Actively Traded Private Issuances: Wall Street Hops on the Bandwagon

Well, well, well. It took a little longer then expected but it finally happened: some Wall Street firms stepped up with an answer to GSTrUE. As discussed in today's Financial Times:

Merrill Lynch , Lehman Brothers, Morgan Stanley and Citigroup are among a group of investment banks developing an electronic trading platform for unregistered securities to compete with existing systems such as the one created by Goldman Sachs.

The move comes after Goldman signed up Oaktree Capital, the hedge fund group, and Apollo Management, the private equity firm, to sell unregistered shares through its GSTrUE private trading system. Apollo shares will also trade on a platform created by JPMorgan Chase.

The system being developed by the group of banks is intended to ensure that Goldman, JPMorgan or others do not come to dominate the electronic market for unregistered shares, people close to the matter said.

Not for nothing, but yours truly was all over this over two months ago. From my post titled More Evidence of the Ravages of Sarbox: U.S. Private Placements Overtake IPOs 5/19/2007:

This final point, a point which I raised in my earlier post, is absoutely critical when assessing the magnitude of the threat posed by these alternative exchanges. The retail investor is not the driving force in the equity markets here or abroad, and given the structure of U.S. regulatory doctrine once one crosses into the realm of the "accredited investor" there is much one can do on a private basis. Like start a private exchange. Or many private exchanges. If GSTrUE is successful, as I expect it will be, is there any doubt that Morgan Stanley and the like are close behind? And with the great leap forward in low latency trading technology, what is stopping a flow aggregator like Nasdaq or any ECN from pooling the deals originated on these private exchanges and enabling them to be traded more broadly? In fact, I am almost certain that this is how it will play out. So, to recap, if:

• You have a massive pool of institutional liqudity in need of high-quality product; AND

• You have a sea of high-quality companies that would like liquidity but are put off by the regulatory demands of going public in the U.S.; AND

• You have innovative investment banks structuring these early deals between high-quality issuers and high-quality, leading-edge investors willing to buy a new and untested product; AND

• You have ECNs with capacity that can pool flow across these private exchanges and centralize trading, clearing and settlement in order to broadly and efficiently distribute product; THEN

• You get a withering U.S. new issues market that will slowly and inexorably die on the vine.

We are in the early innings of an extra-inning game, but you can see where things are going. Either Commissioner Cox and his friends in Congress are going to get busy streamlining our public company regulatory environment or else...

 

Comments

[Roger]

Yaser, I don't think there will be an additional regulatory apparatus for these private exchanges. The rules are already promulgated under Rule 144A so nothing more is needed. And will there be "bought deals?" Absolutely. The exchange is merely a mechanism for creating liquidity; dealers will take on risks on private exchanges just as they would public exchanges, through they may well price the risk differently, i.e., no dumb retail to jam in a pinch.

Mr. Geek, I have alluded to different prescriptives but have not written a comprehensive position piece because I don't view myself as a policy wonk. That said, I do think more streamlined, common-sense based financial reporting that costs less to implement makes sense. You have possibly labeled this "lax," which I don't think intelligent but streamlined reporting needs to be. Concerning the issue of quality, companies issuing under 144A are providing disclosures. And companies like Oaktree and Apollo are not hard to understand. And BX is, in fact, a very high quality company. The problem is, the market initially placed an irrational price on them. This is not a reflection of the quality of BX but a reflection on the quality of the investors buying at those elevated valuations.

[Yaser Anwar]

Haha, I anticipated this post as soon as I read the article last night.

Maybe there should be prediction markets for bloggers posts.

On a more serious note: Do you anticipate a self-regulating body for this kind of exchange to be set up by the brokers? I guess we can expect one if trading on this platform grows.

Also, it would be interesting to watch if sell-side firms like GS and others setting up the platforms, will promise to provide liquidity and buy a portion of the issues themselves. Why would they do this? When more firms will enter, I reckon competition to add them to a certain platform, whether GSTrUE or others, will heat up, so as a selling point for companies looking to list.

Then again the platforms sell themselves- raise cash w/ out IPO hassles. I think these guys all will join hands in the future to create one unified platform.

[cfageek]

Roger, you've written many times on this issue. However, you provide no insight or roadmap for how we can make US financial markets and public companies become more competitive nor how they should be regulated?
-Decrease taxes on public company earnings? just kiddin
-less regulation, less SarBox?
-lax financial reporting?
-consolidating regulatory bodies, like UK system.
how?

Sooner or later regulatory oversight on private exchanges and the registered companies will increase. Moreover, pension funds and insurance companies should be strictly prohobibited from investing in such exchanges (Chinese government and companies can invest as much as they want) It's no surprise Merril and other IBs will join the game soon. Looks like it's just another profitable business (for now).
Finally, how do we know the traded companies on these private exchanges are "high quality"? The answer is we don't, and probably we never will. Is BX a high quality investment?!