Dot com risk: grey markets and black swans

By Scott Longley, Editorial Director, Regulus Insights.

'To expect the unexpected shows a thoroughly modern intellect' - Oscar Wilde

The 9% share price fall that prompted Playtech to issue a stock exchange statement late last week was only the most recent example of how listed gambling companies suffer more than most from the financial market phenomenon of risk on/risk off.

This is the theory that in the wider market asset price movements are driven by the level of risk tolerance on the part of investors. The more dangerous or unstable the global political or market environment is perceived to be, the more investors are likely to gravitate towards safe haven investments. However, if the background mood music is tending towards the benign, the greater the likelihood that investors will chance their arm in an effort to generate greater returns.

With gambling companies, though, whether land-based or online it is specifically the decisions of legislatures and regulatory bodies that are more often the trigger for dramatic share price reactions.

In the online gaming sector the passing of UIGEA in 2006 by the US Congress was perhaps the most dramatic example of investors being caught out by a legislatory act of shock and awe. But the wider industry can point to other examples of business-defining government interventions, such as the Russian authorities moving to ban casinos back in 2009, or even the loss of S21 machines from land based gaming venues in the UK in 2007.

Rather like living on an earthquake fault line, regulatory tremors are a fact of life for all gambling companies. Playtech’s Malaysian troubles, and William Hill’s recent contretemps with the Philippines’ authorities, demonstrate that regulatory issues can strike anywhere at any time, and rarely with any direct warning.

Yet even to characterise reactions to regulatory developments, as shocks, is arguably an error in interpretation. The analogy de jour for unexpected legal or regulatory jolts is that they are somehow black swan events; something so out of kilter with the ordinary run of business, that it is hugely unpredictable. Yet there is an inevitability about legal proscription and regulatory limits when it comes to offering gambling services.

Whether it is the slow crawl of online regulation across Europe, the advent of the UK Point of Consumption (PoC) regime, the issues surrounding machine gaming in UK betting shops, the recent news from further flung jurisdictions such as South Africa, Singapore or Malaysia, the direction of travel is all too clear: more elements of gambling are being noticed and either regulated, or seeing bans tightened and enforced. This process also gives the lie to the oft misused term ‘market liberalisation’; while it is legally true that a ‘banned’ market which regulates ‘liberalises’, if grey market operators are already in the market the commercial outcome is not ‘liberalisation’ but restriction and tax.

The steady march of gambling regulation makes grey market cash flow seductive but dangerously unpredictable. Exposure to it can also limit regulated market opportunities. Companies and investors could be increasingly facing an impossible choice between regulated legal clarity but little profit. Or dot com cash flow with significant potential volatility.

Dot com volatility is made more acute because no enforcement action has taken place in any given jurisdiction, and the likelihood of action taking place in the future is somehow more unlikely. The history of online gambling consistently contrives to disprove such optimistic hypotheses.

According to industry lore there was no likelihood of enforcement of anti-gambling laws being applied to online operations directed into the US. That was until July 2006, when the Chief Executive of Betonsports was arrested on charges of violating the Wire Act.

Likewise, industry sages confidently predicted there was no prospect of European authorities resorting to similar such extreme measures. Then the French authorities arrested then co-chief executives at Bwin, Manfred Bodner and Norbert Teufelberger in Monaco in late 2006. The same Gallic plod persuaded the Dutch authorities to detain then Unibet boss, Petter Nylander, at their behest in Amsterdam’s Schiphol airport in 2007. And, of course, PokerStars and Full Tilt were untouchables as far as the US authorities were concerned – until Black Friday in April 2011 when suddenly they weren’t

In Europe the steady ratchet of the introduction of PoC regimes across the continent has been accompanied by the drip, drip, drip of operator market exits, the issuing of blacklists and the occasional prosecutorial threat. The approach of playing the regulated market game while also deriving revenues from grey markets, and hoping for ‘liberal’ interpretations of European law is becoming increasingly untenable.

Moreover, this process of the closing down of regulatory arbitrage opportunities is now global. The comfort blanket of Asia, has been promoted by some – including the odd City scribe – as an essentially riskless market where the likelihood of any crackdown by the authorities on offshore operators is supposedly very slim.

This is an example of applying inappropriate ideas about risk to a complex legal, regulatory and operating situation. There are few listed entities that knowingly take money out of China; but there are some, and there are a lot more private entities that ply their trade far and wide across Asia.

If it looks like a swan, hisses like a swan, and is black like a swan then it’s probably a black swan: Investors and operators alike should not be surprised if it turns round to bite.