Tricom’s aftershocks

Several important issues arise from Tuesday’s dramatic failure by Tricom to settle its January 22 trades until 24 hours after it was supposed to.

First, to what extent has margin lending made the Australian sharemarket less stable and more fragile?

Second, the role of stock lending and borrowing needs to be better understood. Tricom has confirmed in a statement this morning that it was unable to settle because “Tricom’s stock lender failed to deliver the stock”. Yesterday morning Tricom management told its dealers that the custodian of the stock had lent it to someone else who had sold it again.

Third, to what extent were other brokers insider trading once it became known within the market that Tricom had defaulted on settlement?

Finally, perhaps most importantly, how effective is the ASX’s supervision of the market in the context of rampant margin lending, derivatives trading and stock lending and borrowing?

This is the first failure by a broker to settle since Patrick Partners went bust in 1974, and it is absolutely the first time a broker with outstanding settlement claims was allowed to continue trading while it found the stock or the cash.

As a result, the ASX’s behaviour is coming under as much scrutiny by market participants as that of Tricom itself, and the question of whether the exchange – as regulator – did enough, quickly enough in this case, will be judged when the full facts about what happened emerge.

The custodian of the big line stock that was sold off-market by Tricom on January 22 to settle a margin debt is believed to have been ANZ Nominees. The stock is widely believed to be Allco Finance Group, but there is some doubt about this.

As discussed in Business Spectator last week (Short and curly, 24 January), most custodians lend stock these days to supplement the fees they get for doing their job. ANZ is no exception.

On Tuesday January 22, executives of Allco were required to sell a large parcel of shares to meet a margin call. The trade was done off market and under T+5 (trade plus five business days) the stock was due to be delivered to the buyer on Tuesday this week.

The way Tricom’s CEO Lance Rosenberg put it in this morning’s press release was: “The extraordinarily large number of trades executed since Tuesday last week, placed strain on Tricom’s newly implemented internal systems. This led to administrative difficulties in dealing with clients, counterparties (providers of equity finance facilities) and the ASX. The culmination of these events resulted in the Tuesday 29 January delay in Tricom fully settling its obligations with the ASX.”

The story as told to Tricom dealers yesterday morning was that when the firm went to ANZ Nominees on Tuesday for the stock for settlement, the cupboard was bare: it had been lent and sold short (stock borrowing is used to engage in short selling without disclosing it to the market, in contrast to ASX-approved short-selling, which requires disclosure).

Normally in that situation there are two solutions: the stock is borrowed from elsewhere for settlement or, failing that, the broker can settle with bridging cash until the stock is recovered from the borrower (usually no more than two days).

But in this case the stock was illiquid and there wasn’t enough available to be borrowed, plus the amount of money was so large that, in the current credit conditions, Tricom’s bankers baulked and refused to extend its overdraft.

As fate would have it, Tricom’s main bank is ANZ. So while one part of ANZ was failing to deliver stock for settlement, another part was refusing to cough up the overdraft to cover the shortfall with cash.

Separately neither action by the bank was particularly unusual or out of line; together they were utterly disastrous.

Such was the ensuing confusion and pandemonium that it took 24 hours to sort out. Moreover Tricom has been forced to reduce its margin lending dramatically to get the extra cash.

The transaction finally settled at 2.25pm yesterday afternoon, by which time Tricom had been rocked and its reputation trashed, the market had been crunched two days in a row despite successive rallies in New York and the ASX was in damage control mode with investigators crawling all over Tricom.

Fair enough that Tricom now be turned upside down to ensure that the almost unheard event of settlement failure does not happen again, but what about looking at stock lending?

For a few shekels over its fee, the custodian has lent so much of an illiquid stock that a customer was left short at settlement. Surely this is a wake-up call about the over-use of this practice. In many situations it can be a useful income stream for market players and can provide deeper liquidity, but it can also reduce transparency.

As for insider trading – the news of Tricom’s non-settlement spread through the senior levels of the nation’s stockbrokers like wildfire on Tuesday, and you can bet that the first thing every broker CEO did upon hearing the news was to ring the head of his proprietary trading desk and tell them to immediately close their long positions and go short.

They would all have known that a failure to settle would hit this market like a truncheon to the back of the knee.

Meanwhile, those on the other side of the sell trades by those brokers did not know about Tricom’s problems.

Was this insider trading? Did those proprietary trading desks find out about Tricom’s failure to settle because of their privileged positions as stock exchange insiders? Did it even occur to them that they might have been using inside information, or did they just assume everyone knew, and that those who didn’t were either dills or asleep?

Selling in the wake of the Tricom settlement problem was not the only reason our market fell over the past two days while Wall Street went up – there has been a sudden wave of concern about the housing market hitting bank stocks for a start – but it was definitely a factor.

Even yesterday morning when news of Tricom’s problems was all over the media, there were no official statements from either Tricom or the ASX, and there was nothing but confusion and speculation in the press.

Tricom promised to make a full statement before the market opened yesterday, but apparently could not get its banks to agree in time. The statement did not eventuate yesterday.

The ASX eventually came out with a brief statement at 2.17pm yesterday to the effect that Tricom had “met its financial obligations”. Apparently settlement had just taken place. By this time the market had reversed an opening rally that had followed Tricom’s promise of a statement, and was in virtual free-fall.

The ASX has now got Tricom on a shorter leash than David Hicks, requiring daily reports, a sort of curfew on access to settlement facilities, on-site regulatory oversight and “independent oversight” of Tricom’s operational and financial control environment.

Tricom said this morning that its equity finance book is $950 million, secured against about $1.3 billion of equity collateral.

In a fragile market where nerves are stretched to the limit, this has been an appalling debacle from which the ASX and the broking industry will have to work very hard to recover.

As for Tricom, there is a lot of very negative comment about the firm now among fund managers, and Lance Rosenberg is facing a difficult task rebuilding his business after this blow.

He said this morning: “Tricom remains financially solid, open for business and fully intends to implement its growth plans both in Australia and SE Asia.”

This story was first published on BusinessSpectator.com.au