Information Arbitrage, Earnings Guidance & Boardroom Diversity
Week Ending 12 July

Theme for this week is information arbitrage – the ability to gather information in one context and benefit from it in another. For better or for worse, Reg FD or not, this practice happens in the investment community today, and it’s something issuers need to keep a close eye out for. Below are two separate mentions of the possibility of information arbitrage – banks hiring credit ratings analysts, and MiFID leading to analysts carrying trading ideas between firms. Our favorite finance writer, Matt Levine, also highlighted another information arbitrage story on Medium from journalist Byrne Hobart. In the piece, he showed the parallels between investigative journalism and “short and distort” activism campaigns, posing the question “should short sellers fund journalists?” (that is, while cringeworthy for IROs, probably legal..). Also, sunshine and apple pie and ice cream and happiness to pick up your spirits in a busy earnings season.

So…here’s the latest news in the IR world.

Buy Side

- We reminded you last week that there were more column inches in the FT than the WSJ with us Yanks on holiday – but it turns out some of those FT column inches were worth noting; here’s a FT Alphaville piece from Julian Hull at Stockviews, with some interesting points on the unintended consequences of MiFID that we hadn’t seen before. For one, UK data shows the shift in the business models of domestic brokers away from institutional revenue and towards corporate advisory revenue (read: banking is already starting to pay for relationships at some brokers).

One novel insight the author offers: the new structure of research regulates the flow of ideas and attaches a legal wrapper to them…but ideas are going to flow faster than contractual agreements; “this inflexibility also means that, for large periods of time, buy-side individuals only have access to whichever analysts made a list at midnight on 31 December…[in the case where] analysts are leaving to set up their own businesses, this opens up the possibilities of serious informational arbitrage between professional market participants.”

- Fitting with our ongoing theme of “passive isn’t always passive” is this piece from Institutional Investor that uncovers the man behind the curtain for a number of quant strategies. Did the Model Do Anything Stupid? interviews the leads from the quant units of Northern Trust Investment Management, Robeco, and Rosenberg Equities (part of AXA Investment Management) to get a feel for how much human input drives the final decision. Michael Hunstad from Northern Trust, as one example, notes that the firm has seen humans respond more effectively to the impact of specific market-moving events such as the grounding of the Boeing 737 Max airframe, where historical trading data that would drive a model has little bearing on the future. We often hear from issuers that have dialogue with managers from self-described “quant shops” – this article might frame how you respond to these firms, who may not want to stray too far from the model, but know that human input must be involved to produce the best results.

IR Best Practices 

- Here’s a different take on the “revolving door” concept that we hadn’t seen before, but makes a lot of sense intuitively. University of Chicago researchers, working with a dataset of ratings agency credit analysts, uncovered the data that supports a hidden incentive for investment banks to hire former ratings analysts. Banks do appear more likely to hire analysts that are more accurate in their ratings, but in general are more likely to hire analysts that covered deals the bank was associated with. Further, a full 27% of the credit analysts cited wound up working for one of the top banks, and 13% wound up working for banks that were associated with a deal they had worked on. The researchers are working with a structured finance data set (ABS, MBS, CDOs, etc.), so the results aren’t strictly relevant to corporate-issued debt…but the concept applies to corporates as well – there does appear to be a natural talent pipeline from credit ratings analysts into banks, and this might have some interesting implications for your relationship with both. (Ratings agencies, are, of course, exempt from Reg FD, and while there are certainly ethics rules that prevent individuals from rating agencies from using information they acquired from non-public sources, well, let’s just say it may be worth watching the career paths of those with knowledge of your company).

- With earnings season upon us and IR teams deep in the throes of assembling the next quarterly release, we thought this academic piece from UCLA Law School researchers, 'Do the Securities Laws Promote Short-Termism?' is an interesting respite for IROs wondering why they’re going through this in-depth a process each quarter. The article covers the entire history arc of earnings releases, guidance, broker estimates, consensus, and securities litigation starting from the 1960s, when companies first started producing quarterly reporting for investors. To summarize, the market has always, and will always, rely on some type of forward projection of companies’ results, whether it’s provided by the company or by the analyst community. The article covers several thought exercises as to how securities laws could be written to make sure companies are judged to the right standard in both short-term and long-term, including outright banning guidance (making the consensus less accurate and less valuable), encouraging more and better-defined guidance (making the consensus more accurate, but less valuable), and requiring companies to have a “duty to correct” projections (making projections and consensus both more accurate by opening up liability). For any that have had the “should we guide to X” debate internally, these questions underly any decisions the company makes.

ESG

- Hat tip to the always excellent thecoroporatecounsel.net for pointing out this Allen Matkins piece on the beginnings of enforcement of California’s newly-enacted law requiring gender-diverse boardrooms for any companies “with principal executive offices in California.” The California Secretary of State published two lists of companies, one presumably the set of companies that would be required to comply with the law and the second those with “reporting in compliance” – but the two lists contain companies that don’t match and aren’t prescriptive to show any companies that aren’t in compliance. The law officially takes effect as of December 2019, but given an inauspicious display of organization here from the state regulator, if your company is subject to the law, it may be worth double-checking with the state to make sure you confirm that the state understands you’re in compliance. “Company refuses to diversify” is another newspaper article that writes itself, and an ounce of prevention may be worth a few pounds of cure measured in newsprint.

Questions? Comments? Enjoying a spot of tea with Alex Morgan? Reach out to your IHS Markit team, or brian.matt@ihsmarkit.com.