A couple of years ago I published Part 1 and Part 2 of the series on trading Bank Guarantees to help make this highly complex and fraud ridden area of corporate finance clearer and as a warning to non-professionals contemplating getting into this highly risky business. In Part 1 I explained the structure of a Bank Guarantee and in Part 2 I explained the aspects of a Bank Guarantee a security that can be traded. In this Part 3, I will explain the mechanism and the intermediaries who trade in Bank Securities. Again, a strong note of caution - this area of corporate finance is unregulated by any regulator and attracts hordes of fraudulent intermediaries looking to make a quick penny by duping gullible investors.
Essentially, Bank Guarantees are traded by merchants involved in large volume international trade. For example, lets assume a food distributor in Europe "EuroMetro" purchases and imports canned sea food from a seafood processing factory in Asia "AsiaSeaFoods". If EuroMetro runs into cash flow difficulties due to the current economic crisis and can't pay AsiaSeaFoods, then a bank guarantee arranged by EuroMetro would pay an agreed-upon sum to AsiaSeaFoods. Similarly, if AsiaSeaFoods was unable to provide the goods, the bank would then pay EuroMetro the agreed-upon sum. In this instance, the bank guarantee acts as a safety measure for the counter party in the transaction. As explained in Part 2, either AsiaSeaFoods or EuroMetro could discount their counter party Bank Guarantee to a trading house, a non banking financial company or wire house through intermediaries.
The legitimate intermediaries (and there are a very few legitimate intermediaries) have created an unregulated international market of sorts in the trading of these Bank Guarantees. Unfortunately, the vast majority of intermediaries are fraudulent and have set up elaborate jargon ridden scams under varying names such as "Secret trading programs" etc. with the sole intention of defrauding potential investors. For the uninitiated, the best piece of advice I can give is to stay as far away as possible from any intermediary who claims to be "representing" buyers or sellers of Bank Guarantees.
Showing posts with label Bank Guarantee. Show all posts
Showing posts with label Bank Guarantee. Show all posts
Wednesday 24 April 2013
Thursday 14 February 2008
What makes a Bank Guarantee a tradable security? – Part 2 of the series on Bank Guarantees and MTNs
In the previous posting I described how Bank Guarantees are used primarily to finance trade. In this posting I will describe the aspects of a Bank Guarantee that make it a tradable security and why this trading activity attracts opportunists (read Intermediaries) in spades to get a piece of the action of this lucrative trade.
The large majority of Bank Guarantees issued by major trading banks worldwide have a term of just over a year (more specifically 1 year and 1 day). A bank will issue a bank guarantee to their (primarily corporate) clients based on the clients’ credit worthiness and their relationship with the bank. The client typically puts up between 50 to 60% of the face value of the bank guarantee. In other words, a bank may issue a bank guarantee of a certain face value to a client against a cash deposit by that client of between 50 to 60% of that face value. It is this feature of a bank guarantee of being issued at a discount to face value that makes it similar to a zero coupon bond and makes it a tradable security.
The clients of a bank guarantee are large major trading corporations such as Nike or Apple and the face values of issued bank guarantees are typically US$ 500 million and up although they can certainly be issued with a face value of amounts lower than this. In addition to providing a negotiable instrument to transact international trade for these clients, the bank guarantee is also used by these clients as a means of raising extra capital by selling the bank guarantee.
The clients to whom the bank guarantee is issued may sell that bank guarantee to a third party (such as a securities house like Morgan Stanley) with a markup (usually 10 to 20%). The third party may then sell the bank guarantee to another private party (such as a pension fund) with another markup (again 10 to 20%). This private party may then choose to hold on to the bank guarantee and redeem it for full face value at maturity (at the end of the 1 year and 1 day period). It is important to note that the issuing banks themselves never enter into agreements to sell their financial instruments and a third party buyer’s bank will not enter into an agreement to purchase the financial instrument. The private agreement to trade the bank guarantee is always between the buyer and the seller. No banker or securities officer will act on behalf of the buyer or seller. That being said, this is where informed intermediaries come into the picture arranging private buy/sell transactions between buyers and sellers for a “consulting fee” of typically 1% of the transaction amount for the buyers and sellers representatives. When the face value of the bank guarantee is US$ 500 million in multiple tranches, the “consulting fee” for the introducing intermediaries can be a king’s ransom indeed. This is exactly what attracts the hoards of intermediaries and the broker chains.
Since Bank Guarantees are issued by banks to their clients for the first time (known as “fresh cut” bank guarantees in industry jargon), they do not appear on any Central Securities Depository screens such as DTC or Euroclear for screening, authentication, or settlement. The MT-103 is used to send a conditional SWIFT transfer of cash funds used for fresh cut bank guarantees. Hence settlement of payments for Bank Guarantees must be transacted through NON-Euroclear Delivery Versus Payment (DVP) procedures agreed in advance by transacting parties. Non-Euroclear DVP Protocol Settlement Procedures do not require such things demanded by intermediaries such as proof of funds, proof of capability, financial capability letter, MT-760 (Bank Guarantee), MT-543 (Bank Commitment), or MT-799 (Confirmation of funds on deposit). This is handled in the bank to bank call, after the contract between buyer and seller is signed and in place. Bank to bank confirmation of funds replaces any need for POF.
Subsequent sales of Bank Guarantees to third parties make them a “seasoned instrument”. There is no such thing as a “slightly seasoned instrument”. Bank Guarantee Instruments are either “fresh cut” which is a new issue to the bank's client that has never been sold to anyone yet or registered with a buyer or they are “seasoned” which is an instrument that has already had a registered owner. The prices of these seasoned instruments depends on the quality of the issuing bank (Bank Guarantees issued by AAA+ banks command a premium) and may be sold typically at 85 to 97% of the face value in these subsequent sales. If Bank Guarantees are sold to securities houses in subsequent sales, the securities houses may register the Bank Guarantee as a security and issue them a CUSIP or ISIN number but this is not the norm.
In part 3 of this series we will investigate how intermediaries attempt to trade bank guarantees and the channels of distribution used by them.
- Eric
The large majority of Bank Guarantees issued by major trading banks worldwide have a term of just over a year (more specifically 1 year and 1 day). A bank will issue a bank guarantee to their (primarily corporate) clients based on the clients’ credit worthiness and their relationship with the bank. The client typically puts up between 50 to 60% of the face value of the bank guarantee. In other words, a bank may issue a bank guarantee of a certain face value to a client against a cash deposit by that client of between 50 to 60% of that face value. It is this feature of a bank guarantee of being issued at a discount to face value that makes it similar to a zero coupon bond and makes it a tradable security.
The clients of a bank guarantee are large major trading corporations such as Nike or Apple and the face values of issued bank guarantees are typically US$ 500 million and up although they can certainly be issued with a face value of amounts lower than this. In addition to providing a negotiable instrument to transact international trade for these clients, the bank guarantee is also used by these clients as a means of raising extra capital by selling the bank guarantee.
The clients to whom the bank guarantee is issued may sell that bank guarantee to a third party (such as a securities house like Morgan Stanley) with a markup (usually 10 to 20%). The third party may then sell the bank guarantee to another private party (such as a pension fund) with another markup (again 10 to 20%). This private party may then choose to hold on to the bank guarantee and redeem it for full face value at maturity (at the end of the 1 year and 1 day period). It is important to note that the issuing banks themselves never enter into agreements to sell their financial instruments and a third party buyer’s bank will not enter into an agreement to purchase the financial instrument. The private agreement to trade the bank guarantee is always between the buyer and the seller. No banker or securities officer will act on behalf of the buyer or seller. That being said, this is where informed intermediaries come into the picture arranging private buy/sell transactions between buyers and sellers for a “consulting fee” of typically 1% of the transaction amount for the buyers and sellers representatives. When the face value of the bank guarantee is US$ 500 million in multiple tranches, the “consulting fee” for the introducing intermediaries can be a king’s ransom indeed. This is exactly what attracts the hoards of intermediaries and the broker chains.
Since Bank Guarantees are issued by banks to their clients for the first time (known as “fresh cut” bank guarantees in industry jargon), they do not appear on any Central Securities Depository screens such as DTC or Euroclear for screening, authentication, or settlement. The MT-103 is used to send a conditional SWIFT transfer of cash funds used for fresh cut bank guarantees. Hence settlement of payments for Bank Guarantees must be transacted through NON-Euroclear Delivery Versus Payment (DVP) procedures agreed in advance by transacting parties. Non-Euroclear DVP Protocol Settlement Procedures do not require such things demanded by intermediaries such as proof of funds, proof of capability, financial capability letter, MT-760 (Bank Guarantee), MT-543 (Bank Commitment), or MT-799 (Confirmation of funds on deposit). This is handled in the bank to bank call, after the contract between buyer and seller is signed and in place. Bank to bank confirmation of funds replaces any need for POF.
Subsequent sales of Bank Guarantees to third parties make them a “seasoned instrument”. There is no such thing as a “slightly seasoned instrument”. Bank Guarantee Instruments are either “fresh cut” which is a new issue to the bank's client that has never been sold to anyone yet or registered with a buyer or they are “seasoned” which is an instrument that has already had a registered owner. The prices of these seasoned instruments depends on the quality of the issuing bank (Bank Guarantees issued by AAA+ banks command a premium) and may be sold typically at 85 to 97% of the face value in these subsequent sales. If Bank Guarantees are sold to securities houses in subsequent sales, the securities houses may register the Bank Guarantee as a security and issue them a CUSIP or ISIN number but this is not the norm.
In part 3 of this series we will investigate how intermediaries attempt to trade bank guarantees and the channels of distribution used by them.
- Eric
Sunday 27 January 2008
Debunking the myth of “secret trading programs”: All about Bank Guarantees – Part 1
In a world fraught with Bank fraud, one often comes across unregistered brokers who invite you to join a “secret trading program” among “prime European banks” that will make you rich by trading “prime bank guarantees” which can bought at a discount and sold at enormous premiums shortly thereafter. This author has heard of claims being made of 27% return a month and of US$ 10 million being converted to US$ 100 million in a year. On top of this you are told that due to the regulations, you can join this “secret trading program” through invitation only and have to sign letter of non-disclosure and often “a letter of no solicitation” and proof of clean funds. The claim is also made that the procedures and cost of the banking instruments are dictated by the issuing bank and your investment is absolutely risk free. This author has heard of minimum amounts of investment from US$ 10 million to “tranches” of US$ 1 Billion or more. None of this could be further from the truth.
The simple truth is that Bank Guarantees do exist and are legally issued by a large number of banks worldwide primarily to finance trade. Unfortunately, a chain of unregistered brokers muddy the waters and try to engulf the business of Bank Guarantees in a shroud of secrecy for personal (often enormous) gain.
First, let us understand exactly what a bank guarantee is. The investopedia defines a bank guarantee as a “guarantee made by a bank on behalf of a customer (usually an established corporate customer) should the customer fail to deliver the payment, essentially making the bank a co-signer for one of its customer's purchases. Should the bank accept that its customer has sufficient funds or credit to authorize the guarantee, it will approve a written contract stating that in the event of the borrower being unable or unwilling to pay the debt with a merchant, the bank will act as a guarantor and pay its client's debt to the merchant.” The bank guarantee is an irrevocable instrument and once issued cannot be cancelled. It’s main role in trade finance is a guarantee of payment reassuring the supplier that he will be paid if he meets his part of a contract or a tender guarantee, bid bond, advance payment guarantee and similar, which belong to the most important instruments protecting the client against default in performance of terms and conditions of a contract.
Bank Guarantees are primarily issued as a letter by the issuing bank and often issued in electronic form via the SWIFT bank to bank telecommunication network as an MT (Message Type) 760 – Issue of Guarantee for moving the bank guarantee from the seller’s bank to the buyer’s bank. In the electronic version, the verbiage of the Bank Guarantee is specified in the field specifications of the MT 760, particularly Field 77C - Details of Guarantee. Bank Guarantees are not registered securities and they cannot be seen on computer systems of Central Securities Depositories such as DTC or Euroclear for screening, authentication, or settlement. Hence settlement of payments for Bank Guarantees must be transacted through NON-Euroclear Delivery Versus Payment (DVP) procedures agreed in advance by transacting parties. The agreed procedures are thus extremely important in the absence of standard DVP procedures for example through Euroclear.
Even though Bank Guarantees are not registered securities approved by regulators for sale to the public, nonetheless, they are fully cash backed financial instruments guaranteed by a bank. It is this aspect of a Bank Guarantee that makes it a negotiable instrument between transacting parties. This negotiable instrument cannot be traded through normal channels since it is not regulated by regulators. Hence the shroud of secrecy surrounding trading of bank guarantees and the need for “letters of non-solicitation.
In next part of this series we will examine how an entire financial industry has sprung up around the leasing or trading of Bank Guarantees that involves intermediaries (sometimes a chain of intermediaries), participating banks and of course the buyers and sellers themselves.
- Eric
The simple truth is that Bank Guarantees do exist and are legally issued by a large number of banks worldwide primarily to finance trade. Unfortunately, a chain of unregistered brokers muddy the waters and try to engulf the business of Bank Guarantees in a shroud of secrecy for personal (often enormous) gain.
First, let us understand exactly what a bank guarantee is. The investopedia defines a bank guarantee as a “guarantee made by a bank on behalf of a customer (usually an established corporate customer) should the customer fail to deliver the payment, essentially making the bank a co-signer for one of its customer's purchases. Should the bank accept that its customer has sufficient funds or credit to authorize the guarantee, it will approve a written contract stating that in the event of the borrower being unable or unwilling to pay the debt with a merchant, the bank will act as a guarantor and pay its client's debt to the merchant.” The bank guarantee is an irrevocable instrument and once issued cannot be cancelled. It’s main role in trade finance is a guarantee of payment reassuring the supplier that he will be paid if he meets his part of a contract or a tender guarantee, bid bond, advance payment guarantee and similar, which belong to the most important instruments protecting the client against default in performance of terms and conditions of a contract.
Bank Guarantees are primarily issued as a letter by the issuing bank and often issued in electronic form via the SWIFT bank to bank telecommunication network as an MT (Message Type) 760 – Issue of Guarantee for moving the bank guarantee from the seller’s bank to the buyer’s bank. In the electronic version, the verbiage of the Bank Guarantee is specified in the field specifications of the MT 760, particularly Field 77C - Details of Guarantee. Bank Guarantees are not registered securities and they cannot be seen on computer systems of Central Securities Depositories such as DTC or Euroclear for screening, authentication, or settlement. Hence settlement of payments for Bank Guarantees must be transacted through NON-Euroclear Delivery Versus Payment (DVP) procedures agreed in advance by transacting parties. The agreed procedures are thus extremely important in the absence of standard DVP procedures for example through Euroclear.
Even though Bank Guarantees are not registered securities approved by regulators for sale to the public, nonetheless, they are fully cash backed financial instruments guaranteed by a bank. It is this aspect of a Bank Guarantee that makes it a negotiable instrument between transacting parties. This negotiable instrument cannot be traded through normal channels since it is not regulated by regulators. Hence the shroud of secrecy surrounding trading of bank guarantees and the need for “letters of non-solicitation.
In next part of this series we will examine how an entire financial industry has sprung up around the leasing or trading of Bank Guarantees that involves intermediaries (sometimes a chain of intermediaries), participating banks and of course the buyers and sellers themselves.
- Eric
Subscribe to:
Posts (Atom)