ECONOMYNEXT – Sri Lanka’s Perpetual Treasuries Plc, a primary dealer in government securities, had placed bids of tens of billions of rupees at bond auctions without funds of their own and defaulted on cash borrowed from the Central Bank, a leaked report said.
Perpetual Treasuries had won bids for Rs42 billion at a controversial bond auction in March 2016 and defaulted on Rs11 billion taken from the Central Bank, a draft investigation report published on LankaTruth, an online publication, said.
Naked Bets
The report, which the Central Bank acknowledged had been leaked, said placing bets of tens of billions of rupees at auction without money to cover them, endangered the entire government securities market.
The March 2016 bond auctions were among the most controversial, as the state debt office, a unit of the Central Bank, offered Rs65 billion of bonds and accepted Rs127 billion, sending yields soaring.
Rates later plunged, giving billions of rupees in profits to the buyers as prices on the underlying bonds rose.
The report said Perpetual Treasuries made profits of Rs4.6 billion in April and May 2016, buying bonds at rates as high as 14.68 percent, partly leveraged with Central Bank money borrowed at 8.0 and 8.50 percent and selling them off.
This means Perpetual had been borrowing money from the Central Bank at lower rates and loaning it back to the state at almost double the rate, pocketing profits on the way.
Critics had said that offering smaller amounts at an auction, misleading the market and then accepting more bids amounts to a rigging of the auction and favouring those with inside knowledge.
The first such large-scale auction came to public attention in February 2015, although volumes had been varied earlier. In that auction, where Perpetual also figured, money from state-run Bank of Ceylon was used.
Controversial Auction
Perpetual Treasuries is a firm connected to Arjun Aloysius, son-in-law of Sri Lanka’s former Central Bank Governor Arjuna Mahendran, who had denied wrongdoing.
At an auction on March 29, 2016, the Central Bank offered Rs40 billion of bonds, but sold Rs27 billion of bonds over the original volume, giving Rs26.4 billion of securities to Perpetual, the report shows.
The leaked investigation report showed that after offering Rs10 billion of 14-year bonds (maturing in 2030) in March 2016, the Central Bank actually sold Rs28.7 billion worth of bonds, giving Perpetual Treasuries Rs10.31 billion of securities, the entire volume it had asked for and more than the total offered in the maturity.
In 10-year bonds maturing in 2026, it was given Rs7.6 billion of securities, after upsizing the volume sold from Rs10 billion to Rs17 billion. Perpetual had bid for Rs10.3 billion.
Perpetual was also given Rs8.45 billion in 9-year bonds maturing in 2025, after it subscribed for Rs8.6 billion. A total of Rs21 billion of 2025 bonds were sold after only offering Rs10 billion at first.
Perpetual only bid a billion rupees and got only Rs50 million in four-year bonds, where Rs10 billion was offered and Rs10.2 billion sold.
The longer the tenor, the larger the capital gains (and big losses to the state) to be made when rates fall.
In a March 31 auction, Perpetual had not submitted any bids for short tenure two- and four-year bonds. But it had got Rs15 billion of 12-year bonds maturing in 2028, after bidding for Rs15.7 billion. For five-year bonds, the firm had bid Rs5.1 billion and got Rs625 million of securities.
No Funds
The money for the winning bids had to be paid on April 01.
The probe report said the firm had to pay Rs36 billion for the bonds, but it did not have enough funds.
Perpetual Treasuries had asked for Rs22 billion at an open market operations (OMO) cash auction where the Central Bank gives overnight liquidity (printed money) against securities, for banks and dealers who may face a cash shortfall.
During the day on April 01, Perpetual had also borrowed Rs19.98 billion from an intra-day liquidity facility, which has to be settled by the end of the day.
The investigation report said Perpetual was unable to provide securities of Rs11.1 billion to fully cover its bid at the OMO auction to get the cash.
The primary dealer had then defaulted on the Rs11 billion from intra-day liquidity facility. The firm had been fined for both actions.
The report did not say whether it was the first time a bank or a dealer had defaulted on an intra-day liquidity loan and failed to provide securities to cover a deal at the OMO auction.
Risky Deals
The investigation report said Perpetual Treasuries had made large bids at auctions without enough funds to cover them, hurting the entire market.
"Such high risk taking can result in a standalone PD (a primary dealer not connected to a commercial bank) facing liquidity and settlement risks, causing negative consequences on the confidence of the government securities market," the report noted.
Perpetual Treasuries had made profits of Rs4.6 billion in April and May 2016, by borrowing from Central Bank windows, the report said.
From April 1-8, 2016, Perpetual had borrowed Rs66 billion from the Central Bank to fund its portfolio. It was 75 percent of the total borrowings by all primary dealers.
From January 2015 to May 2016, Perpetual had made profits of Rs9.8 billion, the report said.
The profits were also booked by selling the bonds to Pan Asia Bank, DFCC and the EPF. In the case of DFCC and Pan Asia, the firm had bought back securities, sometimes on the same day, which needed to be probed further, the report said.
The report also recommended a deeper probe on the activities of the EPF.
Sri Lanka’s new Central Bank Governor Indrajit Coomaraswamy had already stopped the practice of misleading the market by announcing low volumes and accepting bids for much higher amounts, and has said auctions would be further reformed after looking at international best practices.
The Central Bank said last Friday that its governing board "noted with concern the sharp disparity in the performance of primary dealers" and "certain issues related to the pattern of trading activities."
Meanwhile, a probe report by the Sri Lanka Parliament’s committee on public enterprises is also due to be submitted to the speaker later this month. (Colombo/Oct18/2016)