Apollo
Investment Management
UAF & Euroclear:
lessons and issues
Readers of earlier columns will be aware that the biggest disaster in
the short history of the Apollo 001 Fund has been the Union Asia Finance
convertible bond, bought despite the company's known financial predicament
on the strength of a full and very clear guarantee from the Bank of Thailand,
posted in English on the central bank's official website. The bank then
started to wriggle, and ultimately defaulted on its commitment. In undignified
fashion, it ignored all investor representations. For the background, see
Perfidious
Thais, my article of 3 March 1999, and my short
note of 15 June when I discovered that other fund managers had been
similarly suckered before me.
I cut the (substantial) loss on this position in July 1999, as the bond
faced delisting. The decision was not easy, as BankThai's inadequate offer
of zero-coupon baht paper would still have represented a yield to maturity
of well over 20%, whereas a comparable domestic yield would have been in
single digits - but only if paid, and before taxes and expenses, and with
grossly inadequate documentation it was far from clear whether our claim
(to be individually negotiated, not as a class) would be enforceable.
Painful as it is to revisit this, I shall attempt to list some of the
dangers, misconceptions and possible policy issues which occur to me, in
no particular order of priority.
-
Governments, and government institutions, are not necessarily trustworthy.
They
can however get away with a lot, particularly in their own courts, and
on matters not disadvantaging significant numbers of domestic voters.
The UAF bond was subject to UK law, but decisions of international
courts may not be enforceable in Thailand. (The prospectus did include
a warning to this effect.)
An extraordinary 1996 decision of the Consumer Court in India held that
the Unit Trust of India, as a government agency (itself interesting, since
it was then owned by ostensibly privatised financial institutions), could
not be held to the written terms of an investment prospectus, provided
that it could show through internal documents that what it had said was
not what it meant. This had worrying implications for any investor in any
government-related company. (There were hopes of an appeal to the Supreme
Court, and I am not aware whether this occurred; affordability was an issue.)
My most recent experience of "what we said was not what we meant", as
used by government-related entities to end confusion and terminate all
argument, was in Malaysia, where Bank Negara will helpfully make verbal
"clarifications" of some exchange control issues which it does not, in
practice, seem willing to confirm in writing.
Fortunately, despite the unavoidable country risks of taxation, confiscation,
and currency, some Asian entrepreneurs and companies are more reliable
and more principled than their governments.
-
Euroclear is in serious need of reform. Euroclear is an information
sink. Only once did I manage to procure an official notice through Euroclear.
Most documents go missing. We registered our UAF interest with the trustee
- but then needed to re-establish beneficial ownership for each bondholder's
meeting. Our custodian coped with this once, and failed on other occasions.
The trustee mentioned that many institutions had comparable difficulty.
Bondholder apathy may have been partially responsible for low representation
at meetings, but probably most bondholders were uninformed about events
and about meetings, and if informed then unable to participate. The communications
blockages also presents problems for companies which do wish to communicate
with their investors; under Euroclear, they do not know who the investors
are, unless they identify themselves directly. When information does flow,
it often does so slowly: the Kazakhstan Investment Fund recently received
an EGM request through Euroclear, nineteen days after the copy which was
fortunately sent directly to the company. Investors should be able to register
beneficial interest, and have this registration remain in force until the
holdings are re-registered, as with ordinary shares.
-
Most investor information should be public. Any advantages of confidentiality
between holders of a particular security are swamped in practice by the
disadvantages of information not flowing, and by the lack of public awareness
and feedback, and of analytical comment. I believe the trustee's concern
for confidentiality regarding the UAF bonds, although doubtless well-intentioned,
was severely detrimental to the bondholders' own interests.
Convertible bond holders often have privileged information compared
to domestic equity investors; this seems unfair - in my view, if the information
relates to a company which is listed, all investor information should be
available for public access - but in any case the bondholders often fail
to appreciate the significance of this information, and might have been
saved by local analytical input (I am thinking here of specific Malaysian
and Indian issuers).
There is also a public interest in disclosure - which is no panacea,
but tends to make markets more efficient. If information on the Finance
One debacle had been publicly available, fewer institutions might have
fallen for the second-round trick. The shortage of public documentation
may also have contributed to the surprising difficulty I experienced in
arousing the interest of the international press and rating agencies in
the UAF issue (although, at a time of crisis, they undoubtedly had many
choices of stories to cover).
-
Bondmarkets with public participation would be more satisfactory
- or at least could work no less well - than the present market-making
system, where there is frequently no liquidity at all, and notional prices
can be extraordinarily misleading. It may not be widely appreciated how
difficult the custody issues make it for individual investors to deal in
international bonds - even US government bonds - or indeed for Asian investors
to buy the international bonds of their own governments and companies.
Local investors deserve access to these opportunities, for portfolio diversification
and absolute return, and their participation would make the markets more
efficient. It must be possible to devise a better bond market: a worthy
project perhaps for Singapore.
-
Trustees are hopeless when you need them. This is not entirely surprising
as the trustee's job is usually mundane and clerical, and the fees are
correspondingly low. When crisis strikes, the back-office bank staff in
some
remote location are suddenly faced with a lot more work, which is most
unlikely to be remunerative. If a simple way of winding up the instrument
is presented, the trustee may be tempted to recommend this easy way out
of its obligation, rather than fighting for the interests of bondholders.
I believe there may be a role for a more activist "super-trustee" to step
in at the first sign of trouble, remunerated by a percentage of recoveries
which could perhaps be on a rising scale, with the appointment and the
fee levels triggered automatically by the first intimations or events of
default.
-
Structural inadequacies can cause perverse results - in this case,
a lose-lose outcome, where win-win was possible. From the starting point
of the BankThai offer, it would have been logical for the Bank to offer
a cash alternative, which would have greatly increased the acceptability
to bondholders, at no expense and considerable benefit to the offeror,
which could have cut its liabilities while booking an immediate profit.
Logic requires a counterparty: so thin were the ranks of management that
noone could be found to whom the merits of a win-win solution could be
presented.
-
Strong local regulators contribute to safety - as one discovers
in their absence. If there is no local regulator demanding compliance,
inconvenient communications can just be ignored. UAF, Krung Thai Thanakit
and BankThai could just ignore the trustee for months at a time. Few arguments
wear down investors so effectively as non-response. With UAF, this was
devastatingly combined with a late ploy of divide-and-rule. Large investors
are sometimes seduced by the offer of "special treatment"; but rarely are
they well served.
Claire Barnes, 5 September 1999
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