Too dicey

Betting on bitcoin prices may soon be deemed illegal gambling

Regulators increasingly think crypto-derivatives are unsuitable for retail investors




ON SEPTEMBER 24TH the price of a single bitcoin, the best-known cryptocurrency, fell by $1,000 in 30 minutes. No one knows why, and few people cared. There have been similar drops nearly every month since May. Yet for one obscure corner of the market, it mattered.

Exchanges that sell “long” bitcoin derivatives contracts, with which traders bet that prices will rise without buying any coin, soon asked punters for more collateral. That triggered a stampede. By the end of the day $643m-worth of bitcoin contracts had been liquidated on BitMEX, a platform on which such contracts trade. Bets on other cryptocurrencies also became toxic.

Crypto-derivative products, which include options, futures and more exotic beasts, are popular. More than 23bn have been traded so far in 2019, according to Chainalysis, a research firm. But tantrums such as last month’s have put them in regulators’ cross-hairs. Japan is considering stringent registration requirements.

Hong Kong bars retail investors from accessing crypto funds; Europe has had stiff restrictions since last year. Now the Financial Conduct Authority (FCA), a British watchdog, is proposing a blanket ban on selling crypto-derivatives to retail investors. A consultation ended on October 3rd. Its decision is expected in early 2020.

It would take an earthquake for the FCA not to press ahead. In the real world, importers buy derivatives as a defence against slumps in their domestic currency. But crypto-monies are not legally recognised currencies. They do not reliably store value, rarely serve as a unit of account and are not widely accepted. Peddlers of crypto-derivatives, the FCA says, cannot claim their wares are needed for hedging purposes.

That explains why most such derivatives are marketed as investment products. Yet they are not tempting places to park savings. The assets they track are hard to value: virtual monies promise no future cash flows. Prices across cryptocurrencies are strongly correlated, suggesting that demand does not stem from usage or technological advances. Instead it responds to hype (for which Google searches are a proxy; see chart). Thin trading means that prices differ widely between crypto-exchanges, making them a poor reference for derivative contracts. Illiquidity also amplifies swings: bitcoin is four times more volatile than risky physical commodities.




The FCA thinks crypto amateurs fail to understand all this. It estimates that investors in Britain made total losses of £371m ($492m) on crypto-derivatives from mid-2017 to the end of 2018 (net profit was £25.5m, but was mostly captured by the largest investors). Two other features can make losses catastrophic: leverage (platforms typically allow derivative traders to borrow between two and 100 times what they put in) and high trading costs. The FCA thinks its mooted ban could reduce consumer losses by up to £234m a year.

Insiders disagree. “This is a knee-jerk reaction,” says Jacqui Hatfield of Orrick, a law firm. “Crypto-derivatives are just as risky as other derivatives.” A ban could mean consumers invest directly in unregulated cryptocurrencies instead. Exchanges could relocate. In any case, says Danny Masters of CoinShares, which sells crypto vehicles, the regulator should not be choosing which technology thrives or fails.

Yet it is part of the FCA’s mandate to protect consumers against predators. Nearly $1bn in virtual coins were stolen from crypto-exchanges and infrastructure last year, 3.6 times more than in 2017. Such thefts hit the value of derivatives. Manipulation is also rife. “Retail investors are diving in a pool of sharks,” says David Gerard, a bitcoin sceptic. As regulators close in on market abuse, defenders of crypto-derivatives are swimming against the tide.

What a Power Struggle in Beijing Might Look Like

The president won’t fall completely, but his authority could wane.

By Phillip Orchard

 

On Oct. 1, 2019, exactly 70 years since Mao Zedong stood in triumph at the gates of the Forbidden City and declared the creation of the People’s Republic of China, Chinese President Xi Jinping was doing his best imitation of the great helmsman. Dressed in a black tunic identical to the one worn by Mao in his famous portrait at Tiananmen Gate, Xi echoed Mao’s boasts that only the Communist Party of China is capable of protecting China from foreign exploitation. Xi, like Mao, then inspected the People’s Liberation Army – though, this time, instead of American tanks captured by Mao’s forces from the nationalists in 1949, Xi reviewed an extravagant parade of new indigenous weapons systems, including new hypersonic missiles and intercontinental ballistic missiles meant to keep the U.S. at bay.


The message of the meticulously choreographed affair was obvious: The CPC has vanquished the ghosts of the century of humiliation and transformed China into a unified emerging power – and Xi has the unquestioned mandate from heaven to carry forward the project of national rejuvenation started by Mao. But those with a stake in Beijing’s opaque power politics may have been watching for more subtle messages: A curious choice of words in Xi’s speech, or the unexpected presence of a certain official on the rostrum with Xi, or a quiet shift in state propaganda themes – anything that would hint that, as was often the case with Mao himself, Xi’s grip on power was not so absolute.

Some were likely disappointed; the ceremonies were clearly tailored to the purpose of deifying Xi, with state media crowning him the “people’s leader” – a title not used since Mao. Still, in recent months, the frequency of supposed hints of discontent with Xi has picked up again, both among those who believe he is too much like Mao and those who believe he is not enough like Mao. Given China’s socio-economic pressures, along with the trail of purged rivals and discarded norms Xi left behind as he consolidated power, it’d be naive to assume the president is immune to challenge altogether. So it’s worth asking: What might a major power struggle look like?
 
Reading the Tea Leaves
Power struggles in China typically spill into the public sphere with thumb-biting and coded taunts rather than bare-knuckle brawls. The media is too tightly controlled, and the risks of open speculation too high, for the case to be otherwise. Observers are typically stuck parsing sodden tea leaves for clues about unrest beneath the surface. Still, as in any country, rival factions in China have incentives to find ways to weaken each other in the public eye and use the state’s megaphones to build popular support for their objectives. And since state propaganda, official speeches and personnel moves are so carefully scripted, and thus so pregnant with symbolism, even small deviations from established trends can carry enormous meaning. Silence can also be deafening.

One prominent example: Following the death of Premier Zhou Enlai in 1976, with Mao effectively on his own death bed, the infamous Gang of Four (including Mao’s wife) used state media to accuse acting Premier Deng Xiaoping of counterrevolutionary activities, betraying the power struggle raging behind the scenes. Deng, of course, came roaring back after Mao’s death and was promptly rehabilitated in state media, which in time announced the gang’s arrest long after purging them from state propaganda.

Despite the arrival of the information age, little has changed. If anything, Xi’s embrace of a cult of personality, which was frowned upon by Deng, has made problems somewhat easier to detect. When Xi is at the center of nearly everything produced by state media organs, any sudden downtick in official adulation over the president becomes very conspicuous. In late 2017 and early 2018, for example, state media made it clear that Xi was effectively untouchable. Sure enough, at the epochal 19th Party Congress in November 2017, Xi was enshrined in the party’s constitution and succeeded in stacking the Politburo with loyalists. Three months later, at the National People’s Congress, Xi eliminated presidential term limits and, arguably more important, pushed through a staggering reorganization of the machinery of the state.

But cracks began to show. In July 2018, for example, several prominent portraits of Xi in cities across China, as well as one portraying Xi’s father, Xi Zhongxun, as the real architect of the success of Shenzhen, disappeared. The Shaanxi Academy of Social Sciences abruptly announced the end of a highly touted research project into Xi’s time as a student in a rural village during the Cultural Revolution. And the Xinhua News Agency published an article criticizing former Chinese leader Hua Guofeng for cultivating a Mao-style cult of personality – a veiled critique of Xi. For several weeks in late July and August, amid rumors of a coup, Xi disappeared from the front pages of the People’s Daily altogether. Around this time, two of Xi’s most powerful loyalists, propaganda chief Wang Huning, who oversees the effort to deify Xi, and Vice President Liu He, responsible for several contentious issues, including trade negotiations with the U.S. and SOE reforms, also disappeared from the front pages.

If Xi was ever truly threatened, he quickly bounced back and by September was once again monopolizing the media’s attention. But hints of discontent have continued. For example, ideological divisions between Deng advocates (including Deng’s son) and Xi supporters were laid bare in the run-up to the 40th anniversary of Deng’s reform and opening. Xi’s speeches and state propaganda subsequently changed, emphasizing more than before the notions of ideological purity and loyalty to party leadership – and threatening to impose autarky and take the country on a new “long march” if that’s what unity required. But while in 2017, every high-profile speech he made spurred ritualistic demonstrations of loyalty and support among key officials, now they are perfunctory and scarce, even among the president’s closest allies, some of who have remained silent. Perhaps most conspicuous, Xi has repeatedly pushed back the Fourth Plenum of the 19th Central Committee, suggesting concern about exposing the party’s internal divides. Last month, Xi mentioned “struggle” 56 times in a single speech – reviving a theme favored by Mao at the height of intra-party battles in the 1960s and 1970s.
 
Implications
There’s a risk of reading too much into these sorts of things, of course, and of measuring Xi’s control against unrealistic expectations. Some hints could go either way. Does the lack of high-profile purges this year, for example, suggest that Xi is immune to backlash, or simply that there are no potential rivals left worth targeting? If criticism of Xi’s policies increases, does that mean the opposition is more emboldened, or that Xi is confident enough to allow for the level of honest debate needed to avoid the policy pitfalls inherent to an echo chamber? Are tightened capital controls that target private sector tycoons politically motivated or merely meant to fight corruption and rein in reckless financial speculation?

Ultimately, divining the motivation behind certain choices is perhaps less important than understanding the nature of the choices themselves. Right now, Xi has only bad options.

He can’t, for example, micromanage the economy more than he is without prolonging trade tensions with the West, scaring off foreign investment, risking a credit crisis and 
creating a fracture along China’s historical fault line between the interior and the coasts. But he can’t push reform or liberalize too much without abandoning Beijing’s favored tools for staving off an existential socio-economic crisis. And as the global economic slowdown intensifies, the next few years are likely to make disagreement over things like reform and opening an order of magnitude more intense.

Absent a worst-case economic scenario, it’s hard to imagine Xi abruptly falling from power. The Communist Party has probably wrapped its own legitimacy too tightly in Xi’s cult of personality to avoid falling with him. During his first term, moreover, Xi’s sweeping purges smashed up traditional factions, took down extraordinarily powerful figures and their proteges, and reconfigured critical patronage networks that now have him at the center. Xi also took tight control of the PLA, the guarantor of CPC rule.

But even if his formal position is bulletproof, Xi’s real authority – over policy direction, over personnel choices at the next Party Congress in 2022, over lucrative patronage networks – could theoretically be taken from him. And this could prove deeply problematic by, say, reviving crippling factional struggles and leading to paralysis in a crisis. After all, Xi’s consolidation of power in his first term wouldn’t have happened without widespread recognition among Chinese leaders that the turbulent waters ahead necessitate a strongman at the helm. The CPC’s embrace of Xi’s dictatorship may now be causing as many problems as it was intended to solve. But so too would paddling in opposite directions midstream.

China’s 70 Years of Progress

Much of the West, as well as Asia, continues to assume the worst about China – a habit of mind that could have catastrophic consequences. As Albert Camus once wrote, “Mistaken ideas always end in bloodshed, but in every case it is someone else’s blood."

Keyu Jin

jin19_HowHweeYoungPoolGettyImages_jinping70celebration


BEIJING – The celebration of the 70th anniversary of the founding of the People’s Republic of China on October 1 will be an exuberant affair, involving glitzy cultural events, an extravagant state dinner attended by Chinese and foreign luminaries, and a grand military parade in Tiananmen Square. And, at a time of high tensions with US President Donald Trump’s administration, it will be imbued with an extra dose of patriotic enthusiasm. But while China has much to celebrate, it also has much work to do.

The first 30 years of rule by the Communist Party of China (CPC) are judged harshly, owing to the disastrous Great Leap Forward and the Cultural Revolution. But these were not lost decades. On the contrary, major strides were made in modernizing China: local and national power grids were established, industrial capacity was strengthened, and human capital rapidly improved.

As a result, China’s human-development indicators, on par with India’s 70 years ago, surged ahead. From 1949 to 1979, the literacy rate rose from below 20% to 66%, and life expectancy increased from 41 to 64 years. All of this set the stage for Deng Xiaoping’s program of “reform and opening up,” which unleashed China’s rapid economic growth and development over the last 40 years.

Today, China’s to-do list remains long, but its leaders are working consistently to check off agenda items, from reducing inequality and reversing environmental degradation to restructuring the economy. If they are to succeed – thereby solidifying China’s development model as a viable alternative to Western-style liberal democracy – they will need to deliver on two key imperatives in the coming years.

First, China needs to reach high-income status. So far, China has relied on the massive size of its markets and rapid output growth to raise incomes. But these forces only take an economy so far, and China’s institutions, technology, and prevailing mindset remain more closely aligned with today’s $10,000 per capita income than with the $30,000 level to which the country aspires.

Second, China must ensure that the Belt and Road Initiative (BRI) is a success. This means implementing an inclusive program of cost-effective, environmentally sustainable infrastructure construction that does not result in unsustainable debts.

Neither of these goals will be easy to achieve, especially given a challenging external environment. While China revels in its birthday celebration, the outside world – beginning with the United States – is worrying about China’s aspirations to become a global leader in technology and in geopolitical terms.

When a large ship sets sail, its wake will agitate other boats, no matter how skillfully it is steered. And yet China faces the daunting task of keeping other countries calm as it sails on. This will require, above all, open, frank, and consistent communication between China and the outside world.

But the onus is not entirely on China; Western leaders also must be receptive to the country’s efforts. China has long promised the world a “peaceful rise.” Unlike the nineteenth-century US, it has no Monroe Doctrine, which attempts to guarantee its sphere of influence, and claims no “manifest destiny” to expand its territory at all costs. In fact, since Deng, all but one of China’s border disputes have been settled through peaceful negotiations. It took China 11 years to negotiate, inch by inch, its borders with Russia.

Yet much of the West, as well as Asia, continues to assume the worst about China – a habit of mind that could have catastrophic consequences. As Albert Camus once wrote, “Mistaken ideas always end in bloodshed, but in every case it is someone else’s blood. That is why some of our thinkers feel free to say just about anything.”

To avoid falling into the trap of war, Western political and intellectual leaders must not blindly believe those who assume that confrontation with an ascendant China is inevitable. If any historical experience should be brought to bear, it is that of near-misses and miscalculations – reminders of how easily a standoff can become a calamity.

Past incidents – such as the 1999 bombing of the Chinese embassy in Belgrade by NATO forces, or the 2001 collision of US and Chinese aircraft off Hainan Island – have been settled through negotiation. But, given rising antagonism toward China, there is no telling whether leaders would manage to replicate that outcome were a similar incident to occur today.

The first 70 years of CPC rule brought rapid development, but ultimately only modest prosperity. Now, China must shift its attention to raising incomes and implementing the BRI effectively. These goals can be achieved only in a peaceful, stable context. China’s leaders understand that. But they still must convince the West that they do.


Keyu Jin, Professor of Economics at the London School of Economics, is a World Economic Forum Young Global Leader.

The $5tn diaspora: Dimon’s lieutenants take top roles

JPMorgan Chase alumni flex the network as Scharf moves to Wells Fargo

Robert Armstrong in New York


Former lieutenants of Jamie Dimon, second from left. Top roles at other financial institutions include, left to right: Jes Staley of Barclays, Matt Zames of Cerberus and Bill Winters of Standard Chartered © FT montage / Bloomberg


The appointment of Charlie Scharf as chief executive of Wells Fargo is not just a crucial turning point for the troubled San Francisco bank. It also represents further consolidation of the most powerful professional network in global finance: the JPMorgan Chase executive diaspora.

Former JPMorgan executives now lead banks with assets totalling some $4.7tn. Add in JPMorgan itself, where Jamie Dimon is into his 14th year as chief executive, and the sum reaches $7.4tn.

In the UK, Barclays is run by Jes Staley, who previously ran both JPMorgan’s asset management and investment banking divisions, and Standard Chartered is led by Bill Winters, who also did a stint leading the JPMorgan investment bank. In the US, in addition to Wells, PNC Financial, the eighth-largest bank in the country, is run by Bill Demchak, who ran JPMorgan’s structured finance and credit businesses.

Mr Scharf’s JPMorgan career culminated with his leadership of the retail banking division from 2004 to 2012, before he become chief executive of Visa and then BNY Mellon.

The Dimon network does not stop at the banking industry. Frank Bisignano, former JPMorgan chief operating officer, is the chief executive of First Data, the payments company that was sold to rival Fiserv for $22bn in January. Matt Zames, another former chief operating officer, is president of the private equity company Cerberus. Ryan McInerney, now president of Visa, once ran consumer banking at JPMorgan.

Investors and analysts give much of the credit to Mr Dimon’s own management skills. “The skills he teaches, the qualities he looks for, if I was [Wells’ chair] Betsy Duke or head of another search committee, I would look right to JPMorgan,” said Tom Brown, a longtime bank investor and commentator. “The highest praise I can give someone is that they make complicated issues simple, and Jamie and Charlie [Scharf] are so much alike in that way.”

Certainly, the credentials of any JPMorgan alum are burnished by the outstanding performance of JPMorgan shares, which have almost tripled over the past 10 years, far outpacing all other big US banks. The bank did not go through the near-death experiences that convulsed so many rivals during the financial crisis.

“JPMorgan being JPMorgan definitely helps,” said Jeffrey Harte, an analyst Sandler O’Neill. “Managers could focus on running their businesses during the crisis when others were in survival mode.” He cites strategic consistency and an emphasis on accountability in both good times and bad as hallmarks of the Dimon regime.

Several industry insiders note that JPMorgan’s outsize influence is not without precedent, pointing out how executives at Citigroup in the 1980s and 1990 went on to play important roles at other institutions. One of these was Mr Dimon himself. The list also includes Richard Kovacevich, who went on to lead Wells Fargo.
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Not everyone thinks that the enthusiasm for executives who have worked under Mr Dimon is entirely benign. “Whenever we have a hero, we develop cultures around that — look at Silicon Valley and Steve Jobs, and everyone walking around in black turtlenecks. There is definitely too much emphasis on the persona and not enough on the leadership behaviour,” said Lindred Greer, faculty director at the Sanger Leadership Center at the University of Michigan.

Dave Ellison, who runs a portfolio of financial stocks at Hennessy Funds, thinks that the world of banking has become too cosy. “These boards of directors is a moneyed club — they all know each other . . . I was hoping Wells Fargo would take a chance on someone new, someone out of the box who would shake things up.”

The world of very low rates and increasing technological competition requires that banks think in new ways, Mr Ellison said. “But here is another case where they are bringing in someone else who is in the club, rather than taking a chance on someone new.”

Masters of the universe

The rise of the financial machines

Forget Gordon Gekko. Computers increasingly call the shots in financial markets




THE JOB of capital markets is to process information so that savings flow to the best projects and firms. That makes high finance sound simple; in reality it is dynamic and intoxicating. It reflects a changing world. Today’s markets, for instance, are grappling with a trade war and low interest rates.

But it also reflects changes within finance, which constantly reinvents itself in a perpetual struggle to gain a competitive edge. As our Briefing reports, the latest revolution is in full swing. Machines are taking control of investing—not just the humdrum buying and selling of securities, but also the commanding heights of monitoring the economy and allocating capital.

Funds run by computers that follow rules set by humans account for 35% of America’s stockmarket, 60% of institutional equity assets and 60% of trading activity. New artificial-intelligence programs are also writing their own investing rules, in ways their human masters only partly understand. Industries from pizza-delivery to Hollywood are being changed by technology, but finance is unique because it can exert voting power over firms, redistribute wealth and cause mayhem in the economy.

Because it deals in huge sums, finance has always had the cash to adopt breakthroughs early.

The first transatlantic cable, completed in 1866, carried cotton prices between Liverpool and New York. Wall Street analysts were early devotees of spreadsheet software, such as Excel, in the 1980s. Since then, computers have conquered swathes of the financial industry.

First to go was the chore of “executing” buy and sell orders. Visit a trading floor today and you will hear the hum of servers, not the roar of traders. High-frequency trading exploits tiny differences in the prices of similar securities, using a barrage of transactions.

In the past decade computers have graduated to running portfolios. Exchange-traded funds (ETFs) and mutual funds automatically track indices of shares and bonds. Last month these vehicles had $4.3trn invested in American equities, exceeding the sums actively run by humans for the first time. A strategy known as smart-beta isolates a statistical characteristic—volatility, say—and loads up on securities that exhibit it. An elite of quantitative hedge funds, most of them on America’s east coast, uses complex black-box mathematics to invest some $1trn. As machines prove themselves in equities and derivatives, they are growing in debt markets, too.

All the while, computers are gaining autonomy. Software programs using AI devise their own strategies without needing human guidance. Some hedgefunders are sceptical about AI but, as processing power grows, so do its abilities. And consider the flow of information, the lifeblood of markets.

Human fund managers read reports and meet firms under strict insider-trading and disclosure laws. These are designed to control what is in the public domain and ensure everyone has equal access to it. Now an almost infinite supply of new data and processing power is creating novel ways to assess investments.

For example, some funds try to use satellites to track retailers’ car parks, and scrape inflation data from e-commerce sites. Eventually they could have fresher information about firms than even their boards do.

Until now the rise of computers has democratised finance by cutting costs. A typical ETF charges 0.1% a year, compared with perhaps 1% for an active fund. You can buy ETFs on your phone. An ongoing price war means the cost of trading has collapsed, and markets are usually more liquid than ever before.

Especially when the returns on most investments are as low as today’s, it all adds up. Yet the emerging era of machine-dominated finance raises worries, any of which could imperil these benefits.

One is financial stability. Seasoned investors complain that computers can distort asset prices, as lots of algorithms chase securities with a given characteristic and then suddenly ditch them. Regulators worry that liquidity evaporates as markets fall. These claims can be overdone—humans are perfectly capable of causing carnage on their own, and computers can help manage risk.

Nonetheless, a series of “flash-crashes” and spooky incidents have occurred, including a disruption in ETF prices in 2010, a crash in sterling in October 2016 and a slump in debt prices in December last year. These dislocations might become more severe and frequent as computers become more powerful.

Another worry is how computerised finance could concentrate wealth. Because performance rests more on processing power and data, those with clout could make a disproportionate amount of money. Quant investors argue that any edge they have is soon competed away.

However, some funds are paying to secure exclusive rights to data. Imagine, for example, if Amazon (whose boss, Jeff Bezos, used to work for a quant fund) started trading using its proprietary information on e-commerce, or JPMorgan Chase used its internal data on credit-card flows to trade the Treasury bond market. These kinds of hypothetical conflicts could soon become real.

A final concern is corporate governance. For decades company boards have been voted in and out of office by fund managers on behalf of their clients. What if those shares are run by computers that are agnostic, or worse, have been programmed to pursue a narrow objective such as getting firms to pay a dividend at all costs?

Of course humans could override this. For example, BlackRock, the biggest ETF firm, gives firms guidance on strategy and environmental policy. But that raises its own problem: if assets flow to a few big fund managers with economies of scale, they will have disproportionate voting power over the economy.

Hey Siri, can you invest my life savings?

The greatest innovations in finance are unstoppable, but often lead to crises as they find their feet. In the 18th century the joint-stock company created bubbles, before going on to make large-scale business possible in the 19th century.

Securitisation caused the subprime debacle, but is today an important tool for laying off risk.

The broad principles of market regulation are eternal: equal treatment of all customers, equal access to information and the promotion of competition.

However, the computing revolution looks as if it will make today’s rules look horribly out of date.

Human investors are about to discover that they are no longer the smartest guys in the room.