Probe into whether laws were broken

The Financial Services Board (FSB) is attempting to establish the full extent to which investors may be exposed to the multi-billion-rand collapse of South Africa’s largest unlisted company, First Strut.

The FSB is also investigating whether any of the laws and regulations that govern bond issues have been contravened.

Asset management companies are receiving letters from the FSB asking them what exposure, if any,

they had to First Strut’s co-arrangers of the bond issue, Rand Merchant Bank, a division of FirstRand, and Standard Bank. McNab says warning signals about problems with the bond issues started to appear shortly before the allegedly selfarranged murder in June of one of the company’s owners, Jeff Wiggill.

One of the conditions that companies such as IAM had set for providing the cash was that First Strut must change its auditors. The new auditors were due to be appointed in June, when First Strut’s financial statements were supposed to be released.

Global Credit Ratings withdrew the BBB rating because the financials were not available. A bond with a rating below BBB is considered a “junk bond”.

McNab says that Investec’s R435-million exposure to First Strut is part of the more than R40 billion in corporate debt that Investec manages on behalf of its South African institutional clients.

The debt was placed in seven close-ended funds (there is a predetermined limit on the amount corporate bonds, which were listed on the JSE with an investment-grade rating of BBB.

FSB spokesperson Tembisa Marele says the investigation has a threepronged approach, to determine whether there was:

Compliance with the listing requirements for debt securities;

Market abuse, including whether insider trading occurred and/or false statements were made in connection with the First Strut bonds; and

Compliance by the credit rating services in assigning a BBB rating to the bonds.

Marele says the FSB is still in the early stages of its investigation. that may be in the funds). The funds are part of the Investec Credit Opportunities Strategy Portfolio,.

The total value of these seven portfolios, which aim to produce high- yield returns above those offered by cash, is R15 billion.

McNab says the funds in the Credit Opportunities Strategy Portfolio have an excellent five- year track record (both before and after the collapse of First Strut), with returns above 13 percent a year since inception.

However, he concedes that the default will reduce the returns by about 40 basis points (0.4 percent) over the life of the funds.

The best fixed-income returns come from the corporate bonds, because the market more than compensates investors for expected defaults, McNab says.

He says that a default is not normally the result of fraud but rather of adverse market conditions or operational problems at the business that issued the bond.

The risk of default is factored into the total expected returns of the portfolio. If asset managers wanted to avoid the risk of default, they would have to invest in “risk-free” AAA-rated bonds – but investors would receive far lower returns, McNab says.