Laws put in place to protect you are being side-stepped
The financial services industry and its regulators are going to have to take a long hard look at themselves if investors are not to lose total confidence in financial markets.
Apart from the very serious major scam that we report on this week, there are too many things happening, and the regulator and the prosecuting authorities seem to have an inability to act decisively and with alacrity to stop these excesses.
To my mind there is little difference between the way that Johan Bakkes is alleged by the curators of Corporate Money Managers (CMM) to have abused investor funds and the way unit trust money market funds are investing in products created by banks that transfer their risk to uninformed investors.
Among the sins of Bakkes is that he took investor money that should have been invested mainly in short-term (90 days and less) investments but instead lent a fair proportion on the long ter m to property developers, before they had turned a sod. Many of the developers defaulted, so Bakkes kept rolling over the debt.
And remember this point for later: Bakkes had a credit rating agency, Global Credit Ratings, giving some of his complex structures and instruments investment-grade ratings. This was done to befuddle investors.
Now let’s look at bank products being used by the collective investment scheme money market funds (and probably bank money market accounts as well).
The banks take a lot of the money owed to them – from home loans to motor vehicle loans to extremely high-risk credit card debt – and bundle it into what they call securitisations.
Yes, you have heard the word before. These are the same animals that banks in the United States were structuring using high-risk property loans.
The banks then go off and sell these securitisations to investors like you and me. In effect, they transfer the default risk (the risk of the borrowers not repaying the money) to you and me.
But money market funds cannot invest in them because they are long-term debt. So some overpaid whizz-kid came up with a solution: bundle the debt into new securitisations and call them conduits, which have a maturity period that meets the requirements of money market funds.
These securitisations of securitisations receive the same credit rating as the bank, based on the fact that the bank guarantees to pay in money if there is a liquidity problem – in other words, if the securitisations are not paying up enough money to cover the conduit payments.
It is not a guarantee that the banks will make good on any defaults on the debt, or that the banks themselves won’t default.
Apart from the theft allegations, can you spot the difference between what Bakkes was doing and what the banks and the money market funds are doing? I can’t.
It is unacceptable that financial engineering can be used to evade the intentions of the Collective Investment Schemes Control Act (Cisca).
The same is being done in converting taxable interest income to non-taxable dividends with a financial sleight of hand mainly to enable big corporations to escape paying tax that is rightfully due to the state.
So the industry itself needs to examine the way it behaves, sidestepping laws that are there to provide protection for investors.
The industry and the regulators, and probably the legislators too, need to have a close look at why they failed investors so badly in the CMM case.
The legislation and the structures are there to frustrate people like Bakkes. And remember, he follows Angus Cruickshank, who stole more than R200 million from an unregistered money market fund in the Ovation linked investment service product company.
I do not understand how a system set up to prevent theft can fail so badly. Not once, but twice. The question with CMM is: who is to blame? Is it the custodian, the credit rating agency, the auditors, the regulator, the legislation? Is it all of them? It strikes me that all the parties were depending on each other to be thoroughly diligent rather than going the extra mile themselves.
What gets me is that everyone gets paid, including the curator, but by whom? By you, the very people from whom the money was stolen. So why are investors paying curators, the credit rating agencies, auditors, management companies that provide white labels to the likes of Bakkes, financial advisers, regulators and even the legislators? Your money is being stolen anyway.
It is time that we as investors received a proper explanation and not limp excuses and pathetic denials of responsibility.
PARTNERS IN CRIME
A significant problem, to my mind, is that the crooks, so to speak, can choose their partners. We report today on how mCubed, another questionable outfit, fired Standard Bank as its custodian because the bank was prepared to go out and bat for investors. Well done, Standard Bank. You deserve an award for this but not for your securitisations.
But why should the institution that is using investor money be allowed to select its credit rating agency or custodian? Surely it should be the investors who select the credit rating agency and custodian.
My understanding is that all too often the issuers of these many complex financial instruments go shopping for the rating agency that will give them the best rating.
I heard that, at a recent meeting between major financial service industry companies and credit rating agencies, one of the foreign-based agencies arrogantly told the financial institutions, who raised this very problem, that it would not be dictated to by local hillbillies. I don’t know the name of the agency yet. When I find out I will let you know, and you should then never invest in anything rated by this agency.