Tales from the City: a fictionalised look at how finance works

http://www.guardian.co.uk/commentisfree/joris-luyendijk-banking-blog/2012/feb/29/tales-city-fictionalised-short-story

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To mark the 50th post on this banking blog, two outsiders are reflecting on the interviews published so far. First we had a lecturer in organisational psychology and today we have Brett Scott. Brett is a writer, activist and ex-broker who works in financial reform initiatives. He writes a great blog and here he explains why Karl Marx would have made an excellent hedge fund manager. Brett decided it might be interesting to show how the interviewees' niche activities all link up, and this gave him the idea of connecting the interviews together in the form of a short story. He has used the "voices of finance" as the basis for the characters, but still, this is fiction. Brett knows none of the interviewees personally.

The financial system is about constant flow. Money sloshes around like water and financial intermediaries build canals, blow up dams and steer it via funds, investment products and bank accounts into productive and unproductive investments, shaping the economic landscape in the process.

There are many reasons to believe that the current system blatantly favours those intermediaries, and that the majority of investments they facilitate are unproductive.

The financial crisis, for example, was largely a story of intermediaries – such as investment banks – enriching themselves while guiding money into the mother of all unproductive schemes: an opaque housing bubble pointlessly flipped around like a hot golden potato until it exploded.

In cynical moments, I also might suggest that the system is too fragmented, unaccountable and incompetent to deal with itself, and that nothing has really changed.

There are, however, areas of finance that are productive. This project finance manager helps create useful infrastructure projects that otherwise wouldn't happen. Fund management is useful if it succeeds in helping pensioners in their retirement. Even derivatives can be useful for risk management, although they've mostly been used for risk escalation. Retail banking is clearly useful, albeit the high-street banks are notoriously bad at it.

One area of finance I think is useful is venture capital, and I found the interview with the sassy venture capital fundraiser fascinating. Her job is to coax investors to give her firm money, which they then use to purchase stakes in small or medium businesses that need money to expand. Those investment decisions will be made by a portfolio manager, assessing the future potential of those ventures.

Venture capital meets mergers and acquisitions (M&A): so you want to sell a company?

Let's start with the Venture Capital Fundraiser, and let's imagine her looking across her Mayfair office at the portfolio manager. Their VC fund has an eight-year lifespan. Within that time they need to invest in a handful of businesses, raise their value, sell them again ("exit"), and return the money to the investors. If done skillfully, everyone makes loads of money. If not, the team will struggle to raise money again.

Her particular VC, fund though, has unusual constraints, being sharia compliant. They are restricted in what companies they can invest in, and the Islamic prohibition on interest means they cannot use debt to artificially hike returns in a sea of leverage.

Thus far, the team has invested in companies that have largely gone nowhere. Their only winner is a medium-sized Moroccan telecoms company, bought several years ago for £20m. It's possible that they will be able to sell it at up to eight times the value of their original stake, which could raise the overall performance of their fund.

But selling off a business is tricky. They need a good idea of its value and a range of potential buyers who agree with them on that. That's not an objective process; it's an intensely political process. This is the reason why investment bank M&A and corporate finance professionals exist.

The Portfolio Manager is talking to one now, an eager analyst from a small corporate finance boutique who's spent the last year trying to build a relationship with the firm. He's taken it upon himself to create a rough valuation of their Moroccan asset and research potential buyers. He reckons his boutique could help the VC firm sell to a FTSE 100 company looking to expand their Moroccan operations.

VC Portfolio Manager, though, is reluctant to use the services of the boutique, having been courted by a high-spending MD of Corporate Finance at one of the large investment banks. The MD took him out to Gordon Ramsay's a few weeks ago, and even paid to pass some deal ideas by a Competition Lawyer to identify which buyers would possibly run foul of competition authorities.

"You know that egotistical MD is going to screw us for excessively high fees," says Fundraiser, "And then he's just going to stick some junior onto the case. We should go with that boutique firm instead. Better service and lower fees."

She knows that Portfolio Manager likes the idea of a big investment bank facilitating their deal. They play on his vanity. Her view of M&A bankers is less charitable: glorified consultants making spreadsheets, all using the same staid methodologies to guess the value of companies. It's a highly imprecise art, and it's not like JP Morgan would actually do a better job than anyone else.

Still, it's an alluring draw to be courted by a smooth-talking, gel-haired member of the international banking elite.

"JP Morgan has higher fees," says Portfolio Manager, "but they can get us a higher price for the asset. These big guys are just better connected. The MD already reckons he's lined up a private equity buyer."

"Isn't it problematic that a private equity buyer would use excessive debt to purchase the asset? We're supposed to be sharia compliant."

"Once we sell it it's no longer ours, so it no longer needs to be sharia-compliant."

"But the money we receive from the sale would have been borrowed. Doesn't that taint our returns?"

"Well, we'll phone up the Islamic cleric in Malaysia and get his opinion."

"Which one?"

"The one who is a little more liberal."

She looks at her mobile phone. She thinks she just might return the call of that recruiter instead, just in case things don't go as planned.

M&A meets corporation: so you want to buy a company?

FTSE 100 CEO: "Some young analyst at a shit little corporate finance boutique has pitched us an idea. He thinks we should buy that Moroccan telecoms unit owned by the weird Islamic venture capital firm.

M&A Lawyer: "Are you considering buying it?"

FTSE 100 CEO: "Yes, to make sure it doesn't compete with us. I don't want some unknown boutique running the deal though. I want my man at Morgan Stanley on board, the MD of M&A. He's been useful to me over the last few years and he's having a bit of a lean patch. Besides, he told me over golf that he's in trouble with his wife and needs some positivity. He'll drive their price down through the ground. Can you get me someone to do due diligence on an opaque Moroccan company?"

M&A Lawyer: "Those guys at the data management firm can do the monkey work. I have their sales guy phoning me all the time. Let's throw him a bone."

Sell-side broker-dealers: join our rogue trading graduate programme

On a Canary Wharf trading floor, the investment bank Equity Sales Intern is preparing sales bumf to send to fund managers. He's feeling nervous. His university friend is an intern in the M&A division of the same bank, and she might have accidently mentioned details of a potential deal they're working on, trying to help a FTSE 100 company buy a Moroccan telecoms outfit.

He shouldn't have been given this information, but Chinese Walls are surprisingly easy to breach after a few cocktails. He wonders whether he can impress the traders by subtly leaking them the information. They've been treating all the interns like crap since they arrived. Maybe it could be a way to get noticed by the emerging markets Investment Strategist …

He sees Cruella de Vil, the interns' nickname for the equity division's Chief Operating Officer. She's hyper-vigilant about potential breaches of Chinese Walls, lest the bank gets hit with insider-trading scandals. Her Risk and Compliance Consultant has recommended in a not-so-subtle way that their systems are in dire need of modernisation, lest rogue traders find ways of gaming it.

She's hired an external IT Consultant and Developer to help improve the trade reporting system, but in the process has managed offend the internal IT Business Analyst, who feels her territory infringed upon. Everything's been tense after an incident with a plastered trader that arrived in the office at 3am and tried to wreak havoc in the Asian markets. The trader had a meeting with the Employee Relations Manager the next day, and was led out by security, but not before trying to urinate on her desk.

They kept the story out of the news, but they've been forced to get a Partner from an accountancy firm to check that the accounts are in order. "You're going to end up with a serious problem if you're not careful," Partner says. "Just ask my PR officer friend about the media fallout when his firm's brokers were caught front-running their fund manager clients."

Buy-side fund managers: old-school managers v new-school programmers

The Fund Manager is in his office. He's having a bad day. All the brokers and dealers are getting wind of some potential deal involving a FTSE 100 telecoms company. He's just got a call from an Institutional Stock Broker flogging him with research from her supposedly hotshot Research Analyst. It's the normal generic stuff about how an acquisition in North Africa might affect the acquiring company's share price.

His phone rings again. It's that Salesman from the brokerage house, trying to flog the same stuff from his research guy, rapping on about a definite buying opportunity. The Fund Manager can't stand this guy and his bullshit talk. These bloody brokers are like ravenous wolves baying at his gate. "Thanks," he says. "I'll think about it."

He shuffles through letters, opening one containing a glossy brochure from the asset management division of smaller European bank, prepared by their Head of Marketing. "Oh great, some crap structured product. Why are these guys trying to peddle this shit to me again!" His analysts look around, then go back to work. The last time he bought weird structured products they were impossible to value. He still has to phone up a Bond Pricer to get some sense of what they're worth.

He calls her again now: "Hi Lucy. Can you believe these guys, trying to sell ratcheting floaters again? By the way, I was looking at your latest valuations of our structured portfolio. I think the assumptions you're using are excessively conservative. Surely our holdings are worth more than that?"

Bond Pricer smiles to herself. These fund managers always think their portfolios are worth more than they actually are. "We offer our independent interpretation of the value. If you don't like it, take me to a nice restaurant." She sees her mobile phone ringing. It's her Journalist friend from the bond magazine, probably wanting an inside scoop on the Euro crisis. "I've got to take another call."

Fund Manager reluctantly answers the phone to a Primary Research Firm Manager, who's trying to get him to purchase their independent research. "You can't trust those bank salesmen," Research Manager says. "They're just trying to offload their traders' inventory onto you." Fund Manager is only paying partial attention, ogling the Investment Management Adviser who's in for the day assessing the state of his trading systems. He drifts off, looking at his inbox flooded with analysts' reports. Reading any of it could take up the whole afternoon.

In the office below there's a high-frequency trading company. In the time it takes the fund manager upstairs to make tea, they've entered and exited a trade 14 times. They don't know what they're trading and they don't care either. The Computer Programmer is not concerned about real-world events. All that matters is the black box they call "the engine".

Computer Programmer wonders whether his hedge fund operations are useful. He thinks of his friend, who is also a quant, but who helps to combat fraud and money laundering at the high-street banks, working alongside a Risk Analyst who helps assess mortgage applications.

Such value judgments will have to wait. The markets close in 10 minutes and he's got a date with the pub. He gets into the lift. There's a man in there who looks at his casual jeans with disdain. Undoubtedly some anal fund management type. They walk out into the London evening, and up to Ye Olde Mitre.

The end of the day: the financial treadmill

The Financial Journalist is at the pub counter. Across the room is an Insurance Broker, talking about marine liabilities while pushing away a drunken older colleague making unwelcome advances. The insurance old-boys club are unmistakable. "They're the ones who couldn't make it in banking," Journalist thinks to himself. "Spoilt, English rich-boys, outclassed by the young international mercenaries of the investment banking elite."

A young guy is talking loudly to his girlfriend is on the phone, braying about a deal he's working on involving a Moroccan company. He should know better than to do that around journalists. "I could do these guys jobs better than they can," thinks Journalist. He wonders whether he should apply for a job as a bank analyst. He did get a random call from a desperate recruiter the other day, trying to elicit his CV, thinking he was a banker.

At the next table there's a young former-M&A banker talking to his cousin, a prospective intern in mathematical finance. The former wants to become a financial consultant. The latter reckons he's destined for trading floor glory.

Journalist glares at them. Their talk sounds like a tacky interview dress-rehearsal. Why not do something useful, like retail banking? He knows the answer. It's the same reason that I don't do retail banking. Because we think it's boring. I want to uncover news. They want to create news. We all want to be important superheroes.

It's debatable how much of the financial sector is truly newsworthy though. It's mostly the same stuff repeating itself in cycles, just with different names. Financial professionals are nodes in a giant global network that dwarfs them. They create it without even realising it, and then go to the pub.

I meet Joris in a City cafe. I work in alternative finance, a small but growing community that believes the system can be changed. It disturbs me that the financial sector is a fireworks box of talent, mostly getting wasted on dull, overpriced thrills and cocaine nights leading nowhere. There's no point in being scared of the financial sector though. It's better to empathise.

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