LehmanÆs structured notes put trustees in the spotlight

HSBCÆs role as trustee is put to the test as recovery work on assets could mount to billions of dollars.
Since Lehman Brothers Asia stopped providing secondary market quotes and liquidity to investors on September 16, retail, institutional and wholesale clients in the region have been scrambling to determine what to do with the outstanding notes still on their hands.

It is anyoneÆs guess as to exactly how much in structured notes Lehman has sold to Asian clients in recent years, when such products boomed in the region. At the market peak of 2006, structured product desks were bringing in billions of dollars of investments from all types of clients.

Enquiries on arrangements for asset recovery by AsianInvestor to distributors and regulators continue to go unanswered. Officials at this stage can only say they are monitoring the situation and talking with the trustees.

HSBC Securities Services is known to be LehmanÆs trustee across multiple jurisdictions in the region. The current crisis will no doubt put its trustee function to its most strenuous test to date. After multiple calls to various business heads of the group, no one has been able to respond to AsianInvestor's question on what contingency plans HSBC has to recover assets for investors.

As previously reported by AsianInvestor, London derivatives clearing house LCH Clearnet had already declared Lehman Brothers International (Europe) in the United Kingdom (responsible for processing guarantee notes) and Lehman Brothers Special Financing SA (its derivatives arm responsible for issuing structured notes) as 'defaulters' on September 15.

WestLB is about to take over Lehman Brothers Financial ProductsÆ portfolios û many of which are SPVs for structured notes û as a pre-arranged contingent manager. Investors will find no comfort in that fact that WestLB will administer the trading book and facilitate an orderly wind-down of the portfolio, but ôassumes no financial responsibility to mitigate or offset credit or market riskö.

Trades with Lehman Brothers Derivative Products, on the other hand, will be closed out. The termination of all positions will occur as of September 23 û after payments to LBDP and counterparties have been made. (Lehman Brothers Special Financing is a sponsor to LBFP, and in turn, LBDP is Lehman Brothers Special FinancingÆs sponsor.)

Many investors hoping to recover assets are now scrutinising the æSAÆ suffix in the company name of Lehman Brothers Special Financing. This identifies the vehicle's final jurisdiction as Belgium, and therefore offshore from the point of view of American bankruptcy courts, where many investors hope the matter will remain.

Rating agency Fitch reaffirmed the triple-A counterparty rating granted to Lehman Brothers Financial Products and Lehman Brothers Derivatives Products today. Fitch says, however, that all its ratings will be withdrawn after outstanding trades in these vehicles are resolved.

As the credit crunch turns into a global panic, rumours are circulating among institutional investors in Taiwan that Citi, Deutsche Bank and Goldman Sachs are providing secondary market quotes and even liquidity to favourite clients for some of these suspended structured notes. These banks are reportedly snapping up these notes at 30 cents on the dollar.

An insurance CIO now looking to offload such products from his portfolio confirms he has so far recovered one-third of the value, and that his juniors are getting unsolicited calls from the banks, but he questions what to make of the quotes. ôThese guys are either desperate to pick up new business, or they are seeing this as a distressed asset.

ôPeople are still hopeful they will be able to recover the assets û at least thatÆs how we look at the situation now. But if this situation continues, this will perhaps go down in future finance textbooks as the cleverest distressed investment scenario known to date. Then we will need to start working on asset recovery with the lawyers and trustees. We havenÆt gone that far yet,ö he says.

In years past, structured notes were sold either through private placements to institutional clients, or through æwhite-labelledÆ or branded products which were packaged for wholesale distributors, which in turn sold them to retail investors.

It is impossible to know how much of their notional value is still outstanding in Asia. Regulators across the region are reassuring market participants that the final impact of the Lehman bankruptcy will be insignificant.

TaiwanÆs Financial Supervisory Commission has been the only regulator in the region so far to come up with exposures among domestic investors: $2.5 billion, split evenly between retail and institutions.

Hong KongÆs Securities & Futures Commission and SingaporeÆs Monetary Authority of Singapore say they are still working with the trustee, HSBC, to identify and price outstanding exposures to Lehman structured products.

JapanÆs Financial Supervisory Authority has responded to the crisis with the most aggressive order in Asia to date. The FSC has issued an asset retention order to stop all capital outflows from LehmanÆs accounts to offshore affiliates of Lehman or other financial institutions.

According to a memo from Lehman's chapter 11 (bankruptcy) filing in the United States, nine out of the 30 largest unsecured creditors of Lehman are Japanese financial institutions, including Mizuho, Nippon Life, Shinsei Bank and UJF, totalling $1.67 billion.
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