True Features and Associated Risks of Minibond

Wing Hang Bank (永亨) had been selling Minibond over a few years. Most minibond series were rated as "Medium Risk Investments". Minibond was promoted and explained to clients as "Credit-Linked to 7 well-known companies" as the key features and risks. The fact that the CDO Colalteral was credit-linked to over 100 companies had never been discussed to clients.

1. Downplayed Risk Rating ?

The Minibond’s only asset was collateral and Swaps. The CDO collateral in fact was comprised of CDS referencing to credit risk of over 100 entities and could be credit-linked to entities at sub-investment grade. The CDS in the CDO collateral synthetically transferred the credit risk of over 100 reference entities to Minibond holders. Therefore, the value of minibond was not only affected by the credit-event with the 7 well-known companies, but also was greatly affected by the credit events related to the 100+ reference entities in the (synthetic) CDO collateral.

Did the "Medium Risk Investments" rating significantly downplay the true risk of minibond ?

Maybe, the “Medium Risk” rating on the Minibond is a strong evidence to suggest that the BBanKK either intentionally downplayed the true risk of the minibond, or the BBanKK proceeded with the Minibond sale without thorough understanding of the true risks related to the Minibond, all for the purpose of maximizing the sale of the Minibond ?


2. Omission of Material Information ?

the BBanKK passed Program Prospectus & Issue Prospectus to their clients. The prospectus dedicated many pages on the “credit-linked to 7 well-reference entities”, the 7 reference entities’ ratings, and the impact of any default event related to the 7 well-known reference entities.

The CDO collateral of Series 27 in fact had 155 CDS with 25 entities at sub-investment grade. The CDS in the minibond’s CDO collateral synthetically transferred the credit risk of the reference portfolio to Minibond holders. The risks of the Minibond greatly depended on the information regarding number / name / rating of the reference entities & reference obligations in the (synthetic) CDO collateral and the rules regarding their default event. No professional intermediary could have valued the Minibond using only the information provided in Program Prospectus & Issue Prospectus & marketing material.

SFC Code of Conduct requires that "Intermediaries were still under an obligation pursuant to the Code of Conduct to explain the nature and risks of the product they were selling", and "make adequate disclosure of relevant material information".

Let's take a look at now disclosed Minibond structure:
(i) Minibond had CDS with 7 well-known reference entities;
and:
(ii) Minibond CDO Colalteral had CDS with over 100 reference entities (some were at sub-investment grade).

What ware the reasons for the BBanKK to decide that only informaiton of (i) was material information and information of (ii) was not relevant material information to clients ?
What were the reasons for the BBanKK to decide that information of (i) reprensented the true features and associated risks of minibond?
What were the reasons for the BBanKK to decide not mentioning a word on information of(ii), and disclose all the information of (i) only?

The interest rate of Minibond (on average) was about 1% - 1.5% higher than the libor rate at the purchase time, for the long 4-7 year lock up period (due to no liquidity). Imagine what kind of people would be attracted to a long 4-7 year lock up period with such a return.

7 versus 100+ (or 7 versus 155), CDO Collateral information and the 100+ reference entities' information should be the more relevant material information to the true risk of the Minibond than the 7 well-known companies' information.
- was there any staff from the BBanKK ever discuss with their clients about the CDO collateral?
- was there any staff from the BBanKK offer their clients any collateral information (document) ?



3. Explanations givens by the BBanKK's staff
Some BBanKK staff explained the product feature and associated risk as following:
- Credit Event of the 7 reference entities;
- No liquidity and had to hold till maturity;
- Get 100% principal back on maturity if no credit event happens.

BBanKK staff seemed to only aware of the information about “credit-linked to 7 reference entities”, because they never discussed with their clients about the reference entities in the CDO collateral.

4. Misprepresenation of the True Nature of the Minibond ?

The Minibond was presented and explained as "Credit Linked to 7 Reference Entities”. The CDS in the minibond’s CDO collateral synthetically transferred the credit risk of the reference portfolio to Minibond holders. The Minibond was in fact credit-linked to “7+over100” reference entities.

Is it possible that the BBanKK negligently, or worse, intentionally, misrepresented the true nature and characteristics of the Minibond, omitted the material risk associated with the minibond either because the BBanKK did not understand the true nature and risk of the Minibond or because the BBanKK worried that truthful and transparent information would hurt the Minibond sale.

Further, clients were never told exactly how the proceeds of the Minibond sale would be used and were not told that such proceeds were in fact not invested into any real debt/loans of the reference companies.

5. Inadequate and Faulty Due Diligence ?
the BBanKK's due diligence was inadequate and faulty, on the contrary of their own claim “product due diligence was properly conducted by our Bank” (Dec2008). Evidence is as follows:
a) the BBanKK rated the Minibond as Medium Risk Investment, considerably downplaying the product's true risk level.
b) It was never mentioned to clients that the Minibond was not invested into any debt / loans / bonds issued by any of the 7 reference entities. It was never explained to clients that the Minibond CDO collateral was referencing to the credit risk of many (over 100) entities.
c) It was never mentioned to clints that a "AAA-rated CDO" may not invest into any debt/loan/bond at all, and that "AAA-rated CDO" was not the same as a "AAA-rated" bond.
d) It was never explained to clients about the risk related to CDO or Synthetic CDO.
e) And clients was never told to be aware that the Minibond was, in fact, not only credit-linked to the 7 reference entities, but also credit-linked to over 100 entities in the CDO collateral portfolio.

Could it be that, instead of exercising reasonable due diligence, the BBanKK in fact collaborated (possible fraudulently), with the Minibond issuer, hiding the risk of the synthetic CDO from their retail clients, with the objective of increasing the sale of the Minibonds.


6. "香港銀行業向來依據最高的專業守則經營".
Can we ask Wing Hang Bank to give us a brief description about the key feature and associate risks of the Minibond? Wing Hang Bank's staffs were not shy of explaning the features and associated of risks in the past few years' minibond sales period.

All the relevant training procedure and sales guidence would show public that the Wing Hang Bank in deed 依據專業守則經營.


"You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time."