Pension Fund Hedging and the Bond Market

The Bank of England had to step into purchase gilts yesterday after the bond market looked like collapsing totally. Some £65 billion was spent to do it. This has created panic and uncertainty in the financial community and even affected equity markets.

I will give my comments on these events although I certainly do not claim to have any knowledge of pension scheme management and bond markets. So please correct me if I get it wrong.

Defined benefit pension schemes buy gilts (Government issued bonds) so as to match future liabilities to pay pensions. In recent years they have not only been increasing the amount invested in gilts as opposed to equities but have also been using liability driven investment strategies (LDIs) by using derivatives.

In essence they have been hedging their positions and using derivatives to maximise returns so far as I understand it.

What happened apparently was that the Chancellors announcements last week caused government bonds to fall in price and that resulted in margin calls on the pension funds. That caused bond prices to fall further as funds sold holdings to meet the margin calls. A vicious down trend resulted.

Derivatives are always dangerous. Warren Buffett called them “financial weapons of mass destruction”. The FT reports that Lord Wolfson warned the Bank of England that LDI strategies “always looked like a time bomb waiting to go off”. Pension funds using LDI strategies have risen to £1.5 trillion to give you some idea of the massive size of these operations.

What was the Financial Conduct Authority (FCA) doing to ensure that pension funds were not following risky strategies? Nothing at all it seems. So this looks like yet another failure by the FCA in their regulatory role. There is also The Pensions Regulator (TPR) which has a role in regulating workplace pension schemes who seem more interested in ensuring diversity in pension scheme trust boards and climate change reporting rules than ensuring financial risks are not excessive if you look at their web site.

It would seem that derivatives have been sold to pension schemes by clever City whizz kids with disastrous results and we are all paying for it now.

FT Articles worth reading on this subject:  https://www.ft.com/content/5802c53b-3130-462c-8fb3-e3e6203f10a7 and https://www.ft.com/content/e2dfb060-a578-45a1-865f-e2e05d86990a

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Adjustments, Adjustments and Adjustments at Abcam, Oil+Gas Companies and FCA Decision on Woodford/Link.

Abcam (ABC) published their interim results yesterday (on 12/9/2022). I have commented negatively on this company and its Chairman before despite still holding the shares.

The same game continues – revenue up but reported operating profit down and cash flow from operations down. But adjusted operating profit up. What are the adjustments? These include:

£2.6 million relating to the Oracle Cloud ERP project (H1 2021: £2.0m); £6.0 million from acquisition, integration, and reorganisation charges (H1 2021: £3.5m); £9.0 million relating to the amortisation of acquired intangibles (H1 2021: £4.0m); and £13.0 million in charges for share-based payments (H1 2021: £6.7m).

The ERP project costs continue and I very much doubt that they are getting a justifiable return on the investment in that project now or in the future. Together with the acquisition, integration and reorganisation charges it just looks like a whole ragbag of costs are being capitalised when they should not be.

The company also announced there would be a webinar for investors on the day and a recording of it available on their web site later. Neither was available on their web site on the day or at the time of writing this. More simple incompetence!

The share price of Abcam has been rising of late which just tells you that most investors are unable to look through the headline figures and the sophistry of the directors.

As a change from investing in technology companies such as Abcam who of late are massaging their accounts, and not paying dividends, my focus has turned to commodity businesses. I have even been buying oil/gas companies such as Shell, BP, Woodside Energy and Serica Energy plus several alternative energy companies. There is clearly going to be a shortage of energy worldwide for some time while institutional investors have been reducing their holdings in some oil/gas companies simply from concerns about the negative environmental impacts and long-term prospects as Governments aim to reduce carbon emissions. But in reality the progress on carbon reduction is slow and I feel oil/gas companies will be making good profits for a least a few more years. Energy has to come from somewhere and these companies should do well and can adapt to the new environment easily. In the meantime, they will be paying high dividends and/or doing large share buy-backs.

I am generally not a big holder of commodity businesses as their profits can be volatile and unpredictable as they depend on commodity prices. These can be moved by Government actions or political disruptions such as the war in Ukraine. Will the war end soon? I have no idea. But even if it does there is likely to be a new “cold war” if Putin or other hard line Russian leaders remain in charge. I never try to predict geopolitical changes but just follow the trends in the stock market.  

The partially good news for Woodford investors is that the FCA has formed a provisional view that Link Fund Solutions may be liable for £306 million in redress payments to investors for misconduct rather than losses caused by fluctuations in the market value or price of investments. In other words, it may be nowhere near covering investors losses in the Woodford Equity Income Fund. They have announced this simply because Link is currently subject to a takeover bid which they have approved subject to a condition to commit to make funds available to meet any shortfall in the amount available to cover any redress payments. I suspect this is going to make gaining a full recover for investors somewhat problematic.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Useless Financial Ombudsman and FCA plus Defective Insolvency Regime

The stock markets are in turmoil now everyone is back from their holidays and facing up to the realisation that with high inflation and looming recessions the stock market may not be the best place to be for investors. I have moved more into cash and more defensive shares but cash is not the place to be for very long when inflation is eroding its value by more than 10% per annum. Stocks are getting cheaper as the short-term speculators and inexperienced investors exit so there will soon be bargains to be had while there are still few good alternatives when banks are paying less interest than inflation and fixed interest bonds are collapsing in capital values as interest rates rise.

I have written before about how useless the Financial Ombudsman is after I complained about the time it took to complete a transfer of a SIPP from one platform to another – see https://roliscon.blog/2022/04/28/the-financial-ombudsman-is-useless/ . It took over 5 months and I complained to the Financial Ombudsman about the delays in May 2021. After lengthy correspondence and an initial offer from the sending platform which I rejected as derisory, they have accepted that there was an unnecessary delay of 9 days at one stage in the transfer process. The Ombudsman has now proposed compensation of £350 for the inconvenience caused and £139.75 for the loss of investment return. This I have reluctantly accepted although my complaint about the receiving platform is still outstanding.

It has therefore taken 15 months to resolve the complaint which I do not consider reasonable. But the key problem is the Financial Conduct Authority (FCA) not laying down strict rules about the time to complete transfers of investment holdings as they do for bank accounts. Both the FCA and Financial Ombudsman are toothless in essence and do not provide reasonable protection to investors.

ShareSoc has just issued its latest Informer Newsletter to members and it makes for a good read. One good article is on 4D Pharma (DDDD) which recently went into administration. This company claimed to be “a world leader in biotherapeutics” but it was a typical jam tomorrow story company. I never held the shares so I cannot judge whether the claimed prospects were realistic or imaginary but it does appear to have been very badly managed such that it ran out of cash. Unfortunately shareholders have no recourse against incompetent or inept directors.

But the key point to highlight is the typical wildly excessive costs of the administration which has run up costs of over £580,000 in just a few weeks. Shareholders should never expect any return from an administration and this case is no different. There may be some assets (mainly IP) in the business but after the administration costs and settling debts, there may be nothing left.

The insolvency regime needs major reform. At present the big beneficiary of administrations are insolvency practitioners who to a large extent can do what they want and charge what they want. The insolvency regime seems to have been designed for the benefit of the insolvency profession. I suggest the regulations in this area should be totally reformed and administrations should be a court supervised process as per Chapter 11 in the USA.

Another article in the ShareSoc Newsletter is on Blancco Technology Group (BLTG) in which I did hold a few shares for a while. There was a complaint to the FCA about the accounts of this company which were grossly misleading and the auditors (KPMG) have been fined £3,500 with costs of £2,743. A derisory and disgraceful outcome and another example of how weak the financial regulators are in the UK.

Ultimately the cases of 4D Pharma and Blancco reinforce the point that you should never invest in a company unless you have absolute confidence in the prudence and ability of the directors.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Transparency Task Force Attacks FCA and Sophisticated Investor/HNWI Status

Following on from the BBC Panorama programme on the Blackmore Bond scandal the Transparency Task Force have launched an attack on the incompetence of the Financial Conduct Authority – see https://www.transparencytaskforce.org/letters-to-mps-about-blackmore-bond/ . It includes a letter you can send to your Member of Parliament asking for some reform.

I agree with most of their recommendations on how matters can be improved.

One issue I would also raise is that the Panorama programme made it clear that risky and unregulated investments were sold to individuals who would not normally have qualified as “sophisticated investors” or as high net worth individuals, as is required.

It is possible to ‘self-certify’ yourself as a HNWI or a sophisticated investor. To self-certify as a HNWI you have to earn at least £100,000 per year or have net assets (excluding your property, pension rights and so on) of at least £250,000.

To self-certify as a sophisticated investor you must: have been a member of a business angels network for at least six months; or have made at least one investment in an unlisted security in the previous two years; or have worked in a professional capacity in the provision of finance to small- or medium-sized businesses in the last two years or in the provision of private equity; or be or have been within the last two years a director of a company with a turnover of at least £1m.

These are quite low hurdles and as the investor is only making the declaration with no checks necessary or evidence provided it is wide open to abuse. The company accepting the certification only has to have a reasonable belief that it is correct.

I suggest the HNWI limits should be raised and that those who claim to be sophisticated investors actually pass a simple examination on financial matters or have a recognised business/accounting qualification to prove what they are claiming.

There are simply too many cases of dubious investments being sold to widows and retired folks who have no way to judge the prudence of the matter.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Panorama Attacks FCA over Mini-Bond Failures

The BBC’s Panorama programme last night did a good job of pointing out the failure of the Financial Conduct Authority (FCA) to prevent fraud on investors in “mini-bonds”. In this case the focus was on the collapse of Blackmore Bond where 2,000 people lost £46m when the company collapsed. But there have been several other similar cases.

Mini-bonds are unregulated investments so should only be sold to “sophisticated” investors who might understand the risks. In this case people who clearly were not were persuaded to invest in property developments with “guaranteed” returns of up to 10%. Who was providing the guarantees? A company based in Costa Rica. A lot of the investors’ money was wasted on marketing costs and management fees paid to the directors. The investors were lured into putting money in via boiler rooms and internet advertising.

The FCA were told about the abuses but apparently did very little to stop it. Andrew Bailey who headed the FCA at the time failed to act. He subsequently has been made Governor of the Bank of England – a reward for failure it seems.

For more details see:  https://www.bbc.co.uk/news/business-62504445

Comment: It is surely wrong for the FCA not to have taken action on this matter when it was first brought to their attention. Many investors put money in after that and when it was obviously a dubious investment scheme.

The FCA simply says it was outside their remit to step in as it was not a regulated business registered with the FCA but that is not good enough. In fact the promotion of mini-bonds is a regulated activity. But any action taken by the FCA was too little and too late. See https://commonslibrary.parliament.uk/research-briefings/cbp-9272/ for more background.

This is in essence another example of the managerial incompetence of the FCA in the same way that it has failed to prevent a number of frauds on stock market investors, or tackle them when they have become apparent. Likewise the promoters of the Blackmore Bonds do not appear to be facing any legal penalties.

SNP MP Peter Grant said this in Parliament: “in 50 years from now or 100 years from now, our successors will be in the successor to this Parliament bemoaning the fact that billions of pounds have been taken out of the pockets of hard-working people and used to fund a luxury lifestyle for charlatans, crooks and conmen”. That’s a fair summary of the reality.

How to ensure you don’t fall victim to such promotions? I suggest the following:

  1. Don’t put all your life savings into unregulated investments and diversification is the key.
  2. Don’t fall for promises that are unlikely to be achieved – such as promising a “safe” return of near 10% when big financial institutions are offering much less. This tells you that they are high risk investments.
  3. Make sure you have widespread investment experience before you dabble in unregulated investments such as in mini-bonds and EIS companies.
  4. Don’t trust anyone, however glib they are. Make sure they have a track record of managing money responsibly.
  5. Flashy web sites and glossy literature are warning signs, not positive endorsements.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Gore Street Energy Fund Dividend Waiver and Directors’ Jobs

At the forthcoming Annual General Meeting of Gore Street Energy Storage Fund (GSF) in addition to the usual resolutions shareholders are asked to approve a “whitewash” of the illegal past payments of dividends (`resolution 15). This regularly happens when a company fails to file a statement of distributable reserves at Companies House showing it has sufficient reserves to cover the dividend. It seems to happen about once per year to my holdings for example. In fact it happens so often that one would have thought the company directors and auditors would be careful to check that issue before the dividend is approved.

It is interesting to note the number of jobs or roles that the directors have in this company. The Chairman Patrick Cox seems to have a multitude of appointments – too many to be detailed in fact. Likewise Caroline Banksy, who chairs the Audit Committee has 5 directorships and the other directors are not short of positions either.

Personally I think the work involved in being a director or a public company means that it is difficult to do the job properly if someone has more than 3 or 4 such commitments. Maybe that is why the issue of the dividend payment was overlooked.

There is no reason to vote against resolution 15 but I think shareholders should consider whether they should vote “FOR” all the directors.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Austin Review of Capital Raising and Dematerialisation

It’s the mid-summer doldrums in the stock market and with investors having more time on their hands, what better time to issue a 265 page document entitled “UK Secondary Capital Raising Review” (see link below). This document covers a number of very important issues to investors after a review by Mark Austin as Chair of a committee that has looked at the way the UK stock market operates in certain areas. I will only cover some of the key points below because it is a long and complex technical document but Mr Austin has done a fine job in bringing out the key issues in his report to the Chancellor:

  • He spells it out early on in these sentences: “…….we as a market need to be bold and brave in our thinking. We need to look at our existing rules and practices with a fresh set of eyes and a blank sheet of paper, and ask ourselves with a bottom-up rather than top-down approach – what is the right regime for us as a market for the next decade and beyond? …….That requires bold thinking and potentially addressing vested interests that have organically (and understandably) grown up in the past couple of decades due to how the system currently operates – and that may have made our capital markets fit for purpose in the past couple of decades but will not necessarily make it fit for purpose in the coming two decades”.
  • Secondary capital raising is one area he looks at in detail. He says: “There are many – sometimes competing and overlapping – structures, views and guidelines that create a complex architecture. Practice has built up over many years. It is, for want of a better phrase, an area that is very ‘whack-a-mole’ in nature, in that when one issue is addressed, it often causes another that needs to be addressed to pop out elsewhere – usually for a different set of stakeholders”. Retail investors are ill-served by existing practices and have been missing out on placings for example. Mr Ausin says, and quite rightly, that “As much of a company’s existing shareholder register as possible – including, importantly, retail investors – should be able to participate in any capital raising in a timely way, whatever its structure. Again, technology and digitisation have a key role to play here”.
  • Pre-emption rights are important to shareholders to avoid dilution but the rules on what is allowable are not defined in law but are promoted by a “Pre-emption Group” – in essence a club of city grandees. The Austin Review suggests it should be put on a more formal basis which is surely sound policy. The Review also covers the use of “Cash Box” transactions to get around the current legal limits on share issuance which should surely be outlawed and is one option suggested in the Review.
  • One matter discussed is the complexity and delays that occur when a rights issue or open offer is chosen as the fund-raising method. This discourages their use and the reliance instead on placings to expedite matters and reduce costs which prejudice private shareholders and smaller institutions. The key problem is the lack of a complete digital register of shareholders (including beneficial owners who hold shares in nominee accounts). That frustrates rapid communication with investors. Where a general meeting to vote on a proposal is required this currently requires 14 or 21 days notice to shareholders but the proposal is to reduce that to 7 days – an impractical objective unless electronic communication is possible. That will certainly assist rapid fund raisings which are sometimes required but it might also obstruct the ability of shareholders to communicate their concerns to other shareholders in time to oppose a vote. I suggest this requires more consideration.
  • The Review spells out the key priority in this sentence: “Raise the priority of an ambitious ‘drive to digitisation’ to facilitate innovation, stewardship and improved market infrastructure, which is actioned by a Digitisation Task Force with an independent chair and a clear set of principles to be followed”.
  • That will include “the eradication of paper share certificates and that “– it should seek to ensure that rights attaching to shares flow to end investors quickly and clearly and that investors are able to exercise those rights efficiently”. That is currently obstructed by the prevalent nominee system and the obstruction of some nominee operators (stockbrokers and platforms).
  • I have of course written extensively on the issue of dematerialisation and the use of nominees extensively in the past – in fact for more than 15 years with little action on the issue being decided. It is well overdue! ShareSoc has run a campaign on this issue where you can see the issues explained – see https://www.sharesoc.org/campaigns/shareholder-rights-campaign/ . There needs to be a “bottom-up” reform of the ways share are held and transactions recorded as the Review suggests. The current system is way too complicated and needs reform to improve shareholder democracy and market efficiency. Dematerialisation of all shares in public companies is a given requirement and all shareholders should be on the share register so that issuers (public companies) know who their investors are and can communicate with them quickly and easily. That is also a requirement for improved shareholder democracy.  

In conclusion, the Austin Review is a well-researched report and is essential reading to anyone who invests in the stock market. It includes detail reviews of how other international markets such as Australia operate. Let us hope that its recommendations are followed through with some urgency.  For retail investors the proposals should be welcomed not feared.

Austin Review: https://www.gov.uk/government/publications/uk-secondary-capital-raising-review

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Prospectus Publishers off the Hook

The Government has published how it proposes to reform the Prospectus Regime. Among the welcome changes are the ability to omit a prospectus when shares are being issued to those who already hold equity securities in the offering company, subject to certain conditions, including that the offer is made pro-rata to a person’s existing holding.

The need for a prospectus introduced a costly barrier to the issue of shares via a rights issue and prejudiced private investors. It was always rather daft that those who already held the shares were assumed to know nothing about the company in which they held shares and required to be informed in detail about it. In general the proposed new prospectus rules are a welcome simplification. See link below for the details.

However the liability to investors for a false or misleading prospectus will remain but the following paragraph gives cause for concern.

“Para 14. While retaining the existing statutory remedy for false, misleading or omitted information, the government intends to raise the threshold for liability that applies to certain categories of forward-looking information in prospectuses. This will ensure that a person responsible for the preparation of a prospectus is liable to pay compensation only if: a) that person knew the statement to be untrue or misleading; b) was reckless as to whether it was untrue or misleading; or c) in the case of an omission, if that person knew the omission to be a dishonest concealment of a material fact.”

It has proved to be legally difficult to make liability for omissions from a prospectus stick – for example in the Lloyds/HBOS case. The above paragraph will require litigators to penetrate the minds of the directors and publishers of a prospectus and prove they knew that they were misleading investors – an impossible task.

This is not a helpful change at all.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Gamma Communications AGM and FCA News

I have received the Annual Report and Notice of the Annual General Meeting for Gamma Communications (GAMA). Despite the fact that this company specialises in electronic communications and actually say in their Annual Report that “This year we have adopted a digital first approach reflecting how we operate as a business”, they expect me to physically attend the AGM in central London at 10.00 am on the 19th May. There is no electronic attendance via web cast or hybrid meeting supported. This is a waste of my time for what is likely to be a routine event. I have written to the Chairman to complain.

Their registrar Link Group also failed to include a proxy voting form with the AGM Notice so I had to use my own. This is a repeated failing recently by Link Group which undermines shareholder democracy. They seem to be trying to force everyone to register for their electronic voting system. I don’t mind voting electronically but that should be provided by a simpler system such as that used by Computershare.

The Financial Conduct Authority (FCA) have published a press release that says “The FCA has finalised rules requiring listed companies to report information and disclose against targets on the representation of women and ethnic minorities on their boards and executive management, making it easier for investors to see the diversity of their senior leadership teams”. They have simply gone ahead and implemented new rules that were the focus of a public consultation which I severely criticised – see https://roliscon.blog/2021/08/06/diversity-but-at-what-cost/ . What feedback did they get to the public consultation? They have not said and no report has been published on it. I have asked for more information to see what support they got for these proposals which I consider to be political gestures which will have no benefit but add a lot of costs to listed companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Reform of Defamation Act to Stop SLAPPS

Today the Government has announced that it intends to reform the Defamation Act and take other steps to stop abusive legal practices. In particular the use of expensive lawsuits to inhibit free speech – so-called Strategic Lawsuits Against Public Participation (SLAPPS).

This is particularly relevant at the moment as it is alleged wealthy Russian oligarchs have used the high cost of litigation to stifle public criticism of their actions and past careers. Just by commencing a legal action on claimed defamations they can force the defending party to run up costs of thousands of pounds and the threat of pursuing it through the courts at even higher costs effectively bullies the defendants to concede defeat and withdraw. The current English legal system effectively allows the wealthy to defeat justice.

It is suggested that the “public interest” defence could be strengthened and a need to prove “actual malice” be introduced, although to my mind that would not solve the problem as it would just lead to more lengthy debate by lawyers. This would not be a simplification in essence.  

SLAPPS are not new of course but may have become a growing industry for lawyers to feed on. For example, it was well known that fraudster Robert Maxwell used lawyers to intimidate reporters and suppress negative stories on his activities.

But the real problem is that such cases are always tried in the High Court. That means there is a complex pre-action protocol and discovery phase and when it gets into court, potentially several days of multiple QCs acting for both parties at enormous cost.

It not only makes defending against allegations of defamation exceedingly costly, particularly if the pursuing party uses delays, complications or repeated claims to increase the costs, but it also makes it prohibitive for someone to make a claim for defamation unless they are quite wealthy. The risk of losing a case when the other side have run up enormous legal costs puts off most people from pursuing such cases.

In summary libel cases are too expensive and can only be pursued or defended by the very wealthy even when the complaints might be quite trivial in nature. The whole system needs reform with minor cases being considered by more junior courts and a cap on costs being imposed early on.

Government announcement:  https://www.gov.uk/government/news/government-clampdown-on-the-abuse-of-british-courts-to-protect-free-speech

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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