Infamous bond issue of 27 February 2015: Was it a scam, fraud or embezzlement?

With all the hype created by interested parties to make the 30 year Treasury bond issue as the biggest scam that ever happened and depicting this to be a worse blow to the Central Bank than the LTTE bomb blast, it turns out, even the COPE could not find anything other than a Rs. 526 million opportunity cost, which was only 1% of the Rs. 50 billion purported loss claimed by critics and some deviations from procedure

By T. Mallawatantri

There is no other topic that is so widely discussed and bandied about nowadays than the Treasury bonds issue of 27 February, despite the feverish election campaign slogans which has engulfed the populace entirely. 

It is ironical that many who comment on the topic including some professionals are hardly conversant with bonds or their operational procedures. So before touching the issues involved, it is sensible to understand the concept.

Bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. 

Owners of bonds are debt holders, or creditors, of the issuer. Bond can be of two varieties depending on the manner in which it pays out the ‘interest’. If the instrument carries a fixed coupon rate (the yield) it will be paid during the year, usually every six months at the stated rate, say 5%. There are also bonds with ‘zero coupon’ rates. Here the yield or profit to the holder is paid in the form of a discount. E.g.: A Rs. 1,000 bond, face value, will be sold at Rs. 950 and the difference is the yield.

There is an inverse relationship between the bond rate and the prevailing interest rates. For instance, if a zero-coupon bond is trading at 950 and has a par value of 1,000 (paid at maturity in one year), the bond’s rate of return at the present time is approximately 5.26% [(1000-950)/950 = 5.26%]. 

For a person to pay 950 for this bond, he or she must be happy with receiving a 5.26% return. But his or her satisfaction with this return depends on what else is happening in the bond market. 

Bond investors, like all investors, typically try to get the best return possible. If current interest rates were to rise, giving newly issued bonds a yield of 10%, then the zero-coupon bond yielding 5.26% would not only be less attractive, it wouldn’t be in demand at all. Who wants a 5.26% yield when they can get 10%? To attract demand, the price of the pre-existing zero-coupon bond would have to decrease enough to match the same return yielded by prevailing interest rates. In this instance, the bond’s price would drop from 950 (which gives a 5.26% yield) to 909 (which gives a 10% yield) (1000-909= 91: 91/909*100 = 10.01%). Therefore the bond is sold at a discount. Similarly, if the rate is less, say 3%, the bond will have to be sold at a premium, i.e. 970 (1000-970= 30/970*100 = 3.09%).

The former Governor, a few banking professionals and some politicians raised a hue and cry about billions lost, one famous political figure claiming to be an expert economist estimated the loss to the country as Rs. 50 billion. So let me quote Ajwad Shariz (Independent Consultant, Granada Hills, California), a Sri Lankan born professional who had done an analysis on the purported loss.

“You need to compute the value so that you are in the present. You can’t add present monies to future monies, this is a “no, no” when you compute time value of money. So what is computing time value of money? If a person loses Rs.1000.00 today and the interest rate was10.4%, it is the same as losing Rs. 2000.00 in seven years, or Rs. 4000 in 14 years (This is called the rule of 72**.) If you take 72 and divide by the rate of interest, in this case 10.4, it will give you the time it takes to double the money, through compounding interest). 

Therefore losing Rs. 1,000 today and losing Rs. 4,000.00 in 14 years, is not the same as losing Rs. 5,000.00 (1,000+4,000) today, but it is the same as losing 2,000.00 today. The time value of money is a basic and core principle of financial calculations, and the newspaper articles and the politicians have ignored it. The result has been the erroneous calculations that add up money due in 20 and 30 years with money due in the present year, without discounting future payments to the present value. The result is incorrect calculations that hugely exaggerate the loss.

** In finance, the rule of 72, the rule of 70 and the rule of 69.3 are methods for estimating an investment’s doubling time. The rule number (e.g., 72) is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling. 

Inaccurate Stipulation of the base rate: All calculations of loss are based on estimating the “extra interest” that was paid for the 30 year bond. ”

According to the draft report of the COPE, there was no loss in the magnitude of Rs. 50 billion but only an opportunity cost and commitment for the Government through the discount to be offered amounting to Rs. 526 million* (para 13 )

* This figure is only an estimate and can change over time.

When the matter came to the lime light, the opposition and some professionals went to town. The Prime Minister appointed a three-member committee which exonerated the Governor of wrongdoing but went on to recommend further probing. Three eminent persons, Dr. G. Usvattearachchi, Economist, Dr. A. C. Visvalingam, Engineering Consultant, and Chandra Jayaratne, former Chairman, Chamber of Commerce, even filed a fundamental rights petition in the Supreme Court claiming that the Treasury bond issue contained serious irregularities, lacked transparency and did not adhere to the accepted best practices of good governance and was possibly tainted by conflicts of interests and related party transactions. The Supreme Court dismissed the Petition on 14 May 2015 on the premise that there were no grounds for this petition and accepted that it is not up to the courts to prescribe procedures to the Central Bank.

The critics were not happy and the opposition brought a motion in Parliament to debate the bond scam as it was called then. The Speaker prudently referred it to the Parliamentary Committee on Public Enterprises (COPE) which appointed a sub-committee of 13 members to investigate and submit a report in two weeks. 

Draft COPE report in circulation – Though the COPE Sub Committee and the COPE itself did not officially sanction the release of the draft report, it has now come to the Public Domain, the highlights of which are circulated among many having access to computers (e-mails). The following main observations of the COPE (as given in the draft now in circulation) is reproduced below as summary extracts with the writer’s observations. The COPE recorded evidence and or obtained statements from 49 witnesses including the present Governor of Central Bank. The following are summary extracts from the draft COPE report.

I – The Director General of Treasury Operations indicates to the Superintendent of the Public Debt Department (PDD) of the Central Bank which has exclusive rights to issue Treasury bonds, of the Government’s funding requirements for the ensuing period and the Central Bank then resorts to two methodologies to find the necessary funding by issuing debt instruments like Treasury bonds. One is by Auction for which biddings are placed by registered primary dealers and the other by direct or private placements also by the primary dealers. The Government’s fund requirement for 2 March 2015 was Rs. 13.55 billion. The Domestic Debt Management Committee (DDMC) of the PDD on 27 February 2015 recommended to raise Rs. 1 billion by issuing 30 year bond by primary auction and Rs. 12.55 billion by direct placement for which covering approval had been obtained subsequently from the Governor (para 06).

II – The advertisement for the Rs. 1 billion 30-year maturity bond at 12.5% coupon rate was published on 26th February and 16 primary dealers including EPF 

( Employees Provident Fund ) have bid for Rs. 20.708 billion by 11.10 a.m. on 27 February (para 07).

III – The Treasury Bond Tender Committee convened at 12.30 on 27 February decided to increase the amount of the Primary Bond auction up to Rs. 10.058 billion instead of the previously announced Rs. 1 billion. According to the COPE findings, this is a deviation from the earlier DDMC decision. At the said auction, Rs. 10.058 billion was raised by issuing 30 year bonds on 9.3510 to 11.7270 weighted average yield rate (WAYR) from 14 primary dealers. The PDD has recommended to raise Rs. 2.608 billion as the best alternative but at the end of the minute by Superintendent Public Debt Dept. addressed to the Head of front office stating “Governor instructed to raise funds up to Rs. 10 billion taking into consideration additional fund requirement of the Government”. 

The approval of the DDMC was obtained for the borrowing program at 15.00 hrs the same day. The Governor approved the Debt Borrowing program on 2 March 2015 placing a minute, “that the bonds be issued under the established rates to EPF, NSB Fund management Co Ltd. and Sri Lanka Insurance Corporation”. The COPE report emphasizes here that the Governor has approved the Direct Placement method by this minute.

The Governments funding requirement of Rs. 261.683 billion was to be met by borrowings approved by the DDMC fulfilled by Rs. 89.683 billion through Treasury bills and Rs. 172 billion by issue of Treasury bonds with additional Rs. 1 billion through primary auction.

The Governor has approved this program subject to “1) raise Rs. 40 billion through issue of 30, 40 & 50 year bonds, 2) EPF, NSB, SLIC to be asked to stabilise rates”. However COPE observed a deviation by the PDD here (para 08).

Observation – Though this change of procedure was found to be unusual by the COPE, it has not determined that this was irregular or tantamounts to any unethical or fraudulent act.

IV – According to personal representations made to the COPE, the Governor had visited the PDD at 10.45 hours while the bidding was in progress and remained till the bids were closed. Thereafter he returned with two deputy Governors at 12.30 hrs after bids had already been closed and looked at the list of bidders and suggested to accept all bids amounting to Rs. 20.708 billion. However when Dr. M.Z.M. Azim Additional Superintendent PDD and N.K. Seneviratne Superintendent PDD pointed out the undesirability of that action, Governor had instructed the PDD to raise Rs. 10 billion from the Auction and to convey .the decision to the Tender Board. Officials have agreed to go ahead with it as the Governor did not wish to go for direct placements (para 09).

Observation – As Governor of the Central Bank, Arjuna Mahendran has every right to enter the Public Debt Department and there is no direct or circumstantial evidence found by COPE to implicate any irregular directive or instruction given by him to the tender committee. He has merely suggested that a higher amount be accepted since there were bids but acceded to the advice of senior officials.

V – The cope finds that as a consequence of resorting to accept bids through primary auction, the blame for which is directed at the Governor, the rates were pushed higher and therefore, the opportunity to restrict rates (WAYR) by accepting direct placements, was lost. The change in procedure apparently was not approved by the Monetary Board*. It is mentioned that the Primary Dealer Perpetual Treasuries would not have got the chance to procure the bonds if the Auction was restricted to Rs. 1 billion (para 10).

Observation – This looks like pure conjecture on the part of the COPE as in the money market, there are unpredictable events and speculation which may provide a different outcome. Besides, it was clear to the cope that Perpetual Treasuries submitted their bid through Bank of Ceylon and as far as CBSL was concerned, it was dealing with Bank of Ceylon and it could still succeed even if bids were submitted through direct placements.

*It is however mentioned in para 11, that the Governor had informed the Monetary Board of the temporary suspension of the procedure which was ratified by it subsequently. 

VI - Para 12, “ if this treasury bond was issued the way it was advertised, i.e. Rs. 1 billion worth Treasury bonds were issued by Primary Auction in those circumstances, the bids could have been accepted at 10.4652 weighted average yield rate when bid price was Rs. 104.50730 level. At that stage, it would have been quite possible to stop issuing bonds under Primary Auction and issue the rest of the treasury bonds following the Direct Placement system by informing the primary dealers to bid for treasury bonds at 10.4652 WAYR. If the latter system was followed it could have prevented the increase of WAYR up to 11.7270 and to decrease the bid price up to 90.16990”.

Observation – This is again pure conjecture not supported by direct evidence.

VII - Para 13, draft report of the COPE tries to make out that by deciding to go for Primary Auction on 27 February instead of direct placements, a trend was created to raise weighted average yield rates for Treasury bonds and it compelled the Government to incur an opportunity cost and commitment for discounted prices amounting to Rs. 526 million. This charge it appears is aimed at the Governor. It goes on to observe that there was not going to be any difficulty to raise funds at acceptable rates if the earlier practice was continued. This the COPE says is a decision taken without proper study or evaluation. 

However, there is no implication that it was a decision taken to benefit a particular dealer or individual. 

Observation – Here again, there is no finding directly against Governor, Arjuna Mahendran for any unethical decision or wrong doing on his part. 

VIII – Para 14 – The COPE observes that the CBSL the direct placement method for awarding Treasury Bonds is carried out by land line Telephone communication and there appeared to be no complaints.

Observation – COPE appears to favour direct placement method as against more transparent bidding through primary auction.

IX – Para 15, COPE finds that there is a serious internal control lapse on the part of the CBSL that the Tender Board document with signatures of members on its decision can be picked by any person and possibly leak to the media. 

X – Para 16 and para 17 goes on to explain the pattern of bidding by Perpetual Treasuries after 27 February and the opportunity cost (Rs. 526 million) and commitment expense on discounted prices resulting from this change consequent to the Decision of the Governor. It goes on to say that the decision has led to the increase of the entire interest rate structure of all bonds. It further observes that this decision was unexpected and surprised the Market. It quotes evidence of dealers of several Primary dealers.

XI – Para 20 – Perpetual Treasuries Ltd. (Primary Dealer) is owned by Perpetual Capital Ltd., a shareholder of which is Arjun Joseph Aloysius and son in law of Governor Arjuna Mahendran. Prior to Governor assuming duties, he had been a Director of Perpetual Treasuries and had resigned on 16 January 2015. Siromi Wickremasinghe, sister of former Governor Ajith Nivard Cabral, was also a Director of Perpetual Capital Ltd. from 2013 and resigned on 9 March 2015.

Observation – It would appear that there could be conflict of interest (involving related party transactions with the Central Bank) but there is no evidence recorded in the draft report to establish that any individual or company had made use of the nexus. It is also a fact that conflict of interest does not necessarily result in corruption or unethical benefit.

Conclusion – With all the hype created by interested parties to make the 30 year Treasury bond issue as the biggest scam that ever happened and depicting this to be a worse blow to the Central Bank than the LTTE bomb blast, it turns out, even the COPE could not find anything other than a Rs. 526 million opportunity cost, which was only 1% of the Rs. 50 billion purported loss claimed by critics and some deviations from procedure. There is no record in the draft COPE report now in circulation that the Governor Arjuna Mahendran had acted against the rules, was involved in any irregular deals or given any unethical directives to Central Bank officials, particularly to favour any related party.