CIPS (China International Payment System) Hysteria Largely Dispelled?

AA Reporting from His Secure Location: Sometimes You Need More Than Just the Hat

When the PRC announced its intent to create CIPS--the China International Payment System, now renamed the Cross- Border Interbank Payment System--some trumpeted it as a replacement for SWIFT and another, perhaps, the fatal step in global de-dollarization, heralding the end of the primacy of the US dollar.  Here’s one particular brilliant “insight” cast in terms of “white and black hats” and “blessings”. 

Most of this commentary was ideologically-driven:  a preconceived notion in desperate search for  validation. When your ideology gives all the answers, analysis is not only very easy but very facile. You just fit the facts or what might pass as “facts” around the preordained answer.

My favorite exemplar of this way of “thinking” is the assertion that the ruble is fully supported by gold and thus in some way superior to the US’s “fiat” money.  That’s “supported” like Golden Belt Sukuk was “asset backed” –“way back” it turned out.  No doubt AA is missing the opportunity of a lifetime by not converting his deposits to rubles and depositing them in a Russian bank. What could possibly go wrong?  But then I resisted buying Golden Belt Sukuk so I have a track record for missing out.  

Some of it was based on the latent hysteria that often informs discussions of politics and economics, particularly when certain actors are involved.  Here there was a veritable trifecta:  possibly including China, Russia, and Iran – an “axis of evil” for some.  But as the video above shows for others an “axis of virtue”.  Count your blessings!   And note the white cowboy hat on the wall in the video!

At the time there were more balanced analyses like this one from the FT which cast CIPS  as an attempt to simplify the process of making cross-border RMB payments to promote internationalization of the RMB and perhaps lessen exposure to alleged spying and the threat of denial of SWIFT services.  As it turns out these latter goals appear not to have been met as will be outlined in a following post.  CIPS may well facilitate greater “regulatory supervision” (but not “spying” for sure) of offshore RMB-denominated transactions by PRC authorities.

SWIFT’s 25 March 2016 press release by and large put an end to nonsense about CIPS as a global replacement for SWIFT or should have. 

“The MOU sets out plans for a strategic collaboration to develop China’s Cross-border Interbank Payment System (CIPS) using SWIFT as the secure, efficient and reliable channel to connect CIPS with SWIFT’s global user community.”

But there are still holdouts.

Ideology is a powerful thing in the face of mere facts. Here’s one from Jim Willie over at the aptly named website “Before It’s News” carrying a dateline four days after SWIFT’s press release.  I guess the site name means the articles are written before looking at the news.

What’s clear or should be now is that CIPS is not a replacement for SWIFT.  It’s analogous to CHIPS – a New York-based bank-owned utility that makes the bulk of cross-border payments in the US dollar. That is, CIPS is a payment utility like CHIPS or CHAPS, not a secure messaging system like SWIFT. 

Why create CIPS? 

The PRC is looking to promote the internationalization of the RMB.  CIPS is designed to streamline the currently cumbersome process of making cross border RMB payments.  It is also a way to bring this payment “traffic” within the PRC.  As a result of bringing that traffic onshore, PRC authorities will have more visibility into offshore RMB payments than they previously had.  

But could we have figured out that CIPS was highly unlikely to replace SWIFT when CIPS was first mooted?  Yes!

Because there’s a lot of apparent confusion about precisely what SWIFT does, let’s start with some basic facts as they’re part of the foundation of the argument to follow.

SWIFT not hold any accounts, nor does it execute any payments.  It transmits payment instructions to financial institutions that then “make” payments either (a) through utilities (like CHIPS or CHAPS) or national payment systems (like FEDWIRE, CNAPS2—China’s domestic RMB payment system) or  (b) on their own books (book transfer) when they hold the account of the intermediary or final beneficiary. 

That is, assume Bank A receives a SWIFT message from Bank B ordering Bank A to debit Bank B’s account and pay Bank C for account of Person or Company K. 

1. If Bank A holds the account of Bank C, it will make payment on its own books (an internal payment or book transfer) unless Bank B instructs it otherwise. As the name implies, the payment is made within Bank A.  Bank A’s assets and liabilities don’t decline when the transfer is made.  All that happens is that the amount of the payment is moved from Bank B’s to Bank C’s account –an internal shift within liabilities.   
2. If Bank A doesn’t hold Bank C’s account, it will pay the correspondent Bank that holds Bank C’s account either through the utility or national payment system (in banker speak a “wire transfer”).  In this case Bank A’s assets and liabilities will decline by the amount of the payment and Bank C’s correspondent bank’s assets and liabilities will go up by the amount of the payment.  Here there’s an actual movement of funds out of Bank A to Bank C’s correspondent.

While SWIFT is probably the most convenient and most used method to send and receive payment instructions, it is not the only way.  If SWIFT denies a financial institution access to its system, that financial institution can use a variety of other methods (proprietary PC based systems that mimic SWIFT, or other methods like telex, facsimile, email, letters) to send payment instructions to its correspondent.  These will often be more cumbersome and costly and less secure, but if the correspondent is willing to accept them, the payment can be made.

What’s involved in creating a global replacement for SWIFT?  

First a side digression to place this question in context. Creating a bi-lateral alternative or regional alternative would be much easier.  Most internationally active banks offer their customers PC-based systems for transmitting payment orders and receiving account information though such services are limited to two-way communication between the specific customer and a single bank.  Banks in Russia and China offer these services and could easily set up a communications system. If there was a preference to avoid the internet, a cable could be laid.  But that would not be a global replacement.

Putting aside the not inconsiderable cost of creating a new SWIFT, one would have to build a system offering similar services at the same or lower costs, persuade existing SWIFT clients that there was a good reason to shift from SWIFT, and at least for now convince them to shift a large portion of their transactions to the RMB.  That of course would require that the banks’ customers shifted their transactions to the RMB away from the dollar or other currencies.  All this seems to AA to be well beyond a hard slog.

SWIFT works.  That’s why it is the global communication utility. It is as embedded in the payments world as Microsoft software is in the PC world, though I’d argue that SWIFT has the better product. 

Here’s the hill to climb.

1. More than 11,000 financial institutions in more than 200 countries use SWIFT. 
2. SWIFT supports more than 150 payment and settlement systems around the globe.  
3. In 2015 SWIFT handled over 6.1 billion messages related to payments (in a wide variety of currencies not just one), securities transactions, treasury operations (FX dealing, interbank deposits, swaps, loan syndications, gold trading), trade finance (letters of credit, collections).   With this sort of volume fixed cost per transaction is low.  Variable cost is very low.  How does an upstart match this advantage? 
4. SWIFT offers a robust range of products beyond “mere” payments, including financial messaging, bulk file transfers, secure internet browsing/web access for SWIFT members’ clients, a comprehensive suite of compliance and analytical tools --anti-money laundering, sanctions enforcement, etc. 
5. And does so with 99.999% reliability year after year after year.  Its credibility as a reliable partner is proven.

Beyond these obstacles there is another very serious impediment to getting banks to embrace CIPS as an alternative to SWIFT: currency.

CIPS is likely to be limited to a single currency—the RMB.   Today only about 40 percent or so of SWIFT payments are in dollars (Page 5).  What do foreign banks do with the other 60% of their payments?  Run two communication systems?  SWIFT for everything but RMB? And CIPS for RMB?  That’s operationally cumbersome and thus expensive in an environment when cost minimization is key.

On top of that the RMB is less attractive than the dollar and likely to remain so for a long time because of concerns about transparency, business ethics and fair dealing, legal redress, market size (availability of sufficient investable RMB denominated assets), and their liquidity and credit quality to name just a few of the challenges the PRC faces in making the RMB a true alternative to the US dollar. 

Don’t mistake this comment as a Pollyannaish view that the dollar’s place in the world economy is unassailable.  It isn’t.   Sadly, our “own goals” are likely to be the main factor in the dollar’s fate.  Richard Dunne step aside for the real pros!  Any alternative currency will also have to offer the same or greater benefits than the dollar.

Next post will discuss some of the issues arising from how CIPS is likely to operate.

EU Commission Irish Tax Ruling in Re Apple: Tim Cook and Abu Arqala Outraged

AA is Paying Attention.  Are You?

This Tuesday the EU leveled some pretty serious allegations against both Ireland and Apple regarding Irish tax treatment of two Apple subsidiaries. 

Tim Cook, Apple's CEO, is outraged.  With just nineteen eloquent words he both defended Apple's reputation and demolished the EU's apparently baseless allegations. More here.

“When you’re accused of doing something that is so foreign to your values, it brings out outrage in you.”

I've boldfaced a few words above to highlight what I think is the central point in Tim's argument. 

Values!  Values, indeed. 

Where would we all be if people and corporations didn't have values? It isn't and shouldn't be "all about the Benjamins."  There are some principles or values that should guide our lives as individuals and corporations. Character informs the values chosen. And actions more than words demonstrate both character and values. 

That being said, sometimes things are "foreign to one's values".  In AA's experience often when they are foreign (cross-border).

Frankly, since learning about the EU's no doubt intemperate ruling, I've been so outraged that I haven't been able to post. 

But today I'm calm enough to go on record in joining Tim in his outrage, or perhaps, more precisely in outrage.  

In the interest of fairness and to show you how the EU has apparently overstepped the bounds of common sense as well as the sovereignty of Ireland, let's give voice to the EU's allegations.  After reading them, I'm sure you will be as outraged as AA and equally comforted by Tim's eloquence! I've added boldface to some of the text below to highlight the EU's no doubt spurious reasoning and overreach.

"Member States cannot give tax benefits to selected companies – this is illegal under EU state aid rules. The Commission's investigation concluded that Ireland granted illegal tax benefits to Apple, which enabled it to pay substantially less tax than other businesses over many years. In fact, this selective treatment allowed Apple to pay an effective corporate tax rate of 1 per cent on its European profits in 2003 down to 0.005 per cent in 2014."

In fact, the tax treatment in Ireland enabled Apple to avoid taxation on almost all profits generated by sales of Apple products in the entire EU Single Market. This is due to Apple's decision to record all sales in Ireland rather than in the countries where the products were sold. This structure is however outside the remit of EU state aid control. If other countries were to require Apple to pay more tax on profits of the two companies over the same period under their national taxation rules, this would reduce the amount to be recovered by Ireland

The two tax rulings issued by Ireland concerned the internal allocation of these profits within Apple Sales International (rather than the wider set-up of Apple's sales operations in Europe). Specifically, they endorsed a split of the profits for tax purposes in Ireland: Under the agreed method, most profits were internally allocated away from Ireland to a "head office" within Apple Sales International. This "head office" was not based in any country and did not have any employees or own premises. Its activities consisted solely of occasional board meetings. Only a fraction of the profits of Apple Sales International were allocated to its Irish branch and subject to tax in Ireland. The remaining vast majority of profits were allocated to the "head office", where they remained untaxed 

Therefore, only a small percentage of Apple Sales International's profits were taxed in Ireland, and the rest was taxed nowhere. In 2011, for example (according to figures released at US Senate public hearings), Apple Sales International recorded profits of US$ 22 billion (c.a. €16 billion[1]) but under the terms of the tax ruling only around €50 million were considered taxable in Ireland, leaving €15.95 billion of profits untaxed. As a result, Apple Sales International b. In subsequent years, Apple Sales International's recorded profits continued to increase but the profits considered taxable in Ireland under the terms of the tax ruling did not. Thus this effective tax rate decreased further to only 0.005% in 2014.

 The EU has prepared an "infographic" which provides a summary overview of the tax structure.

I trust you share my outrage and Tim's too.   

Interesting New Blog: Uncensored Middle East Monetary Musings

AA Can See All The Way to Dubai and Even Budapest, But Sadly Not Through The Stargate

An interesting new blog:  Uncensored Middle East Monetary Musings.

Take a look.

Finance is Not the Economy

That's Where the Real Thinking is Done

Michael Hudson and Dirk Bezemer published a great article about a week ago on the net "Finance is Not the Economy".  Well worth a read.

The article focuses on one of AA's favorite topics: how the failure to account for the financial sector means that economic analysis is incomplete and therefore incorrect.  That is not to say the economics will ever be more than a best guess. 

A failure on at least two fronts--impact of the financial sector on the economy and the risk of financialization of the economy.

One thing did catch my eye - lack of a reference to Rudolf Hilferding.

APPREHENDED!!!!

Law Enforcement File Photo

Yesterday quick thinking and alert DHS agents prevented a likely tragedy when they intercepted a dangerous individual about to enter the US via Los Angeles International Airport. 

This follows similar captures in White Plains (2012) and Newark, New Jersey (2009). 

While the media has not reported this, AA understands from unreliable sources that a concerned foreign citizen, identified only as a Mr. Salman K., provided the tip that led to this arrest.

Societal Worth of US Big Banks Part II Beyond Advertising

Actions Speak Louder Than Words, At Least That's What Some Folks Say

In a previous post, I noted the advertising campaign that major US banks had launched to rebut no doubt unfair characterization of them as “reckless” and “too big”.

Ads are fine but sometimes the most compelling argument is how you live your life or conduct your everyday business.

Turning back to the Grey Lady’s coverage of this story, a quote from Jamie Dimon of JP Morgan Chase pictured above, doing his best for humanity, sets the stage.

“When Mr. Dimon was asked in February how he would explain to an analyst’s mother-in-law the benefit of being a large bank, he conceded, “We have a hard time explaining those things to the public.”

Mr. Dimon went on to say: “We make loans. We help companies. We help communities. We are the Rock of Gibraltar in the tough times.”    

In just a few powerful words, he’s made the case for the big banks. 

The central justifying theme is “helping”.  Or "doing one's best for humanity" as in an interview with Fox News 13 January 2015 which you can watch here. 

Of course, banks also have a duty to make an honest profit for their shareholders. 

As Krimes v. JPMorgan Chase Bank NA, 2:15-cv-05087, U.S. District Court, Eastern District of Pennsylvania (Philadelphia) no doubt shows there doesn’t have to be a conflict between an "honest" profit and "doing one's best for humanity" or "helping communities".

In 2008 JP Morgan won a no-bid contract to provide ex- convicts from all Federal prisons in the US prepaid debit cards which they could use to withdraw money they had earned in prison or money that had been sent to them while they were incarcerated.

According to Fortune magazine,

“But when the convicts were freed and tried to access their money, they found that they had to pay huge fees for what seemed like ordinary services.

The former prisoners had to pay $24.50 if they wanted to get a lost card replaced quickly; $10 to withdraw money at a teller window; and $1.50 if they didn’t use the account for a month, according to the Financial Times. They even had to pay $0.45—or the equivalent of two hours of work in prison, the FT notes—if they wanted to check their account balances.”

AA side comment: $0.45 doesn't sound like much until you scale the fees to the convicts' wages per hour to get an idea of the relative cost of the service.

Bloomberg quoting an unnamed ex prisoner:

“I left prison with $120,” an unidentified former inmate said in the complaint. “Because of the fees, I was only able to use about $70 of it.” 

More here.    And here.

Success in achieving goals is a function of attitude and aptitude so they tell AA. 

Perhaps, encouragement to "try harder" would be in order as AA is confident in the presence of aptitude at JPMC.

Department of Manifest Absurdity: Big US Banks Launch Ad Campaign to Demonstrate Their Worth to Society

If You Can't See the Obvious Link to Big Banks, Take as Many Looks as You Need Until You Can.

The New York Times reports (and when the NYT reports AA pays more than his useful careful attention even when the  reporting doesn’t cover metals) that big US banks are engaged in a major advertising campaign to demonstrate their societal worth and why they should be more loved

Not one to usually share the spotlight AA will uncharacteristically let the NYT speak for itself.  The Grey Lady’s comments are in quotation marks.  AA’s thoughts are indented and in italics.

“At both the Democratic and Republican conventions, the nation’s biggest banks were again cast as the bad guys, criticized as being too big and too risky.”

AA:  Note the charge “too big” and” too risky”.   How will the banks prove that they’re not reckless and a danger to national economies?   Glad you asked.

“This week, as the Olympic Games begin in Brazil, one of the big banks, Citigroup, is offering a rebuttal with a series of prime-time television and digital ads featuring images of sweaty athletes, the Space Shuttle and an early A.T.M.

[AA: Heartwarming video here, but be warned if you're a sensitive sort, you might break down crying.]

“Our business is helping Americans make progress,” the ad’s narrator says, as a runner with a prosthetic leg sprints down a track.

AA:  Impeccable logic. .Show hard working folks at their tasks which no doubt have something to do with banking.  What precisely isn’t clear.  Used an ATM? Have a credit card?  In any case a powerful rebuttal against "recklessness" and "riskiness". And one which shows big banks’ virtue.  Smart move as I believe there were some no doubt unfounded allegations about big banks’ ethics and morality.

AA understands from thoroughly unreliable sources that JPMorgan is preparing its own commercials.  Jamie Dimon, known for his no nonsense suffer no fools approach, is reportedly going to appear in a series of ads featuring animals.  Among the ads planned, one features Jamie with whales off the coast of London or Washington state (location yet to be finalized).   Another with cuddly puppies, ice cream, and adorable children.   Tag line:  “Banking making a kinder gentler future for all of us”.

As a banker, AA knows the value of getting a fee for advice, but in a spirit of reckless (I am a banker after all) generosity (here the analogy breaks down), some ways this “geometric logic” could be applied to other cases. 

Goldman is reportedly assisting the US authorities with inquiries into its conduct and fees (a cool half a billion) for the US$6.5 billion in notes (bonds to the layman) it arranged for 1MDB in 2012 and 2013.   Two of the note issues were to fund-–well at least partially—1MDB’s acquisition of power generation assets.  AA sees a compelling ad featuring Malaysian farmers toiling alongside their water buffaloes.  Sweaty and tired after a hard day’s work, they settle back to listen to one of the fireside chats given by Malaysia’s prime minister.  One old chap speaks up.  “I remember when we didn’t have power”.  Tears in his eyes, he turns to the camera, “Thank you, Lloyd”.

Several Malaysian businessmen—LOW, TAN, AZIZ--have been charged with misappropriating 1MDB funds (to use the US Department of Justice’s happy turn of phrase).  Some of the funds are alleged to have been used to acquire works of art as well as fund a Hollywood blockbuster.  Key the camera.  The Parthenon, the Coliseum (Rome), Hagia Sophia, the Pyramids.  Voice over by an actor with an appropriately sonorous voice (Morgan Freeman?)  “Culture is what defines a civilization.”  Pictures of The Rjiks Museum, Museuminsel, The Louvre, The Tate, The Metropolitan Museum of Art.  “Reflected in great art that is still accessible to us today.”   Pictures of the three gentlemen named earlier.  “Art patrons before they are businessmen.  Supporting culture in all its forms”.

And then there is the Islamic Republic of Iran.  Perhaps a harder case with some audiences.  I see a testimonial by Candy Charms who recently visited for some cosmetic surgery.  Nose, if you're interested. According to the Mirror, she said.  "Loved Tehran. The people are so kind and generous.  "Really overwhelmed by the whole trip. The people are so amazing.  Tag Line: “Amazing Iran.  Friendly people.  The most advanced medical care at a reasonable cost”.    Let’s go local with the link on this story from Gulf News as the Mirror article is accompanied by some unsuitable pictures.

Public Poll: To Move or Not to Move?

AA has had more than one suggestion that he needs to "keep up with the times" and move his hard hitting blog from BlogSpot to a more congenial and modern venue:  Wordpress.

So if you have a view, please leave a comment.

AA's concerns with the move are all about loss (I just can't seem to shake that "bond guy" appellation no matter how hard I try): 

1. Losing the few regular readers he has in the shuffle.
2. Losing his modest ranking in internet search engines.  Hard won, I might add, over years of diligent hard work that no doubt proves "big banks" are a value to society and deserving of much more love.

Technically the move should be well within AA's modest skills.   And AA has call on some related IT resources if need be.

Also AA keeps a very low profile so don't expect any personal replies.  That doesn't mean offers aren't welcome, just that it pays to be cautious.

1MDB Scandal: "The UAE Connection"

This post deals with the second “phase” of the alleged misappropriation of funds from 1MDB and is based primarily on the US Department of Justice (DOJ) complaint against Red Granite, producers of The Wolf of Wall Street.    (the “Red Granite Complaint” or “Complaint”).   Paragraph not page numbers are used to cite the Complaint.  Where other sources are used, I’ve included links to websites, when possible.

Before I begin one very important note.

The US DoJ has filed complaints.  Certain parties mentioned in the complaints have been accused but have not been convicted of any crime, nor have they had a chance to neither respond to the charges made against them, nor have their responses and the original complaints tested by the judicial process.  At this stage all that can be said is that allegations have been made.  Please bear that in mind as you read this post. 

As before the focus is on connections to the GCC, though AA will be unable to resist excursions off his natural turf should the information be compelling.

In this post, I’ll look at the involvement of IPIC and Aabar, specifically that of two individuals who were officials of those companies at the time of the alleged misappropriation: 

· H.E. Khadem Abdulla Al-QUBAISI, Managing Director of IPIC (until 2015) and Chairman of Aabar (until 2013)  

· Mr. Mohamed Ahmed Badawy Al-HUSSEINY, CEO of Aabar until 2015.

I’d note that both these individuals’ names appear in the Complaint unlike the officers of PetroSaudi International (discussed in an earlier post) who were not explicitly named.

The Aabar Phase – Overview (Paras #9-10 and Paras #112-120)

During 2012, 1MDB raised US$3.5 billion in notes (laymanspeak “bonds”) arranged and underwritten by Goldman Sachs to fund the purchase of energy assets in Malaysia.  There were two issues each for US$1.75 billion.  IPIC guaranteed the issues either “directly or indirectly” as per the Complaint.  (Para 114).  1MDB also provided guarantees because the issuers of the Notes were newly created subsidiaries of 1MDB with no track records of their own.

The Complaint alleges that US$1.367 billion of the proceeds (39 percent of face value and 43 percent of estimated net proceeds) were diverted to a Swiss bank for the account of Aabar Investments PSJ in the British Virgin Islands (Aabar – BVI or BVI).  Despite the similarity to IPIC subsidiaries Aabar Investments and Aabar Investments PSJ, the BVI company was not owned by IPIC or Aabar. 

Funds were later allegedly transferred from the BVI account to an account controlled by TAN Kim Loong, described by the Complaint as an associate of Mr. LOW and further transferred presumably to disguise their origin and then used to acquire assets and transfers were made for the personal benefit of officials at 1MDB, IPIC, and Aabar.

The Aabar Phase Selected Details (Paras #121-227)

May 2012 US$1.75 Billion 5.99% Notes Issue Maturing 2022 (CUSIP XS0784926270)

Paras #122-127:  In order to fund its purchase of power generation assets from Tanjong Power, 1MDB decided to raise70 percent in Malaysian Ringgit (MR) from local banks and engaged Goldman Sachs (GS) to arrange and underwrite the Notes to fund the remainder.  After GS’s fees and transaction expenses, the net proceeds of the US$1.75 billion issue were estimated to be US$1,553,800,000.  Approximately, US$810 million of the proceeds were to be used for the purchase.   The remainder (US$744 million) was to be used for “general corporate purposes, which may include future acquisitions” as per the offering circular.  

AA side comment:  That is, almost half the proceeds were for unspecified “general corporate purposes”.  That pattern continued with the subsequent deals.  A natural question is why 1MDB continued to issue more Notes while accumulating an apparently ever increasing cash hoard.  There is a natural dilemma bankers face in structuring transactions.  The bigger the deal, the bigger the fees and, thus, the larger the personal bonuses.  On the other hand the banker has a duty to both the issuer and investors to ensure that amounts raised are appropriate.

Para #130 – Goldman earned US$192.5 million--11 percent of the Notes face amount--in fees (US$17.5 million) and commissions (US$175million). 

AA Side Comment:  Much has been made of the fees GS made on the three bonds it arranged for 1MDB.  The percentage appears “rich” but Goldman was underwriting the issues.  If it could not place the bonds, then it would wind up owning them itself.  It is also a fact that “debutante” (first time) issuers pay more in interest and fees than more “seasoned” issuers. Besides being a debutante, 1MDB presented a set of issues that increased the riskiness of the deal.  While it is owned by the Malaysian state, 1MDB is not full faith and credit.  As well, 1MDB had a very aggressive (risky) capital structure –one that would delight the heart of the stereotypical Kuwaiti “investor”:  maximum use of OPM --heavy on debt and low on equity.  1MDB’s fiscal year is 31 March so let’s use 2012 financials as a starting point. Then, before the Note issue, equity was already a scant twelve percent of total assets.  Not much structural balance sheet protection for lenders or bond investors.  By 31 March 2013, it was five percent.  Any banker or investor with a modicum of intelligence could have factored in this issue and seen that 1MDB’s already weak credit profile would be weaker after the issue. The riskier the issue, the higher the bankers’ fees. 

1MDB Financials here. 

Paras #129 and #146 – Within one day of closing of the issue (21 May 2012), 1MDB transferred approximately US$577 million to the Swiss account of Aabar Investments PJS – BVI. Note that Tanjong was paid US$650 million (Para #144).

Para #134 – 1MDB granted Aabar Investments PJS – BVI a ten year option to acquire up to 49 percent of these assets for a maximum of MR1,225,000,000.  Note that the compensation for the IPIC guarantee is going to an alleged unrelated party not to an IPIC or Aabar entity.

October 2012 US$1.75 Billion 5.75% Notes Issue Maturing 2022 (CUSIP XS0829573913)

Paras #137-139  This issue also for US$1.75 billion was arranged and underwritten by Goldman, guaranteed by 1MDB with “indirect” guarantee provided by IPIC.  The Notes were to fund the purchase of energy assets from Genting.  Net proceeds after expenses and Goldman’s fees were estimated at US$1,636,260,000 of which US$692,357,340 was for purchase of the Genting assets. As before the rest was for “general working capital purposes”.   Roughly fifty-eight percent of the issue.   This just reinforces the issue above about 1MDB’s real need for such large issues. 

AA Side Comment:  Assuming a rough US$4 million for expenses, as was the case with the first issue, Goldman’s fee was roughly US$110 million, six percent of the face amount of the Notes, and 57 percent of the fee on the first issue.  This validates the comments about debutante issues above. The lower fee may also be due to the support IPIC provided for the issue.  For more on that see below.

Para #141 – 1MDB guaranteed the Notes but IPIC did not.  IPIC “nevertheless agreed to privately secure the bonds on a bilateral basis with Goldman. No reference to IPIC’s indirect guarantee was included in the offering circular.”

AA Side Comment:   If IPIC originally provided credit support to the issue, it would seem that Goldman would have to disclose this to potential investors as a material fact.  However, if the support were in connection with the underwriting, then GS would not have had to disclose this information.  In an offering circular for the 1MDB guaranteed US$3 billion note 2013 issue by 1MDB Global Investments, the second US$1.75 billion is described as guaranteed only by 1MDB.  . 

This is all very strange “privately” securing the bonds “on a bilateral basis with Goldman” sounds as though IPIC is providing support for the underwriting.  This might have been structured as a “put” option.   If GS couldn’t place the Notes, it could exercise the option and “force” IPIC to buy the bonds immediately.  Perhaps, it was structured as a credit default swap, with GS being able to claim after default.  In any case, it doesn’t sound like IPIC’s undertaking extends to holders other than GS.

Para #141 – As compensation for procuring IPIC “indirect guarantee”, Aabar BVI was granted an option to acquire up to 49 percent of the Genting assets for up to ten years.  As the Complaint alleges, BVI is not an IPIC/Aabar entity and thus the compensation owed them was misappropriated.

Para #152 – One day after the second issue closed, 1MDB transferred US$790 million to Aabar BVI’s Swiss account, bringing the total transferred to US$1.367 billion.   Per Para #116, 1MDB recorded these transfers as “deposits” at Aabar Investments PJS in its financial statements. 

Disposition of Funds at Aabar – BVI

As outlined above, the Complaint alleges that US$1.367 billion was transferred to Aabar BVI’s Swiss account.  What happened to the funds?  I’m not going to recite details of the intermediary transfers, though I will make a general comment on the mechanics.

AA Side Comment: Not completely relevant to this post, but interesting.  The names of all the intermediaries allegedly used for the subsequent funds transfers make them sound like investment firms or funds.  (Paras 173-176) Two of them were actual investment funds according to the Complaint.  The Complaint notes that Aabar moved money into these two funds through CITCO.  That’s a tantalizing comment.  It suggests the possibility that these transfers did not pass through normal commercial banking payment channels, that is, Aabar moved funds to its account at CITCO and then instructed CITCO to credit accounts on its books. This would make detection harder.  In any case the use of “investment firms/funds” to move money provides an apparent justification for the transfers: investment firms (not individuals) making investments.  If true, a neat way to disguise the transactions and deflect any AML (anti-money laundering) queries.     

Para #181 and 182– US$473 million in four transfers between 29 May and 30 October 2012 to Bank Privee Edmond de Rothschild Luxembourg for the account of VASCO Investment Services SA, described as “affiliated with AL-QUBAISI” who is the “beneficial owner”.

Para #186  to 189 -US$55 million in four transfers between 29 May and 3 December 2012 to BHF Bank Frankfurt for Rayan Inc.  AL-HUSSEINY is identified as the “beneficial owner”. 

Paras #190-192 - US$11.6 million in two transfers 18 December 2012 and 22 January 2013 to Bank of America Texas for MB Consulting for “Services Rendered” of which AL-HUSSEINY is identified as “beneficial owner and sole signatory.”

Paras #194-196 - US$30 million to AMBank Malaysia for the account of Malaysian Official 1.  As per my post about PetroSaudi International, MO1 would appear to be the current Prime Minister of Malaysia.

Paras #197-198 – US$5 million to Falcon Bank Zurich for account of 1MBD Officer 3 identified as 1MDB’s General Counsel and Strategic Director in Para #27. 

Paras #202 – US$238 million to Red Granite Capital.  A portion of these funds are alleged to have been used to produce The Wolf of Wall Street, acquire assets, and fund a gambling vacation in Las Vegas.

AA Side Comment:  I can’t resist.  According to the Complaint, Paras #222-225 Red Granite transferred US$41 million to Alson Chance (AC) in June 2012.  On 10 July 2012 AC transferred US$11 million to the Venetian Casino in Las Vegas for deposit to LOW’s account.   On 15 July 2012, five days later, an apparently very unlucky LOW withdrew US$1.1 million from the Casino (US$0.5 million for the remainder of the deposit and US$0.65 million for chips.  Of course, gambling is not the only thing that one can spend money on in Las Vegas.  And Mr. LOW was hosting several people, including a former 1MDB officer and a famous movie star. On the other hand, chips are “bearer instruments”.   If I want to pay you, I can give you some chips.  When you cash them in, they are “winnings” and there is no obvious connection to the provider.  

The UAE Connection

Let’s look at some of the allegations made against AL-QUBAISI and AL-HUSSEINY as well as some other UAE connections.   Please note that AA’s comments are not assertions of wrong doing by the individuals named, but rather comments on what the allegations would mean, if they are indeed true. 

Para #115 - H.E. Khadem Abdulla ALQUBAISI and Mohamed Ahmed Badawy AL HUSSEINY were directors of Aabar Investments PSJ-British Virgin Islands, the company allegedly used as the first link the misappropriation of the US$1.367 billion.  They were at the same time officials of IPIC and/or Aabar, entities that were also defrauded in the scheme.  If the allegations are true, then they also participated in weakening 1MDB which could lead to calls under the guarantee.   See Para #162 for 1MDB’s claim that the BVI is indeed owned by Aabar/IPIC. 

Para #125 – When a Goldman MD met with Shaykh Mansour Bin Zayed, the Chairman of IPIC, to discuss the first bond issue, LOW was present, though “not involved in the deal” as “far as” the Goldman MD “was aware”. 

It’s interesting to speculate on how LOW became involved in the meeting.  Introduced by ALQUBAISI?  Direct relationship? 

What are the chances the LOW just popped by when Goldman’s MD came for a no doubt pre-arranged meeting to talk about the transaction?  Another “remarkable coincidence”?  That being said, Sh. Mansour is no doubt a very busy individual with many demands on his time.  Perhaps, he is double booking appointments as way of meeting all those who need to talk with him. 

Paras #131 and 141- 1MDB issued options as compensation for IPIC’s guarantees, but these were granted to the BVI which is not related to either IPIC or Aabar, according to the complaint.   The options granted the BVI the right to buy up to 49% of the two power projects financed with the bonds over a ten-year period.  For the Tanjong option, AL HUSSEINY allegedly signed on behalf of the BVI.  Thus, IPIC/Aabar was also a victim of “misappropriation”.   See also Para #162.

Paras #181-192- As outlined above, ALQUBAISI allegedly received US$473 million and ALHUSSEINY US$66.6 million.

AA Side Comment:  Geez we all want a bit when we retire, but US$473 million? Surely a lot more than 10,000 Swiss Francs a month.  Seems like a rather “princely” sum for a mere “excellency”.   As noted before on this blog, AL QUBAISI acted as an intermediary for Shaykh Mansour Bin Zayed on the Barclays capital raising.  If the 1MDB allegations are true, perhaps, he (QUBAISI, not Sh. Mansour) decided it was time to “wet only his beak”.  Rather a bold and highly risky move by an individual whose continued livelihood in the UAE depends on remaining in Sh. Mansour’s good graces. Sh. Mansour is personally committed to IPIC and the tarnishing of its name in a scandal is no doubt unwelcome as well as what would appear to be betrayal by a very trusted business partner.      

1MDB Scandal: The Curious Case of PetroSaudi International

If You Were Owed $700 Million, What Would You Do?

Much has been written following the US Department of Justice’s 20 July 2016 filing of (at least) sixteen complaints to seize assets alleged to have been purchased with the proceeds of an alleged misappropriation of $3.5 billion from 1MDB, Malaysia’s state-owned strategic investment and development fund.

List of Cases:  CV 16-05362; CV 16-05363; CV 16-05364; CV 16-05366; CV 16-05367; CV 16-05368; CV 16-05369; CV 16-05370; CV 16-05371; CV 16-05374; CV 16-05375; CV 16-05376; CV 16-05377; CV 16-05378; CV 16-05379; CV 16-05380.

Not one to be left behind, I’ll be contributing my own thoughts.

Given the focus of this blog, my initial posts will deal with GCC entities that were involved in transactions with 1MDB and thus may have wittingly or unwittingly participated in the misappropriation.

Unless otherwise noted, the primary source document I’m using is the DOJ complaint against Red Granite, producers of The Wolf of Wall Street (the “Red Granite Complaint” or “Complaint”).  I will cite sources paragraph numbers rather than page numbers as “sourcing” for various points.

Before I begin one very important note.

The US DoJ has filed complaints.  The parties mentioned in the complaints have not been convicted of any crime, nor have they had a chance to neither respond to the charges made against them, nor have their responses and the original complaints tested by the judicial process.  At this stage all that can be said is that allegations have been made.  Please bear that in mind as you read this post.

Let’s start with PetroSaudi International (“PSI”), a privately owned Saudi company founded in 2005, its CEO and founder and a Saudi royal prince described as the “PSI Co-Founder” in the Complaint.  While their names were not disclosed in the Red Granite Complaint, enough information was supplied so that they could be separately identified. 

• PSI’s website identifies Mr. Tarek Essam Ahmed Obaid as CEO and founder. 
• Press reports identify Amir Turki Bin Abdallah Al Saud as the co-founder of PSI.  But note he is not mentioned on PSI’s website.  The second link contains copies of documents from a variety of sources that purport to confirm Amir Turki’s role in the company.
• The Guardian
• The Rakyat Post.

The Complaint alleges that the misappropriation of funds took place in three phases: the Good Star Phase ($1 billion); the Aabar BVI Phase ($1.367 billion) and the Tanore Phase ($1.2 billion).

While I want to focus on what appears to be curious behavior by PSI and its principals in this post, let’s start with some details about the alleged misappropriation to provide context.

The Good Star Phase - Overview

Para #8 - In the Good Star Phase (2009-2011) more than $1 billion was illegally transferred to an account in Switzerland belong to Good Star Limited, which is alleged to have been under the control of LOW Taek Jho instead of to accounts of PSI or the 1MDB/PSI JV.  The transfers were in two tranches: $700 million (2009) and then $330 million (2011) as detailed below.  

First Tranche - $770 Million

Paras #40-112 contain a detailed analysis of the Good Star Phase including the alleged diversion of funds and use of the funds for asset acquisitions and payments to parties involved.

Para #60 – On 30 September 2009 1MDB issued two payment orders to Deutsche Bank Malaysia to pay: (a) $700 million to RBS Coutts Switzerland for the account of Good Star (the alleged fraud) and (b) $300 million to JP Morgan Suisse for the account of 1MDB/PSI JV (the “JV”).  This latter payment appears to be in line with the JV agreement and so is not described as fraudulent in the Complaint.  Note that 1MDB’s instructions did not specify the names of the beneficiary accounts only their account numbers.   

Paras #60-77 detail the compliance questions that Deutsche raised with 1MDB and Malaysia’s central bank and those RBS Coutts raised with Deutsche.  Both banks request the names of the beneficiaries of the payments not just account numbers as identifiers.  As per standard payment protocols, any compliance questions that Coutts had would have to be routed to/through Deutsche, not directly to 1MDB.  1MDB advises the names and that Good Star is owned by PSI.

Paras #81-90 detail questions raised by 1MDB’s Board about the $700 million transaction’s conformity with the JVA, including an unacted upon request that the $700 million be returned and paid “through the originally agreed channel” (Para #85).  This request was apparently turned aside by a 1MDB officer’s statement that funds had been paid to PSI.

Second Tranche - $330 Million

Para#94 – Between 20 May 2011 through 25 October 2011, 1MDB made five payments totaling $330 million to Good Star’s account for drawdowns by the 1MDB/PSI JV under a loan facility provided by 1MDB to the JV in June 2010 (Para #92).  A 1MDB official told 1MDB’s board that the JV had instructed that the payments go to PSI.  Once again the payments went to Good Star.

Curious Behavior by PSI and the PSI Co-Founder

Without prejudging their eventual responses to the Complaint, AA found two incidents of “curious” behavior by PSI and the PSI Co-Founder.

An apparent lack of follow-up on the $700 million shortfall initial JV payment due in September 2009.

Two payments made from the PSI Co-Founder’s account to a high ranking Malaysian official’s account at a Malaysian bank.

Apparent Lack of PSI Follow-Up on the $700 Million JV Payment

Para #52 – As per the JV Agreement 1MDB was to contribute $1 billion to the JV.  As per the Complaint the JV only received $300 million.  I didn’t see anything in the Complaint that PSI, its CEO, or any other PSI official ever contacted 1MDB about the shortfall.  AA finds it rather remarkable (hence this remark) that PSI did not press for the funds, perhaps contacting 1MDB’s Board or as a last resort going public.   A seventy percent shortfall and no apparent complaint.  AA will be mighty interested to read PSI’s response to learn what he’s missing.

Para #96 – In May 2011, the CEO of PSI requested that 1MDB inform Coutts that the first two payments (totaling $95 million) made to Good Star earlier that month were for Good Star and not PSI.  However did the CEO learn about these transfers to an account over which he had no control or ownership?  Even more remarkable at this juncture is that still short a “cool” $700 million from the initial JV payment, he apparently did not ask about the missing funds.  Or perhaps he did. Could it be that the DoJ didn’t consider that relevant to its case?  That seems unlikely because that would provide the DoJ another argument that the $700 million was “misappropriated”.

For the sake of completeness there is perhaps another reason why there was no complaint. Alleged internal PSI documents that were leaked/sold to a Malaysian website opposed to the current Malaysian Prime Minister purport to show the project had zero value. 

See the section below about blackmail.

Alleged Payments from PSI Co-Founder to Private Bank Customer in Malaysia

Para #101 on 18 February 2011 Good Star transferred $12.5 million to the account of the PSI Co-Founder at Riyad Bank.  On 23 February 2011, the Co-Founder’s account transferred $10 million to a private banking account at AM Bank Malaysia for Malaysian Official 1.  On 10 June 2011 Good Star transferred $12 million to the PSI Co-Founder’s same account.  On 13 June 2011 that account made a similar transfer to AM Bank Malaysia.  This formulation is meant to cover the possibility that another party was operating the account under a POA and that the PSI Co-Founder was unaware of and did not approve the transfers.

Para #102 the holder of the account at AM Bank is identified by the DoJ as Malaysian Official 1 who the Complaint alleges was the recipient of a $681 million transfer from Saudi Arabia in 2013.   That would appear to identify the holder as the current Prime Minister of Malaysia.  The Wall Street Journal. 

The reason for the payments from the PSI Co-Founder’s account is not specified in the Complaint.  Perhaps they were gifts as Malaysia’s Attorney General said was the case with the 2013 $681 million. 

Saudi royals would appear to be quite a generous lot.  Perhaps, this as well explains the apparent lack of follow-up by PSI on the “missing” $700 million JV payment.  AA definitely should cultivate more Saudi royal clients, though it would be just my luck that their innate generosity has been tempered by recent and no doubt unwarranted accusations of unethical behavior.

Perhaps like the famous Devonia transaction, the Saudi shaykh bought something from the holder of the AM private bank account and sold it to Good Star.  Shares in Sibneft?

For the sake of considering all the possibilities and not because AA has a suspicious mind, perhaps, it was a kickback of some sort.  Seems a rather meager commission on such a large amount.   Also it seems rather strange to one’s kickback payment transferred to an account in one’s own country easily identifiable.

If indeed it was a kickback, then the roughly 20% “commission” for making the payment is in line with Devonia precedent for the use of “shaykhly” accounts. 

• The Financial Times
• The Independent

Not Relevant But Too “Good” to Omit:  The Independent article claims that at a meeting among Shaykh Sultan, Mr Abramovich and Mr Berezovsky a bank compliance officer asked the good shaykh for a copy of his passport and proof of residence, the shaykh handed him some UAE dirhams and said “my face in on these”.  The article notes a hearty burst of laughter by the participants but is silent on whether other KYC documents were produced.    

Blackmail by Former PSI Employee

Just about one year ago (17 July to be precise), Singapore’s Straits Times reported on the apprehension of a former PSI employee who was arrested by the Royal Thai Police and charged with attempted blackmail of his former employer and the sale of PSI documents to opposition figures in Malaysia. Apparently the individual had secured an earlier payment from PSI.  The payments don’t necessarily prove any wrongdoing by PSI. The earlier payment may have been made for other reasons, e.g., to avoid a scandal that would tarnish one’s name and business opportunities even if it’s not true.

• The Straits Times

These would appear to be some of the alleged PSI documents sold by the former PSI employee.  Note the SR is part of the opposition in Malaysia.

• The Sarawak Report.