Note key risks in perpetual securities, MAS cautions

Would-be investors should be aware of how they differ from regular bonds

By Magdalen Ng, The Straits Times, 17 May 2012

THE Monetary Authority of Singapore (MAS) has issued a word of warning to investors caught up in the investing flavour of the month - perpetual securities.

The MAS cautions that perpetual securities are not like regular bonds, and says investors should consider the key risks of any products before investing in them.

In response to queries, an MAS spokesman said yesterday that issuers offering perpetual securities to retail investors are required to comply with the Securities and Futures Act (SFA).

This legislation 'requires proper disclosure of the feature and risks of the product either in a prospectus or an offer information statement'.

'Investors should note, among other factors, that perpetual securities, unlike plain vanilla bonds, do not have a maturity date and the issuers are not obliged to redeem the perpetual securities.'

However, the MAS did not confirm if it had met bankers over concerns on the unprecedented run of perpetual bond sales with retail investors in Singapore, as reported by Reuters, on Monday.

Perpetuals are bond-like instruments, and offer attractive interest returns. However, unlike bonds where an investor gets the interest and principal according to a fixed schedule, issuers of perpetual securities can defer coupon payouts under certain circumstances. Repaying the principal is also left to the issuer's discretion.

The MAS noted: 'If issuers do not exercise the redemption option, investors who wish to exit their investments can only do so by selling them in the secondary market. They will therefore be exposed to market price fluctuations, which could be quite severe, especially if interest rates go up. They may also be exposed to the risk that there could be a lack of willing buyers in adverse markets.'

Retail investors were able to buy into the $500 million offered by Genting Singapore through the automated teller machines of local banks, as per a regular initial public offering.

This is because perpetual securities meet the requirements of an 'Excluded Investment Product' under the SFA. Consequently, they can be sold without advisory services that can point out risks, so long as there is a prospectus available.

While the MAS 'expects issuers to make clear to investors the difference between perpetual securities and other bonds', there is no way of knowing whether the person who reads the prospectus fully comprehends the literature.

While the general public can apply through the ATMs, OCBC Bank sells certain investment products such as dual currency returns and perpetual securities only to their Premier Banking customers and other sophisticated clients.

'We have a structured process of recommending appropriate investment products to these customers. This sales and advisory process requires our sales staff to conduct a financial needs analysis with our customers, which includes understanding their financial objectives, risk profiles, and investment horizons,' said Ms Koh Ching Ching, head of group corporate communications at OCBC.

A DBS spokesman said that retail perpetual bond offerings are marketed just like retail equity and retail plain vanilla bond offerings.

'At the IPO stage, the purchase of these retail instruments is generally self-directed as DBS does not sell them over the counter at branches. Retail investors are referred to the IPO prospectus or offer information statement and can subscribe to them via ATMs.'

*Perpetual securities: It was a response, not an alert

OUR comments on perpetual securities offered to retail investors were made in response to questions from The Straits Times on the risks of perpetual securities ('Note key risks in perpetual securities, MAS cautions'; last Thursday).

The Monetary Authority of Singapore (MAS) does not issue alerts or warnings about specific products.

We agree with Mr Lawrence Loh ('Perpetual securities: Alerts from MAS should be timely'; last Saturday) and Mr Chrys Mendis ('MAS caution lacks balance'; Forum Online, Monday) that investors must ultimately take responsibility for their actions.

However, we also expect issuers and financial institutions that offer investment products to disclose the risks and features of products clearly to investors.

This allows consumers to make informed financial decisions with a good understanding of their own risk appetites.

Angelina Fernandez (Ms)

Director (Communications)

Monetary Authority of Singapore

ST Forum, 24 May 2012

*Perpetual securities: Alerts from MAS should be timely

PERPETUAL securities have been in the market for some time now, and media reports have explained the differences between them and regular bonds, so it is puzzling that the Monetary Authority of Singapore (MAS) has decided to issue an alert only now ('Note key risks in perpetual securities, MAS cautions'; Thursday).

If the aim is to caution investors, is it not too late? In any case, investors like myself who invest in perpetual securities are fully aware of their features.

What is more important is the underlying strength of the issuer, as it indicates its ability to pay the dividend when due.

Or has the MAS realised only now that it has to be seen to exercise its moral responsibility towards investors, given the 2008 financial crisis, so as to absolve itself from blame should a similar situation occur?

Following the 2008 financial crisis, banks were required to conduct financial analyses of customers, and recommend appropriate investment products.

This procedure essentially places the onus of responsibility on the customers should an investment turn bad, and protects the banks.

It is possible, and this has been done before, to engineer the financial analysis score, in order to qualify a customer to purchase riskier products than his risk profile allows, if he so wishes. In any case, his endorsement on the financial analysis form indemnifies the bank.

Ultimately, investors have to take responsibility for their investments. All the additional paperwork and procedures introduced after the 2008 financial crisis only serve to amplify this. However, should there be reason to issue alerts, the MAS should ensure that they are done in a timely manner.

Lawrence Loh
ST Forum, 19 May 2012

Getting to know perpetual securities
They offer regular payouts at fixed rates, but are not like regular bonds
By Yasmine Yahya, The Straits Times, 20 May 2012

They might sound a bit complicated but perpetual securities have been selling like hot cakes over the past few months as retail investors queue up to get a slice.

And who can blame them? In an economy where interest rates are near zero and stocks are becoming more volatile, we are all thirsting for simple financial products that can bring us steady returns.

But there is a catch: Regulators are saying that the 'perps', as they are commonly known, might not be as simple as many assume.

The Monetary Authority of Singapore (MAS) warned investors last Wednesday that perpetual securities are not like regular bonds and, therefore, are riskier.

An earlier Reuters report citing unnamed sources said that the MAS had held two informal meetings with bankers in recent weeks as it is worried that local retail investors might be taking on too much risk or buying perps without a full understanding of the product.

The Sunday Times spoke to several experts to nail down the nature of this new kid on the investment block.

What is a perpetual security?

A perpetual security acts much like a bond, giving the holder regular payments at a fixed rate.

For example, the perpetual security issued by Genting Singapore last month will pay investors 5.125 per cent of their investment a year.

And like bonds, the company that issues the perps will likely redeem them at a certain point - in Genting's case, in 10 years' time - and return the initial sums to investors.

But note that word 'likely'.

Unlike with bonds, the company is not legally obliged to pay out a regular distribution. It can choose to defer a payout, and do so indefinitely.

The company also has a right to never redeem the bonds - hence the term 'perpetual'.

Perpetual securities also rank lower than bonds in terms of their claim on the company's assets.

If a firm collapses and has to be wound up, bondholders are paid first from whatever assets that have been liquidated.

Holders of perpetual securities would be next in line - if there is any cash left.

Investors holding preference shares come next and finally, holders of common stock - again, if anything is left in the kitty.

Perpetual securities also take precedence over common stock when it comes to dividends and distributions. The company must distribute payouts to perpetual securities and preference shares holders first, before it can declare a dividend for its shares.

DBS Bank's head of fixed income Clifford Lee notes: 'As long as the company doesn't pay coupons on the perpetual security, it can't pay dividends to shareholders. If it decides that it wants to pay dividends on its common shares, then it also has to pay out all the deferred coupons accumulatively.'

That means a company has to pay out its latest distribution plus any distributions that it had previously missed.

What are the risks of perpetual securities?

First, the company might defer all distributions and choose not to redeem the perpetual security, which means zero returns on your investment.

It is also harder to sell a perpetual security than a common or preference share.

There is also the risk that an investor might not be able to get out of the investment when he wants to. These investments typically do not have as much liquidity as shares or equities.

'Compared to conventional straight bonds which have maturity dates, investors in perpetual securities are subject to risks in the secondary market which are mainly market, credit, liquidity and price risks,' Mr Marcus Teo, the head of HSBC Singapore's high-net-worth channel, says.

Third, there is interest rate risk.

If interest rates rise rapidly over the next several years, the distribution rate on existing perpetual securities would not look attractive any more.

In such a situation, the issuing company might also be less motivated to redeem the perpetual security.

'Why should they if they are getting funds from you at a lower rate than the market interest rates?' notes Mr Mano Sabnani, chief executive of financial consultancy firm Rafflesia Holdings.

And at that point, it is likely that the value of the perpetual security would fall, he adds.

'With bonds, you could still look forward to getting your capital back.

'Say you bought a bond with a 2 per cent coupon and then interest rates rose. The value of the bond would fall but when it is nearing the maturity date, people would still buy it because they could buy the bond at a cheap price and make money when the company returns the principal amount.

'But with perpetual security you can't look forward to that as they may not call it back and return the principal.'

Given such an environment, most people would be looking to sell while few would want to buy - so investors would be stuck with their perpetual securities.

What are the advantages of perpetual securities?

HSBC's Mr Teo has a straightforward answer: 'Compared with equities, perpetual securities tend to be less volatile and provide a regular stream of income.'

No doubt, the payout rates being offered by the companies issuing perpetual securities definitely beat the interest rates investors would get in a savings account.

And given that the stock market is becoming ever more volatile, being able to receive regular fixed payouts a few times a year does sound attractive.

Of course, there is that risk that the company might just decide to defer all distributions indefinitely.

However, Mr Lee of DBS says this is unlikely with big firms.

'The ones which have issued perps so far are top-tier names, such as Global Logistic Properties, SingPost and Hyflux,' he notes.

'If they defer their coupon payments, their stock price will plummet because a coupon deferment means no dividend, so it's quite punitive for them to defer the payouts.'

This means it is vital for investors to choose perpetual securities very carefully, he adds.

'Investors must only look at companies whose credit they are very comfortable with.

'They should also check the dividend history of the company - if it has been paying regular dividends over many years, that gives a lot of assurance that the company will continue to pay a dividend, and therefore, the chances of it deferring a coupon are lower.'