Matt Levine Ripped My Face Off: CEF, FX, A

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Katie, it is ominous out there.

The skies are darkening as we speak.

It's Thursday at 2 o'clock and change.

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will I get home?

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Will you get home?

Gosh, I hope so.

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Hello and welcome to the Money Stuff Podcast, your weekly podcast where we talk about stuff related to money.

I'm Matt Levine and I write the Money Stuff column for Bloomberg Opinion.

And I'm Katie Greifeld, a reporter for Bloomberg News and an anchor for Bloomberg Television.

I feel like we got feedback last week that people are like, please more ETF stuff, which is unusual for us.

I feel like maybe the people who leave comments are actually just contrarians.

Like,

we messaged

the default view is no more ETFs.

Yeah, and we messaged so heavily that people don't like this that they were compelled to write, actually, we like this, and here are our thoughtful thoughts on them.

But we're not talking about ETFs now.

No, no, we're talking about a cousin.

Which are really I mean, but ETF is a term of art, but is it a fund that trends on an exchange?

Sure.

But yeah, we talk a lot about.

I write a lot about people who are trying to jam private stuff into retail investors.

The people doing most of the jamming are the people doing like private credit funds.

But the thing that the retail investors want the most is probably like SpaceX and OpenAI, right?

They're like, I don't want private bonds.

Just give me SpaceX.

Yeah.

Private credit is like sold by financial advisors, but like SpaceX is bought.

And it's hard because you need to go find shares of that.

And I think a lot of people have in various ways had had the thought, what if we didn't find shares, right?

What if we just did naked derivatives on SpaceX or OpenAI stock or whatever, right?

And the idea is you find someone who wants to be short OpenAI, and they write a contract saying, I'll give you the returns on OpenAI.

And you package that into a box and you sell it to retail investors.

And then the retail investors get long OpenAI and whoever wants to be short gets short open AI.

Yeah.

You're just only exposed to the price action, theoretically.

And And there's a certain amount of counterparty risk, sure.

Right, right, right.

Right.

I've written about, we've talked about people who do like various tokenizations, various things.

And I wrote this week about River North doing these paired closed-end funds, which is like really the way to do this, like ultimately.

It's a paired closed-end fund.

And it's on this index of, it's like the Prime Unicorn Index, which is sort of an index of big private companies.

Sort of, sort of.

Sort of.

There's some public companies in there too, to keep it honest.

Two of its top 10 holdings are public companies.

Maybe they don't update that frequently or something.

This is as of July 16th.

No, no, no, but like.

Oh, they don't rebalance.

Yeah, yeah.

Like, you know, you have some unicorns in your index, they go public.

Sure, sure.

But right, so it's got like SpaceX, it's got some Anthropic, it's got some of the hits.

And what they're doing is they are writing cash-settled swaps on that index.

The index measures, let's say, the value of these private stocks and public stocks.

There's some questions about how you measure the the value of private stocks.

But these companies,

there's like secondary trading, there's funding rounds all the time.

It's fine.

You can get a value.

And then they have the index, so they have the price and they have just cash settled swaps on that index.

And you can go long or short.

So there's a long fund that gives you exposure to this unicorn index.

And there's a short fund that gives you negative exposure to this unicorn index.

And the obvious trick is they completely offset.

So net, nothing happens, right?

Net, it's like if someone wants to go long and someone wants to go short, then we issue shares to each of them.

And poof, we have both a way to invest in private companies and a way to short private companies, which some people want, right?

Some people think it's a bubble, et cetera.

Yeah.

And so you get two delightful products to sell to retail without

doing any economic activity outside of it, right?

You don't have to buy shares.

You don't have to.

do anything.

You just offset retail bets against each other.

So typically when we talk about closed-end funds on this podcast, we talk about...

We do.

We true do.

We do, you know,

we dabble.

We often talk about how they trade at discounts.

Does that matter at all here?

That these are going to launch and then probably trade at a discount.

I have no idea how they'll trade.

In fact, there is a history of unicorn-y closed-end funds trading at huge premiums, right?

Right.

So they'll trade at some dislocation.

Maybe it's not a discount.

Right.

If you look at the structure of this, there's like some stuff that suggests it shouldn't be too dislocated.

So one thing is like

they are termed cash settled swaps.

So this settles in 2027, I think.

The termination date is not clear, but it's

2027 isn't the name.

So this is a thing that like you buy it and in two years you get a payoff.

So

only so much discount you should really demand because you'll hopefully get you'll get your cash back in two years.

And then the other thing that is interesting for discounts and premiums is like there are these two offsetting funds.

Right.

So like if they both traded at a discount, you could buy both of them, and then you have a really interesting instrument, right?

If you buy the long fund and you buy the short fund, both at a discount, then you basically have captured the discount, but you have two years of counterparty risk, weirdness risk,

swabs risk, or like, you know, fundamentally no market risk, I think.

Probably.

This is not investment advice.

I hope these launch.

And if they do trade at a discount, like my first PA trade in

20 years will be buying both of them.

Don't fruit on yourself.

I will definitely not do that, and it's not an investment advice.

I might do that.

I might do that just for, just for giggles.

I read last week about auction rate securities, which is like my only PA trade ever was when I was a banker and like the auction rate securities market got dislocated.

And so I bought one lot of auction rate securities.

Yeah, you did.

I had like a 7% yield.

I was like, oh, look at me living dangerously.

God.

That did work out for you, though.

Oh, yeah.

I made 7% for like a week.

All right.

That was good.

That's pretty good.

You didn't lose money.

Half a thought I had because I live in ETF land is, you know, we talk about inverse single stock ETFs and there's some element of volatility drag there.

And if you hold these long term, then it could be painful.

Is there any funkiness that could happen on the short side here?

The inverse ETF problem, the volatility drag problem, comes from rebalancing.

Yeah.

The rebalancing exists because

every day you are offering the ETF to people and you want to give them down from today, right?

And so you're rebalancing to get the right amount of exposure.

With this thing, it's just swaps.

It's a little easier.

They're not leveraged.

And you

are not giving them like down from today.

You're giving them

the total return over the period.

So I don't think there's too much in the way of volatility drag.

There's some possibility that something can get funky if the index goes up a lot.

There's like a cap on returns.

Like, there's some possibility of weirdness where if you buy the thing in six months, you're not getting quite the negative one times exposure you wanted, which is like the opposite of volatility.

The volatility drag exists because every day you're getting exactly the same proposition, which is like negative one or two times or whatever the ETF's exposure.

And like, here there's not that.

Here, there's just like there's a term to swap, and you can buy in at any time to the swap.

Or even you can't buy in at any time because it's a closed end fund, so they don't have to be continuous offering.

But, um,

no, it's very simple.

And, you know, like it's based on this index.

Yeah.

I think in large part because it's nice to have a third-party calculated index for your cash settled swaps.

So you can be like, oh, the thing's settled at whatever the price of the index is today.

Like, and someone else is doing the index.

But if this works, you could do it for

single names.

You could do it for OpenAI.

You could have the inverse OpenAI fund and the yes OpenAI fund, and you should offer that that to people with no financials.

I don't know.

It seems like a stretch, but we're in a brave new world of like, it's not clear what securities regulations apply to anything anymore.

And if you wanted to do a single-stock closed-end fund that's just like betting on and against a private company, could you do that?

I mean,

two years ago, I would have said no.

Now I'm like, yeah, I don't know, maybe.

These closed-end funds do seem like a stepping stone to that reality.

So

they're very close to that reality.

I mean, we talked about XYZ, right?

Or the Destiny tab.

Yeah, that's the end of the trades that has private companies and trades at a huge premium.

And we talked about how, like, Stripe, for example, or some of these private companies would not love this.

So I would imagine that they would also theoretically not love this either, even though we're talking about swaps here.

I mean, with Destiny, like...

Were they using forwards?

They owned various cats and dogs, but like one thing they owned was like forwards on stock, which is like those forwards are physically settled, right?

Those forwards are basically someone who owns Stripe stock, signs a contract saying, I will give Destiny my Stripe stock as soon as I'm allowed to, right?

When Stripe goes public.

And the reason they do that rather than just selling the shares is because Stripe doesn't let them sell their shares, right?

They have some transfer restrictions.

Stripe, and probably every private company that transfer restricts its shares, probably says you can't do a forward contract.

Forwards are to Stripe no better than selling the shares right now.

And so it's not clear whether these forward contracts are valid.

And if they're not not valid, then bad things could happen like Stripe saying, no, we get that stock instead of it going to Destiny when Stripe goes public and they settle the forward.

Here, there's like Stripe gets no say.

The private companies get no say.

They're not involved at all.

There's no contract on their stock.

Nobody has to own their stock at any point.

It's just purely a cash-settled side bet between two people that don't involve the private company.

So there's not a lot they can do.

Yeah.

And that's sort of what I was getting.

They could put out a statement being like, we're not involved and you shouldn't do it.

But

they can't stop it.

It might be like an annoyance, rather.

Yeah, yeah.

I mean, like, it's not going to change their lives.

It's tripe or whatever, but it's.

I did like that you make the point, though, that if you're buying into this closed end fund, you're not funding a private company, you're not giving your money and putting up.

Yeah, exactly.

It's just the price action.

Right?

Yeah,

that's truly the reality that we're stepping towards.

I mean, it very much is.

And

people want to gamble on private companies.

God bless them.

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You know who doesn't want to gamble?

UVS clients on range target profit forwards.

We don't know because they lost.

That's true.

Bigly, apparently.

The FT has really owned this story.

Yeah, so UVS, I don't know.

I don't want to blame UVS.

As a former derivative salesperson, I sympathize.

Banks sell derivative products, right?

Like you work in FX, right?

And like the thing you do is like clients come to you and are like, I would like to change my Swiss francs for dollars.

Sure.

And you're like, okay.

And they'll be like, how much will that be?

And you'll be like, 0.0001 basis points or whatever, right?

You've charged them the genius amount of money.

And so you spend all day in the lab cooking up things that could be more expensive, right?

You're like, what if?

And you try to like give them a product that sounds cool.

And there's only so many products that can sound cool.

But like what they were doing is, I don't know, it's got names.

It's like a conditional target target redemption forward or a range target profit forward.

Yes, RTPS.

Yeah, whatever.

Anyway, household name.

The thing they were doing is basically like, we will sell you dollars.

It seems to have been like European, Swiss, whatever clients buying dollars, right?

So UBS is like, we will sell you dollars at like three-tenths of a cent below the like forward price.

So you're getting a bargain.

But if the actual price in a month or whatever goes below that target price, we will sell it to you at that target price.

So you'll get not a bargain.

You'll get like a bad deal.

You'll be buying above market.

And we'll sell you twice as much in that situation as in the good situation.

So basically, like we will sell you dollars at a better than market price most of the time.

And then some of the time we'll sell you many more dollars at a much worse on the market price.

Right.

So basically the clients get a good deal in like 80 or 90% of scenarios.

So you have a good thing to sell them.

You're like, oh, look, you're getting a good deal.

I want to go.

And then they get a terrible deal.

They get like really really hosed in like 10 of scenarios and unfortunately the bad scenario came true and all the clients were like we didn't know what we were signing up for and ubs is sad and sorry and has made apparently the fd reported made more than 100 goodwill payments yeah which basically is like a refund of the money they lost or we're so sorry please don't leave us we won't do it again it's not just the money it's that the ubs banker has to go to the client and like the interview the client is like you didn't even bring any materials.

Like, it's like they just go

and look you in the eye, like very sincerely sorry.

And they're like, We're not even pitching a different derivative today.

Today, we're here to just talk about how sorry we are.

It's a really touching moment.

Yeah.

And they also have internal trainings where they're being told not to scam clients.

And also, role-playing, like how these meetings should go from now on when you're pitching.

Right.

It's this great tension in investment banking where obviously you want the client who, when you come to them with some crazy derivative, they're like, okay, sure, sounds good.

And they don't like bid it out to get the price down or like model it up themselves.

They're just like, sure,

I trust you.

Right.

But like, those people are really good clients and they make you a lot of money until something goes wrong.

And then like, it looks bad in court, you know?

Yeah.

The client who really trusted you, the client who was not sophisticated at modeling, you know, FX volatility.

Like, those are not the clients that you want to go to court with.

So it's a delicate balancing act where two years ago, UVS was probably rewarding the people who rought in the

dedicated clients in large size, and now it's like, no more of that.

Well, the FTA gave some great examples of the harm that was wrought by some of these trades really kind of blowing up.

One client lost more than 3 million Swiss franc, which equates to like $3.7 million.

Another person said that they lost 15% of their assets.

They also asked the bank to exit the investment a few days after Trump's Liberation Day.

And apparently, according to FT reporting, UBS sold these products to customers with the equivalent of fewer than $800,000 or so.

So, I don't know.

It's just a weird trade in general to put on.

Like, this sounds like something like if you were a big business trying to hedge your currency exposure, maybe this would make sense.

But selling it to even like very wealthy individuals is weird yeah whatever like the way that the ft describes it is that these products offer limited upside but expose clients to potentially unlimited losses that's everything that's like accumulators it's like everything right it's like the trade is everything except buffer etfs baby i know but like the for so many wealthy clients the trade is like you can get two percent more on your money by like taking some black hole of risk right

and then you know you have the meeting and they're like but what do you think the chances are of that black hole of risk happening right and the client's like like, oh, it sounds good, right?

And they buy it and they get 2% extra yield and then like the black hole happens and they're very sad.

Yeah.

Here the black hole was the ration d'etares and the dollar plunging.

I will say you were talking about the sympathy that you feel towards

these bankers who make these derivative products.

I don't forget that's cool and awesome.

That's a moral of me.

That's true.

But I was one of them.

I only sold a sophisticated client.

Right, for sure.

None of them got their faces ripped off.

I'm not even kidding, really.

No.

Well, I'm kidding a little, but none of them got their faces.

too.

Wow.

Someone's going to write in and say Matt Levine is going to be able to get a little bit of a little bit of my face off.

I really didn't.

I was also very ineffectual, so it was fun.

My first beat at Bloomberg was covering FX as a little baby journalist.

And the period that I was covering FX, there was no volatility in currency markets.

You had to beg people to read your stories and also really scrape the bottom of the barrel to find stuff to write about.

I joined Bloomberg in like 2016 and stopped covering currencies in 2019.

So President Trump's first term actually gave us something to write about.

But

this trade probably wasn't as risky.

It probably really was fine 90% of the time because the type of volatility that we saw in

the Swiss franc dollar exchange rate on Liberation Day,

that wasn't happening for a long time.

I mean, you saw it across asset classes.

Like, what does that tell you, right?

I mean, like, if this trade had been perfectly explained to like

clients who were not professional FX traders, but were smart and sophisticated you know financial people this trade had been perfectly explained like the perfect explanation is in the ballpark of like you will get some extra you know yield or profit or whatever most of the time but if the dollar plunges

like it does not usually plunge then you will get your face ripped off yeah right and like some people would have been like okay i'll take that bet and then the dollar plunged and they got their faces wrapped off yeah and so yeah like i've heard about this before like there are clearly some customers who did not understand what they were getting into and naughty of UBS to sell them something they didn't understand.

But also probably some people are like, I will make the bet that the dollar will not be super volatile and the dollar is super volatile.

Yeah, you know,

but like, look, everyone else is getting a goodwill payment.

I actually get a goodwill payment too.

Yeah.

I mean, you would think that they would happen potentially across asset classes.

Like every asset class had an outsized move on Liberation Day.

Right.

And there's something about FX where people, people, smaller customers get sold weirder stuff.

I mean, they're definitely equity trades like this, right?

Like we've talked about, like, is it the accumulator?

We've talked about like structured note trades that kind of have this shape, right?

Yeah.

But I don't know.

In FX, it does seem like people take more random gambles.

And also, like, people don't expect as much volatility.

And then, you know, when they get volatility, they're very sensitive to it.

It's a strange market.

It was a fun trip being there for like two and a half years.

Right.

If you're in like the business of selling equities, there's a lot of like, you know, you can do buffers and stuff, but there's a lot of just like, ooh, buy open AI.

It's a good stock, right?

If you're in the business of selling FX, like you're kind of instantly going to weird Derotos.

Yeah.

Yeah.

Sometimes they buck.

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Which leads us to insurance.

Insurance sometimes blows up too.

Yeah.

Well, trying to get us to hurricanes somehow, but I can't quite make the metaphorical jump.

So anyway,

demo test.

Ten minutes, I'm going to make a literal jump into the hurricane here.

Oh,

it's raining in New York.

It's raining in New York.

And like, they've already preemptively shut down all transit.

Well, all the subways keep breaking.

Right.

I have to take a subway and then a train.

It's going to be a bad.

My dad is picking me up today, so I'm happy.

Okay.

So.

Florida.

Florida.

So there are a lot of houses in hurricane zones.

It's hard and expensive to buy insurance on your house if it's in a hurricane zone.

There is.

People have jumped into the gap to meet that market of failure.

Conceptually, the way you do it is you start an insurance company and you don't have any money.

And you start selling insurance policies to raise money, right?

And if you do this for 20 years without a hurricane, you'll have so much money that you can pay off any claims.

Right.

But if you do it for one year and then there's a hurricane, you will not have so much money that you can pay off any claims.

And so there's a risk in starting a new,

I'm dramatically oversimplifying.

And in fact, new insurance companies are supposed to be well capitalized, but you know, conceptually, you start a new insurance company, you raise money by selling premiums.

And then

if there's no hurricanes, you're great.

And if there's lots of hurricanes, you go to zero.

And that's hard to do because insurance companies have to be rated.

There's a couple of like big ratings agencies.

And there have been a number of stories recently.

There's one in the Wall Street Journal this week and Bloomberg wrote about it last year.

There's a ratings agency, it's like a mom-and-pop operation called Demotech that rates a lot of smaller, less well-capitalized insurance companies and it gives a lot of them A ratings and they have a higher incidence of their A-rated companies becoming insolvent within a reasonable period of time.

30 times more likely.

30 times more likely than the other ratings agencies that use more traditional methods.

Somewhat meaningful.

And it's like, why does this exist?

Well,

people want to buy insurance.

Someone sent me there's a Monty Python skit where a reverend comes into the insurance office and says, Why aren't you paying my claim?

And he's like, Oh, you see, you bought the never pay policy, which never pays off.

It's a great policy if you don't have a claim, but if you have a claim, it never pays.

It seems like people want the never pay policy.

Yeah.

You know, I've written a little bit about why.

And like, it's an interesting, like, systemic answer, which the answer is that these insurance companies have enough money that

if you like

burn your house down by accident, they'll pay your claim.

They have that kind of money.

What they don't have is the money to pay off everyone's claim if there's a big hurricane.

If like a town is wiped out.

And

why would you want to buy insurance that protects against you accidentally burning your house down, but not a hurricane?

The answer, I think,

is that you

probably correctly believe that there's some sort of bailout coming if your town gets wiped out.

Yeah.

And like in insurance, like this is really quite literal, where there's like state guarantee funds that basically will step in to cover wiped out insurers.

So if you're a homeowner, you can buy the bad insurance policy figuring, you know, either it'll pay out or if it doesn't pay out, someone else will step in to pay it out.

And then like there's a question of why do states allow this?

Like, because the states fund the guarantee funds and like, you know, they're on the hook if this insure doesn't pay out.

Yeah, I think the answer is that's a problem for another day.

And right now, it's nice to have insurance, right?

So, like, if you're like a Florida politician and people can't get insurance to buy houses in Florida, that's really bad for you, right?

Yeah.

And if they can get insurance, that's good for you.

And if the insurance doesn't pay out and the state government has to step in to guarantee the insurance, that's a problem for later.

Yeah.

And so there's a certain amount of short-sightedness where regulators, politicians are all happy to go with a system where

the insurers are not necessarily all that well capitalized because that's a problem for someone else to figure out later on.

Yeah.

This is not the same thing, but it kind of reminded me of the conversation we were having about Egan Jones a couple months ago.

That is the ratings agency that basically gives pretty high ratings to private credit investments and has a track record of a lot of those private credit investments not going so well.

Or, you know, you think about it gave pretty good ratings to Chicken Soup for the Soul, it gave good ratings to Redbox, and those went belly up.

But there is a space for these rating agencies.

Yeah, it's a similar dynamic in that ratings are not really for the consumer of the ratings, right?

Like you're not getting insurance from an A-rated insurance company because you want insurance from an A-rated insurance company.

There's some sort of like regulatory backdrop.

And so if ratings are kind of generous, like a lot of people are very happy to have generous ratings.

And so there's a market niche for people who are willing to provide generous ratings.

Yeah.

And I mean, it's all just future problems to deal with.

So

everything is A-rated now.

Yeah.

It hasn't defaulted yet.

Yeah.

And who knows what'll happen.

Hey, so this episode is coming out on August 1st.

And in August, people, including Matt Levine, take vacations.

So we're going to do another mailbag episode.

So make sure you send us your cool questions, moneypod moneypod at bloomberg.net.

And there's a pretty high likelihood that we'll answer some of them.

Matt, I might.

We might do a mailbag episode.

We might.

There's a medium probability it'll answer.

If your questions are good enough.

Go nuts.

If your questions are good enough, we will do a mailbag.

So it's up to you.

Yeah, sure.

Yeah.

It's up to you.

It's all riding on you.

And that was the Money Stuff Podcast.

I'm Matt Livian.

And I'm Katie Greifeld.

You can find my work by subscribing to the Money Stuff newsletter on Bloomberg.com.

And you can find me on Bloomberg TV every day on Open Interest between 9 to 11 a.m.

Eastern.

We'd love to hear from you.

You can send an email to moneypod at bloomberg.net.

You can also subscribe to our show wherever you're listening right now and leave us a review.

It helps more people find the show.

The Money Stuff Podcast is produced by Anna Mazarakis and Moses Andam.

Our theme music was composed by Blake Maples, and Sage Bauman is Bloomberg's head of podcasts.

Thanks for listening to the Money Stuff Podcast.

We'll be back next week with more stuff.

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