Complexity of Credit Linked Notes

Dear Minister Mentor

An investor asked me to send this letter to you. I hope that you can find the time to read it. Thank you.

Dear Mr. Tan

I do not understand how MM Lee has come to conclusion that Minibond investors invested with their eyes open. Many financial experts have expressed their views that the minibond products are too complex for any ordinary investor to comprehend. The following are quotes from the financial experts:

1. Mr. R. Sivanthy, business times senior correspondent : (Straits Times 20/09/08) If you want a front-row lesson in first-class financial obfuscation for structured products, then look no further than the way the recently collapsed Minibond Series 3 notes were packaged and marketed.

Up to $200 million of these notes were sold to a gullible public who probably thought they were buying a five-year bond issued by six leading banks that paid a 5 per cent coupon per year, but were in reality not only exposed to the United States housing market but also to a complex credit default swap arrangement whose substantive party was the now-bankrupt Lehman Brothers.

Moreover, while it is possible to piece together the actual substance of these notes from the documents available, it is a tedious process and arguably not within the ability of the average retail investor.

Finally, if disclosure was weak, then so was knowledge among distributors. Some brokers did not understand the true nature of the instrument and sold it as a bond. Maybe the name had something to do with it, though as investors have now found out painfully, what they had bought was not a bond but a convoluted swap-based instrument.

2. Mr. Tan Kin Lian, former CEO of NTUC Income (Weekend Today, 04/10/08)
Mr. Tan interest in such credit-linked securities did not come about only now. It began when they first appeared on the market two years ago. With the help of another financial analyst, he had studied such products closely. The complex way in how these products were structured baffled him.

When financial experts who spent many hours to read the prospectus could not figure out what the structure was. How can you expect the general public who were sold these products to understand the risk that they were taking?

Even Mr. Tan was shocked with extent of the risks involved. “I became horrified to learn the true nature of the structure and the extent of the high risk”

3. Professor Ivan Png, National university of Singapore (Sunday times 26/10/08)
The Lehman bankers who designed this products were not only smart in finance, they were also geniuses in marketing. They gave the name “Minibond Limited” to the special purpose vehicle that issue the notes. So the shorthand name for the credit-linked notes issued by Minibond was simply “Minibond”. But of course, the notes were not bond at all. It took me quite a few hours to pieces together an understanding of the structure notes from the pricing statement.

I cannot guarantee that my understanding is complete and you may not rely on it as I am not a financial adviser.

The other condition is more difficult to understand. According to the pricing statement, the synthetic CDO was some how based on a portfolio of 150 securities and the value of the CDO depended on those securities.

The pricing statement did not disclose the identities of the 150 securities referenced by the synthetic CDO.

Complex? Absolutely.

4. Associate Professor Low Buen Sin, Finance at Nanyang Business School. (Sunday times 26/10/08)
Are structure products very complex instruments? Yes, they can be. Some structured products are not easy to comprehend even for very seasoned wealth managers. Let us use credit-linked structured products that are similar to Minibond and Jubilee Series 3 as an illustration of the level of complexity that it can get to.

5. David Gerald. SIAS’ president and CEO (Weekend Today 2/11/08)
While some of the conditions are straightforward, understanding the entire 54-page document requires advice from a professional.

It is clear that having considered the document in it totality, that the structured products in question are not suitable for ordinary small investors especially for the “vulnerable group” unless they have sought professional advice or understood the prospectus and the document.

6. Associate Professor Lan Luh Luh of the National University of Singapore’s Department of business policy. (Clarification from Dr Lan Luh Luh 03/11/08)
I mentioned that I never invest in things I don’t understand, because many of these structured products are really, really very complex.

I also mentioned that there should be more stringent requirements as to the qualifications of these financial managers – from the Lehman episode, it can be seen that quite a number of them did not even understand the products that they were selling (which I found out as well when I talked to some of them on many previous occasions).

Pang