VC funds have too much money

Yesterday’s Lex column in the FT (paywall) commented on the mountain of cash sitting in VC funds. According to analysts at Goldman Sachs, approximately $121bn is waiting to be invested. This reveals two things:

  • Investors are hungry for VC returns.
  • VCs are having a tough time finding viable investments.

The first point is understandable, given the paltry returns elsewhere.

The second is interesting. It’s not for a lack of startups vying for cash. And not just startups, there are plenty of ongoing businesses that could use an infusion, which they might not be able to get from ever-more-conservative banks.

Could it be that investment firms are understaffed? Or could it be that the opportunities don’t meet the requirements?

The pressure is on, as cash holdings weigh down the overall returns, which further down the line will affect the amount of cash coming in.

This could explain the interest of some VC firms in alternative investments. A few weeks ago Harvard Business Review looked at the surge of interest on the part of VCs in ICOs, or “initial coin offerings” – tokens issued on a blockchain that confer value or utility.

In spite of their tenuous legal situation (are they securities? are they currencies? For now they are largely unregulated), institutional investors are attracted by the potentially high returns and the liquidity. And institutional interest could explain why several recent issuances were sold out within minutes.

The danger is the paucity of supply relative to the funds available. VCs could end up competing for stakes in blockchain projects, which would push valuations to ridiculous levels.

There is no way that crypto investments could make even a small dent in the piles of unused cash. CoinDesk Research revealed that 2016 saw a total of $236m of investment in ICOs. Even if 2017’s offering were to triple, it would still be miniscule in comparison.

This creates a potentially dangerous situation. Even if only 1% of the surplus cash wanted to try out an ICO opportunity, the imbalance in demand and supply would distort market fundamentals.

A bubble in the ecosystem would do damage – when it pops, investment and development are likely to be set back for years.

 

 

 

Trying to enforce Mifid II could kill it

The FT reported yesterday (paywall) that the European Securities and Markets Authority (ESMA) has issued guidance toughening the rules on securities trading transparency.

Under the upcoming Mifid II rules, banks will no longer be able to offer clients fixed income products kept on their own books (which accounts not only for most fixed income trading in the market, but also for a large chunk of bank trading profits).

The new statement closes a loophole that would have allowed banks to band together to form “dark pools”, effectively trading securities on the books of other members in the group, without needing to go through pesky public exchanges.

ESMA has made clear that any such group would need regulatory approval.

The potential consequences of this clampdown (and all the others embedded in Mifid II) could on the one hand be positive: increased transparency is likely to push down bond prices and open up the market.

Or, they could be negative: rather than make bond trading more transparent, the market movers (mainly banks) could decide to curtail their trading operations, which could result in a less liquid market.

The potential negative impact could also be what ends up killing Mifid II implementation.

Why? Because of the power of the banks.

Let’s backtrack a bit: Mifid II is all about increasing the transparency of securities markets, and enhancing investor protection.

Equities are already mostly transparent. The same cannot be said of fixed income, where trading has traditionally been over-the-counter (OTC).

Banks dominate the fixed income market, where they make most of their money (allegedly due to the lack of transparency). As the deadline for implementation approaches, we could well start to see significant pushback from an influential sector.

Surely ESMA could tell the banks to shut up and behave? If you have small children, you know how that generally turns out. Any large bank could resort to the typical two-year-old defense of “I’m going to hold my breath until you do what I want”. And it’s unlikely that ESMA will want a messy bank failure on its hands.

Giphy
Giphy

Also, one of the largest purchasers of bonds in Europe is the European Central Bank, which has been buying fixed income at the not inconsiderable rate of €80bn a month (now down to €60bn). I doubt very much that they will be happy with a change that is likely to reduce bond prices, let alone one that could provoke a contraction in liquidity. There aren’t enough bonds to meet demand as it is.

Furthermore, a possible result of the clampdown will be a migration of the market for European bonds to the US, which has a more relaxed attitude to bank bond trading. Since a large chunk of Trump’s cabinet seems to be made up of ex-investment bankers, that attitude is unlikely to change any time soon.

Losing an important market to the US is not something that the various organizations with confusing initials that currently govern Europe are likely to be happy about.

So poor, beleaguered ESMA could well come under pressure to go easy on market transparency. But if it does, then Mifid II unravels. Parts of it could still be implemented, and brokerage houses and asset managers will still have to scramble to improve reporting and lower costs. But the essence, the need to increase market transparency to protect investors and to avoid a repetition of the financial crisis, will be tainted.

Bitcoin funds – alternatives to ETFs

by Steve Buissinne via StockSnap - bitcoin funds
by Steve Buissinne via StockSnap

Now that the Winklevoss Bitcoin ETF is off the table, it’s worth looking at the alternatives, present and future. What can you invest in if you want exposure to bitcoin without holding bitcoin?

In chronological order of listing, we start with a couple of Scandinavian funds.

The first publicly traded vehicle was an Exchange Traded Note (ETN), not an Exchange Traded Fund (ETF). An ETN is a debt note designed to provide investors with a return linked to a certain benchmark. On maturity, the investor will get the initial cash back, plus or minus the change in value of the underlying asset. An ETN can be liquidated before maturity by trading it on an exchange, or by handing in the relevant amount of the underlying asset to the issuing bank.

ETNs and ETFs are similar in that both track an underlying asset, both have lower expenses than actively managed mutual funds, and both trade on major exchanges. The main difference between them is that with an ETF, you’re investing in a fund that holds the underlying asset. With an ETN, you’re not – the return is tracked and calculated. Since an ETF is not backed by an asset, its credit worthiness is tied to the reliability of the underwriting institution.

In May 2015, Stockholm-based XBT Provider launched the first bitcoin-based ETN, on the Stockholm Stock Exchange (part of Nasdaq Nordic). It was called Bitcoin Tracker One and was denominated in kronor. Bitcoin Tracker EUR, denominated in euros, followed a few months later.

Trading of the two was briefly suspended a year later when XBT Provider’s parent company – KnC Group (which also owned bitcoin miner KnC Miner) – declared bankruptcy ahead of the bitcoin halving. XBT Provider was swiftly bought by Global Advisors (Jersey) Limited, a Jersey-based investment manager (of which more down below).

Both notes are now available in 179 countries (if investors have an account on Nasdaq Nordic), and both prospectuses have been approved by the Swedish financial supervisory authority.

In December 2016, Global Advisors (Jersey) Limited listed the Global Advisors Bitcoin Investment Fund on the Jersey Stock Exchange. While the vehicle had been created in 2014 and had received regulatory approval from the Jersey Financial Services Commission, this listing made it the first regulated bitcoin fund to trade on a recognized, regulated exchange. Rather than just hold bitcoin, it actively manages holdings in order to outperform the underlying asset.

The custodians for the fund are Gemini and itBit, both regulated bitcoin exchanges. Although the fund is pitched as a pure bitcoin play, its charter allows it to hold up to 25% of its wealth in non-bitcon assets.

The Bitcoin Investment Trust (BIT) was the first US-based private investment vehicle to invest exclusively in bitcoin. While technically it is a fund that can be traded and is available to certain segments of the public, holders can only sell one year after purchase.

BIT began raising capital on SecondMarket, an alternative exchange for private stock owned by Digital Currency Group CEO Barry Silbert, in September 2014. SecondMarket made a $2m seed investment in the fund. BIT is aimed exclusively at institutional and accredited individual investors, with a minimum investment of $25,000.

In 2015 it launched a new sponsor, Grayscale Investments. It also moved its trading to the OTCQX, the leading over-the-counter exchange in the US, where it resides today. The fund usually trades at a significant premium to the underlying asset, largely due to the low liquidity.

Other bitcoin ETFs are awaiting their turn in the spotlight. Next up is SolidX, which submitted its proposal in 2016. A ruling is due by the end of this month. And earlier this year, Grayscale Investments filed a proposal with the SEC to list BIT as an ETF in a $500 million initial public offering.

Furthermore, the Winklevoss brothers have said that they will continue to work with the SEC to address its concerns. While the barriers are high, it sounds like they haven’t given up.