Friday, November 07, 2008

Minibond Saga in better explained form

Hi Mr. Tan,

The name "Minibonds" itself is a misleading word for investors. Whatever money you have invested in this "Minibonds" are not invested in bonds of the six reference banks or bonds issued by Lehman Brothers. This is how it works.

Lehman Brothers may or may not buy any bonds from the six reference banks but it is just using these banks as "reference entities", some sort as a "bet" with Minibonds holders. There are basically 5 entities involved in the Minibonds arrangement.

1) Lehman Brothers as the credit risk swap partner.

2) Lehman Brothers has created an empty shell company Minibond Ltd which will issue the Minibonds to investors.
3)The investors.
4) The money taken from investors will be invested in a basket of AA financial products from 150 companies which includes CDOs which is basically collateral debts obligations, some of them are related to SubPrime debts.
5) The reference entities which have nothing to do with investors' investment other than being a betting reference: i.e. if any one of them failed, it would be a credit event that make investors lose money to Lehman Brothers.

For simplicity to understand the whole arrangement, just take it that Lehman Brothers has bought some bonds from these six reference entities and it needs somebody to insure its risk of exposure to these banks. It did not insure its risks from insurance companies like AIG but instead, via this Minibonds arrangement, bought insurance from investors like you.

Through the Credit Risk Swap, you as an investor has agreed to sell insurance to Lehman Brothers with regards to the reference entities. In order to become an insurance agents of Lehman Brothers, you will need to come up with money as collateral. This money is collected from you via the financial institutions that you bought the Minibonds and given to Minibond Ltd to invest in a basket of CDOs issued by 150 companies.

Whatever returns from these CDOs issued by these 150 companies (variable returns) are given to Lehman Brothers. In return, Lehman Brothers will give Minibonds Ltd a FIXED premium (most probably higher than 5.1%) and Minibonds Ltd will give investors 5.1% returns for their investment. Now, the variable returns from the Collateral Assets may be higher or lower than 5.1% but investors will only get back 5.1%. It means that Lehman Brothers will take the risk of variable returns from these Collateral Assets in return for your risk taking on the reference entities. This complete the Credit Risks Swap, swapping your risks of variable returns for a fixed returns, while you in return, insured Lehman Brothers for their risk exposure to the Six reference entities.

The problem is that Minibonds Ltd, under the control of Lehman Brothers, may choose to invest in a higher risk instruments or CDOs because it would be very profitable if the returns from these investment is higher than 5.1% that Lehman Brothers promised you. Especially so, when they do not need to bear the risks of defaults these CDOs or any of the assets in the basket of Collateral Assets. The returns from these Collateral Assets, they take but you bear the risks of defaults from these assets. Under the contract, once a CREDIT EVENT happens, the whole arrangement will be liquidated. The Credit Event involves:

1) If any one of the reference banks failed, it is considered as a Credit Event and the investors will have to pay Lehman Brothers for the insurance it bought via the Credit Risks Swap. Meaning, investors will lose all money invested.

2) If more than 11 companies of the 150 companies listed in the Collateral Assets failed, or a certain percentage of the CDOs or credit-linked derivatives held as Collateral Assets go into default, the whole Minibonds will be liquidated and any loss from these defaults will be born by investors (not Lehman Brothers).

But the definition of Credit Event does not includes the failing of Lehman Brothers as the Credit Risks Swap partner. Thus, at this moment, investors do no face immediate liquidation of the Minibonds and suffer immediate losses. However, investors RISK losing a lot of money due to the fact that the value of the basket of CDOs and other credit-linked derivatives held as Collateral Assets has devalued tremendously due to the present financial crisis. The likelihood of a credit event triggered by the failing of a substantial number of companies within the list of 150 is very high at this moment.

Furthermore, as Lehman Brothers has gone into bankruptcy, it will no longer give you the 5.1% as it promised and in this financial crisis, the variable returns from the basket of CDOs and credit-linked derivatives would be nearly zero as most of them are linked to SubPrime products.
1) What was sold to the unsuspecting and gullible investors ? Is it a Credit Default Swap( CDS ). What is a CDS ?

Credit Default Swap, also commonly known as Credit Risk Swap, is a mechanism whereby two parties "exchange risk". In this case of Minibonds, it is totally an UNFAIR swapping. The "RISK" Minibonds Investors swapped with Lehman Brothers is the VARIABLE RETURNS from the basket of Collateral Assets they implicitly invested via Minibonds Ltd controlled by Lehman Brothers. However, the risk of the failing of the whole basket of Collateral Assets are not insured by Lehman Brothers. Thus, Lehman Brothers will not compensate investors if they lose money due to defaults of the CDOs and credit-linked assets held in the basket of collateral assets!

This is where the tricky part is. Lehman Brothers could use Minibonds Ltd to invest in many HIGH RISK financial derivatives to get very high variable returns and it will benefit from these returns while only giving back a fixed 5.1% to investors. But if these HIGH RISK derivatives failed, investors will have to bear the brunt. On the other hand, Lehman Brothers has used the Six Reference banks as a risk bet to Minibonds investors. It seems to me that using such reference entities of "Low Risk" nature as Credit Default Risk exchange is MISLEADING as it creates an impression of "LOW RISKS" while in fact, the amount of RISK investors born is very much higher as they are responsible for the risk of the Collateral Assets!

2) What is the purpose of REFERENCE ENTITIES ( REs ) ?

The REs are prominently displayed in the brochure and fooled us into thinking we are investing in their bonds. As explained, the Reference Entities are just a reference of "Risk" that Lehman Brothers is swapping with you. Your money invested did not invest in these banks but rather in a list of 150 companies' credit-linked derivatives which may be of HIGH RISKS nature. The main Risk that investors is taking lies in the basket of Collateral Assets.

3) The money collected from investors, what did they do with it.

The money collected from investors are invested in a basket of HIGH RISK derivatives issued by 150 companies. High risk derivatives may give high VARIABLE returns but the returns from these High Risk derivatives was swapped by the arrangement of CREDIT DEFAULT SWAP, to Lehman Brothers. That means that investors are bearing the HIGH RISKS of this basket of derivatives (not bonds, but CDOs and credit-linked derivatives) but Lehman Brothers has taken all the returns from these derivatives and in return, only promised to give you a FIXED return of 5.1%!

4) The REs have not defaulted,but the value of our investments have plumetted to almost zero. What is the rationale behind this incomprehensible senario?

Although the REs have not defaulted but the basket of HIGH RISK derivatives that your money actually invested in as a basket of Collateral Assets has actually diminished due to the financial crisis that we are facing. Although you as investors have not enjoyed the high returns from these high risk derivatives (which you have swap and given to Lehman Brothers for 5.1% return) but you bear the risks of defaults or devaluation from these financial derivative instruments.

5) Did the distributor
misrepresented this product and/or concealed the material fact ?

a) From the many descriptions given by investors with regards to the information they received from sales representatives, it is a CLEAR MIS-INFORMATION and MIS-REPRESENTATION of this product. The RISK you faced is not LOW as the failure of any one of the six reference entities. You, as an investor, also face risk of defaults or devaluation of the basket of HIGH RISK financial derivatives issued by the 150 companies and yet, you did not enjoy FULLY the potential high returns from these instruments but taking the risk of these instruments!

Basically it means that, somebody used your money to invest in HIGH RISKS products and keep all the potential HIGH RETURNS from your investment but in return, they only give you back a FIXED 5.1% and you bear all the risks of defaults and devaluation of these products. I believe if this is represented properly to you, many investors would not be investing in this product. I mean, who wants to bear all the HIGH RISK while taking back only a FIXED 5.1%?

b) I am not in the position to say whether "they knew but did not tell you" or they conceal any material facts because I am not vested and would not know whether those front line sales representatives actually know what they are selling in the very first place. I believe not many people really understand this Lehman Brothers Minibonds when it was first sold. If those financial elites at MAS actually study the whole structure carefully, they would realize that this Minibonds is DETRIMENTAL to consumers' interests and it is a totally UNFAIR Credit Default Risk Swap as Lehman Brothers controlled the Swap Party Minibond Ltd.

I hope this explanation is clear enough for you to better understand and appreciate the whole Minibond Saga.....



Anonymous said...

this is very well explained in layman terms!

Ting SL

Anonymous said...

and still I can not understand. I have a degree in engineering.

Anonymous said...

It is too late for the existing investors but will benefit the future generation.

Anonymous said...

By the way, someone should send a copy to MAS too for their information in understanding the investors plight.

kilroy said...

I don't think the chappies at MAS who "vetted" this product truly understood the mechanics of the con investment structure...yes send them this!

zhummmeng said...

Thanks to LLK for painstakingly deciphering the mystery of the structured products. Although in layman terms I still have difficulty understanding the working mechanism of these products. I am sure the prospectus didn't give in these terms or had them in the prospectus.
The question is, did the RMs know about this and if they didn't know it was irresponsible of them to give advice. Even they knew in details how did they advise the Ak Peks and Ah Sohs and the educated layman in 20 minutes? It isn't easy. The answer is there was no intention to explain clearly and to help the investors but it was to make a sale, that was all about it. You notice that majority of the cases was 'product advice' and the KYCs were filled as an after sale activity and the investors were not given a copy.
These products should not have been sold. They are scams.

Anonymous said...

Mr/ Ms LLK,
Thank you for this well-written piece. It is detail, yet understandable to a layman like me.
Hope the authorities would enforce this as a benchmark for disclosure in any future financial products.

Meanwhile I guess investors would have to be more cynical or exercise (the often touted panacea)due diligence.


Anonymous said...

For future generation, the financial engineers will come out with another type of minibomb... different techniques, different names, but just as toxic.

Concerned said...


Please send a copy of your write up to MAS, chairman and MD of MAS, CEO of all FIs who created or distributed the products, the 3 independent experts appointed by MAS to oversee the complaints and maybe the Straits Times, etc

Concerned said...

RMs who are employed by FIs are usually very young, normally graduates with a few years of working experience, many with no degrees in finance or banking. So how to expect them to understand the structure of such complicated products if they are not thoroughly
drilled by their so called experts in their organisation. Further they are pressured by their superiors to produce certain quotas per quarters or so. The result is 10,000 investors being lead to purchase the structured products. Therefore, the whole responsibility lies with the arranger and distributor of these products

by the FIs to sell structured products, unit trusts, etc, etc

Anonymous said...

Yes, looking at the length of the post, the explanation is detailed. But I still don't understand much.


Anonymous said...

Thanks for the explanation for the minibond. How about the High Notes 2 and High Notes 5 from DBS ?It sound similay, 8 reference Entities, secondary basket of 100 or 150 company, and a company called constellation?? Please comment.


Anonymous said...

Hi LLK ,

Thanks for the explanations.

I have 2 questions :

1. Through the Credit Risk Swap, ‘Investors of minibond’ sell insurance to Lehman Brothers with regards to the reference entities. So Lehman Brothers insure its risks from these “ minibond investors “, instead of from insurance companies like AIG?

2. The money, collected via the local FIs that the ‘minibond victims’ paid, was given to Minibond Ltd to invest in a basket of CDOs issued by 150 companies . What is the number of these (150) companies failed before the whole minibonds are liquidated ?



Anonymous said...

LLK, a very commendable article and a great contribution to Minibond investors.

Obviously, some people were caught napping, which has led to this fiasco.

Anonymous said...

Could there be a case of dereliction of fiduciary duty with

1) the use of very high risk "underlying securities" while promoting "solid foundations...low risks" ?

2) why are these "underlying securities" never publicly displayed for all to see, especially the customers when they signed up, and even now ?

3) the replacement of the list of "underlying securities" with even higher risk ones, without consent of the customers who are owners of the mini-bonds?

Will the authorities examine these issues promptly ?

Anonymous said...

Do the authorities really expect the public to believe that only the "vulnerable" are shocked to find that they were actually buying "insurance" and "swapping" around with sophisticated "investment" bankers ?

If the banks (except DBS, of course) and FIs were fooled by "investment" bankers too, we can all understand. But, please help us by giving our money back.

Will the mainstream media do the right thing by highlighting the scam, instead of humiliating the victims ?

bsd said...

you need more than a banking or engineering degree to understand the structure and value the risk of the product.. you need a financial engineering degree.

Anonymous said...

Here is to clarify that this article is sent to me by a friend. It is not written by me.
After reading it, I feel that it should be made known to everyone, especially the affected investors, both the Minibonds and High notes 2 & 5. (They are similar.)

Quote another investor's words from another blog: "The intention to mislead starts from the design of the product".


Anonymous said...


Much thanks for sharing this insight with us.

If the the FI and the RMs were to explain it in this manner, they would be cleared of misrepresentation, miselling and in the worst case scenario, cheating. But then again, no one would have bought these products including the "vulnerable" group. Everyone can smell a dead rat and know the scent is different from a rose!

10.13 Are you suggesting that we should drop our claims and move on?
The government should take a leaf from the US where purveyors of such toxic scams are fined and forced to refund all monies to investors. We were told that our regulatory authority is working behind the scenes. Let's hope that something along the lines of what the US did would develop to benefit all investors who were hook winked.

Anonymous said...

If you read the Minibonds in this article as HN2, the issuer Lehman Brothers as DBS, the 6 reference banks as 8 reference banks in HN2, the Minibonds Ltd as Constellation Investment Ltd in HN2, the 150 entities with 11 defaults as 100 entities with 5 dafaults in HN2, you will get the picture of how HN2 is created and worked.

Anonymous said...

This is extremely informative. Although I still do not quite understand how the whole thing works, but I do get the gist of it. It is obvious that what we were told by the RMs are completely different from what the real situation is. I am sure no one would have bought this product if we had read this article. Clearly a con job! How can we forward this to the "big wigs" at MAS, FIDReC and the press? Can someone please help?

Anonymous said...

ok, now I see it. That means affected investors should get back their investment in full and the FI are to carry out the compensation.

After this saga, have nothing to do with:
- madman or similar term
- minibomb or similar term
- death notes or similar term

freeier said...

maybe the details are correct, but the article serves more to confuse than to enlighten.

and it might not actually be so 'confusing'... alot of different interpretation of the product.

drop the insistence in talking about 'insurance' and it wld make the article more sensible.

Anonymous said...

A degree in finance and banking won't help much in understanding mini bonds. Only those who have many years of hands on experience in securitisation, credit derivatives will be able to have a true grasp of how the structure works and the risk (now realised) taken by investors. This is not something a engineer, doctor, accountant, banker can understand and by just reading the propectus. To read and understand how it works is one thing but to appreciate the true risk is another. So, don't worry if you don't understand; it's normal.

Anonymous said...

I totally DISAGREE with what Freeier said. I felt that LLK has explained very clearly the risks involved in the minibond. Those are the exact details that should have been disclosed to investors upfront. Also, I find it perfectly appropriate to use the word "insurance". Indeed, Lehman Brothers have been using investors of the minibond as insurance company. The only reason why they did not choose AIG or other insurance company is because given what they WERE investing, you can bet that the premium will be way higher than 5%.


Anonymous said...

LLK, thanks for the explanation. I think I understand now, or may be closer to it. It is irony that all invesors are cheated because the 6 RE can be anything they cooked up since they didn't used the money to buy the bonds at all. So what is GCT talking about High Risks, High Return? From what he says I think he also did not understand how Minibonds worked!

Anonymous said...

It is really disgraceful that MAS did not catch on to the product & allowed it to be sold to the retail investors. They even allowed SRS to be used for a while thus making the situation worst. This gave the false impression that the Minibond is a safe product. To the extend that even the Town Councils were also conned. The Town Councils dared not even release the amount they lost. So much for transparency. I hope the senior management and political leaders running MAS realised that they have by their negligence caused the general public to lose $508 million dollars of honest hard earned savings. A lot of people also lost their retirement savings because of their mistake. How are they going to compensate them? Should they also not "do the right thing" & own up to their mistakes. That is the honorable thing to to. The alternative is to carry the guilt with them to their graves. Should they also not "do the right thing" and prosecute the banks. Why are they still not prosecuting the banks here like ABN AMRO, Maybank etc for cheating their customers when the other countries have deem fit to do so. Why? Doesn't our government pride itself in being honest, righteous, transparent, always acting without fear or favour. Doesn't our national pledge say that our nation will be built on justice? Where is the justice when banks who cheat their customers are so swiftly helped by the goverment but the people in government drag their feet and just give lip service & token help to the victims who are cheated by the very same bank? "We the citizens of Singapore pledge ourselves as one united people, regardless of race, language or religion, to build a demoncratic society based on justice...." Where is the justice?

Concerned said...


Please let me add something.
The only assets of Minibond Ltd is the underlying assets and the swap arrangements. In a credit event, the noteholders rank behind every party to the claims of the underlying assets, (including the swap counterparty, the cost of unwinding the arrangements, etc.) For all this, noteholders just have an upside of about 5% and an almost total lost of their investment.

LeeSeng said...

The term insurance is the real meat. The difference lies with when the compensation money is put on the table. Under normal insurance, when the unfortunate event triggered, insurance company investigate and decide how to compensate. For minibond case, investor a.k.a insurance company had prepared that money. And when unfortunate event triggered, investor cannot investigate what happened and decide how much to compensate.

With the usa housing bubble a signal at year 2006? I wonder investors were insuring half dead patients? And only insiders like lehmans know?

Anonymous said...

It's scam scheme on the part of Lehman Brothers!! MAS should step in, investigate & prosecute such chow angmos cheaters & swindlers!!


Anonymous said...

Really, just what is the obsession of lingo these days

A term is a way to describe a thing or an event.

It does NOT manifest it.

I can call it any way i want regardless I kept it alive or lost it.

Be dispensed with terminology - thats part of the Illusionment. Get to the real cream of things.

freeier said...

you people that wikipediaed all your life on CDS are just missing the point altogether.

CDS are a form of derivative that gives the seller the exact replication of a purchase in corporate bonds. Any financially savvy treasury trader will be able to appreciate that.

the market is too sentimental. if you want to beat the enemy, at least have a clear understanding of the product itself.

and CDS are liquid markets. any claims of the FI using minibond to help 'insure' their position are quite absurd. Effectively that could be the result, but the FIs do not need to go through so much trouble just to insure their portfolio. 1. They can sell it since buying a CDS by them from the investors is equivalent to selling the bonds economically, 2. They can get the insurance from the market without much reputation risk.

So back to the argument, the only reason they did the product is for a. them to make money, b. the distributors to make money.

all the half past six understanding of the product please throw it in the dustbin, it won't help any of the cause of getting any compensations.

Anonymous said...

i heard URA also bought minibonds... and all keeping mum. Out of the 10000, only a few hundreds officially complained. the rest include top guns/govt officials, lawyers, doctors, etc who must 'save face'.

Anonymous said...

yea you heard, how much can we trust from what you heard? how do we not know it is just another story?

all i know is if everyone is making money, where did the money come from?

it has to come from someone else's pocket rite?


print more money

Parka said...

Thanks for the explanation, LLK.

For those who don't understand basically, here's what it means in one sentence:

You're insuring Lehman Brothers for their business risks.

So for those who are mis-sold, you'll be feeling like you didn't buy what you thought you were buying.

Anonymous said...

I hope our governement officials have the courage to own up their mistakes. It is disappointing that Town Councils are losing so much money yet not admitting their mistakes. They still claim that a certain amount is for them to make investments. At least do proper research before investing Singaporeans' hard-earned money to dubious investment products. I am worried our government stance. It seem like they feel that it is alright to lose a few millions since they help Singapore to reach first class status. Perhaps MM Lee is right, some of our government officials are too complacent. It is worrying. At least the Town Council should have the decency to announce the amount lost and what they are going to do instead of keeping mum.

Anonymous said...


Thanks for posting the article.

A lot of english words, but I don't quite understand what the article is trying to say. For e.g.: "Lehman Brothers may or may not buy any bonds from the six reference banks but it is just using these banks as "reference entities", some sort as a "bet" with Minibonds holders." Are these speculation or did LB buy the bonds?

If the market is a bull market, and none of the reference entities collapse or 150 entities all still standing but unfortunately, Lehman still collapsed - so what happens to these Minibonds? Holders still collect the 5.1%?

BTW, when I placed my fixed deposit for two years with any bank, can anyone tell me what the bank did with my money and give me a lousy 1.5%? I hope there is some transparency there.

I was hoping for more transparency with my CPF OA and SA too ... how come only getting 2.5% and 4% returns!

Anonymous said...

just to share an experience.

an RM approached me once to sell a structured product, and proceeded to explain the different scenarios and the payout for each one of them. i asked how it works, in other words, what kind of investment(s) the money is used to buy to generate those returns. i did not get an answer.

Anonymous said...

Nice site its very interesting site! your site is fantastic.

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