LONDON (IFR) - The way in which lead banks put orders into Middle East bond deals is coming under the spotlight, with some bankers arguing the practice is misleading investors as it is not clear how real those bids are.
Order books containing lead orders is commonplace in the Middle East as banks use their financial firepower to muscle in on mandates. A $500 million five-year bond last week from Commercial Bank of Qatar, for example, had a $1 billion book with $200 million of lead interest made public during the deal’s execution. Often, though, the size of leads’ support is not disclosed.
Furthermore, critics say, there is a distinction between an order from a lead bank’s treasury or trading operation reflecting genuine investor demand and one from the syndicate desk, which in essence is an underwriting position and therefore should not be included in the book.
“It’s complete and utter game playing; pulling the wool over issuers’ eyes,” said one banker. “It’s not the job of the bank to underwrite, it is to intermediate. The bank should do that in the most professional way possible – not to take the risk. It’s poor practice for bankers to be using lead manager orders and representing that as benefiting the issuer.”
Not only do these so-called orders distort the book but, given that syndicate desks generally exit their positions once bonds are free to trade, the practice can lead to big price volatility.
And at a time when bond market practices are coming under greater scrutiny because of regulations such as MAR and MiFID II, some believe the term ‘joint lead manager interest’ is being abused.
“Are these real orders? Is it misleading investors?” asked a second banker. “If [a commitment] has been given to support a transaction, then maybe it shouldn’t be called an order or be included as a joint lead manager order. We have to be careful.”
The introduction of MiFID II has brought a degree of transparency to the market, but there are still grey areas not covered by regulations.
While it is not just in the Gulf where there is a blurring of lines between what is a real lead order and what is not, sources say the problem is prevalent there.
The Middle East has moved on from the days when deals were essentially club loans. Nonetheless, it is still not a properly intermediated market with multiple banks given lead manager roles on deals, especially for financials and sukuk offerings.
“If you have a lot of regional banks on the trade, then you have to assume the deal is being backstopped,” said a banker at an international firm based in the Middle East. “It stems from regional banks desperate to get involved in a transaction.”
However, it is not just regional banks whose behavior is being questioned - after all, they have local treasury operations, though that in itself does not mean that treasury will always be putting in the order. But some international banks are also at fault as they seek to build their Middle East businesses.
It is well known that certain bond mandates are won through providing a financial commitment to the transaction, typically 10 percent of the overall size. The client, in turn, will not care which area of the banks has provided the commitment.
“The way [mandates] are documented is either through a side letter or email,” said a fourth banker. “These are very soft documents with a number of get-out clauses.”
As lead banks never disclose where their order is coming from, the lack of transparency makes it impossible to know how rife the practice of syndicate-driven order books is.
Some syndicate bankers say their firms do not allow them to engage in such behavior.
“We [cannot] take a large position. We are not a prop desk,” said one. “We can take a position in terms of management of the deal - going short, for example. But anything bigger and compliance would have a phone call through quickly.”
But that has not stopped others. Sources say suspicions have been aroused in past transactions when, at the time of allocation, a bank says it does not want any bonds and fudges its commitment. “These are the shenanigans that go on,” said the second banker.
For their part, investors could be seeking greater certainty about how much support a deal actually has. A sixth banker said that on a Gulf bank transaction he worked on this year, “some investors left an order contingent on the deal being oversubscribed without lead manager interest”.
However, this banker is comfortable with the general state of affairs regarding lead orders.
“I don’t think it is misleading. I just think it is a dynamic investors need to assess whether they are comfortable.
“For instance, we could have a book that is two times subscribed, but with nothing but brokers and trading accounts, and nobody would complain as that isn’t disclosed. At least there is some level of disclosure in this instance.”
Still, some banks are taking action by refusing mandates if they have to provide a lead order to win them - though they will provide a backstop as long as that is a separately negotiated act.
Bankers suspect the practice of artificial lead support will eventually die out. “It works until it doesn’t,” said the second banker, who believes that changing market conditions will force banks to rethink.
“As the market is becoming tougher, it will expose this behavior.”
additional reporting by Robert Hogg; editing by Philip Wright, Alex Chambers