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“Cannot see the wood for the trees” in the bond saga


Comments / {{hitsCtrl.values.hits}} Views / Thursday, 24 November 2016 00:01


untitled-6A great deal of noise about the bond saga. Many column inches in the papers. Committees of investigation. Many reports. But after all this, little clarity, about any scope for any action!

These goings-on reminded me of that old English proverb, “cannot see the wood for the trees,” which means, because of looking closely at the trees in front, one might not be able to see the whole forest behind. The bond saga is a bit like that. Anger at Perpetual making a large profit has prevented a clear understanding of what happened. 

A simple sequence

If one were to follow the simple sequence of events, then presto, it all becomes clear. It becomes a tale of four people. 

Government bonds

A bit of background to set the scene. The Government needs funds over and above what they collect from taxes. To meet the shortfall they borrow from the public. Those who lend money are paid interest. The rate to be paid is stated on every bond sold. A person who buys a bond can sell it on the market at any time. They can use it as collateral to borrow from a bank, or they can keep it under the pillow and earn the interest.

Selling bonds

If one sells a bond, the price they get, depends on the prevailing market rates of interest. So if one buys a bond for 100, paying an interest of 10%, he gets 10 per annum. If the market rate of interest falls to 5%, the man with the bond can sell it for 200, as the man who pays 200 will get 10 as interest which is a 5% return!

So if you can buy a bond at auction at a rate of interest much higher than the prevailing market rate of interest you will be a very happy chappy. You can sell it and make a fat profit with no sweat at all. That is what happened with the Perpetual story, which has given rise to the great bond saga.

The process of selling Government bonds 

The Central Bank has appointed a number of primary dealers. They and the EPF are the only institutions authorised to buy Government bonds at auctions conducted by the Central Bank. Primary dealers can, and will sell the bonds they buy at auction.

Before an auction takes place, a person in the Central Bank is responsible for informing the primary dealers of the amount (in terms of rupees) that will be put up for auction.They may also be told informally the rate of interest the Central Bank expects to pay.

Each primary dealer firm will normally discuss it at their firm, and decide on the quantum they will bid for, and the rate of interest. They will then line up the money to pay for the bonds. All very straightforward.

The great bond sale

In brief what happened was as follows. Before the date of the auction, the primary dealers were informed that one billion rupees of Government bonds will be put up for auction. On the day of the auction the Government put 10 billion of bonds up for auction. The primary dealers at the auction were surprised (that’s a major understatement). Okay, they were angry, amazed, and felt deprived of the opportunity to bid as they were not told before the auction that it was 10 million (and so they had not arranged the funds to bid). This had never happened before.

One primary dealer namely Perpetual was apparently not surprised, had lined up the finance, and I read had also arranged for another primary dealer, the Bank of Ceylon, to buy for them. Perpetual bid and got the bonds at a rate of interest well above the market rate and subsequently sold these bonds at a good profit. In slang terms they made a killing! The questions:

Who is to be blamed? Who has committed a criminal offence? Etc.

If a simple sequence of events is followed it all becomes as clear as the morning sun at sunrise, and tells us on whose neck we should put the noose. It becomes a tale of four people.

Mister A is the person who informed the primary dealers before the auction that one billion will be up for auction. He must be asked who told him that it was one billion.

If he names the person as mister B, then mister A is off the noose as he has not committed an offence.

Mister B is asked why he told A that it was one billion. If he says that it was the decision made by the Central Bank to offer one billion for the auction, then mister B is also off the noose.

Mister C was the person on the day of the auction who put 10 billion up for auction. If he says it was a spur of the moment decision made by him on the day of auction, the noose is round his neck. He has to be sacked for irresponsible behaviour.

However If mister C says on the day of the auction he was told by mister D to put 10 billion up for auction, then the noose is around Mister D. He should be sacked for irresponsible behaviour.

Mister C is off the hook as he was following instructions. 

What is the offence?

A has not committed any offence. B has not committed any offence. If C was instructed to put 10 billion on the day, he too has not committed an offence.

That leaves D. He has to be sacked for irresponsible behaviour by not following the normal procedures for putting bonds for auction.

Who is mister D? If he was the governor he should be sacked for irresponsible behaviour. If he was not mister D, in addition to mister D, the Governor must be sacked for incompetence for allowing such things to happen.

No crime anywhere

The Government got the 10 billion and accepted the rate.

What is the offence committed if mister D had told Perpetual that 10 billion will be up for auction?

Insider trading (which is getting and using information not in the public domain to make a transaction and make a profit) does not come into the frame. I believe our law on insider trading relates only to trading in the shares/bonds of public listed companies. So we must await comment from the lawyers.

I will not be surprised if mister D cannot be charged with any offence.

Even if he had told Perpetual, they will not admit it. Perpetual could take up the position that it was gut feel (and the gut was not tickled by anyone else to create this feeling) that something larger than one billion will be put up for auction as the Government was very short of money.

Perpetual has done nothing wrong. As a primary dealer, they went to the auction, bid for the bonds put up for auction, their bid was accepted by the Central Bank and subsequently they sold the bonds. All very normal activity of a primary dealer.

So Perpetual will be off the hook as well.

Cannot see the wood for the trees

Now that we have cleared the trees, we can see the wood clearly. We see Perpetual having a nice picnic in the woods and they are not looking over their shoulder to see whether any policemen are advancing towards them. 

It was a ploy

Get the funds ready, bid at rates higher than market rates, and hope that the other primary dealers do not bid at near market rates. They did not and did not ask that the auction be postponed. So the ploy worked. The upsides are a lot of profit. Hardly a downside, just the Governor’s neck.

The Government got the cash. If everybody knew it was 10 billion prior to the auction, what would the rate of interest been at auction? Nobody can give a precise answer.



(The writer has done this, that, and the other, here and abroad including being Chairman of First Capital Plc, 

a primary dealer.)


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