Gregory Turnbull-Schwartz
The rating agencies have rolled over like the love-struck puppies they were pre-financial crisis, awarding an investment grade rating to a new HSBC issue that fails to meet even the minimum obligations of a bond.
The rating given by Moody’s and Fitch to a recent HSBC borrowing bears little relation to the actual instrument, which is much closer to equity – or even a receipt – than a bond.
The bank is clearly a good credit risk in our view. However, the way in which HSBC wrote the document governing the borrowing is troubling. First, it states ‘interest payments on the securities are discretionary and the issuer may cancel interest payments in whole or in part, at any time’.
Then, in terms of repayment, it says ‘the securities have no scheduled maturity’. In our view, a piece of paper that says that you have no right to receive interest payments and no right to receive your money back is not a bond. It is more akin to a receipt from a charity describing your donation.
The document even allows the borrowing to be considered as equity for regulatory purposes, meaning that the UK regulator agrees that this type of borrowing is like equity. Yet the rating agencies are saying that it is an investment grade rated bond.
It seems a far stretch and we think that given the lack of any obligation to pay investors and the realisation of that by the regulator, the rating agencies have really rolled over on their backs like the love-struck puppies they were prior to the financial crisis, begging for revenue from the investment banker’s table.
To compound the problem, there is a real danger that instruments such as this eventually end up in bond indices because of their investment grade rating. That would make it difficult for managers of bond funds to avoid investing in the product, which would benefit the banks – because the ‘bonds’ generate fee income and allow them to raise quasi-equity more cheaply – and the rating agencies, but no-one else.
It is the general public who it would not suit. If that were to happen, the rating agencies would have effectively colluded in getting yet another unsound investment product stuck into people’s retirement funds. Let’s hope the regulators are doing their job behind the scenes and that these do not end of in indices despite the rating agencies’ current lax approach to the matter.
This type of instrument can, in select cases, have a place in portfolios, but it is essential that investors do their homework and not rely on ratings. As sophisticated investors, we can and do analyse these instruments and from time to time take positions in them in a disciplined way.
That does not mean we should not expect better from the rating companies that failed so spectacularly in rating mortgage related debt only a little while ago.
Gregory Turnbull-Schwartz is a fixed income manager at Kames Capital.
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