Bonds away

PUBLISHED : Monday, 31 October, 2011, 12:00am
UPDATED : Monday, 31 October, 2011, 12:00am


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There is a lot of confusion about minibonds. Given the size of settlements, the instruments were not mini, and they weren't bonds either. They were complex investments that involved a troublesome structure known as a collateralised debt obligation (CDO).

CDOs are a grab-bag of debt instruments of varying quality that are pooled and then sliced into tranches, with the top tranche typically (and, as was seen during the financial crisis, often erroneously) rated triple A. The complexity of CDOs meant that Hong Kong retail investors had no clue what assets backed minibonds and, indeed, the offer documents were utterly vague on this matter.

The minibonds that caused Hong Kong investors so much pain were linked to CDOs arranged by Lehman Brothers. They were also linked to Hong Kong blue chips such as HSBC, Hutchison Whampoa, Swire, and so on. The minibond issuer offered insurance against default by these blue chips, for which it received income that was used to boost the interest payments of the minibonds. If any one of these entities went bust, the value of the minibonds would have dropped substantially.

Minibonds piled on many layers of default risk, all for a modest boost in interest income. But it was the default of Lehman Brothers that did this instrument in. The event saw much of the collateral linked to the minibonds claimed by other creditors, with little money returned to Hong Kong's minibond investors.

The instruments were hopelessly complex, and so was the language of the offer documents. But moments of clarity did creep in, such as this standard disclaimer: 'You could lose part, and possibly all, of your investment.'