Cai Jin

Bond market: A Lehman moment?

A Swiber vessel at a shipyard in Singapore. In the wake of the offshore services firm's default, questions are being asked about the seemingly lax bond market and what can be done to safeguard investors' interests as well as tighten regulations in th
A Swiber vessel at a shipyard in Singapore. In the wake of the offshore services firm's default, questions are being asked about the seemingly lax bond market and what can be done to safeguard investors' interests as well as tighten regulations in the market.PHOTO: REUTERS

Some may want firms issuing bonds to get a credit rating, and investors' status may have to be redefined

Until offshore services firm Swiber Holdings ran aground two months ago and defaulted on its debts, companies in Singapore had never had it so good, with bonds of every hue and shade which they issue being snapped up like hot cakes.

What is more amazing is that even companies whose share prices had suffered a beating were able to raise huge sums at relatively low interest rates - and getting away with it without having to get their bonds rated by a reputable credit ratings agency.

The bulk of these unrated bonds were bought by "accredited investors" - individuals deemed sophisticated enough to look after their own financial interests because their personal assets exceed $2 million or they earn at least $300,000 a year.

Given the negligible returns from bank deposits and worries about putting hard-earned nest eggs into the volatile stock market, I can understand why investors turn to corporate bonds which would look like a logical alternative, given the safe and steady returns they seem to offer. The naive assumption - rightly or wrongly - is that in a well-regulated financial centre such as Singapore, nothing can go wrong since there ought to be sufficient checks to ensure that bond issuers are in the pink of financial health and would not default on their payments.

If only things were that simple. Most of the bonds were issued on the "wholesale" market where a much less stringent set of rules applies because it is confined to only fund managers and "accredited investors".

But one question to ask is whether safeguards requiring a bank to do a customer knowledge assessment with a retail client before he is allowed into complex investment products should also be applied across the board to "accredited investors". In my view, this is only prudent, since a bank's relationship manager should be well-apprised of his client's risk appetite before peddling any risky and unsuitable products to him.

When a company launches a bond offering in this market, it only has to issue an information memorandum which looks rather more like a sale brochure than the thick prospectus issued for an initial public offering (IPO). And some retail investors may not even get to see this "brochure" - instead, they get an e-mail or a phone call from their bank's relationship manager outlining the bare details of the bond issue such as its size, the interest rate payable and the maturity period.

And, unlike an IPO, which is open for subscription for a few days, these investors are often pressured to make a commitment within a few hours. This is despite the fact that big sums are often involved. To buy just one lot of such a bond, an investor has to put up as much as $250,000.

Now, when times are good, this would not have mattered, since bond issuers are able to service their interest payments and roll over their debts when they mature with fresh bond issues.

But what happens when a big bond issuer such as Swiber defaults? Stories begin to emerge about the not-so-sophisticated uncles and aunties who claim they were pressured into buying bonds of companies which they knew next to nothing about.

In what looks like a replay of the Lehman minibond scandal, it turns out that many of them may not have been as wealthy as the "accredited investor" status made them out to be. And it may not be right to equate their financial sophistication with their purported wealth. Some may have become "accredited investors" because they own a property whose price has shot up sharply, and who may have had some spare cash to invest because they withdrew their Central Provident Fund monies after turning 55.

So far, the number of affected bond holders is not known, but the sums involved may well exceed the $520 million loss sustained by almost 10,000 investors during the Lehman debacle eight years ago.

Some have blamed the banks for signing them up as "accredited investors", which raised their risk profile and enabled them to buy the risky IOUs of unrated bond issuers, despite their lack of financial know-how. This would hardly seem fair to the banks, considering that they were only fulfilling the desire of their clients for higher-yielding investments.

But some will say that regulatory loopholes - such as a lack of requirement for a credit rating - that allow even low-quality companies to raise funds with relative ease ought to be looked into and plugged.

One company boss observed that when he inquired about doing a bond offering outside Singapore, he was told his company would need to get a credit rating and do a cashflow forecast. He did not face the same requirements here.

Few banks here require attestation of any sort from companies on their ability to repay their debts. Instead, one big draw appears to be the income which they can earn from pushing out bond offerings to their network of retail, private banking and institutional clients.

One former banker said: "If the distribution channel works, the bank gets a lot of deals and the bond market becomes a great way for it to earn a big fee income without committing its balance sheet."

There is also typically a shortfall in the disclosure in explaining to clients the fee arrangements which the bank has with the bond issuer - and the commissions relationship managers and private bankers reap for selling the bonds.

He flagged other flaws. After an IPO, there are ongoing listing requirements set by the bourse, and a company's share price is transparent because its stock is publicly traded. But for a bond offering on the wholesale market, the bank, which distributes it, is the only market-maker, offering buy and sell quotes on it. It may also be a big lender to the bond issuer, which gives it inside knowledge of its financial health.

The former banker said: "There may be Chinese walls between the corporate lending side of the bank and its bond trading desk to prevent leakage of material information. But this potential conflict of interest should have been flagged right from the start."

What happens if a bond issuer goes belly up? Another potential conflict of interest may arise as the bank has to weigh its obligation to its shareholders to get its loans repaid as well as fulfil its fiduciary duties to bond holders.

The former banker said: "There ought to be a framework to minimise the conflict of interest when a bank acts as a lender as well as distributor of debt instruments."

No doubt, regulators are taking steps - with plans to stiffen safeguards like giving individuals who would qualify as "accredited investors" the option to be treated as retail investors and tightening the $2 million net worth threshold so that an investor's primary home can only contribute up to half that value.

But one question to ask is whether safeguards requiring a bank to do a customer knowledge assessment with a retail client before he is allowed into complex investment products should also be applied across the board to "accredited investors". In my view, this is only prudent, since a bank's relationship manager should be well-apprised of his client's risk appetite before peddling any risky and unsuitable products to him.

Above all, surely more efforts should be made by regulators to ensure that investors - even "accredited" ones - have sufficient time to examine the details of a bond issue. This will surely be in line with the caveat emptor spirit which we would like investors to adopt on all their investments.

The furore banks encountered over the Lehman mis-selling fiasco may have abated, but it does their reputation no good to have their clients accusing them of abusing their trust each time there is a big blow-up in the market.

A version of this article appeared in the print edition of The Straits Times on September 26, 2016, with the headline 'Bond market: A Lehman moment? '. Print Edition | Subscribe