Monday, October 27, 2008

This is what Minibonds is all about!



The name "Minibonds" itself is a misleading word for investors. Whatever money you have invested in this "Minibonds" are not invested in bonds of the six reference banks or bonds issued by Lehman Brothers.

This is how it works. Lehman Brothers may or may not buy any bonds from the six reference banks but it is just using these banks as "reference entities", some sort as a "bet" with Minibonds holders. There are basically 5 entities involved in the Minibonds arrangement.

1)First of all, its Lehman Brothers as the credit risk swap (I will explain what credit risk swap entails in this case later) partner.

2)Secondly, Lehman Brothers has created an empty shell company Minibond Ltd which will issue the Minibonds to investors.

3)Third, the investors.

4)Forth, the money taken from investors will be invested in a basket of AA financial products from 150 companies which includes CDOs which is basically collateral debts obligations, some of them are related to SubPrime debts.

5) The reference banks which has nothing to do with investors' investment other than being a betting reference: i.e. if any one of them failed, it would be a credit event that make investors lose money to Lehman Brothers.

For simplicity to understand the whole arrangement, just take it that Lehman Brothers has bought some bonds from these six reference entities (banks) and it needs somebody to insure its risk of exposure to these banks. It did not insure its risks from insurance companies like AIG but instead, via this Minibonds arrangement, bought insurance from investors like you.

Through the Credit Risk Swap, you as an investor has agreed to sell insurance to Lehman Brothers with regards to the reference entities. In order to become an insurance agents of Lehman Brothers, you will need to come up with money as collateral. This money is collected from you via the financial institutions that you bought the Minibonds and given to Minibond Ltd to invest in a basket of CDOs issued by 150 companies.

Whatever returns from these CDOs issued by these 150 companies (variable returns) are given to Lehman Brothers. In return, Lehman Brothers will give Minibonds Ltd a FIXED premium (most probably higher than 5.1%) and Minibonds Ltd will give investors 5.1% returns for their investment.

Now, the variable returns from the Collateral Assets may be higher or lower than 5.1% but investors will only get back 5.1%. It means that Lehman Brothers will take the risk of variable returns from these Collateral Assets in return for your risk taking on the reference entities. This complete the Credit Risks Swap, swapping your risks of variable returns for a fixed returns, while you in return, insured Lehman Brothers for their risk exposure to the Six reference entities.

The problem is that Minibonds Ltd, under the control of Lehman Brothers, may choose to invest in a higher risk instruments or CDOs because it would be very profitable if the returns from these investment is higher than 5.1% that Lehman Brothers promised you. Especially so, when they do not need to bear the risks of defaults these CDOs or any of the assets in the basket of Collateral Assets. The returns from these Collateral Assets, they take but you bear the risks of defaults from these assets.

Under the contract, once a CREDIT EVENT happens, the whole arrangement will be liquidated. The Credit Event involves:

1) If any one of the reference banks failed, it is considered as a Credit Event and the investors will have to pay Lehman Brothers for the insurance it bought via the Credit Risks Swap. Meaning, investors will lose all money invested.

2) If more than 11 companies of the 150 companies listed in the Collateral Assets failed, or a certain percentage of the CDOs or credit-linked derivatives held as Collateral Assets go into default, the whole Minibonds will be liquidated and any loss from these defaults will be born by investors (not Lehman Brothers).

Afternote: Someone asks me about where does the prospectus point out about Credit Event no. 2. This is the tricky part, when you were sold the product, they did not point out directly the more important risk involved in the collateral assets and in the base prospectus , it was not listed as "Credit Event" or "Risk" but instead it was listed under the section on Mandatory Redemption. I have seen the pricing statement and such important HIGH RISK was not prominently mentioned also. Someone pointed out that under the various series'prospectus, it was mentioned as follows:

- for minibond series 3 if 10 credit events happen to the 150 companies, investor would experience some loss of principal. If there are 12 such credit events investor will loss all principal.
(Prospectus pg 20)

- for minibond series 5, if 11 credit events happen to the 150 companies, investors would experience some loss of principal. If there are 13 such credit events investor will loss all principal.
(Prospectus pg 21)

- for minibond series 7 (they don't even state the numbers now). Investor will experience some loss of principal if a "specified amount" of loss from the unknown number of companies.
(Prospectus pg 22)

Most important of all, the prospectus did not list out the 150 companies



But the definition of Credit Event does not includes the failing of Lehman Brothers as the Credit Risks Swap partner. Thus, at this moment, investors do no face immediate liquidation of the Minibonds and suffer immediate losses.

However, investors RISK losing a lot of money due to the fact that the value of the basket of CDOs and other credit-linked derivatives held as Collateral Assets has devalued tremendously due to the present financial crisis. The likelihood of a credit event triggered by the failing of a substantial number of companies within the list of 150 is very high at this moment.


Furthermore, as Lehman Brothers has gone into bankruptcy, it will no longer give you the 5.1% as it promised and in this financial crisis, the variable returns from the basket of CDOs and credit-linked derivatives would be nearly zero as most of them are linked to SubPrime products.

Thus, with this basic understanding of the product Minibonds, I shall answer Peter's questions:

1) What was sold to the unsuspecting and gullible investors ? Is it a Credit Default Swap( CDS ). What is a CDS ?

Credit Default Swap, also commonly known as Credit Risk Swap, is a mechanism whereby two parties "exchange risk". In this case of Minibonds, it is totally an UNFAIR swapping. The "RISK" Minibonds Investors swapped with Lehman Brothers is the VARIABLE RETURNS from the basket of Collateral Assets they implicitly invested via Minibonds Ltd controlled by Lehman Brothers. However, the risk of the failing of the whole basket of Collateral Assets are not insured by Lehman Brothers. Thus, Lehman Brothers will not compensate investors if they lose money due to defaults of the CDOs and credit-linked assets held in the basket of collateral assets!

This is where the tricky part is. Lehman Brothers could use Minibonds Ltd to invest in many HIGH RISK financial derivatives to get very high variable returns and it will benefit from these returns while only giving back a fixed 5.1% to investors. But if these HIGH RISK derivatives failed, investors will have to bear the brunt.

On the other hand, Lehman Brothers has used the Six Reference banks as a risk bet to Minibonds investors. It seems to me that using such reference entities of "Low Risk" nature as Credit Default Risk exchange is MISLEADING as it creates an impression of "LOW RISKS" while in fact, the amount of RISK investors born is very much higher as they are responsible for the risk of the Collateral Assets!

2) What is the purpose of REFERENCE ENTITIES ( REs ) ? The REs are prominently displayed in the brochure and fooled us into thinking we are investing in their bonds.

As explained, the Reference Entities are just a reference of "Risk" that Lehman Brothers is swapping with you. Your money invested did not invest in these banks but rather in a list of 150 companies' credit-linked derivatives which may be of HIGH RISKS nature.

The main Risk that investors is taking lies in the basket of Collateral Assets.

3) The money collected from investors, what did they do with it. I saw the swapping chart in your blog in chinese. Can you kindly prepare one in english and email to me so that I can photocopy and distribute this sat. at speakers corner to help investors achieve some understanding.

The money collected from investors are invested in a basket of HIGH RISK derivatives issued by 150 companies. High risk derivatives may give high VARIABLE returns but the returns from these High Risk derivatives was swapped by the arrangement of CREDIT DEFAULT SWAP, to Lehman Brothers. That means that investors are bearing the HIGH RISKS of this basket of derivatives (not bonds, but CDOs and credit-linked derivatives) but Lehman Brothers has taken all the returns from these derivatives and in return, only promised to give you a FIXED return of 5.1%!

4) The REs have not defaulted,but the value of our investments have plumetted to almost zero. What is the rationale behind this incomprehensible senario.?

Although the REs have not defaulted but the basket of HIGH RISK derivatives that your money actually invested in as a basket of Collateral Assets has actually diminished due to the financial crisis that we are facing. Although you as investors have not enjoyed the high returns from these high risk derivatives (which you have swap and given to Lehman Brothers for 5.1% return) but you bear the risks of defaults or devaluation from these financial derivative instruments.

5) Did the distributor :-
a) misrepresented this product ( not aware of it's true nature and operating mechanism )
b) concealed the material fact ( they knew but did not tell us )

a) From the many descriptions given by investors with regards to the information they received from sales representatives, it is a CLEAR MIS-INFORMATION and MIS-REPRESENTATION of this product. The RISK you faced is not LOW as the failure of any one of the six reference entities. You, as an investor, also face risk of defaults or devaluation of the basket of HIGH RISK financial derivatives issued by the 150 companies and yet, you did not enjoy FULLY the potential high returns from these instruments but taking the risk of these instruments! Basically it means that, somebody used your money to invest in HIGH RISKS products and keep all the potential HIGH RETURNS from your investment but in return, they only give you back a FIXED 5.1% and you bear all the risks of defaults and devaluation of these products. I believe if this is represented properly to you, many investors would not be investing in this product. I mean, who wants to bear all the HIGH RISK while taking back only a FIXED 5.1%?

b) I am not in the position to say whether "they knew but did not tell you" or they conceal any material facts because I am not vested and would not know whether those front line sales representatives actually know what they are selling in the very first place. I believe not many people really understand this Lehman Brothers Minibonds when it was first sold. If those financial elites at MAS actually study the whole structure carefully, they would realize that this Minibonds is DETRIMENTAL to consumers' interests and it is a totally UNFAIR Credit Default Risk Swap as Lehman Brothers controlled the Swap Party Minibond Ltd.

I hope my explanation is clear enough for you to understand.

Goh Meng Seng

27 comments:

Ramseth said...

I think most aunties and uncles with be blurrer than ever after reading your attempt at explanation.

Anonymous said...

Is our CPF similar to the CDO? Temasek Holding / GIC takes high risks to get high returns, but the CPF members get 4% only? Is that why we need a minimum sum scheme to ensure that funds used to buy toxic assets cannot be withdrawn by CPF members.

Anonymous said...

You lost me after the first few paragraphs.

I can't complete even half of this article.

Will bookmark and try again when I get my PHD in in some Financial Thingamajit.

Anonymous said...

Dear Mr Goh,

Can we consider the MiniBond saga as a scam by the top bankers? Can we report the case to CAD or police? Kindly advise.

LuckySingaporean said...

In a few words - TOXIC and UNFIT for CONSUMPTION.

Why does one even have to file a complaint to get his money back?...This product is a defective product....like a TV that does not work as a TV...minibonds are not bonds.

Anonymous said...

Its well written. Thanks.

Anonymous said...

Well written. Too bad finance is too technical for most people, even university undergrads.

Anyway, it's a scam. And it's telling that despite the wrongdoing, and despite the information asymmetry (which gives greater reason why intervention is necessary), our government is still trying to wash their hands off.

Anonymous said...

anon 11.32
report to police or CAD?
Then you would have to report MAS
to to police or CAD cause they should have approve these instruments in the first place.
Besides HKG and Sin, I don't think
its been sold elsewhere in Asia cause their financial regulators are more prudent?

Anonymous said...

Thankyou very much for your time and effort, I have learnt something today (although I am not a investor to any of these financial instrument).

If the mechanics of "Minibonds" is what as described, would it be the same if I am asked to loan someone money so that he can go gamble with it in, say 150 casinos. In return, I will get a regular fixed interest payment during the loan period and all my money back at the end of it, but only if he didn’t lost them first to the casinos (as he is not responsible for what he does with my money). But my money is otherwise safe, unless a tsunami hit Sentosa, tornado strike the Padang or Mount Faber erupted …

If this is correct, it must be a very very skilful person to be able to “straight” sell these things or the buyers who must be very very “relax” about their money, to the point that perhaps they feel using it to start a camp fire, would be the next best thing for it….

Goh Meng Seng said...

Lucky Tan,

For the credit event number 2, I could not verify when I am writing this one but its only logical because, this is to protect Lehman Brothers from losing money. i.e. If 10% of the high risk derivatives failed, Lehman Brothers collection of the returns from the basket of collateral assets will most probably lower than 5.1%.

AS for anonymous 12.25,

You are spot on. That is what I think Lehman Brothers wanted, to take money from you to play high risk derivatives to earn high return while giving you a fixed 5.1%. But if the gamble failed, they don't need to bear the brunt of the losses while investors will have to pay for these losses.

This is effectively better than borrowing from other sources, which they will ultimately have to pay back in full. And its even better than issuing a 5% coupon bonds because they don't even need to bother about paying back the principles of the bonds! Lose money, those investors' problem, make money... Lehman Brothers enjoy the profits.

Goh Meng Seng

Goh Meng Seng said...

Lucky Tan,

I have found one clause in the prospectus of Lehman Brothers Minibond that may give some clue to the liquidation of the minibonds in the event of defaults of underlying collateral assets:

Prospectus can be found at:

http://theonlinecitizen.com/wp-content/uploads/2008/10/minobond-prospectus.pdf

It is written on Pg 8, clause under Mandatory Redemption:


"If all or some of the Underlying Securities relating to a Series
become repayable prior to their stated maturity or there is a
payment default in respect of any such Underlying Securities, the
Notes of that Series shall become repayable in whole or in part. See
the section headed “Master Terms and Conditions of the Notes –
Redemption, Purchase and Options” for further details."

Read Pg 39 on B) Mandatory Redemption

Goh Meng Seng

Anonymous said...

I like the way Annon (9:30 pm)put it, very creative indeed.

Now, I try to apply for HN's case. I was asked to loan someone money in return of some pocket money. He went gamble with it in, say 100 casinos. Now tsunami hit Sentosa, tornado strike the Padang or Mount Faber erupted …(Lehman Bro gone....). He still keeping my money. The money may be lesser now due to his current bad luck on the gambling tables.

Now, He said he has $0.00 in its pocket?? Anyone beleives it??

Please correct me, anyone?

Anonymous said...

This is not the full picture as no mention was made with regards to the GE/MBIA bond (which is the collateral for the synthetic CDO basket).

Thanks Mr. Goh for attempting to explain the Minibond structure but I just hope the full picture is given to readers of this blog.

Goh Meng Seng said...

Dear Anon 11:43

I am only concentrating on Lehman Minibonds in its general structure because that's what I know best for the moment.

There is a report on Today about DBS High Note 5 as a FLAWED Product as it has made investors as "insurer" of the bank. Lehman Minibonds is similar to that but furthermore, it is flawed in making investors liable to other people's gambling risk while only taking back a small fixed interests.

I heard about GE structured product which is inherently high risk in nature also. Maybe someone could enlighten us as I do not have prospectus or materials on such products.

Goh Meng Seng

Anonymous said...

Mr GMS

Please don't mind that I offer some corrections to the picture.

Between "Minibond Limited" and "150 companies....", is another empty shell company created by Lehman. Let's call it "X".

"Minibond Limited" took money from "Minibonds Investors" and gave to "X".

"X", in return, issues its own company notes to "Minibond Limited". Since Lehman guarantees on the company notes, they are upgraded to at least "AA" status.

"X" then uses the money to buy over the "150 companies..." from Lehman, probably at face value.

So, the "150 companies..." becomes the underlying securities for the "AA" Company Notes issued by "X", to "Minibond Limited".

In turn, the "AA" Company Notes becomes the underlying securities for the Minibond Credit-Linked Notes issued by "Minibond Limited", to "Minibond Investors".

When Lehman falls, the guarantees for the "AA" Company Notes no longer stands. Minibond Credit-Linked Notes will have to fall back on the actual market value of the "150 companies..", which could be far lesser than face value.

Anonymous said...

Good and clear explanation by Meng Seng about minibonds, I would encourage all affected to read it carefully.

Just wish to add something to point 2 about Credit Event:

- for minibond series 3 if 10 credit events happen to the 150 companies, investor would experience some loss of principal. If there are 12 such credit events investor will loss all principal.
(Prospectus pg 20)

- for minibond series 5, if 11 credit events happen to the 150 companies, investors would experience some loss of principal. If there are 13 such credit events investor will loss all principal.
(Prospectus pg 21)

- for minibond series 7 (they don't even state the numbers now). Investor will experience some loss of principal if a "specified amount" of loss from the unknown number of companies.
(Prospectus pg 22)

Also note that the 150 companies are not known at the point of purchase!

Ro

Anonymous said...

to anonymous 4:17 PM

what about Minibond Series 1 & 2?

what are their consequences in the event of defaults?

Anonymous said...

Thank you Mr Goh for enlightening us on the workings of the minibonds.

As an investor in the minibonds, I had some difficulty understanding the various explanations given by various parties on the mechanics of the minibonds.

Your explanation is easier to understand and should give people from the various regulatory authorities a better insight (in case they themselves don't fully understand the mechanics of the minibonds)as to how the people of Singapore, whether they were vulnerable or not vulnerable, were "con" into investing in the minibonds.

I invested a six figure amount in these minibonds on the believe that such products, being allowed to be sold to the citizens of Singapore, were approved by the regulatory authorities after having vetted through them to ensure that we don't have "Nigerian type scams" being thrown at the people of Singapore.

Goh Meng Seng said...

Anon 10.16am

It is really sad indeed that our very highly paid elite regulators did not really bother to take a closer look at the whole structure. In fact, I was told, Minibond is classified as "bonds" and it is even sold to CPF holders!

They depended blindly on distributors' recommendation and the big names like Lehman Brothers and the six reference entities. Worse of all, they depended on the flawed credit ratings giving by big names and lack the independent ability to access the whole structure carefully.

When I first read the base prospectus, it was all filled with legal and financial jargons that I really doubt anyone, regardless of whether he knows how to read English or not, could actually understand and crafted out the mechanism of these products.

I even doubt that lawyers without basic financial understanding could really figure out what it is all about.

I am happy that my little effort on explaining the mechanism of Minibond in the simplest way possible, could help many of you in your course of pressing claims of mis-representation and mis-selling against the financial institutions that sold you the product. Good Luck.

Goh Meng Seng

Anonymous said...

Try this alternative explanation.

http://www.lioninvestor.com/minibonds-update/

Anonymous said...

Reposting again for clickable link

Minibond explanation

Benny said...

I wonder if you guys know about this forum http://forums.delphiforums.com/sisualai/start

Anonymous said...

reposting again for clickable link

Minibond forum for victims

Anonymous said...

Not sure if you/anyone is still reading this Oct 2008 posting.

My quesiton is:
did the propectus list the fact that the 11th default (out of 150 company) would cause 100% principal loss? I saw a page naumber was listed too.
Here is another minibond blog:
http://minibondVictim.blogspot.com.

It listed a limilar fund in australia, but the fund's prospectus is very different from Hong Kong's minibond prospectus.

Anonymous said...

what is the difference between conditional bond and mini bond?

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