About 700 Singaporean retail investors discovered on Friday that any investments they’d made in financial products called Pinnacle Notes (series 9 and 10) were, following a notice from Morgan Stanley, likely worthless.
Reported the Straits Times:
The notes in question were sold solely in Singapore, through five distributors – brokers DMG & Partners, Kim Eng Securities, OCBC Securities and UOB Kay Hian and lender Hong Leong Finance.
…
According to notices put up on Morgan Stanley’s website, Standard & Poor’s had slashed the ratings of the underlying assets of Series 9 and 10 from AA to CCC-.
The downgrade has also triggered a mandatory redemption event – industry-speak for a forced asset sell-off.
Investors will only get a ‘pro-rata share’ of the proceeds, but a notice on the Morgan Stanley website hints that noteholders are unlikely to get a cent.
‘Given the current market values of the underlying assets…we anticipate that investors will lose all of their original principal investment,’ it said.
Saturday saw a small protest in Singapore’s speakers’ corner, demanding that the state’s financial regulator – the Monetary Authority of Singapore, MAS – intervene.
You can see the sales prospectus for the Pinnacle Notes here. The Pinnacle notes are basically the same as another product Singapore’s retail investors got burned by recently: minibonds. (Incidentally with minibonds MAS intervened.)
The Pinnacle notes, like the minibonds, are forms of credit linked notes. In spite of apparent complexity, they’re actually pretty simple. The idea is that investors get a note which is linked, via CDS to a small portfolio of credits.
In the case of Pinnacle 9 and 10, those credits were Australia, Hong Kong, Singapore, Singtel and Temasek.
On the downside, if any one of those credits defaulted, then investors would lose their money. On the upside, a short investment over 5.5 years had the potential to return 5.00% annually. Plus of course, the fact that the five credits were three gold-plated sovereigns, a massive telco and one of the world’s largest sovereign wealth funds.
So what went wrong? Read Josh’s blog (HT Felix Salmon). It provides a thorough and clear explanation.
The thoroughly scurrilous revelation being that…
Each Series of Notes will be secured by, amongst other assets, US Dollar denominated Synthetic CDO Securities that are rated at least AA on the date of investment therein.
Pinnacle noteholders were exposed to their five reference entities via CDS. Meaning that the position was unfunded: being derivatives the cash raised from the noteholders wasn’t needed upfront (it would only be called upon in the event of a default or a collateral call). In most synthetic structures there is, then, a cash account, into which the upfront proceeds of the sold notes are placed.
Normally – sanely – this cash is invested in ‘risk free’ cash or cash-like assets: bank accounts, CDs, money market funds, Treasuries etc.
In the case of Pinnacle series 9 and 10, Morgan Stanley had structured the deal so that the cash was instead invested in synthetic CDOs.
Not even the highest tranches of synthetic CDOs.
Here’s the synthetic CDO in question. The money went into the AA tranche, returning 1.3 per cent margin.
The synthetic CDO has subsequently lost all that money. You can read our view on synthetic CDOs here.
_______
The bottom line though, is that this kind of product should never have been made available to retail investors, and no sane regulatory authority would have allowed it to have been.
So please MAS, you try explaining synthetic collateralised debt obligations to the average investor, because the below, frankly, does not cut it.
