February 18, 2021
Happy GameStop day! If you want to follow along at home, I have a drinking game for you in item 4, while items 5 through 7 should help bring you up to speed on some of the issues.
- In this week's 1,870 words: The reason to get rid of patents on COVID-19 vaccines; the reasons not to; a water sale; the homeownership gap; and much more.
If you want to ask me anything, I'll be answering questions on Reddit tomorrow at 3pm EST.
- I didn't have space this week to write about Citibank and Revlon, so maybe ask me about that!
1 big thing: The problem with vaccine patents
Open-source the vaccines. That's the message being sent by the People's Vaccine Alliance, a coalition that includes Amnesty International, Oxfam, and UNAIDS.
Why it matters: Manufacturing capacity needs to be scaled up dramatically — and cutting out the need for laborious, expensive and secretive negotiations with vaccine patent holders could help.
What they're saying: "None of the manufacturers today are remotely capable of meeting demand on a timely basis," says Knowledge Ecology International's Jamie Love. "Vaccine manufacturers are currently hoarding technology, for commercial reasons."
By the numbers: Of the 108 million people vaccinated so far, only 4% are in developing countries. Nearly all of those have been in India, where Oxford University ensured that the Serum Institute of India would be licensed to produce its vaccine at the same time that AstraZeneca received control of the intellectual property.
- The global economy will lose $9 trillion if the developing world fails to receive timely access to vaccines, according to a study from the International Chamber of Commerce. Half of that cost will fall on rich countries.
- The three largest vaccine manufacturers in the world — GSK, Merck, and Sanofi — are still largely absent from the attempt to manufacture as much vaccine as possible.
The big picture: "We need to build new capacity," says Oxfam's Niko Lusiani. "Even if it takes two years, it will still be useful — for COVID-19, for future pandemics, and for future strains."
- "Freeing up IP will unlock a lot of public and private investment into vaccine production."
Pfizer CFO Frank D'Amelio said on the company's earnings call this month that while "pandemic pricing" in the U.S. is $19.50 per dose, "a normal price that we typically get for a vaccine" would be $150 to $175 per dose.
- The pandemic pricing gives Pfizer a profit margin of well over 20% — but D'Amelio said that "there's a significant opportunity for those margins to improve once we get beyond the pandemic environment" — when pricing will free up and factories become more efficient.
How it works: While international trade law does allow countries to overrule patent protection for vaccines, countries tend to be very reluctant to do so. That's partly because they fear retaliation and also because they need help with the technical knowhow involved in manufacturing the vaccines.
2. The case for patents
The other side: Opening up manufacturing to a point where the patent holders have no oversight could lead to quality-control issues.
What they're saying: "It is a fairly complex biological process," says Thomas Cueni, director general of IFPMA, the International Federation of Pharmaceutical Manufacturers and Associations. "A lot of things can go wrong. If you own the brand, you have a responsibility to have quality partners."
- Ensuring GMP — Good Manufacturing Practices — would be much more difficult without the patent-holders being directly involved.
Opponents of open-sourcing vaccines also say there's no evidence that there's much, if any, spare manufacturing capacity, or that simply freeing up patents would cause such capacity to be built.
- Total vaccine production is already growing faster than expected, with the existing patent holders ramping up fast. When they have an economic incentive to do so, they will be more likely to share the know-how needed not only to make their vaccine, but to do so at scale.
3. Nestlé liquidates its waters
Did you know that Poland Spring was owned by Nestlé? Well, soon it won't be.
- It's being sold to private equity firm One Rock Capital Partners, along with the rest of Nestlé's North American spring waters business, for $4.3 billion.
The press release took pains to note that Nestlé will retain "international premium brands, local natural mineral waters and high-quality healthy hydration products," while chasing "emerging consumer trends, such as functional water."
Background: Nestlé's rights to the water it sells remain disputed.
- Pressure group SumOfUs has been leading a campaign centered on six of Nestlé’s spring-water sites in North America. Angus Wong, the campaign manager, tells Axios that he "will continue to fight with these communities until One Rock Capital Partners returns these water sites to the community."
4. The GameStop hearing begins
It's GameStop hearing day on Capitol Hill, so here's a drinking game you can play while you tune in to C-SPAN.
- Take a drink any time any of these terms is mentioned. For the full experience of trading GameStop during a short squeeze, take an extra drink any time you get four in a row.
The big picture: There's little consensus about what went wrong, if anything, during the trading mania at the end of last month, as Axios' Courtenay Brown reports.
- As a public service, then, I'll try to explain in brief — in the items below this one — the three most important policy issues that are likely to arise during the hearing.
5. Payment for order flow
Payment for order flow, or PFOF, sits at or near the top of the list of people's complaints about market structure.
- The big picture: Every stock trade involves a buyer and a seller. If you're a large institutional investor, your ideal counterparty is a small retail investor who is unlikely to have better information than you do.
- As retail trading increases, it creates competition for that order flow among high-frequency traders (HFTs), all of whom want to take the other side of the retail trade.
- That competition takes the form of so-called "price improvement" — better prices than seen on the official stock market exchanges — which in turn gets split between retail investors and their brokers. The broker's slice is the notorious PFOF.
Driving the news: Public, one of the smaller app-based brokerages, announced this week that it had stopped sending its order flow to HFTs in return for PFOF. Instead, it's sending those orders directly to exchanges, even though doing so, the company admits, is more expensive.
- Normally, if orders are sent directly to exchanges, there's no price improvement at all. But some exchanges, including NYSE, Nasdaq, and BATS, have "retail liquidity programs" where HFTs can once again compete to offer price improvement for what they assume are low-information trades.
- It's not clear that trading with HFTs via retail liquidity programs will end up giving customers better prices than the status quo of going to the HFTs directly.
How it works: Trades on Public will still be free, but customers will be able to add an optional tip of no more than 5% of the value of the trade.
- When customers do tip, the tip will almost certainly be substantially larger than the amount that Public used to receive in PFOF. That was about 0.1 cents per share, for S&P 500 stocks — so a $1,300 order to buy 10 shares of Apple would have netted Public about 1 cent.
- The tip increment on that $1,300 order will start at $1 — 100 times larger than the old PFOF payment. The maximum tip of $65 would be 6,500 times more than the standard payment that Public would previously have received.
The bottom line: The real problem with PFOF is not that it costs customers a lot of money. Rather, it's that it gives brokerages like Robinhood an incentive to maximize the amount that their customers trade, even if that much trading is not in those customers' best interests.
- The best way to disincentivize trades is to charge for them. Thanks to Robinhood, however, $0 trading commissions are here to stay — even (especially) for highly-risky options trades.
6. Short selling
The reason that GameStop stock rose so sharply last month was, paradoxically, because so many people had bet that it was going down.
Why it matters: That kind of bet — known as short-selling — is often considered distasteful, or worse.
- Driving the news: Robinhood CEO Vlad Tenev set the tone for today's hearings by tweeting this week that "it should not be possible to short sell more shares than are out there."
- The blog post he linked to subsequently had to be edited to admit that "as long as there is short selling, there will always be a chance that short sellers can short more shares than there are outstanding."
Between the lines: Short-selling involves borrowing a share from one person and selling it to someone else. Since both people then own the stock, the process effectively increases the gross number of shares outstanding, while keeping the net number of shares constant (since the person shorting the stock effectively owns -1 shares.)
- This process is normally harmless, and helps with liquidity and price discovery.
- Tenev says in his Congressional testimony that Robinhood "does not allow short selling."
- He doesn't mention that he's happy to facilitate billions of dollars' worth of trades in put options, none of which would be possible without other market participants hedging those options by shorting stocks.
By raising the specter of "naked shorts," and even raising the question of whether short selling should be allowed at all, Tenev perpetuates the fallacy that when a stock has a large short interest of more than the free float, that's evidence of nefarious activity or market manipulation.
The bottom line: Short selling is a time-honored, much maligned, and little understood part of the financial markets. More famous CEOs than Tenev — including Elon Musk — have railed against it, but there's no political consensus to try to curb it.
7. Settlement times
The oddest part of the Robinhood position on short selling is the part where the company claims that problems with shorting could "potentially" be avoided by implementing "changes to the stock settlement process."
Why it matters: Currently, stock trades are settled on a T+2 basis — two days after the trade happens, the buyer transfers money to the seller.
- Robinhood CEO Vlad Tenev blames the T+2 system for the fact that he was forced to curtail trade in GameStop stock last month. He has advocated for real-time settlement, where you pay for stock the second that you buy it.
Reality check: Tenev's stated aim in moving from T+2 to real-time settlement is to reduce the amount of collateral he would need to hold at DTCC, the central clearinghouse. But such a move would be far more likely to vastly increase his collateral requirements.
- As the DTCC explains, the current T+2 system only requires brokerages like Robinhood to put up the net amount of money they owe at the end of the day. Since on most days in most stocks the amount of purchases is very similar to the amount of sales, the total transferred can be surprisingly small.
- Real-time settlement, by contrast, would require that "all transactions in the U.S. market be funded on a transaction-by-transaction basis, thus losing the liquidity and risk-mitigating benefits of today’s netting features."
- The total number of transactions needing to be settled would explode, and therefore the number of failed transactions — including failed short-selling transactions — would also soar. Collateral requirements would skyrocket.
The bottom line: It makes a certain amount of sense to move from T+2 to T+1 or even T+0.5, where trades are settled on the same day that they're made. Those changes would have negligible effects on the DTCC's collateral requirements.
- Moving to real-time settlement, however, is utterly unrealistic.
8. Chart: The racial gap in homeownership
9. Coming up: Biden's first summit
G7 leaders will meet — virtually —for the first time since April on Friday, writes Axios' Courtenay Brown.
- Why it matters: It's the first major multilateral summit of the Biden presidency. Trump postponed the G7 meeting that was slated for late last year.
Details: UK Prime Minister Boris Johnson, the "host" of the gathering, will call for equitable distribution of the coronavirus vaccine around the world.
- Leaders of Canada, France, Germany, Italy (Mario Draghi!) and Japan are expected to attend.
10. Building of the week: Fundatie museum, Netherlands
Dutch architect Eduard Louis de Coninck built the neoclassical courthouse in Zwolle, Netherlands, in 1938.
- The building became a museum in 2005, and boasts a permanent collection that includes works by Rembrandt, Turner, Monet, Van Gogh, and Mondrian.
- When the museum ran out of space in 2010, Hubert-Jan Henket designed the "Art Cloud" extension on top of the old building, clad with 55,000 ceramic tiles.