Friday, March 20, 2009

Brilliant Bank - A Fairytale With A Conflict Of Interest?

Once upon a time there was a successful bank called Brilliant Bank. It grew more than 10% every year for the past 20 years and then successfully ventured into fund management. Brilliant Bank had the best return on capital, best return on assets, the lowest NPLs and the highest capital adequacy ratio among all other banks in the country. Heck, it even compares very well with other banks in the region.

Thanks to their steady and careful management culture, their fund management business also witnessed similar growth patterns as the bank. The fund management unit is 100% owned by the bank. Funds under management grew exponentially. After a few years they have about 20 pure equity or equity linked funds. The total funds under management for equities may well be around RM10bn. The total market cap for the bank is around RM20bn.

The unique thing is that in almost every single fund, Brilliant Bank shares will almost always be one of their top 3 holdings. Fair enough that Brilliant Bank has performed exceedingly well over the long term, and that in turn has helped many of the funds to outperform their respective indices. But surely everyone can see that this has to be a gray area when you want to talk of things like transparency, conflict of interest areas, corporate integrity issues, etc.

So much so that the amount of shares held by the "funds" in Brilliant Bank may reach 5%-10% of free float of the bank. Decisions are made by fund managers, working in a fund management unit 100% owned by Brilliant Bank. Really, nobody sees any conflict of interest here??!!

Anyway, in this fictional story, nobody complained because Brilliant Bank performed well, and hence the funds also performed well. There will come a time, if and when Brilliant Bank digs a hole in some financial exposure, and say loses 70% in value over a short period of time. Can we expect the unit holders of the funds to start complaining then? If that happens, what will be the repercussions if the funds were to buy even more shares in Brilliant Bank.

When is buying substantive shares considered as "supporting the share price", and when it is not? If the action is done by one party, that is easy to gather evidence, but what if the buying is by 20 funds? When can we say there is collusion, and when there is no collusion.

I am just writing a fictional story (gulp), but maybe certain things are even more obvious in reality than in fiction. In order to prevent this fictional story from becoming a non-fiction tragedy, I would like the Securities Commission to look closer to the following rules or conventions:

a) do we have a clear guideline when a majority owned fund management unit buys shares in related companies; there must be guideline on percentage of funds' exposure and even minimum time line in holding the shares; there must be safeguards that minority shareholders will not be disadvantaged by the timing of the trades that these funds enter into

b) there must be utmost transparency in how much shares, at what price, and when were the shares acquired and disposed to all unit holders

In the meantime, Brilliant Bank continues on its merry ways by producing good results and getting liquidity mopped up by the ever growing fund management unit. You scratch my back, I scratch your back... but hey, your back is my back!!

p/s photos: Meisa Kuroki


MK - don't know much, must learn more said...

G' afternoon Dali,

er.. is this hypothetical bank running around in the guise of being the public's bank?

value investing in malaysia said...

Agree with u.

The fund mgt unit is certainly supporting its parent company. another thing is the brilliant bank is the best performing bank in the country, hence the inclusion is somewhat necessary and logical.

But one more issue arises!

“There will come a time, if and when Brilliant Bank digs a hole in some financial exposure, and say loses 70% in value over a short period of time.”

At this time, will the fund mgt unit buying more shares of brilliant bank and be seen as supporting the latter share price - like shares buyback but by a subsidiary?? And do they disposed the brilliant bank shares when it is overpriced? Maybe you can check the changes in the funds report if you want to know the real answer.

Time will tell.

yj said...

Another POnzi Scheme ?..

Shadow said...

Wont it be great if this Brilliant bank is also supported by a Brilliant Stockbroking Co (another fictional 100% owned subsidiary). The fund management unit then channels the maximum allowable trade to this subsidiary. A great strategy since the stockbroking unit would not have done well except for the support of the subsidiary fund management fund size... and the commission generated is then captured under non interest income for Brillant Bank (Every bits help to get the highest ROE, ROA, etc).

Just a thought. To maintain the highest capital adequacy ratio that you mentioned. Brilliant Bank in theory may call for rights issue (some innonative tier-1 capital?), which may send the share price downwards by say... 20%, and to make things more interesting, wont investors be asking why their funds invest in 10% of the total NAV on a single related company?

Thought i might just spice up the story on this fictional bank!

see said...

Whoa! this brilliant banks sounds familiar. Have always wondered how they keep their NPL so low year after year - for real ah? From my experience their fund mgt also in shroud of secrecy - won't let 3rd party investment advisers even sniff around their funds

GreenTea said...

Good Day Dali,
You are not the only one who is suspicious of the consistent perfomance of this bank. One well known top financial analyst told me to be careful of the said bank 2months ago. Hope this is not another Ponzi Scheme!

Implosion said...

Brilliant bank may well be operating in a country without clear rules of corporate governance or an independent body that acts as a watchdog. That being said, what's the worse that could happen to this said fictitious bank? Government intervention?

Chowpiao said...

My only comment/favourite : Eventually all shit will float!

xatomic said...

haha time to short it then

yj said...

I did some checking and found out you r 100% right! Thanks for the the alert!!!

elizabeth said...

I hope this fictional story has a happy ever after ending.... if not, kaput lah kita!!

Shawn Cheng said...

I know which bank you refer to. Unfortunately I also have some monies invested in their fund. Judging from their annual report, they indeed used the money from the fund to invest in parent company. Do you think that we all in deep shit this time? If that's the case, then I think a lot of Malaysians will kaput, not only Elizabeth...

Moolah said...

My dearest Dali San,

Wasn't this the small bank that was shorted by some mad lembu at around 10 bucks?


Ng said...

Good morning, I have been following your blog for quite some time, would like to ask u for some advice.
Has been investing in Malaysia equity since Nov '08 (MBB, IOI, Genting & AMMB)
Do u think is a good idea to liquate the position and invest in Singapore or HK. Lately losing confidence in the govt and the state of the economy. Our market has been extremely quiet & it seems foreign long term funds are ignoring this market.

Maverick said...

Fully agree Dali, I did notice this in the past, quite worrysome.

The other strange thing is the unbelievable number of funds they have. I can think of a Malaysian equity fund, Malaysian bond fund and some international funds, but they have literally dozens and dozens of funds. Some of these funds have names that dont cover the contents at all. And yes, the largest holding in most of these funds is indeed by far ...... "Private" Bank.

CP said...

Hi Dali,

Hearing what others have said, it is just confirming some 'rumours' I heard from my best-of-friends working at the HQ.

Wonder if there is any worry parking our money, and not buying its stock, I mean.

Enlighten us. Thanks.


solomon said...

Interesting. We need some tree shakers like you to alert those enforcers. Actually no lah, it could be well a fictitious and coincident story.

By the way, just in any detective story, not all enforcers are good to smell this out because they are not in the industry long. Or too long in job until they are out of touch??

Like a democratic country, you have division of executive powers. Do you need that in a company?

iamyuanwu said...

It's an open secret. I didn't notice it until I invest in Brilliant Funds and eventually became a sleeping agent.

Also Brilliant Bank's huge dividends help prop up Brilliant Funds performances.

Definitely a conflict of interest, and if 1 entity fails, the other will be dragged along with it. I'm gonna question my 'agent' about it.

Lets hope it ends like a Disney movie.

WY said...

Hi Dali,

Your article is a good read. You have valid points here.

Some opinions:
1. I wonder whether the fund management business's transactions are considered as related parties transaction. If it is, guidelines on related party transaction can be used.

2. In unit trust's prospectus, there are restrictions on how much % of the fund can own a single company. This may be a guideline to use. I wonder how effective regulator is enforcing on this %.

3. Probably there should be a law for Bank to own certain % of their own fund management arm to align interest. Much like Warren Buffett owning his own stocks of Berkshire Hathaway.

1. You mention about equity linked funds. Do you know whether the fund is formed using equity-linked swap ? has to be extra vigilant on swap..

ning said...

the brilliant bank already benefited from the very first stage by getting CHEAP capital channel from its fund management arm, without the needs to call for right issues and issue of bond which definitely pay a higher interest than dividend payout.

during the peak of the market, brilliant fund launched quite a numbers of new fund! a lot of malaysians sudah kaput...