Monday, October 16, 2006

Taking the BIS

If there is one group that consistently brings a smile to Macro Man’s face, it is the tin foil hat brigade at GATA and other goldbug paranoia societies. Their constant invective about the barbarous relic and why it should really be at $5000/oz provide Macro Man with the same sort of amusement that Aesop’s fables provide to seven year olds the world over. It is with a great deal of trepidation, therefore, that Macro Man finds himself on the same side of the fence with the goldbugs when it comes to one nefarious operator in global financial markets: the Bank for International Settlements.

Macro Man’s primary beef with the BIS is the contempt with which the so-called “central bankers’ central bank” holds the private sector. Specifically, the BIS needs to decide whether it wants to be a public sector entity or a private sector asset manager. On the one hand, the BIS is a central bank; it has regulatory/supervisory responsibility, conducts research using privileged information, and has central bank level access to foreign exchange, bond, and money markets. Moreover, it also acts as a broker for other central banks in executing currency and bonds deals pertaining to reserves shifts.

However, the BIS also acts as an asset manager. Their website proudly boasts of offering a “range of asset management services” including the management of global bond mandates on behalf of their central bank clients. This is presumably done on an active basis, given that the BIS suggests that it can offer “an attractive and competitive return” on their assets under management. Herein lies the problem. The BIS is essentially competing for central bank mandates and having its performance evaluated against the private sector.

Yet the BIS has access to a wealth of information-much of it sensitive-that is denied to the private sector. Unless the BIS has very rigid Chinese Walls in place-and Macro Man does not know if they do or not, but suspects that the answer is no-then their asset management arm is trading off of privileged information. In most markets, that is called insider trading and someone goes to prison. Granted, currency markets are not regulated so this is not illegal; yet it is surely contrary to the spirit of regulatory regimes that exist in other financial markets. And what does it say about the BIS, which ostensibly is at the heart of ensuring the smooth functioning of global markets, that they are willing to exploit a gap in the regulatory regime?

However, unbridled arrogance and contempt for the private sector is nothing new for the BIS. Prior to 2001, some shares in the BIS were actually held by the private sector. This was a legacy from the foundation of the BIS in 1930, when the Fed (in perhaps their only worthwhile decision of the first half of the decade) refused to take up their allocated share. The gap was filled by private sector banks, thus placing some 15% of the shareholding of the BIS in private hands. By 2001, however, the BIS decided it now longer wished to be associated with the hoi polloi, and unilaterally announced that it was cancelling its listed private sector shares. The compensation offered, CHF 9000 per share, was deemed to be farcically low by the institutions whose shareholding were being looted by the BIS. The resulting lawsuit ordered the BIS to pay another CHF 5458 to its erstwhile shareholders-more than 60% greater than its original offer. Macro Man wonders: if the BIS was willing to screw its shareholders so badly, what reservations might it have in using inside information to screw asset management competitors? Macro Man suggests that the answer is ‘none.’

Unfortunately, this is likely a problem that is here to stay, as there appears to be little appetite to call the BIS to heel. Meanwhile, the Basel bad boys will continue to enjoy inside information and straddling the fence between interbank counterparty and AAA platinum customer. It’s hard to see a happy ending for the private sector, either sell side or buy side, from the participation of the BIS in the asset management business. Their behaviour is just one of the reasons why currency markets have been such a wasteland for the last few years.


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