investigations after web domains resembling their own were registered to an email address of an employee at Sanjeev Gupta’s metals empire,” which is pretty weird!) The point is just that if you are in the business of financing real receivables and also fake receivables, any time someone finds a fake receivable and says “aha, fraud!” you can say “no no no we meant to do that, that was an intentionally fake invoice, you just don’t understand how the prospective receivables financing business works.”

I do not envy Grant Thornton. Their job right now is pretty much going around to companies, presenting them with invoices, and getting laughed out of the room: “That’s not our invoice, we’ve never even heard of Liberty Commodities or Greensill, get outta here.” And then they go back to Greensill with their findings and get laughed out of the room again: “Of course it’s not their invoice, they were just a potential customer, how could you be so naive?” And then Grant Thornton has to tentatively ask, “Well, okay, but then who is going to pay this invoice?” And then there is a long awkward silence.

Collateralized SPAC obligation

The end of 2020 and beginning of 2021 were pretty much the best times ever to take a new special purpose acquisition company public. A SPAC issues stock for $10 a share, puts the money in a pot, and goes looking for a company to merge with. If the SPAC finds a target, they merge; the target becomes a public company and gets the money in the SPAC pool, while the SPAC shareholders get shares of the newly merged public company. If the SPAC doesn’t find a target within two years, it gives its shareholders their $10 back, with a little bit of interest.

One rough way to think about SPACs is that they are a way to do tomorrow’s initial public offerings today. Early 2021 was a great time to go public — so good, in fact, that you could raise money even for companies that weren’t ready to go public. Raise money today, put it in a pot, and in a year or two when some private company wants to go public it can merge with the pot and collect the cash raised today. You pre-sell IPOs while the IPO market is good, and then harvest them later when the market has cooled.

Meanwhile, though, the SPACs trade, on the stock exchange, and when the market does cool it seems a little weird to buy a $10 share of a pot of cash that might one day be an acquisition. Not disastrously weird — it’s a pot of cash, $10 is worth $10 — but a little weird, weird enough that the promise to return $10 might trade for $9.95. If you have $10 and want to park it somewhere safe and earn a Treasury rate of interest, you can buy Treasuries. If you are going to be induced to park it in some weird SPAC — where you don’t know exactly when you’ll get your $10 back, and you have to monitor the SPAC to make sure it doesn’t do a dumb acquisition (or to make sure you exercise your withdrawal rights and get your $10 back if it does) — you will need a higher return than you’d demand on Treasuries. If SPACs are just cash instruments, they will trade at a discount to their cash value, because they are kind of an annoying form of cash. 

In late 2020 and early 2021 of course you would pay a premium to cash value for a SPAC, because the expectation was that every SPAC would find a sweet company to take public and make a favorable deal. A SPAC was not a cash instrument but a way to buy a hot private company’s initial public offering and capture the “IPO pop.” And that is still true for some high-profile SPACs that seem like good bets to strike good deals. But there are a lot of SPACs, and the mood has shifted, and now many of them are kind of weird cash instruments:

Some 300 special purpose acquisition companies debuted in the first quarter of this year, creating an oversupply with at least 302 that hadn’t bought anything yet and were trading for less than the cash raised in their public offering. They’re also facing an eventual deadline to liquidate if they don’t come up with a deal.

Typical discounts as of March 31 averaged around 1.22%, with some selling for as little as 96 cents on the dollar, according to data compiled by Bloomberg. Count up all those pennies plus interest earned by SPACs on their idle cash, and the potential take amounts to a cool $1.09 billion.

“It’s creating mark-to-market losses, but also extraordinary opportunity,” according to Steve Katznelson, chief investment officer at Radcliffe Capital Management.

As of March 31, it would cost about $81.4 billion to buy all those SPACs -- shares and units -- trading below $10, according to data compiled by Bloomberg. Assuming a Treasury yield of 0.05%, two years from IPO to expiration and warrant values of zero, an investor would walk away with around $82 million in accrued interest on top of the principal.

So if you could efficiently buy all the discounted SPACs and hold them to maturity, you’d earn about 1.22%, which is maybe not incredible but definitely beats, you know, a 0.05% Treasury yield. These things seem quite safe: The money is held in trust, you can demand it back if the SPAC doesn’t do a deal in two years or if it does a deal you don’t like, and there is no real history of SPACs not returning the cash. As a money-market investment, it pays you a little extra in exchange for its weirdness.

But who am I kidding, earning 1.2% on your cash for a year or two is not an “extraordinary opportunity.” No, no, clearly the trade here is to take this opportunity and lever it 20 times. Borrow at 0.2%, lend at 1.2%, lever it 20 times and you make a 20% return. SPACs are technically equities, and after last week I am not sure that banks will be too jazzed about giving you a lot of leverage on equities, but perhaps you could get some capital-markets leverage. You build a Collateralized SPAC Obligation (CSPACO), put some SPAC shares in a box, issue tranches of claims on the box, convince the ratings agencies that SPACs never default, get the senior 95% tranche rated AAA, sell it to money-market funds at a 0.2% yield and you are in business.

The thing about SPACs is that they are both a wild speculative way to bet on unproven — even unnamed — new companies, and also a boring but complicated safe cash investment. Not, usually, at the same time. The SPAC glut came about due to enthusiasm for wild speculation; the discount-SPAC glut, though, is about the yield on the boring safe investment. Wall Street knows how to make boring safe investments fun. I will personally be a bit disappointed if the SPAC boom doesn’t give way to a SPAC securitization boom.

Digital yuan

Sure, okay:

A thousand years ago, when money meant coins, China invented paper currency. Now the Chinese government is minting cash digitally, in a re-imagination of money that could shake a pillar of American power.

It might seem money is already virtual, as credit cards and payment apps such as Apple Pay in the U.S. and WeChat in China eliminate the need for bills or coins. But those are just ways to move money electronically. China is turning legal tender itself into computer code.

Of course I disagree. If you have $5,476.23 in a checking account at a bank, that money consists only of a computer entry at the bank. The computer entry isn’t a reference to a box containing 50 $100 bills, 23 $20 bills, a $10 bill, a $5 bill, a $1 bill, two dimes and three pennies, all neatly labeled with your name and account number. There is no box, there are no bills, and the money in your checking account is, only, the computer entry at the bank. If you send me $200 of that money, using a credit card or debit card or payment app or wire transfer, nobody sticks 10 $20 bills in an envelope to courier to me or my bank. Your bank reduces the number in your account by 200, and my bank increases the number in my account by 200, and those numbers are the only possible “legal tender” involved in the transaction. The electronic entries are not “just a way to move money” — some external thing in the world — “electronically”; the electronic entries are money itself.

The point of a “central bank digital currency” is not the digital, because all modern currencies are predominantly digital. The point is the central bank: While most currencies exist as book entries on the ledgers of commercial banks,[2] the digital yuan (like other proposed CBDCs) will exist as book entries on the ledger of the People’s Bank of China. Instead of (or in addition to) having a bank account at your local bank, you’d have an account at the PBOC, and you’d be able to spend yuan directly from that account.

The main point of CBDCs, then, is to let central banks do policy stuff directly with consumers, instead of filtering macroeconomic policy through banks and markets. “Policy stuff” often means macroeconomic policy:

Digitized money looks like a potential macroeconomic dream tool for the issuing government, usable to track people’s spending in real time, speed relief to disaster victims or flag criminal activity. …

The money itself is programmable. Beijing has tested expiration dates to encourage users to spend it quickly, for times when the economy needs a jump-start.

Expiring money! That’s cool. But you could administer other sorts of policies with central bank digital money too:

It’s also trackable, adding another tool to China’s heavy state surveillance. The government deploys hundreds of millions of facial-recognition cameras to monitor its population, sometimes using them to levy fines for activities such as jaywalking. A digital currency would make it possible to both mete out and collect fines as soon as an infraction was detected.

All of this stuff can be done conventionally, with the usual banking system. You could mail stimulus checks to people, announce a tax increase to take back the stimulus at the end of the year, and create a new tax credit for spending the stimulus on appropriate things: That’s basically expiring money? But it’s cumbersome and complicated; just depositing money in their accounts and taking it back if it isn’t spent is easy and slick. Similarly you can definitely send someone a notice of a fine and then garnish their bank account, but that is administratively complicated compared to managing their bank account and deducting the money instantly.

I don’t really buy that central bank digital currencies will dramatically change the nature of money, and I’m not sure why China’s digital yuan would materially affect the global hegemony of the U.S. dollar. But surely central bank digital currencies can be convenient for central banks, and for governments.

Should index funds be illegal?

To be clear, I ask that question a lot, but I am mostly kidding. I think the answer is “no.” I think there are some weird and troubling aspects of the rising dominance of huge index funds: They concentrate a lot of power in the hands of a few big asset managers (the “Problem of Twelve”), and there are suggestive though not conclusive arguments that they could dampen product-market competition, help inflate bubbles and reduce the allocative efficiency of stock markets. These are novel and interesting problems in corporate finance; it is not intuitive how big a deal they are or what should be done about them, and they are fun to talk about. But mostly I figure that, in the aggregate, investors are going to own the stock market, so for most investors it probably makes sense to just do that directly for low fees rather than do it in a more complicated way for higher fees. 

These are all very familiar themes to Money Stuff readers, but here is Annie Lowrey in the Atlantic kind of arguing that index funds should be illegal?

The problem in American finance right now is not that the public markets are overrun with failsons picking up stock tips on Reddit, investors gambling on art tokens, and rich people flooding cash into Special Purpose Acquisition Companies, or SPACs. The problem is that the public markets have been cornered by a group of investment managers small enough to fit at a lunch counter, dedicated to quiescence and inertia. …

The antidote lies not just in fixing passive investment, but in making markets be markets again. Perhaps we could all use a little more of that manic stock-picking energy, not less.  

It hits the usual themes: Index funds are “worse than Marxism” because they don’t make capital-allocation decisions; there are so few of them and they have so many votes; if all the companies have the same owners they won’t compete with each other; etc. Part of me is always happy when these issues get mainstream attention, because if regulators do try to ban index funds that will be funny and give me something to write about. Mostly, though, I keep my money in index funds, and I’ll be sad if they are banned.

CEO psychology

A standard form of paper in corporate finance is, like, “if a chief executive officer has [some hobby or trait], what does that mean for her company’s [some measure of performance or behavior]?” The most classic result is probably that when the CEO plays a lot of golf, the company’s return on assets is lower than average. But there are a lot of hobbies, and a lot of different dimensions along which companies can perform, so there are lots of different ways to mix and match. Ideally you’d have a good psychological story, along the lines of “Hobby X is risky so the company takes more risk” or “Hobby Y is boring so the company is more boring,” I dunno. Anyway CEOs who fly planes avoid taxes:

We find evidence that CEOs’ hobby of flying airplanes is associated with significantly lower effective tax rates and a greater propensity to engage in the most aggressive forms of tax avoidance such as tax sheltering. The effect is economically as well as statistically significant. Cross-sectional tests reveal that the baseline results are not sensitive to managerial remuneration incentives, suggesting that intrinsic incentives derived from endowed traits are not easily moderated by extrinsic motivation from compensation contracts. However, our analysis shows that the baseline result only holds in settings where managers are subject to high levels of monitoring by institutional shareholders, suggesting that strong managerial oversight helps direct managerial thrill-seeking tendencies towards value creating endeavors. Taken together, our paper highlights the significant role that CEOs thrill-seeking tendencies play in driving corporate tax planning activities.

That’s the abstract to “CEO Endowed Trait and Corporate Tax Avoidance: Evidence from Pilot CEOs,” by Ghasan Baghdadi, Edward Podolski and Madhu Veeraraghavan. I like the notion that thrill-seeking CEOs will seek the thrill of avoiding taxes, but only if they “are subject to high levels of monitoring by institutional shareholders.” Otherwise they will just get their thrills by, uh, flying airplanes all the time? But if their shareholders keep an eye on them and force them to stay in the office and do work, they will have to get their thrills at work, by avoiding taxes.

Also fun is that the paper considers the “competing view ... that thrill-seeking tendencies are irrelevant for corporate tax planning activities,” because … corporate tax planning is boring? Like, if your idea of fun is flying your own airplane, your idea of fun might not be structuring partnerships to shelter taxable income. 

Thrill-seeking can alter the type of activities that CEOs find interesting and where CEOs exert influence. It is therefore possible, that thrill-seeking CEOs allocate more time and effort towards entrepreneurial challenges at the expense of more mundane tasks such as tax planning. The precise way in which CEO thrill-seeking tendencies affect tax planning strategies, if at all, boils down to an empirical question that this paper addresses.

But it finds, empirically, that thrill-seeking CEOs do in fact seek thrills in tax structuring. 

Things happen

Citadel Gets the Spotlight. Credit Suisse Takes $4.7 Billion Archegos Hit, Replaces Warner. Mizuho investigates possible losses from Archegos collapse. Yellen Pushes for Global Minimum Tax Rate on Multinational Corporations. China Asks Banks to Curtail Credit for Rest of Year. Italian and French banks revive ‘doom loop’ fears with bond buying. As Texas Freeze Gas Bills Come Due, Cue Up the Lawsuits. Ketchup shortage. Brood X or Gen X? Dog Surfing Championships.

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[1] I mean, between Greensill and its clients. I am not entirely sure how good the disclosure was to investors who bought into the funds that bought Greensill loans.

[2] Well, most currencies exist in a sort of two-tier system; in the U.S., banks hold “reserves” at the Federal Reserve (which are electronic, and are money), but consumers and businesses have “deposits” at banks (which are also electronic, and also money). The consumer and business deposits exceed the amount of reserves — it’s “fractional reserve banking”; the banks are *creating* money — but there is still a form of central bank digital currency (the reserves) available only to banks. When people say “central bank digital currency,” though, they don’t mean normal bank reserves; they mean a CBDC that is available to consumers and businesses.

 

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