Laws put in place to pro­tect you are be­ing side-stepped

Weekend Argus (Saturday Edition) - - GOODPASTIMES -

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.

FI­NAN­CIAL EN­GI­NEER­ING

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.

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