SoftBank and The Dong

Illiquid Illusions and Market Manipulation

Ranjan here, and this week I'll be talking about price discovery and valuations.

A number of you have written in that you're enjoying my mid-aughts trader nostalgia. While I in no way intend this newsletter to become some kind of therapeutic, backwards-looking exercise, there's one story I have to tell you, and it helps provide context to the current travails of SoftBank.

It involves the Vietnamese Dong.

MARKET-MAKING

There are a lot of jobs out there that your parents probably won't understand. "Bank Trader" was certainly one of them. My parents assumed I picked stocks, and I tried to explain to them it was best understood as an industrial-level foreign exchange teller, like the ones they dealt with when they landed at the Calcutta airport.

While we took a good deal of proprietary risk: "I think the Thai Baht will weaken in value so I'll short it"), the majority of the job was facilitating transactions for clients and managing the adjacent risk: "A client needs to sell 100 million USD worth of Thai Baht. I will buy it from them, and then decide whether to hold it or sell it right away into the market.”

Emerging market derivatives were a whole other can of worms. In a currency derivatives trade, you never exchange the actual underlying asset or currency, but just sign a contract that you both agree to settle up in US Dollars at a future date, based on a what a 3rd party says the foreign currency was worth ("Today, the USD/THB is 30.00. I will bet you 1 month from now the USD/THB exchange rate is 31.00. If it's 32.00 then you owe me $1.00. If it’s 30.00, then I owe you $1.00”).

Hopefully, that didn't get too confusing. Currencies and derivatives are quite simple once you get the basic rules down in your head.

THE DONG

As one of the younger people on the EM trading desk, I'd get stuck with a bunch of the smaller currencies no one wanted to deal with. You'd get funny requests, like some corporate client asking you for a price in the Vanuatu Vatu or the Costa Rican Colon. A huge coffee chain would need to pay its growers, and you were effectively their FX teller. The amounts were usually minimal enough ( < $1 million) and it was more a side service than a profit-center.

In May 2008, one of the head salespeople stood up and asked for a price in the Vietnamese Dong, in the amount of $5mm USD. Our team looked around at each other, and my boss nodded at me. The currency only traded as a derivative and had almost never been requested, but the client was a big one. It was also a bit odd that it was a hedge fund, as normally these smaller currencies were requested by corporate clients who had operating interests in the country. After some brief resistance, my boss said I had to make a price.

I quoted them, and very quickly became the proud owner 5mm USD worth of virtual Dong. Again, because it was a derivative, I didn't actually have a bank account owning the currency, I only owned the risk. In currencies, even in emerging markets, a 1-2% move is still considered a pretty big deal. A 5% move is a huge deal. A $5mm position wouldn’t kill me, so I was comfortable waiting to hold this through the weekend.

It was a Friday, and I left for a friend's wedding in Ann Arbor, Michigan. At the Sunday night wedding, I received a call from our Asia office. The VND "fixing rate", which is the official rate published by their central bank, against which your books were marked, had just weakened by over 10%.

My P&L was now down $500k. I asked them if there were any buyers in the market, but there were none. Even if I wanted to get out of the trade, I couldn't. It was a long weekend so I just had to wait. I was scheduled to get back Monday night, and called to see if I should change my flight to the morning, but my boss said it was fine, as it wouldn’t make a difference (there would be no activity during the U.S. daytime anyways).

Monday night, US time, Asia called and the position was down another 15%. The trade was now down $1.5mm. For context, that was somewhere between 20-50% of my average yearly P&L. Given it was still May, it was a huge chunk of my year's gains (for further context, we'd get paid out anywhere between 2-7% of our year's profits - with that incredibly huge range determined by a number of internal political factors).

THE RISK OF THE DONG

Tuesday morning, I went into work and the dressing down began. The head of our team was from Mexico, and I don't think he quite understood the hilarity of repeating the word Dong. "Did you not understand the risk of the Dong?" "If you can't handle the Dong why are you quoting it? I don't care who the client is."

I was a bit of an aloof asshole, as I had just taken the GMAT and planned to escape to an MBA within the next two years, which probably infuriated him more. I distinctly remember also having the thought, "I'll just leave and go work for the Obama campaign". Looking back, I have to laugh at the arrogance that I had an iota of a transferable skill valuable to a political campaign.

The conversation escalated to the head of trading, who was a 6'4" ex-marine. He was American, and I think understood the absurdity of having a heated conversation while saying the word Dong, because he was careful to shout "the Vietnamese Currency." But the yelling was even louder and he kept referencing the loss as “being taken out in a body bag”.

Finally, a buyer (another big bank) came into the market, and our leadership and I agreed we'd sell and clear the position at at the massive loss. A few days later, the currency started to rebound.

The weirdest part of the whole thing was that the actual Vietnamese currency never really fluctuated. Only this really esoteric derivatives settlement calculation did. I would later find out that the big bank who had bought it from me, was, purportedly, one of the two banks that the Vietnamese central bank would consult in setting that reference rate. This wouldn’t have been illegal, though. It was just part of the game.

ILLIQUID ILLUSIONS

I bring all this up, partially, because any testosterone-driven human drama involving the Dong makes for good newsletter fodder, but more so, with regards to the ideas of illiquidity and market manipulation.

I know this will sound incredibly insensitive, but when trading emerging market derivatives that was "part of the fun". If you were a big player, you could move entire markets. As in the case above, sometimes you lost, big. That poker-like gamesmanship was what gave you the rush.

It would come out years later that there were entire chat rooms (which I was luckily never invited to) that would, in fact, rig similar fixing rates. People went to jail.

It was seared into you that the only true price is the one where you can get out. The rest is just a psychological game. So this whole tech private market valuation thing has always felt a bit weird to me.

UP AND TO THE RIGHT

I know we're all laughing at that SoftBank pitch deck, but it's only been a few months since we all said that WeWork's valuation was $47 billion. But it never was, and WeWork's value did not drop by 75%, or whatever it was. That was all an illiquid illusion. Trading emerging markets, where there were only a few players, was the wild west, but WeWork was way worse. At least there were buyers AND sellers.

In private markets, there are only buyers, which invariably distorts the market with an upward bias. The only selling pressure comes from the cash constraints of the underlying company. WeWork was even crazier because there was only one player controlling the entire market.

And it gets much weirder. That one buyer, SoftBank, normally would be constrained by the amount of cash in its coffers. But in this case, the Vision Fund had essentially unlimited access to the balance sheet of SoftBank Corp., the large, publicly traded Japanese telecom.

That last push in January 2019 which skyrocketed the value from $20 to $47bn came, not from the Vision Fund, but from..SoftBank Corp. I think? (from TechCrunch)

As it stands, including the $2 billion that WeWork looks to receive from SoftBank imminently, SoftBank will have sunk $10 billion into the company. Perhaps it’s no wonder that the newest $2 billion is not coming from the Vision Fund but from SoftBank directly. (Son sometimes invests off SoftBank’s balance sheet directly, for expediency’s sake and, presumably, in a case such as this one, when there may be pushback from Vision Fund investors.)

(Note: how have no financial journalists broken down the crazy commingling taking place between Vision Fund and SoftBank Corp.?)

So you have a market with one buyer and no sellers. That one buyer has unlimited access to cash. And then, let's throw in that SoftBank was in the process of raising a second $100bn+ Vision Fund, and the higher the paper profits, the easier it would be to raise it. And I thought trading Dong derivatives was a shady, opaque market ripe for manipulation.

SECOND FUNDS AND FIRST HOMES

A few years ago, a friend who is a partner at an early-stage fund bought a new apartment that was not cheap. His fund had "been doing very well", but I was always confused because, while they were invested in some new unicorns, none of the investments had achieved a liquidity event (there were some smaller acquisitions, but none of the “big winners”). He explained to me that their early success on paper had allowed them to raise a much bigger second fund, and the management fees alone allowed for the apartment purchase. He noted that when they started seeing the “real exits” was when the “real money” would be made. His apartment, however, felt very real when you walked in.

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Note #1: When I first learned that the head investor of the Vision Fund, Rajeev Misra, was not from the world of private capital investing, but rather from the bank trading world, I was a bit suspect. While having made some money certainly made me think I understood private-market tech investing, it didn't. Our world was pure risk management propelled by bits of financial engineering and accelerated by lots of gamesmanship. That is kind of what these crazy SoftBank rounds have felt like. (My co-host Can had linked to this great WSJ story on Misra last week).

Note #2: While that Dong debacle hit my P&L hard in mid-2008, I ended the year with the highest profits of my career. Everyone in our whole group did. That's one of the great rubs of the financial crisis. If you were at one of the last banks standing, the only ones with good credit lines, you became the only game in town. And, while the bonus percentages declined significantly, everyone still got paid something.

Note #3: This new SoftBank WeWork turnaround deck is bananas, but again, we’ve seen this madness since back in June 2010! The slide below, from the 2010 vintage, really feels like it could be the album cover for the new band I want to create after writing this piece, Illiquid Illusion.