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From my blog singaporealternatives.blogspot.com
<a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s1600-h/minibond.gif"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;" src="http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s400/minibond.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5251425763720710642" /></a>
I have gathered a couple of news articles from Hong Kong which give better perspective of the whole issue.
What is MiniBond in the very first place? The picture above is a simple illustration I gather from Hong Kong Economics Daily newspaper. Yes, it is written in Traditional Chinese and I hope you could read it well.
Anyway, in short, the whole Minibond instrument comprises two parts:
1) The AA or AAA bonds as the basis of the structure (Right side of the diagram)
2) The Credit Risks Swap which involves a Vehicle (in this case, Lehman Brother's collective of financial bonds and instruments).
The first part (right part of the diagram) of the instrument is easy to understand. The money paid by the investors are used to buy AA or better rated bonds. The coupon rate or interest payment by the bonds are given to the investors on an annual basis.
However, to increase the returns of this instrument, the bonds are used as the basis to provide "insurance" for the other vehicle, like a collection of bonds or derivatives or financial entities. In this case, Lehman Brothers' collection of financial instruments. It means that Lehman Brothers will give the bond holders a certain percentage of premium to exchange for protection of its own credit risks. This is what Credit Risks Swap all about.
Literally, it means that Lehman Brothers, as an financial institution, needs to insure its own credit risk of honoring all the bonds or financial derivatives it sold in the market. Instead of buying financial insurance from a insurance company (or reassurance companies), it chose to pay a risk premium to Minibonds holders in return for an insurance against any of its losses in the event of credit events that it suffers.
Why would Lehman Brothers pay a risk premium to Minibonds holders for such Credit Risks Swap rather than buying insurance from a insurance company? Most probably it is much cheaper to do a Credit Risks Swap than paying hefty insurance premiums for its own credit risks.
The amount of "additional returns" that a Minibond provides for its investors depends on who or what the Credit Risks Swap is done with. If the Credit Risks Swap involves a collection of Junk Bonds, then naturally, due to the higher risks of Junk Bonds, the return would be higher. In this case, prior to the collapse of Lehman Brothers, it was considered as a relatively "low risk" financial entity by virtue of the facts that it was the 4th largest Investment Bank in USA. Thus the overall return of Lehman Brothers Minibonds is relatively low.
Well, if everything goes well and there is no credit issues or events for Lehman Brothers' collection of financial instruments, the investors could get all the interests paid plus the AA bonds they paid for when the Minibonds matured. But if there is anything happen to Lehman Brothers, then they could have to compensate Lehman Brothers for its loss due to these credit events like bankruptcy or inability to fulfill its financial liabilities. i.e. The Minibonds holders are required under the agreement, to act as an insurer of Lehman Brothers. It means that the AA bonds that are bought under the Minibond agreement would be cashed out and used as a compensation to Lehman Brothers to fulfill the obligation of the Credit Risks Swap.
This is the interesting part, small investors acting as insurer of a big investment bank!
The various articles have suggested that the regulators have not taken a pro-active stand in regulating the sales of these financial instruments. In the mini-bond issue, the returns are "improved" by virtue of the credit risks swap taken up by the financial instruments. In this case, Lehman Brothers bond is the vehicle that the bonds has taken up the risks swap. Yes, nobody would consider Lehman Brothers as a "high risk" financial entity but that is also why the returns is just 5.1%. If the vehicle involves consist of junk bonds, then one would expect a higher return.
The crux of the matter is whether investors are being misled in the whole dealings. But I guess the contract or agreement they have signed would have a clause that says the investors are briefed and understood the product, including all the risks involved. This is where the banks or financial institutions have covered their backsides. But the contract would most probably be very vague on what kind of risks they have explained to the investors. This is where improvement on regulation could be made. SPECIFIC risks and possibilities must be stated CLEARLY in BOLD, not in fine prints.
Even if the regulators come up with the requirement of putting different categories on the different financial instruments being sold, it is difficult to classify Mini-Bonds which involves two parts of financial structures: Bonds + Credit Risks Swap. Unless the regulations include the declaration of all possibilities of defaults and risks involves, I would say that no matter how good the products are marketed and sold, there will always be investors who will claim ignorance. Where does it end?
While I empathize with many aunty and uncle investors, but the point is, if they are not sure about what they are buying, they should not buy it in the very first place. If all investment decision in any instruments is solely based on the returns alone, then I would say that our investors, including aunties and uncles, will not evolve smarter at all. That is why I feel that we need to strengthen investors education. The plight of these aunty uncle investors is really sympathetic but they could not avoid their part of responsibility. If they chose to invest blindly, then they will have to bear the consequences. Very sad but this is basically how capitalist system works. Unless they could prove that they are being misled with clear evidence of mis-selling or misrepresentation by the institutions.
From the legislative perspective, there are rules could be set to avoid such chaos and disputes. For example, if the financial institutions that sold the financial products did not list out in BOLD of the various risks and possibilities within the marketing tools, contracts and agreements, then if one of the unlisted possibilities occurred and losses are incurred, then the investors should have the right to claim compensations from the financial institutions that sold them the products. For example, in this case, if the contract did not list the possibility of Lehman Brothers being bankrupted and the implications behind it, then the consumers have the right to claim compensations from the financial Institutions for their losses.
This will shift the burden of legal responsibilities of clear representation of risks to the financial institutions. If their presentation of risks is not all inclusive, then they will have to bear the risks of taking losses.
But I bet even with that legislation, there will always be investors that would claim ignorance. I mean, how would one measure the risk of Lehman Brothers being bankrupted at that point of time when it was the 4th largest investment bank in USA? It has no end. One has to learn that near zero possibility is NOT IMPOSSIBLE. However small the risk and possibility it is, there is still risks involved.
In the case of Hong Kong handling the issue of this MiniBond saga, the main argument is that those front line sales personnels are hardly trained and knowledgeable about this product that they were selling. I mean, this is a VERY COMPLEX derivative product that involves very abstract concept of credit risks swap. I would say that if the investors want to fight their case, they would have to provide all the marketing brochures and such, to show that the financial institutions did not explain or show clearly what a credit risks swap is all about. Then they could argue that the contract they have signed with that clause of claiming the investors have understood the product and all the risks involved, are totally invalid because due to this missing part of explaining credit risks swap.
This is the only plausible legal point that grievance investors could bring up against the financial institutions.
<a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s1600-h/minibond.gif"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;" src="http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s400/minibond.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5251425763720710642" /></a>
I have gathered a couple of news articles from Hong Kong which give better perspective of the whole issue.
What is MiniBond in the very first place? The picture above is a simple illustration I gather from Hong Kong Economics Daily newspaper. Yes, it is written in Traditional Chinese and I hope you could read it well.
Anyway, in short, the whole Minibond instrument comprises two parts:
1) The AA or AAA bonds as the basis of the structure (Right side of the diagram)
2) The Credit Risks Swap which involves a Vehicle (in this case, Lehman Brother's collective of financial bonds and instruments).
The first part (right part of the diagram) of the instrument is easy to understand. The money paid by the investors are used to buy AA or better rated bonds. The coupon rate or interest payment by the bonds are given to the investors on an annual basis.
However, to increase the returns of this instrument, the bonds are used as the basis to provide "insurance" for the other vehicle, like a collection of bonds or derivatives or financial entities. In this case, Lehman Brothers' collection of financial instruments. It means that Lehman Brothers will give the bond holders a certain percentage of premium to exchange for protection of its own credit risks. This is what Credit Risks Swap all about.
Literally, it means that Lehman Brothers, as an financial institution, needs to insure its own credit risk of honoring all the bonds or financial derivatives it sold in the market. Instead of buying financial insurance from a insurance company (or reassurance companies), it chose to pay a risk premium to Minibonds holders in return for an insurance against any of its losses in the event of credit events that it suffers.
Why would Lehman Brothers pay a risk premium to Minibonds holders for such Credit Risks Swap rather than buying insurance from a insurance company? Most probably it is much cheaper to do a Credit Risks Swap than paying hefty insurance premiums for its own credit risks.
The amount of "additional returns" that a Minibond provides for its investors depends on who or what the Credit Risks Swap is done with. If the Credit Risks Swap involves a collection of Junk Bonds, then naturally, due to the higher risks of Junk Bonds, the return would be higher. In this case, prior to the collapse of Lehman Brothers, it was considered as a relatively "low risk" financial entity by virtue of the facts that it was the 4th largest Investment Bank in USA. Thus the overall return of Lehman Brothers Minibonds is relatively low.
Well, if everything goes well and there is no credit issues or events for Lehman Brothers' collection of financial instruments, the investors could get all the interests paid plus the AA bonds they paid for when the Minibonds matured. But if there is anything happen to Lehman Brothers, then they could have to compensate Lehman Brothers for its loss due to these credit events like bankruptcy or inability to fulfill its financial liabilities. i.e. The Minibonds holders are required under the agreement, to act as an insurer of Lehman Brothers. It means that the AA bonds that are bought under the Minibond agreement would be cashed out and used as a compensation to Lehman Brothers to fulfill the obligation of the Credit Risks Swap.
This is the interesting part, small investors acting as insurer of a big investment bank!
The various articles have suggested that the regulators have not taken a pro-active stand in regulating the sales of these financial instruments. In the mini-bond issue, the returns are "improved" by virtue of the credit risks swap taken up by the financial instruments. In this case, Lehman Brothers bond is the vehicle that the bonds has taken up the risks swap. Yes, nobody would consider Lehman Brothers as a "high risk" financial entity but that is also why the returns is just 5.1%. If the vehicle involves consist of junk bonds, then one would expect a higher return.
The crux of the matter is whether investors are being misled in the whole dealings. But I guess the contract or agreement they have signed would have a clause that says the investors are briefed and understood the product, including all the risks involved. This is where the banks or financial institutions have covered their backsides. But the contract would most probably be very vague on what kind of risks they have explained to the investors. This is where improvement on regulation could be made. SPECIFIC risks and possibilities must be stated CLEARLY in BOLD, not in fine prints.
Even if the regulators come up with the requirement of putting different categories on the different financial instruments being sold, it is difficult to classify Mini-Bonds which involves two parts of financial structures: Bonds + Credit Risks Swap. Unless the regulations include the declaration of all possibilities of defaults and risks involves, I would say that no matter how good the products are marketed and sold, there will always be investors who will claim ignorance. Where does it end?
While I empathize with many aunty and uncle investors, but the point is, if they are not sure about what they are buying, they should not buy it in the very first place. If all investment decision in any instruments is solely based on the returns alone, then I would say that our investors, including aunties and uncles, will not evolve smarter at all. That is why I feel that we need to strengthen investors education. The plight of these aunty uncle investors is really sympathetic but they could not avoid their part of responsibility. If they chose to invest blindly, then they will have to bear the consequences. Very sad but this is basically how capitalist system works. Unless they could prove that they are being misled with clear evidence of mis-selling or misrepresentation by the institutions.
From the legislative perspective, there are rules could be set to avoid such chaos and disputes. For example, if the financial institutions that sold the financial products did not list out in BOLD of the various risks and possibilities within the marketing tools, contracts and agreements, then if one of the unlisted possibilities occurred and losses are incurred, then the investors should have the right to claim compensations from the financial institutions that sold them the products. For example, in this case, if the contract did not list the possibility of Lehman Brothers being bankrupted and the implications behind it, then the consumers have the right to claim compensations from the financial Institutions for their losses.
This will shift the burden of legal responsibilities of clear representation of risks to the financial institutions. If their presentation of risks is not all inclusive, then they will have to bear the risks of taking losses.
But I bet even with that legislation, there will always be investors that would claim ignorance. I mean, how would one measure the risk of Lehman Brothers being bankrupted at that point of time when it was the 4th largest investment bank in USA? It has no end. One has to learn that near zero possibility is NOT IMPOSSIBLE. However small the risk and possibility it is, there is still risks involved.
In the case of Hong Kong handling the issue of this MiniBond saga, the main argument is that those front line sales personnels are hardly trained and knowledgeable about this product that they were selling. I mean, this is a VERY COMPLEX derivative product that involves very abstract concept of credit risks swap. I would say that if the investors want to fight their case, they would have to provide all the marketing brochures and such, to show that the financial institutions did not explain or show clearly what a credit risks swap is all about. Then they could argue that the contract they have signed with that clause of claiming the investors have understood the product and all the risks involved, are totally invalid because due to this missing part of explaining credit risks swap.
This is the only plausible legal point that grievance investors could bring up against the financial institutions.