Comment: Gobbledygook, Chinese walls and the SIB

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The Independent Online
As an exercise in gobbledygook, yesterday's fifteen-pager from the Securities and Investments Board on the use of derivatives during takeover bids takes some beating. It fair makes the head spin, even for those of us who think we know a little about financial markets. The central finding reads thus: "A firm should not use derivatives to enable a customer to buy or sell an indirect stake where the firm knows or has reason to believe that, as a result of inside information, the customer could not properly buy or sell an indirect stake on the open market." So now we know.

Translated into plain English, what this appears to mean is that action taken by Swiss Bank Corporation in helping its client, Trafalgar House, defray the costs of bidding for Northern Electric nearly two years ago, is illegal - "is" being the operative word here for that is not what the law actually says, it is what SIB believes it should say. What makes this document doubly incomprehensible is that at no point does it refer to the Swiss Bank case. "No, no, no," says SIB. "The document does not relate to any particular case. It is merely meant as guidance for future reference". Dear, oh dear. The lawyers really have got to them, haven't they.

We're not subject to any such constraints so here's an attempt to decipher the SIB's pearls of wisdom. When Trafalgar House bid for Northern Electric, it helped pay the costs by having Swiss Bank set up "contracts for differences" in a number of electricity stocks. The question is whether this amounted to insider dealing. Corporate bidders are exempt from normal insider dealing rules. The law allows them to buy shares in a target company knowing that they are eventually going to bid at a higher price. What Swiss Bank did was construct some derivative instruments which gave Trafalgar an economic interest in the Northern share price and that of a number of other electricity companies, but it didn't actually buy the shares. The Takeover Panel considered the matter last year and concluded that this was not a case of insider dealing since buying a derivative is not much different from buying the physical stock. The SIB takes a different view. Buying a derivative is just a way of making money, says SIB, and in circumstances like these it is a one-way bet. As a consequence, the exemption shouldn't apply, claims SIB. A derivative doesn't help further the aim of control, the purpose of the insider dealing exemption.

There were a number of other related matters raised by the Northern bid. One is whether the Chinese walls used by integrated securities houses to separate highly price-sensitive corporate finance matters from the prying eyes of fast-buck traders actually mean very much. The suspicion is that in placing the contract for differences with market-makers, corporate finance effectively forewarned Swiss Bank's trading operation that something was afoot. Swiss Bank fiercely denies this but it did later transpire that its trading operation had built up substantial positions in a number of electricity companies. All of them were quite out of proportion to those that might be expected in the ordinary course of market-making. In effect the bank was proprietary trading in these stocks only it was using market-making privileges to forestall disclosure.

The SIB view of these related matters is that if you ban the original derivative transaction, or what it calls the root cause of the "mischief", then the Chinese walls issue becomes irrelevant since there would be no holes through which to peek. In so doing, however, it takes an interesting little dig at the whole idea of the integrated securities house. "We need to recognise that modern risk management systems, which are understandably designed to enable an integrated house to manage its risk in an integrated way, may cut across, and compromise, the ability of a Chinese wall to maintain a separation between different functions." Just what is the SIB saying here? If Chinese walls don't work, which is the implication, then the whole concept of the integrated securities house falls. Without effective barriers between corporate finance and trading operations, the integrated house becomes essentially corrupt. Privileged information becomes no more than the tool of a no-holds-barred trading operation.

No wonder the SIB feels the need to consult, which apparently it is not obliged to, on matters like these. While many smaller investment banks and pure corporate finance houses are going to find themselves wholeheartedly in support of the SIB's analysis and prescription, the big battalions of the City with their all-powerful securities trading operations will feel not a little threatened by SIB's strictures. The dovetailing of traded securities with corporate finance activity is not a phenomenon confined to Swiss Bank, however aggressive this particular house has been in its application. All the big players do it to some extent nowadays. Gobbledygook, this might be, but it is important gobbledygook none the less. It could provoke quite a fight.

Kissing - and not making up - on radio

Radio may still be a bit of an after-thought as far as the big media players are concerned but that doesn't stop it suffering from some of the industry's worst afflictions. It is just as riddled with big egos and false gossip as television and newspapers. No decision by a government quango will ever be accepted with grace. So it has proved with the Independent Radio Authority's award of the hotly-contested Yorkshire regional licence yesterday, which went to Kiss FM.

Rivals immediately cried foul - confidentially, of course, for many of them will be lining up again for the East Midlands licence and the hottest property of them all, the FM licence for London (no one wants to anger the authority just now). But this time they have a point. The winning consortium is going to use the MSM national sales house, which already controls 61 per cent of the national market. The Radio Authority has in the past expressed concern about MSM's market dominance, but plainly it was not enough to make an issue of when awarding the Yorkshire licence.

Still, the award to a youth-orientated dance station shows encouraging signs of development at the authority, once ridiculed as old-fashioned and lacking in market savvy. Dance was identified as the format that would broaden choice and be financially viable. We did not, thankfully, see a repeat of the Viva syndrome - the award of a licence to a format that didn't stand a chance. Nor did we see another example of awarding licences to small, local players, who have subsequently been bought out by the big players, anyway.

The authority still has its romantics, of course. There are still board members who don't like the big boys of the industry - Capital, GWR, Emap and Chrysalis. But they are beginning to see that enhancing "fair and effective competition" - one of their main criteria - does not necessary mean excluding those with the nous to succeed. Progress of sorts then, but it's a shame the authority didn't feel it necessary to consider the effects on fair competition of yet a further concentration of sales power at MSM.