Sunday, 14 February 2021

Corporate control on the cheap revisited

A few months back I blogged about the role of hedge funds and banks during takeovers and the potential for the combination to have a significant impact on the outcome. Here I just want to add a little sprinkle of detail from the current situation facing G4S.

As things stand, G4S is the subject of two private equity-backed bids, one of which is supported by the incumbent management. Because neither bid has succeeded so far, it is now moving to an auction. 

I've been tracking the derivate positions in G4S built up by hedge funds. Below is an up-to-date list of all the filings I've found. One caveat: I do not know whether any of these positions have been closed out, because I'm not up to speed with filing requirements, so the list below is of the latest disclosed position for each fund, but the starred ones a recent filings (eg Davidson Kempner has not issued a filing relating to G4S since 23 Dec, but PSquared issued one on 9 Feb). To save you the bother of adding them up, total disclosed positions add up to over 36%, recent ones to just under 26%. 

Either way it's significant and the total exposure is bigger than any of the other examples I've looked at, though of course there may be other bigger ones out there. Also the list of funds with exposure has steadily increased - Alpine, Omni and Berry Street all only started producing filings in the past week or two.

The flip side to this, as I've blogged before, is that banks end up holding a lot of stock as counterparties, and if you look at the list of major shareholders G4S discloses on its IR site currently 4 of the top 5 are banks, holding a total of 21.73%.

To simplify to the extent of a truism, this either matters or it doesn't. The banks hold the shares because the hedge funds want derivatives - I don't believe that hedge funds would want/be able to go out and buy a quarter to a third of shares in a target. The combined size of both equity and equity derivate positions is clearly significant, and would be enough to tip a bid one way or another. Why doesn't this get talked about?   

Sunday, 6 December 2020

The costs of loyalty

I've blogged a couple of times previously about the peculiar messaging around consumer 'loyalty'. The repeated used of the phrase 'loyalty penalty', and the message that 'loyalty doesn't pay' from both consumer groups and regulators feels very odd to me. 

As I've said before I think loyalty - which I take to mean a long-term co-operative relationship - is a deeply-rooted human trait. Therefore attacking it is unlikely to lead to humans to conclude that being loyal is a failing on their part, but rather will simply engender mistrust. 

On this topic, I was really interested to see this paper last week, which is part of the CMA's response to a 'super complaint' from Citizens Advice. I've properly read about half of it and skimmed the rest (just being honest!) and it's well worth a read. The 'loyalty penalty' in a nutshell is the cost to the consumer of sticking with the same provider (for energy, insurance etc) rather than switching. This is essentially a price differential between new and existing customers, with the latter getting stung with higher costs (so their loyalty is penalised). As the paper sets out, this cost might be through 'price jumps', when low initial rates reset, 'price walking', where the provider increases costs in steps over time, or because of legacy contract, like when you're stuck on an old tariff. 

Anyway, it's a big enough problem that it has its own name, and this paper looks at academic literature on how and why this comes about and what remedies might be applied. There are loads of interesting aspects to it. For example, early on it is made clear that the approach does not consider 'fairness' - whether it's acceptable in principle to charge different customers different amounts for the same product. 

On the other hand, regulators are concerned about whether vulnerable customers (the elderly, low income households, the less educated etc) are particularly at risk. And they are. Here's a key section (had to screenshot due to weird formatting):    

And a useful table on switching (or the lack of it) in respect of energy provider. 

I feel like there is an ESG point in here. In a number of markets there are providers that are publicly listed. Are returns to shareholders being juiced by taking advantage of vulnerable customers? That might seem a bit of a stretch, but look what happened to the share price of Dignity when the CMA backed off price controls in the funeral service market (which had been considered because of concerns that grieving families were being ripped off).  

Another thought from reading this is that providers are constantly recalibrating their offer, and responding to changed regulatory environments. In an era of big data, these changes are often happening very quickly. I imagine provider algorithms battling it out with price comparison site algorithms. (Ironically one of the price comparison sites - which are supposed to be on the punters's side and aid competition - was fined for breaching competition law in a way that the CMA was likely to lead to higher premiums.) It doesn't feel like a fair fight between the ordinary punter and the providers. 

In such an environment, sending out a message that you will get shafted if you don't shop around regularly - which is the tone of much of the 'loyalty penalty' messaging - doesn't strike me as a genius move. Consumers may simply become fatalistic about getting ripped off wherever they take their business, so switching might seem like a waste of time, rather than a smart response.  

Something that really comes across for me is how much effort regulators are putting into trying to get markets, and market participants, to behave like they are supposed to. Here's another little snippet

This idea of trying to get market participants to behave more like theoretical expectations reminds me of the genesis of the Stewardship Code. Again, if it's in investors' interests to be effective 'stewards' of assets they own, why don't they just do it? Why do they need regulators to encourage them? That's another story, but it does make me wonder how many markets are like this. Combined with the 'unfair fight' I wonder if markets that are a long way from theory can ever be expected to change. 

And just as I was thinking about this, I stumbled across this comment. Basically what's the point of consumer choice in energy markets if most punters can't/don't want to exercise it, and if regulators might make better choices for them?

The fact that this is in a report commissioned by the Competition and Markets Authority is a bit interesting to put it mildly. 

Anyway, worth a read.

Saturday, 28 November 2020

Corporate control on the cheap?

A couple of years ago, I got into the guts of the Melrose Industries hostile takeover of GKN. This deal squeaked through, despite it being opposed by GKN employees.

The bit of it that particularly interested me was the role of hedge funds doing the merger arbitrage trade, which ended up influencing a major part of GKN's shares (and simultaneously shorting Melrose). I say 'influencing' as the overwhelming majority of the funds' exposure to GKN was through derivatives, rather than ownership of its shares. 

My understanding of how this corner world works is that hedge funds utilise equity derivatives primarily because they are cheap. It costs a lot of money to buy 1% of a PLC, and if a hedge fund with a few billion under management went out and bought the shares it would represent both a big expenditure and a very significant position. So using CFDs or swaps enables them to gain exposure to movement in the target's shares without having to pay to own the underlying asset. They obviously pay for the derivative itself, but that's a fraction of the cost of the underlying equity.

As I blogged previously about GKN, my understanding is that, as the counter parties to the derivatives, investment banks end up holding shares. Again, no problem in principle, and everyone is clear that it is the hedge funds which have the economic interest in the shares even if they don't own them. If the hedge funds have long derivatives they make money if the shares go up and lose it if they go down. That in turn means that if the bid fails they lose money, so holders of long derivatives obviously want the bid to succeed (or look to be set to do so - if they got in early they could take profits before the outcome is decided I suppose).

In a hostile bid the bidder essentially makes an offer over the heads of the incumbent management of the target to the company's shareholders. Those shareholders in turn have to decide by a set deadline whether or not to accept that offer. If you're a shareholder you can accept that offer or not (and the management of the target will be telling you to ignore it) and if you're not a shareholder you can't. And by extension, if you hold derivatives, not shares, you're not a shareholder. So you can't respond to the bid. 

So far so simple. But what if you're an investment bank that holds the shares as a counterparty to a derivative holder? You do hold the shares, but only because of the derivatives. How do you decide how to respond? Pure survival instinct is surely going to tip you to support the bid because you know that your valuable hedge fund client is going to lose money if the bid looks like it might fail. It is possible, even, that the derivative is written in a way that stipulates this, though I simply do not know if this is the case or not.

My issue is that this may mean that de facto those holding derivatives are able to exercise influence on the outcome of bid equivalent to that of an investor holding equity. If so this is influencing what we used to call the market for corporate control on the cheap. It doesn't feel right to me that investors whose only interest is in an instrument that mirrors the share price, and its appreciation during the limited timeframe of the process a bid, should be able to influence the ownership of major employers.

I could be off-target on some of this so would welcome any corrections etc from anyone who knows this area better than I do. I will keep private just email if you don't want to comment on here. (I'd also be interested to find out how much gaining an exposure of say 1% via derivatives actually costs vs buying the shares.) But I think I do have the outlines broadly right. If so, I think this ought to attract more attention than it does currently. 

PS. Given that a change in ownership is absolutely fundamental to a company's future this is very obviously a significant stewardship issue. Yet, as I've blogged before, a number of the funds active in the merger arbitrage market do not adhere to the Stewardship Code.

Monday, 23 November 2020

Meat is murder

One of the things we've doing at work since the pandemic hit is looking at the spread of Covid in the workplace, in particular in food processing. My colleague Alice Martin wrote a really good research note on the sector which we published back in September and we're continuing to engage with companies. Earlier this month our research was mentioned in parliament by Labour's shadow minister for food Daniel Zeichner MP.

It struck us early in the year that there was a problem in the sector and our discussions with unions both suggested some particular cases of concern, and alerted us to potential unreported fatalities. To put the latter point another way, unions were aware of Covid deaths in the sector that companies had not disclosed publicly (at least at that point). In addition, by doing a big of digging into various info sources we were able to compare this with prior safety concerns in the sector, which added quite a bit to our understanding.

By late spring/early summer it was clear that food processing in general and meat processing in particular were Covid hotspots and outbreaks were reported at sites all over the world. Notably some research issued by the European Centre for Disease Prevention and Control (ECDC) highlight that in terms of workplace Covid clusters, food packing and processing sites came third after long-term care facilities and hospitals. As of August the ECDC had found 153 clusters reported between March and July in the sector (compared to 591 in care, 241 in hospitals) involving 3,865 cases. 

When we reviewed media reports in the UK, we were able to identify almost 1,500 cases and six fatalities. But these cases were not largely being officially reported as workplace infections. When we looked at RIDDOR reporting of Covid cases in the UK up to early August there were no fatalities and only 47 (forty-seven) cases across the whole country. Since we started highlighting this there seems to have been an uptick in cases, as of today (23 November) one fatality has been reported and 153 non-fatal cases. 

Still, that's a lot less than the numbers of cases reported in the media. To take one example, 250 cases were reported at a single site in Watton in Norfolk. This one is particularly interesting as the rate of infections in Norfolk as a whole has been very low - it was about 25 cases per 100,000 people in North Norfolk - whereas the rate in Watton became the highest in country, at 1,515 per 100,000. This is important because companies have often said that cases identified at work may not have arisen at work, with shared accommodation and travel often highlighted as important factors. This may or may not be true, and we might also question if these factors are themselves created by employment model. 

The fact that food processing is a Covid hotspot is also feeding into public policy decisions. Perhaps not surprisingly, the government has identified workers in food processing as a priority for testing (something also called for Labour politicians in Norfolk), and today I discovered that industry associations are also calling for them to be a priority for vaccination. 

Something doesn't quite add up here. If the risk in the sector is high enough that we need to test and vaccinate the workforce ahead of others, and the cases keep piling up, it's hard to accept that the workplace isn't a signifiant site of transmission, and the RIDDOR figures look far too low. Notably the HSE itself has said there could be significant under-reporting. 

In any case, if you are interested in the S in ESG, and worker safety during the pandemic in particular, I'd urge you to have a look at the sector.

Monday, 17 August 2020

Working from home, working in fear

[There is a] religious element [in attitudes toward work]: the idea that dutiful submission even to meaningless work under another's authority is a form of moral self-discipline that makes you a better person.


[T]he morality of "you're on my time" has become so naturalised that most of us have learned to see the world from the point of view of the [employer] - to the extent than even members of the public are encouraged to see themselves as bosses and feel indignant if  public servants (say, transit workers) seem to be working in a casual or dilatory fashion, let alone just lounging around.


There seems a broad consensus not so much even that work is good but that not working is very bad; that anyone who is not slaving away harder than he'd like at something he doesn't especially enjoy is a a bad person, a scrounger, a skiver, a contemptible parasite unworthy of sympathy or public relief.  

David Graeber, Bullshit Jobs

As we all struggle to come to terms with changed working practices in response to the Covid-19 outbreak, there's a rather unpleasant point I see being made about working from home with increasingly regularity. 

I should probably set out my own view from the outset. I've been working remotely, barring a handful of office days, for five months. I personally prefer it, as I find it enables me to get on with the 'thinky' aspect of my job more easily. However I do feel the need for face to face meetings too, so anticipate a mix of home and office working in future. One thing I *hate* is commuting. Aside from the fact that it's a pain, I feel it's time wasted. If I do the school run in the morning if I work from home I can start work properly by about 9.10 whereas it's nearer 10 if I go to the office, and I find eating into my working day that way stressful.  

I also recognise I'm in a privileged position in that I can work from home easily. This is not the case for many working people either because of their occupation, their living arrangements or other factors. And I take the point that a lot of people find the social aspect of office working important. Working from home should, of course, be a choice offered to people. 

Or should it? Because what I see argued with increasing regularity is that employees need to stop working from home and get back in the office, for their own sake. The argument is that while those working from home might be enjoying it for now, they should be careful what they wish for. If their job can be performed from home, it can be performed from anywhere. Companies might see the benefit of reduced office costs from remote working, but might also see that this could be taken even further, with jobs performed remotely from other countries with (obviously) lower labour costs.

This point has been made by a variety of people including Helena Morrissey, Kirsty Allsop, Allister Heath and, most notably Luke Johnson. In the last case, there's a really (presumably deliberately) unpleasant edge to his comments. Those working from home are 'slackers', will miss out on promotion opportunities, and so on. The message is clear: working from home is risky, you're better off getting back in the office. 

As far as I am aware none of these people have a direct financial interest in office working. If they were the owners of Pret it might be a different story. In addition, the risk they are highlighting is, in essence, not a new one. If many jobs can be fulfilled remotely, and remote working can be done pretty much from anywhere these days, then the risk of your job being off-shored is already there. Perhaps you working from home now has increased the visibility (to employers) of the viability of remote working, but it did not create the risk (if it is a risk). The technology that enables remote working did that.

So if the risk of off-shoring is there in any case, then what message are those working from home being given? It seems like they are being encouraged to work from the office because this will make them visible so their employer does not think about off-shoring their role. That boils down to encouraging presentee-ism as an employment protection tactic for workers. Not exactly what you would expect from exponents of the efficiency of the private sector, but it does chime with David Graeber's view that a lot of private sector white collar work is... errr... bullshit. 

Just for the sake of working these points through I'll assume that someone like Luke Johnson is not primarily motivated by a desire to protect the job prospects of workers who are not in his direct employment. So what else might be going on in seeking to frighten employees back into the office? 

Part of it is undoubtedly a desire to monitor. If people become 'slackers' working from home then get them back where you can keep an eye on them. (Incidentally, this doesn't seem to offer much support to off-shoring as a response. If I can't trust someone located in the same country as me to be sufficiently incentivised to do their job remotely, does paying someone less money to do the job even further away seem likely to solve the problem?) 

There is a strong moralising element in all this too. Part of the criticism of people working from home is that they 'enjoy' it too much. The implication being that a less hateful working experience is somehow too 'easy' and work should be 'hard' (which we see played out in politics through the valorisation of 'hard-working' families). 

I think this gets to the nub of it really. As Graeber suggests in Bullshit Jobs, behind a lot of the bizarre employment practice in the private sector sits a (usually) implicit theory of motivation. This is that people will shirk unless monitored, prodded and so on. A shift to more working from home entails a degree of trust on both sides. Do we allow employees self-determination, or do we insist that they must be in a certain location where their performance can be monitored? (leaving aside the obvious point that technology enables monitoring of remote working too.)

Some of the comments in relation to working from home suggest a lack of trust in people to be self-motivated, and are certainly perceived that way by employees. My own view is that lack of trust in turn creates its own problems. If people feel they are not trusted to get on with their work they will tend to await clear instructions so they don't get it 'wrong'. A hierarchical, monitoring approach to work seems to be unlikely to breed innovation and creativity.

To threaten employees with the risk of losing their job if they seek to work from home is especially unpleasant, and more of a cattle prod than a prod. Job security is important to the large majority of people at work, yet is also perceived to be moving in the wrong direction (according to polling in this). Playing on the fear of unemployment to achieve monitoring and control does not feel like 'stakeholder capitalism', especially given that the current shift to working from home is being driven by a public health risk.

To build on this last point, I wonder how a company going down the route of off-shoring jobs in the current environment would be perceived. Recent polling shows that a very large majority of the public think that while there is no vaccine available workers should be able to decide whether or not to return to the office. If a company laid off UK-based workers working from home because of Covid and replaced them with overseas ones I'm not sure the most common response would be "well, they had it coming".

Finally, we should acknowledge the fact that if this argument is being made means that the question is being asked in some companies. That alone should be a reminder, if you need it, that there are conflicting interests within the firm that can never be wished away, despite the 'win-win' boosterism that is prevalent in ESG-land.

PS. A couple more bits from David Graeber. Experience during the pandemic has only reinforced some of his points.

Shit jobs tend to be be blue collar and pay by the hour, whereas bullshit jobs tend to be white collar and salaried. Those who work in shit jobs tend to be the object of indignities; they not only work hard but are also held in low esteem for that very reason. But at least they know they're doing something useful. Those who work in bullshit jobs are often surrounded by honor and prestige; they are respected as professionals, well paid, and treated as high achievers - as the sort of people who can be justly proud of what they do. Yet secretly they are aware that they have achieved nothing; they feel they have done nothing to earn the consumer toys with which they fill their lives; they feel it's all based on a lie - as, indeed, it is.


[I]magine if a certain class of people were to simply vanish... If we all woke up one morning and discovered that not only nurses, garbage collectors, and mechanics, but for that matter, bus drivers, grocery store workers, firefighters, or short-order chefs had been whisked away into another dimension, the results would be equally catastrophic. If elementary school teachers were to vanish, most schoolchildren would likely celebrate for a day or two, but the long-term effects would be if anything even more devastating... The same cannot be said of hedge fund managers, political consultants, marketing gurus, lobbyists, corporate lawyers...

Saturday, 11 July 2020

Post-democratic ESG

A theme I keep returning to is the lack or decline of democracy in the small corner of world I inhabit. A long time ago, unions in the UK ran an initiative called the Campaign for Pension Fund Democracy which sought to give pension scheme members greater control over their pensions. When I first got interested in what we now call Responsible Investment in the late 90s it was because of similar thought that this would be a route to democratising capital.

Yet if anything democracy has declined. The shift from DB to DC, and towards professional trustees, has reduced direct member involvement in the governance of pension funds considerably. The shift in local government pensions towards pools has likewise in most cases reduced the control that elected politicians have over assets. Many would argue that these changes are a good thing for investment decision-making, but I personally feel we have lost something important along the way.

Meanwhile ESG has exploded in the investment world. Much of it is gimmicky, and the issues I personally care about the most seem to be those that investors spend least time on, and do badly. However the sheer amount of research and numbers of people involved have both grown enormously. 10-15 years ago I could probably name everyone in London in an investment institution (i.e. a pension fund or asset manager) that had a specific ESG job. Now there are loads of them!  

The problem is that, depsite all this, the power isn't largely shifting in the direction of beneficiaries. Instead the process is actually making asset managers more significant political players. As I've said before, this was always the danger with the focus on 'mainstreaming' ESG. Whilst it's obviously preferable that Blackrock supports shareholder proposals on climate than not, I don't think a lot of people have thought through what it means to make Blackrock (which is itself a public company with shareholders) a powerful arbiter of companies social and environmental standards.

Funnily enough I find myself agreeing with something Hayek wrote about the purpose of corporations (even if I don't agree with his conclusion that companies should focus on profit):
"To allow management to be guided in the use of funds... by what they regard as their social responsibility, would create centres of uncontrollable power never intended by those who provided the capital. It seems to me therefore clearly not desirable that generally higher education or research should be regarded as legitimate purposes of corporation expenditure, because this would not only vest powers over cultural decisions in men selected for capacities in an entirely different field, but would also establish a principle which, if generally applied, would enormously enhance the actual powers of corporations."
This really resonates with me today. Again, it's obviously better that corporations (including financial services corporations) seek to adhere to and promote higher standards of social responsibility. But it comes with dangers too, and I think the lack of democracy is a big issue that goes unremarked. It reinforces the very unhealthy tendency for CEO hero worship (*cough* Tesla *cough*). Here's a bit from the ace-a-tronic Winners Take All that nails this point:
All around us, the winners in our highly inequitable status quo declare themselves partisans of change. They know the problem, and they want to be part of the solution. Actually, they want to lead the search for solutions. They believe that their solutions deserve to be at the forefront of social change. They may join or support movements initiated by ordinary people looking to fix aspects of their society. More often, though, these elites start initiatives of their own, taking on social change as though it were just another stock in their portfolio or corporation to restructure. Because they are in charge of these attempts at social change, the attempts naturally reflect their biases. 
The initiatives mostly aren't democratic, nor do they reflect collective problem-solving or universal solutions. Rather, they favour the use of the private sector and its charitable spoils, the market way of looking at things, and the bypassing of government. They reflect a highly influential view that the winners of an unjust status quo - and the tools and mentalities and values that helped them win - are the secret to addressing the injustices. Those at greatest risk of being resented in an age of inequality are thereby recast as our saviours from an age of inequality.  
The second para above is the bit that really bothers me. Corporate-led initiatives are inevitably top-down and shot through with class bias. If you've never had a bad manager, or had to worry about your safety at work, or how much you get paid, or felt unable to speak out about something, you're not going to think these are the sorts of issues that matter.

And corporate preferences crowd out alternatives. For example, it is still under appreciated what a disastrous effect asset manager opposition to employee representation in corporate governance has had in the UK. I am still hopeful that this one will be won in the long term, but there is no doubt that by first opposing workers on boards and then by accepting/promoting the 'designated NED' fudge they have actively blocked the democratisation of companies.

By promoting non-democratic investment institutions as arbiters of social and environmental institutions, we are inevitably going to end up with companies that adhere to ESG standards that are acceptable to financial services companies.

Monday, 6 July 2020

Boohoo in doo-doo

Online retailer Boohoo is in the news for a lot of bad reasons. Allegations of poor working practices in supplier factories, which in turn are linked to a Covid outbreak in Leicester, come after news its had created a new incentive scheme for directors, which it did not put to a shareholder vote.

Much of the recent scrutiny of the company stems from a report issued by the campaign group Labour Behind The Label, which you can find here. Questions about poor working practices in Leicester, including illegal underpayment of the minimum wage, have been raised for years.

What I find interesting about the story is that the risk to the company and its investors from poor labour conditions was obvious. This is a sector where there have been numerous scandals and, as the FT article from 2018 shows, specific allegations of illegal practices in Leicester were not hard to find.

Boohoo even lists labour abuses as both operational and reputational risks in its annual report.

Well it was certainly right about the reputational risk... but if you read the list of mitigating actions / policies the company lists, you might well be reassured.

And it also says it applies "strict labour standards throughout our supply chain" in the blurb about its support for the SDGs.

The lesson here is pretty obvious - you cannot just go by what a company says about labour issues in its annual report. I don't think it's any great revelation that if you only listen to what companies say about themselves you get a very partial picture. Some companies do flat out lie, but more often it's simply the very human inability to be able to see their own flaws, or why others might have a different view. It's why I cannot buy into a model of employee engagement that doesn't involve real employee voice (which to me means unions, board representation etc) and think a model of shareholder engagement on labour issues that is restricted to investors talking to senior management is fundamentally ineffective.

Either some investors don't get this, or they don't care. Having done this kind of work for a long time, I'm afraid there are some investors out there who basically think labour is a cost and unions, labour law etc are barriers that they'd rather companies could avoid. They take a punt on companies with labour practices that they know to be poor because they can make money, and they are willing to look the other way.

(Coincidentally I have a small personal link to this as my dad's side of the family are from Leicester and his mum and dad used to work in a shoe factory there.)