Rather than conduct trade individually, sixteenth-century english merchants formed

Merchant banks

Merchant banks and their descendents private equity firms buy and sell companies or controlling interests in companies rather than just invest in the securities that companies issue. The firms described to this point only buy and sell securities or other instruments to benefit from short-run trading profits or longer-term investment returns.

Typically, investors and traders are not interested in companies as economic entities except to the extent the companies issue securities or other instruments that can be underwritten and traded. In contrast, “merchant banks,” a British term, invest in companies, some of which are not publically traded, to profit from the ongoing operations of the company. In time, the merchant bank might sell the company at a profit.

Private equity firms more often acquire some or all of a company that is publically traded and that has gotten into financial difficulty or that has very depressed market value. The private equity firm may break up the company and resell the pieces. In some cases, the divisions of a publically traded company may be worth more separately than the market value placed on the combined.

When a situation such as this occurs, the private equity firm buys the publically traded firm (or a controlling interests in it) and breaks up the company into pieces to be resold individually. These firms engage in other investment strategies, many of which are created for each specific investment opportunity. Merchant banks and private equity firms may be subsidiaries of other financial organizations. Figure 1.2.2.2.4 shows the products and roles of merchant banks.

The First Global Cycle of Silver (1540–1640): Bimetallic Ratios and the Silver-for-Gold Trade

It is important to keep in mind that private market forces generated the protracted post-mid-fifteenth-century ‘silverization’ of China. The Ming Dynasty tried repeatedly to retard intrusion of silver into (and from) the coastal centers of merchant power. Silver's penetration was irresistible, however, and local governments in maritime regions began specifying that taxes be paid in silver. Gradually Ming rulers abandoned their resistance to silver and implemented the Silver-Whip tax system around the 1570s. The Single-Whip system specified two things: first, myriad existing national levies were consolidated into a single tax; second, many (but not all) tax payments were to be made in the form of silver. Countrywide inventory demand for silver was large, and grew at a rate that outstripped growth in China's inventory supply, causing the price of silver within China to soar to a level double that elsewhere in the world. Considering that China contained perhaps one-fourth of the earth's population by the seventeenth century, with urban centers several times greater than the largest cities of Western Europe, the silverization of China inevitably had global ramifications. China's tribute-trade system also converted to silver, so we are talking about an even larger proportion of global population. Gradual conversion of the world's largest economic entity to silver caused the metal's value to skyrocket in China relative to the rest of the world. China became the world's dominant importer of silver, as opposed to the silver exporter it had been during the Mongol era.

Merchants and officials often discussed profits to be gained by simultaneously importing silver into China while simultaneously exporting gold from China between the 1540s and 1640. Their statements make sense in the context of evolving worldwide bimetallic ratios over time. China's 6:1 bimetallic ratio (recorded early in the sixteenth century, and again in the 1590s) implied that a mere 6 oz of silver commanded an ounce of gold in China, for instance, whereas it simultaneously took 12 oz of silver to purchase an ounce of gold at Europe's 12:1 ratio. Since silver in China was worth double its value in Europe vis-à-vis gold, this also implies that the value of gold in Europe was double its value in China (vis-à-vis silver); thus, evidence of Chinese gold exports alongside massive Chinese silver imports are unsurprising.3 It took two full centuries (from collapse of China's paper-money system in the mid-fifteenth century) for arbitrage gains to be squeezed out, as bimetallic ratios finally converged worldwide at 1:14 by 1640. China's protracted, simultaneous export of gold and import of silver – while the rest of the world exported silver to China and received Chinese exports (including gold) in return – alone provides justification for rejection of imbalance-of-trade explanations for movements of monetary substances around the world. Imbalance-of-trade arguments are powerless to explain why specific monetary substances traveled one direction while other monetary substances traveled in reverse direction. Again, conceptual disaggregation is required to understand global monetary history; each monetized substance must be analyzed independently in supply–demand terms. Given silver's overvaluation in China and gold's undervaluation in Europe, it is unsurprising to find numerous references to a quest for Asian gold – and not to a quest for Asian silver – in the diary of Christopher Columbus.

At a highly abstract level, it is proper to view the entire world as silver's market area during the sixteenth and seventeenth centuries. But even in the case of specific precious metals, the ‘world market’ actually refers to a series of dispersed, overlapping, and interconnected regional markets spread over the globe. It took a great deal of time to integrate these interconnected, but partially segmented, markets. Differences in bimetallic ratios in Western Europe versus China are sometime cited as evidence that there were distinctive markets in these places (indeed, distinct markets within China as well). Similarly, differential bimetallic ratios between China and Japan (or China and India) indicate that markets in these places were also not perfectly equilibrated at all times. However, realization of arbitrage profits due to differential bimetallic ratios is one of the principal mechanisms that acted to integrate distant markets (as was also true for arbitrage profits for cowries and other important trade items). Anytime a product can be sold in one place for more than its purchase price elsewhere (including all explicit and implicit costs), it tends to be transported to the favorable market area. But transportation of silver from Amsterdam all the way to Macao/Canton, for example, was not the only option. One party might transport the product into Eastern Europe or North Africa, another into the Middle East or Russia, and finally into China in the umpteenth transaction. The point is that there were numerous distinctive, yet overlapping markets for silver, overlapping markets that were interconnected at a global level. Thus, there was a single world market and simultaneously there were numerous localized ‘submarkets.’ A simplified two-submarket model is presented in Figure 22.1 for purposes of illustration, with an understanding that we are implicitly thinking in terms of a model that contains numerous submarkets.

Silver is initially undervalued in Area 1, the silver exporting submarket (the Americas + Europe + Africa + Western Asia + South Asia + Japan = the rest of the world), and overvalued in Area 2, the silver importing submarket (i.e., mostly China). The reverse holds for gold; it is overvalued in the rest of the world and undervalued in China. It would obviously be profitable to export silver to and import gold from China in this situation, which is precisely what happened between the mid-sixteenth and mid-seventeenth centuries. The very act of doing this, however, augmented the stock of silver in China (relative to the rest of the world) and augmented the stock of gold in the rest of the world (relative to China). This process continued until arbitrage profits were eliminated, when the price of each metal roughly equilibrated in all submarkets. This model is consistent with evidence of global bimetallic ratios that finally converged around 1640: ‘As a consequence of this large outflow of silver from Japan during the 1560–1640 period, by 1640 the relative value of gold to silver in Japan had become virtually identical to that in China and the world market.’4 Since silver had been overvalued in China since the mid-fifteenth century collapse of its paper currency, it took two centuries of trade in precious metals to equilibrate bimetallic ratios throughout the world. A market equilibration process that spans two centuries may seem surprising from the vantage of conventional microeconomic analysis, but contemporary accounts and bimetallic-ratio history are consistent with the inventory-supply/inventory-demand model sketched in Figure 22.1. Two centuries of silver-for-gold flows were necessary to equilibrate bimetallic ratios throughout the world (via adjustments in inventory stocks).5

Detention

Detention is a concept that has grown largely in response to the difficulties faced by merchants in protecting their property from shoplifters, and the problems and dangers they face when they make an arrest. Generally, detention differs from arrest in that it permits a merchant to detain a suspected shoplifter briefly without turning the suspect over to the police. An arrest requires that the arrestee be turned over to the authorities as soon as practicable, and in any event without unreasonable delay.

All the shoplifting statutes refer to “detain,” not to “arrest,” a terminology probably derived from the thought that a distinction could be made between the two. The distinction is based on the fact that an arrest is for the purpose of delivering the suspect to the authorities and of exercising strict physical control over that person until the authorities arrive. A detention, or temporary delay, would not be termed an arrest as commonly defined. The distinction is difficult to defend, but the statutes are clear. In Illinois, for example:

Any merchant who has reasonable grounds to believe that a person has committed retail theft may detain such person, on or off the premises of a retail mercantile establishment, in a reasonable manner and for a reasonable length of time for all or any of the following purposes:

To request identification;

To verify such identification;

To make reasonable inquiry as to whether such person has in his possession unpurchased merchandise and, to make reasonable investigation of the ownership of such merchandise;

To inform a peace officer of the detention of the person and surrender that person to the custody of a peace officer [5].

California was one of the first states to establish merchant immunity in a 1936 supreme court decision; in Collyer v. S. H. Kress Co. [6], the court upheld the right of a department store official to detain a suspected shoplifter for 20 minutes.

Most statutes include the merchant, employee, agent, private police, and peace officer as authorized to detain suspects, but they do not include citizens at large, such as another shopper. Most of the statutes also describe the purposes of detention and the manner in which they may be conducted. These purposes are to search, to interrogate, to investigate suspicious behavior, to recover goods, and to await a police officer. The manner in which the detention is to be conducted is generally described as “reasonable” and for “a reasonable period of time.”

The privilege of detention is, however, subject to some problems. There must be probable cause to believe theft already has taken place, or is about to take place, before a merchant may detain anyone. Probable cause is an elusive concept and one that has undergone many different interpretations by the courts. It is frequently difficult to predict how the court will rule on a given set of circumstances that may at the time clearly indicate probable cause to detain. Second, reasonableness must exist both in time and in the manner of the detention, or the privilege will be lost.

21.10.1 Transaction irreversibility

Current digital merchant payment systems typically allow transactions to be reversed in case of a dispute between the buyer and the seller, even weeks after the payment had been authorized by the payer's bank. This so-called chargeback process introduces uncertainty in merchants' revenues and cash flows. Worse, it can be abused by fraudsters disowning payments after having acquired the corresponding goods and services.

Bitcoin proponents argue that Bitcoin entirely eliminates the chargeback process as there is no central authority who can mediate disputes between the buyer and the seller. Bitcoin transactions are final and irreversible, so it operates strictly under a buyer beware policy. This reduces opportunities for fraud. However, there are three reasons why this claimed benefit may not in fact be that significant.

First, chargebacks do represent protection for customers, and the costs incurred by banks and merchants to manage the chargeback process (along with the fraud it may engender) may in fact be economically optimal. If there are no chargebacks, the risk of fraud on the buyer side is reduced, but it then reintroduces consumer protection risks (e.g., the risk of having been sold faulty goods). These two types of risks need to be balanced.

Second, while the Bitcoin protocol itself does not contemplate chargebacks, they can be provided by specialized players offering more sophisticated Bitcoin-based payment solutions to merchants. Merchants may feel it is necessary to adopt such solutions in order to offer a more attractive payment option to customers, thus reintroducing the attendant costs and risks.

Third, it should be mentioned that bitcoin transactions are not immediate: Full validation takes 10-20 min, so the notion of transaction finality is itself a bit ambiguous in a Bitcoin payment setting (this is further discussed below). During this transaction validation period, a merchant may choose to withhold the goods for a certain period of time after the buyer has sent the bitcoins. This introduces inconvenience to the buyer in an in-store setting and will engender distrust by the buyer in an online setting. But releasing the goods earlier will expose merchants to fraud if the bitcoins turn out to be invalid.

Functions and Objectives

Successful merchant banks and broker-dealers developed the core activities of modern investment banking, contrasted in Table 41.1 with traditional commercial banking businesses.

Table 41.1. Core Banking Functions

For large investment banks in the United States, Australia, Europe, or Japan, these functions can include corporate finance and broking, advice on mergers and acquisitions (M&A), fundraising, stock exchange listings, credit rating advice, managing privatization programs for governments, the sale and trading of securities, structured finance, venture capital, and fund management. Most investment banks specialize to some degree, so Merrill Lynch is well-resourced in the distribution of securities while Lazard is predominantly a corporate advisory house working in mergers and privatization; Lehman was once a debt capital markets force. The focus of any bank affects its financial shape and funding needs, so that trading-oriented firms such as Barclays Capital or Goldman Sachs will be larger and more capital intensive than advisory specialists such as Greenhill or Lazard.

Modern investment banks differ in one crucial respect from the historic models in that they act not only for clients but engage in risk activities for their own account. This means applying accumulated capital to risk-bearing proprietary trading, investment, or arbitrage. Putting the firm's resources at risk can be highly profitable but easily creates conflicts with client interests and duties of care, and must be subject to rigorous internal scrutiny. Some such practices are well-known to market professionals but caused alarm in official post-crisis enquiries. Banks engaged in structured finance through the creation and sale of complex securities were affected by substantial accounting losses in the collapse of confidence associated with US subprime lending in 2007–08 and were later questioned as to whether their interests in creating securities conflicted with fiduciary duties that they might owe to investors or other clients.

Proprietary trading is not new. British, Dutch, and French merchant banks and German and Swiss universal banks for which no rigid business demarcations existed often held shares in their corporate clients. Banks in Japan and Korea have been central to the post-1949 organization of major conglomerates though complex cross-shareholdings. Large-scale proprietary trading and private equity investment by banks began to spread from the US in the mid-1980s, and came to represent a significant activity for many investment banks. The reward scenario is simple: investing as principal may generate higher returns than acting merely as transaction arranger, even though the research and deal management demands are similar. The impetus for this trend came from two factors, a progressive deregulation of the global financial sector from the 1980s, and technological growth leading to revolutions in trading and the use of financial derivative contracts. To engage in proprietary activity, to deploy costly technology, and to maximize profits from fundraising for clients all require large-scale use of capital, which is costly and explains increasing concentration within global investment banking.

23.8 Inadequacies in the current system and possible mechanisms for overcoming corruption against older Australians

Daly, Merchant, and Jogerst (2011, p. 361), in a review of the literature on elder abuse, concluded that the breadth of research in this area “demonstrates the magnitude of this social and criminal problem as well as the interdisciplinary efforts to identify the victims, causes of abuse, and interventions to prevent it.” However, they argue that only a small portion of the research in this area has focused on the prevention of abuse. They identify only three types of preventative actions that have been subject to rigorous research: education programs, support group meetings, and daily money management programs. They also noted that other appropriate and potential interventions had not been tested in rigorous studies. Other mechanisms include legislation reform, strengthening of the mechanisms for the use of enduring powers of attorney, and guardianship arrangements, among others (Alzheimers Australia, 2014; Daly et al., 2011, p. 361; Mental Heatlh Carers ARAFMI NSW Inc., 2015).

Quantifying and managing merchant price risk exposures

As discussed earlier, renewable energy projects with project finance structures have limited ability to handle large exposure to variations in power prices. These “merchant” price risks directly affect cash flow and subsequently the ability of projects to service debt and meet other obligations. For this reason, projects with large merchant risk exposures are typically financed on balance sheets, relying on standard corporate finance structures. In the European Union, for example, this is relatively common and many new projects are built on balance sheets by large European generation groups. However, even for hedged projects (e.g. those with PPAs or the alternative off-take structures discussed in this chapter) there is often a level of residual merchant price risk. For a project with a utility PPA, for example, the PPA might not cover all of the capacity of the project, leaving some generation (in some periods, for example) exposed to price risks. With the alternative off-take structures, significant residual price risks are very common.

Many corporate PPAs and utility PPAs do not cover the useful life of the renewable energy projects. As a result, the projects are exposed to the merchant price risks for the uncontracted useful life - once the PPA ends, but while the project is still able to generate electricity.

For a commodity power price hedge, for example, the hedge is typically sized to the estimated 1-year p-99 level of generation. Since generation is expected to be higher, the project is exposed to the merchant price risk for the generation quantity between the actual generation output and the hedged quantity.

One subset of merchant risks is transmission basis risk, as discussed in Chapter 9. To the extent that the off-take contracts settle for a price at a location other than the point of interconnection, the project will be exposed to the transmission basis differential. This is a function of the market prices in the two locations (hub vs. project).

4.1.2 History

Both of these markets stem from a certain type of actual or physical business, the spot market. At the start of overseas trade in Europe, merchants undertook ventures in ships they owned, frequently sailing as the master. Those that employed a master instead of going themselves would also have on board a supercargo. While the master was in charge of the running of the ship, the supercargo represented the owner in the trading of goods. Ships would not just visit one or two places overseas and then return home. It was usual for them to visit a number of ports, buying and selling goods. The supercargo's job was to ensure that such trading was profitable. Naturally such ventures took time and were exceedingly risky. Not only was the merchant at home unsure when (or if) the ship would return from the ‘marine adventure’, he could not be certain of her cargo. The risk of the loss of the ship could be covered by the embryonic marine insurance, but the contents of returning holds remained a mystery to the owner until the supercargo jumped ashore. For the owner on board the ship, there was little he could do to sell the goods before the ship docked. Being unable to communicate with traders at the next port prevented him selling the cargo before the ship's arrival.

Either way, the merchant was therefore unable to sell his cargo until it had physically arrived at its destination. The merchants sold their cargoes of cocoa to the apothecaries, manufacturers, etc. either at auctions or, on occasion, privately. For both types of sale, by auction or private deal, the goods were available for immediate delivery. For cocoa it was the start of overseas trade that became known as the cash or spot market. Sales of cocoa by auction in London and Liverpool continued for some time:

By Virtue of an Order of the Commissioners for the Care and Disposal of the Spanish Ships and Cargoes detained, On TUESDAY, the 8th June, and the following Days, at Ten for Eleven precisely, At their SALEROOM, at WESTS WAREHOUSE, BILLITER-LANE 14 Serons Cocoa Being the entire cargo of the Ship San Miguel captured on her passage from South America, and regularly condemned. (Advertisement 1805)

This was not an unusual method of either sale or, for that time, procurement. Also advertised in the same edition of the Public Ledger were the following:

30 Hhds. Cocoa from N.S. del Carmen

473 Tierces Cocoa from Nostra Senora de los Dolores

50 Bales Cocoa from El Dichoso

86 Serons Cocoa from Nova Charlotta from Cumana

200 Serons Cocoa from Princessa de la Paz

357 Serons Cocoa from St Andero from Vera Cruz

6½ Hhds. Cocoa from Sta. Anna from Giuyana

By way of interest: a tierce is a third of a pipe or 42 gallons; a seron is a bale or package and Hhd. (a hogshead) is 52½ imperial gallons. As a rough guide, a tierce would contain some 113 kilos of beans and a hogshead just over 140 kilos.

During the seventeenth and eighteenth centuries auctions developed informally. Held in cities that had developed in overseas trade, the proximity of both the wharves containing the overseas goods and the merchant banks became essential. In Europe, London became a major trading centre, with some auctions conducted in local coffee houses in the City. This continued until the opening of the Sale-Rooms in Mincing Lane during 1811 formalised the sale of cocoa and other commodities. The sale of specific parcels of cocoa continued in this manner, and not only for beans:

The London Commercial Sale-Rooms

On Tuesday January 8

COCOA BUTTER, 35 tons “Cadbury's”

Guaranteed Genuine

C.M. & C. WOODHOUSE, Brokers (Advertisement 1888)

Although the Sale-Rooms were destroyed during the Second World War, the location for trading cocoa and other commodities remained in the Mincing Lane area of London until the 1980s.

The spot market as a means of buying cocoa was sufficient for the small eighteenth and nineteenth century manufacturers of drinking chocolate. Their needs could be fulfilled by this sometimes haphazard method of obtaining cocoa. However, once the larger factories began production later in the nineteenth century, the mills needed regular supplies of consistent quality cocoa. This requirement coincided with improved ships and overseas trade. In the same year that François-Louis Cailler set up his chocolate factory in Vevey, Switzerland (1819), the first transatlantic crossing by a ship with an auxiliary steam engine occurred. A ship solely powered by a steam engine crossed the Atlantic in 1858, two years after German and Spanish colonists began to grow cocoa commercially in Bahia, Brazil. No longer subject to the vagaries of the wind, more ships began plying the trade routes. The first steel hulled ship crossed the Atlantic in 1879, the same year that Tetteh Quarshie had cocoa brought into Ghana.

These major improvements to ship design benefited overseas trade. The commerce of overseas goods changed. Regular sailings to estates and plantations meant that it became possible for manufacturers to buy cocoa due to arrive at some defined period in the future. Such business had advantages for both the manufacturer and the merchant. The manufacturer knew that his supply was more stable; he could be more certain of the type of cocoa he was to take delivery of and when it was due to arrive. The merchant, now unlikely to be the ship owner, knew what margin he could make on the deal, and would not have to rely on local supply and demand factors affecting the auction prices. This was the start of the forward market.

There was one other factor. Bidding at auction is not a private affair. Everyone else in the room knows what has been sold and at what price. Unless the buyer is clever, the others are likely to know who bought it as well. The merchants, all competing for business, disliked the auction process and sought alternatives.

The wish for privacy of contract coupled with the desire to secure regular supplies meant that the forward contract became more popular. Privacy of contract naturally means that only the parties involved know of the trade. It therefore follows that a crowded meeting place, such as an auction room, is not the best place to conduct business. In fact, the term ‘physical market’ does not refer to a place or to an assembly of people. It is the business transacted. The actuals market is therefore spread throughout the world and refers to anyone who buys or sells the physical commodity, in this case cocoa. Although concentrated in certain places where cocoa trading traditionally occurs, like London, New York, Amsterdam and Hamburg, it is not true that the market is located in these specific places.

As the volume of cocoa business increased, merchants also found it easier to conduct business using standardised contracts of sale detailing the particular contract. With the terms of sale established and understood by both parties, little needed to be discussed at the time of the contract. This left more time free for both parties to continue with the business of trading. With the large increase in world production from Africa taking effect during the early twentieth century, those active in the cocoa trade formed three trade associations to cater for their needs.

Free on board (FOB)

The FCC and the CMAA both provide FOB contract terms. Of the two main export terms, FOB is the simpler although CIF and its variations are the more usual. Despite their simplicity, FOB sales usually require the parties to discuss matters in more depth than for CIF terms as the transfer of property and title of the goods require a greater mutual understanding. Under FOB sales, the seller's duties are less than for a CIF sale. The seller of FOB cocoa has to deliver the cocoa on board the ship, usually, although not necessarily, nominated by the buyer, pay for the loading costs if they do not form part of the freight, clear the cocoa through customs and provide all the necessary documentation to allow the export to take place. Note that the FCC provides alternative terms for those wishing to sell on FOB terms that allow for either the buyer or the seller to nominate a suitable carrier. The CMAA FOB terms imply that the seller nominates the carrier. Lastly, the seller must supply the buyer with a clean mate's receipt. In the cocoa trade, the seller usually gives a bill of lading instead of a mate's receipt, as FOB cocoa contracts commonly include additional services. The bill of lading is the main document in the export transaction. It is a receipt for the goods on board the ship and gives title to them, as well as providing evidence of the contract of carriage by sea (contract of affreightment).

In a standard FOB contract it is the buyer's duty to contract for the freight by booking the space on board a suitable carrier. Irrespective of whether the buyer or the seller arranges the freight, once the cocoa is on board the ship it becomes the buyer's risk and he is liable for any further costs. This includes the costs of discharging the cocoa at destination.

With the possibility of the seller providing additional services, it is important that both parties understand the exact terms of the particular FOB sale under discussion. Confusion over sale terms increases costs and may lead to disputes that the parties could avoid by clearer understanding of their respective duties at the inception of the contract. Unclear contract terms are the prime sources of dispute.

As mentioned above, under a strict FOB contract the seller has no further interest in the parcel. However, cocoa is not always sold according to these terms. Under certain cocoa contracts, the seller may still be liable for the quality and weight of the cocoa on arrival at destination which means that the buyer is bound to use a suitable vessel. It is obviously unfair if the parcel deteriorated either in weight or quality because the shipment was on a substandard vessel chosen by the buyer.

3.3.1.3 Asset Management

This division is engaged in merchant banking, traditional asset management, and real estate investment activities. The Asset Management business segment is one of the world’s largest global investment management corporations, offering clients a wide array of equity, fixed income, alternate investments, and merchant banking strategies. The division offers these products to institutional investors and high-net-worth individuals. The division’s alternative investment portfolio consists of hedge funds, funds of private equity, real estate funds, and portable alpha strategies. Morgan Stanley has minority investment stakes in alternative investment firms such as Lansdowne partners, Avenue Capital Group, and Traxis Partners. Real estate and merchant banking businesses include real estate investing segments, private equity funds, corporate mezzanine debt investing group, and infrastructure investing group. Institutional investors of Morgan Stanley include corporations, pension plans, foundations, endowments, sovereign wealth funds, and insurance companies. The Global Sales and Client Services team is focused on business development services for institutional clients. The Asset division of Morgan Stanley offers open-ended and close-ended funds to individual investors through affiliated and unaffiliated brokers and dealers. Morgan Stanley also distributes mutual funds to clients through various retirement plan platforms.