Friday, May 21, 2021

Grenke's audit statement

Grenke is a Geman listed (but global) equipment leasing company who has been subject to a short-seller research report (which Grenke supporters call an attack).

Grenke was late to publish an annual report, but they indicated to the market a date in May (today!) when the annual report would be published.

The question was whether - given the rather florid allegations - KPMG would be be prepared to sign the audit report (thus declaring the short-seller allegations false).

On 17 May the company put out a press release stating that they have received an unqualified audit report. The stock rose sharply. You can find an archived copy of the press release here.

The words of the release outlined what the key issue was - trust in a financial institution.

Here is a direct quote:

"We have delivered. With the unqualified audit opinion, we are regaining trust," says Antje Leminsky, Chair of the Board of Directors of GRENKE AG. "Investors, customers and employees can rely on GRENKE."

Below I publish an extract from KPMG's audit report.

I will leave it to you, dear readers, to decide whether Antje Leminsky has regained trust.

Or whether Antje Leminsky is a suitable person to be the CEO of a public company or a company with in excess of a billion Euro in deposit funding. Or whatever you want.



Following the allegations made public by Viceroy Research LLC, Wilmington, Delaware, USA, in the role of a short seller in September 2020, GRENKE AG’s financial reporting as at the immediately subsequent reporting date has a particularly indicative effect from the perspective of the capital market and other key stakeholders. GRENKE AG’s management is aware of this. In this situation it is particularly important that the judgements required for accounting and measurement purposes are not influenced by considerations that are not appropriate. Not least, there is also uncertainty due to the COVID-19 pandemic.

The key audit matters presented below contain manifestations of the risk of misstatements in the financial statements presented here in the introduction, which we address in greater detail in connection with the specific circumstances.

Existence of lease receivables and interest income from the leasing business

In respect of the accounting, recognition and measurement policies relevant to lease income, please refer to the disclosures in the notes to the consolidated financial statements in Section 3.3 ’Leases’, Section 3.16 ’Revenue from contracts with customers’, Section 4.1 ’Net interest income’ and Section 5.2 ’Lease receivables’.

The Financial Statement Risk

In financial year 2020, lease receivables from finance leases amounted to EUR 5,636.3 million and interest income from the leasing business to EUR 457.1 million. Requirements for the recognition of interest income from the leasing business in accordance with IFRS 16 include the transfer substantially of the risks and rewards from finance leases to the customer.

Leasing is the core business of the GRENKE Group; lease income and lease receivables therefore make up a significant share of the statement of financial position and income statement.

There is the risk that the recognised lease receivables do not exist and that the recognition of interest income from the leasing business is not consistent with actual performance and therefore is not presented correctly in the financial statements.

Our audit approach

Based on our risk assessment and evaluation of the risk of material misstatement in financial reporting due to misstatements and violations, we based our audit opinion on both control-based as well as largely on extensive substantive audit procedures. In determining the nature and scope of the required audit procedures and evidence, we also took into account our findings regarding the effectiveness of the overarching IT controls and the external allegations made by Viceroy Research LLC as indicators of an increased risk of material misstatement.

In respect of the existence of lease receivables and interest income, we conducted an assessment of the methods, procedures and control mechanisms used and first evaluated the design, setup and effectiveness of the internal controls for order acceptance, the transfer of the leased asset to customers, and invoicing as well as, in particular, controls concerning the definition and review of the correct or actual time of service performance or the transfer of risks and rewards. In addition, we evaluated to what extent controls implemented in respect of contract initiation and revenue recognition can be overridden by management. To this end, we also involved the auditors of the consolidated subsidiaries.

As part of the audit focus on risk assessment, we drew a sample from the population of all active leases and lease purchase agreements across the Group as at 31 August 2020 and obtained contract confirmations. In addition, we obtained further contract confirmations from the population of all leases and lease purchase agreements of the GRENKE Group as at 31 December 2020. We performed alternative audit procedures for contract confirmations for which we had obtained no answer. We reviewed the incoming payments to the bank accounts of the six most significant companies for all lease payments as at 1 July, 1 August and 1 October 2020. In this regard, the return debits were also reviewed on a sample basis. At the date of the risk assessment and in performing the substantive audit procedures as at the reporting date, we evaluated the existence of lease receivables using the contractual basis, which consists of leases, the accompanying customer handover certificates, external delivery records and/or dealer invoices as well as incoming payments to bank accounts. In addition, we analysed manual lease and lease purchase income entries during the financial year at the level of the Parent Company according to suitable criteria (e.g. users, dates of entry) as well as manual consolidation entries at group level to identify conspicuous entries.

Our observations

The procedure set up within the Group to ensure the existence of lease receivables and that interest income from leases is recognized consistently with the applicable accounting policies is appropriate.

Measurement of impairment losses on non-performing receivables from finance leases

In respect of the accounting and measurement policies applied for non-performing receivables from finance leases, please refer to the disclosures in the notes to the consolidated financial statements under Section 3.18.2 ’Determination of impairment for lease receivables’ and in Section 5.2 ’Lease receivables’.

The Financial Statement Risk

The consolidated financial statements of GRENKE AG recognise non-performing receivables from terminated finance leases of EUR 525.9 million after impairment losses on receivables of EUR 323.0 million. GRENKE AG applied the provisions set forth in IFRS 9 taking into consideration the lifetime expected credit losses to measure non-performing receivables.

Judgement must be exercised by management for the measurement of impairment losses on non-performing receivables from terminated finance leases. This includes selecting the model used for calculating the loss rates of the terminated receivables by determining recoverability rates (ratio of the total of discounted payments received to the entry balance in the respective processing class), the other estimation parameters used in the model and any adjustments to the model due to findings from model validations. These judgements are subject to uncertainty, which can be amplified by the effects of the COVID-19 pandemic.

In addition, calculating impairment loss allowances is highly complex and depends on a high degree of expertise and specialist knowledge from a limited number of employees and decision-makers.

There is the risk for the consolidated financial statements that the calculation of impairment loss allowances is not carried out in an appropriate manner or is based on inappropriate assumptions, an inappropriate database or inappropriate application of the valuation model and, as a result, the impairment loss is reported in an incorrect amount.

Our audit approach

As part of our risk assessment and evaluation of the risk of material misstatement in financial reporting due to misstatements and violations, we conducted a test of design and an evaluation of the methods, procedures and control mechanisms. By inspecting policies and work instructions, conducting interviews and reviewing the defined methods including their implementation, we gained a comprehensive understanding of the calculation of impairment losses on receivables from terminated lease contracts. In addition, we conducted a test of operating effectiveness at the level of the Parent Company. In response to the risk of material misstatement in financial reporting due to violations, we also reviewed the appropriateness of the debt collection process at the parent company level. Due to the ineffectiveness of controls, in particular general IT controls, identified in the course of the test of operating effectiveness, our opinion is based solely on extensive substantive audit procedures. In determining the nature and scope of the required audit procedures and evidence, we also took into account our findings regarding the effectiveness of the overarching IT controls and the external allegations made by Viceroy Research LLC as indicators of an increased risk of material misstatement.

With the involvement of our specialists, we performed the following audit procedures in particular.

We analysed the general suitability of the valuation model used by GRENKE AG to determine the recoverability rates and the suitability of the estimation parameters that are incorporated into the procedure.

In doing so, we investigated whether the key estimation parameters for calculating the recoverability rates have been calculated in a manner that is methodologically correct and mathematically accurate and have been correctly incorporated into the model to determine recoverability rates on non-performing receivables from leases and lease purchase agreements. In addition, we verified the annual validations of the recoverability rates.

We examined and reperformed the preparation of the recoverability rates at the individual transaction level on a sample basis to determine how these are derived for the calculation of the relevant data from the cash flows and balances recorded in the accounts. The recorded cash flows and variables were compared with the contractual basis. The determination of processing classes (payment status of the lease and lease purchase agreements) and the assignment of non-performing receivables to the processing classes was checked for accuracy on a sample basis.

Our observations

The valuation model for non-performing lease and lease purchase receivables is therefore appropriate and consistent with the applicable accounting policies under commercial law. The estimation parameters were appropriately derived. Not all of the key components of the internal control system are appropriate or effective.

Impairment testing of goodwill

In respect of the accounting and measurement policies applied, please refer to the disclosures in the notes to the consolidated financial statements under Section 3.8 ’Goodwill’; for the related disclosures on judgements exercised by management and on sources of estimation uncertainties please refer to the disclosures in Section 3.18 ’Use of assumptions and estimates’ and for disclosures on goodwill please refer to Section 5.7 ’Goodwill’.

The financial statement risk

As at 31 December 2020, goodwill amounted to EUR 43.6 million.

Goodwill is tested for impairment annually at the level of the cash-generating units. In the leasing segment this cash-generating unit generally refers to the business volume represented in the respective sales regions (countries), and usually corresponds to the legal entities.

Calculation of the fair value is complex and, as regards the assumptions made, is dependent largely on estimates and assessments of the Company. This applies particularly to the estimate of future business and earnings performance of the cash-generating units for the next five years and long-term growth rates as well as the determination of the discount rates. The COVID-19 pandemic has had a considerable influence on this year’s market conditions and has increased uncertainty regarding the measurement of goodwill.

There is the risk for the consolidated financial statements that, in this strained period both in economic terms as well as regarding the Company’s reputation, goodwill is reported in an incorrect amount.

Our audit approach

As part of our risk assessment and evaluation of the risk of material misstatement in financial reporting due to misstatements and violations, we conducted a test of design and an evaluation of the methods, procedures and control mechanisms. On the basis of the information obtained in our audit, we evaluated for which goodwill a need for impairment had already been identified and where indications of further impairment exist. Our opinion is based largely on extensive substantive audit procedures.

With the involvement of our valuation experts, we evaluated the appropriateness of significant assumptions and the valuation model of the Company. To this end, we discussed the expected cash flows and the assumed long-term growth rates with those responsible for planning. We reconciled the growth rates recorded in the respective valuation models for the planning years with the group planning adopted by management. We also evaluated the consistency of the assumptions using external market assessments as well as other external data sources.

Further, we confirmed the accuracy of the Company’s previous forecasts by comparing the budgets of previous financial years with actual results and by analysing deviations for deliberate sample of value drivers.

We compared the assumptions and parameters underlying the discount rate, in particular the risk-free rate, the market risk premium and the beta factor, with our own assumptions and publicly available data. To account for forecast uncertainty, particularly in light of COVID-19, we then examined reasonably possible changes in the discount rate, in the expected cash flows or in the long-term growth rate on goodwill (sensitivity analysis) by calculating alternative scenarios and comparing these with the Company’s valuation results. To ensure the mathematical accuracy of the valuation models utilised, we recalculated the Company’s calculations based on elements selected on the basis of risk.

Our observations

The process underlying impairment testing amounts of goodwill is therefore appropriate and consistent with the accounting policies.

The approach as well as the assumptions and parameters used by the Company are therefore appropriate. Not all of the key components of the internal control system are appropriate or effective.

Full identification of related parties and business relationships with related parties from the perspective of financial reporting

For the disclosures on related parties, please refer to the Section 9.5 ’Related party disclosures’ in the notes.

The Financial Statement Risk

In the case of related party transactions, there is a high risk with regard to recognising these transactions in full and determining the economic substance of the transactions and their terms and conditions. The design of the internal control system, including the financial reporting system, must therefore be adequate and effective also in respect of related party transactions. Accordingly, the corresponding requirement under Section 111a (2) sentence 2 of the AktG [Aktiengesetz: German Stock Corporation Act] in conjunction with IAS 24 applies to GRENKE AG with effect from 1 January 2020.

Related parties are relevant for the financial statement audit, as existing relationships or transactions with related parties can have a direct impact on financial reporting. In addition, transactions with related parties may be motivated by personal motives rather than the usual commercial considerations, which could have potential indirect consequences for financial reporting. Furthermore, audit evidence is assigned a higher degree of reliability if it has not been produced or prepared by related parties.

If there are indications of any circumstances that increase the risk of misstatements and violations in relation to related parties beyond the expected scope or that indicate that such misstatements and violations may have occurred, the auditor is required to expand the audit procedures beyond the customary scope or to perform additional or other audit procedures. We have classified the allegations of the lack of transparency expressed by Viceroy Research LLC with regard to links between related parties and GRENKE AG for business reasons, together with other findings from our audit procedures, as indication of increased audit risks.

Therefore, it was of particular relevance for our audit that the internal control system ensures that related parties and relevant business relationships between related parties and GRENKE AG are fully identified and that these parties and business relationship are named in full respectively become fully known based on audit evidence otherwise obtained.

Our audit approach

Based on our risk assessment and evaluation of the risk of material misstatement in financial reporting due to misstatements and violations, we based our audit opinion largely on extensive substantive audit procedures. In the course of the audit, we expanded the nature and scope of our audit procedures by deploying forensic specialists. Forensic aspects that required retracing included key issues that extended beyond the reporting year and the prior year.

Specifically, we performed the following audit procedures:

We conducted an assessment of the methods, procedures and control mechanisms and initially evaluated the design and setup of internal controls in respect of the identification of related parties, the identification and authorisation of related party transactions as well as the evaluation of the arm’s length conditions of these transactions. We interviewed the Board of Directors and Supervisory Board as well as other relevant senior executives within the Company on related parties and transactions conducted with such parties and evaluated committee minutes. We checked the completeness and accuracy of requests and responses sent by the Company to related parties in key management positions regarding disclosures on transactions and engagements. We also obtained confirmations from lawyers.

We received and reviewed a list of related parties prepared by the Company. Our audit resulted in findings that indicate other related parties that have not been identified respectively analysed by the internal control system. To counter the risk of incomplete information due to violations in the documents provided, we conducted forensic investigative procedures in the form of background research on key people and companies going beyond ordinary professional practice. We examined email correspondence and account movements in the accounts maintained by GRENKE BANK AG as well as other business connections of selected persons.

We also compared the analysis of business relationships with identified related parties of GRENKE BANK AG conducted by GRENKE BANK AG for GRENKE AG with the information provided in the queries and investigated deviations. Confirmations of transactions were obtained from selected – in particular newly identified – related parties. Similarly, we evaluated the state of knowledge and preliminary findings from other external audits that were accessible to us.

We examined the findings obtained in the course of the expanded audit overall in terms of their impact on GRENKE AG’s financial reporting and assessed their implementation.

Our observations

The internal control system for identifying related parties and business relationships with these parties was not effective in all key aspects. By means of the audit procedures conducted in response to the risks identified regarding complete identification of related parties and business relationships with these parties during the audit, we obtained audit evidence that is sufficient and appropriate to serve as a basis for our audit opinion. Based on the findings obtained in the audit, consequences for financial reporting were therefore appropriately derived and implemented.

Completeness of the consolidated group with regard to franchise companies

For the relevant disclosures on the consolidated group, please refer to Section 2.3 ’Adjustments in accordance with IAS 8’ and Section 10 ’Overview of the GRENKE consolidated group’s schedule of shareholdings pursuant to Section 313 (2) HGB’ in the notes to the consolidated financial statements.

The Financial Statement Risk

Due to a wide range of contractual relationships with franchise companies, the GRENKE Group has a complex group structure.

The assessment of whether there is a requirement to consolidate franchise companies pursuant to IFRS 10 requires significant judgement as many factors (potential voting rights, relevant activities, power, variable returns and the connection between power and variable returns) need to be assessed using in-depth analyses. This includes contractual rights, cash flows from contracts, contractual relationships with third parties and shareholders, the nature and scope of financing and guarantees granted and a comprehensive economic assessment. There is also the risk that not all information required for a proper overall assessment is retained and properly communicated and that, as a result, this information is not appropriately taken into account in the preparation of the financial statements and for the purposes of the audit.

There is the risk for the consolidated financial statements that, due to undisclosed relationships between the parties involved or incorrect use of judgement in assessing the factors to be taken into account according to IFRS 10, individual companies that require consolidation (in particular franchise companies) are not taken into account when determining the consolidated group and required disclosures in the notes are omitted. We have classified the allegations expressed by Viceroy Research LLC regarding the completeness of the consolidated group, together with findings from other audit procedures, as indication of increased audit risks.

Our audit approach

Based on our risk assessment and evaluation of the risk of material misstatement in financial reporting due to misstatements and violations, we based our audit opinion largely on extensive substantive audit procedures. In the course of the audit, we expanded the nature and scope of our audit procedures by deploying forensic specialists. Forensic aspects that required retracing included key issues that extended well beyond the reporting year and the prior year.

We largely performed the following audit procedures:

Based on the findings obtained in the past, we conducted an updated assessment of the consolidation requirement in accordance with IFRS 10. We evaluated the internal memoranda of  GRENKE AG on the analysis of consolidation in light of new findings and analysed the franchise, option, guarantee and credit agreements between the GRENKE Group and the franchise companies to determine whether they substantiate power, variable returns and whether the connection between these two attributes is relevant for consolidation. 

In addition, we assessed the external expert opinions and preliminary findings from other external audits regarding a potential consolidation requirement that were made available to us during the audit and discussed the assessments contained therein with the authors. Furthermore, we interviewed the Board of Directors and Supervisory Board of  GRENKE AG as well as other persons familiar with the franchise system. We analysed the cash flows between the franchise companies with their investees and  GRENKE AG. As new documents and findings obtained during the audit gave rise to significant doubt regarding information received at an earlier date, we analysed the email correspondence of selected individuals for indications of the exercise of factual power with the help of our forensic specialists and conducted background research.

To review the implementation of changes to the consolidated group in financial year 2020, we exclusively conducted substantive audit procedures.

Our observations

The internal control system for assessing a consolidation requirement for franchise companies was not effective in all key aspects. By means of audit procedures performed by us during the audit, we obtained audit evidence that was sufficient and appropriate to provide a basis for our audit opinions. Based on the findings obtained, consequences for financial reporting were appropriately derived and implemented by  GRENKE AG.

Other Information

Management respectively the Supervisory Board are responsible for the other information. The other information comprises the components of the combined management report specified in the appendix to the independent auditor’s report, whose content was not audited. 

The other information also comprises the other parts of the annual report. 

The other information does not include the consolidated financial statements, the combined management report information audited for content and our auditor’s report thereon. 

Our opinions on the consolidated financial statements and on the combined management report do not cover the other information, and consequently we do not express an opinion or any other form of assurance conclusion thereon. 

In connection with our audit, our responsibility is to read the aforementioned other information and, in so doing, to consider whether the other information

//  is materially inconsistent with the consolidated financial statements, with the combined management report information audited for content or our knowledge obtained in the audit, or 

// otherwise appears to be materially misstated. 

Responsibilities of Management and the  Supervisory Board for the Consolidated  Financial Statements and the Combined  Management Report

Management is responsible for the preparation of consolidated financial statements that comply, in all material respects, with IFRSs as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) HGB and that the consolidated financial statements, in compliance with these requirements, give a true and fair view of the assets, liabilities, financial position, and financial performance of the Group. In addition, management is responsible for such internal control as they have determined necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, management is responsible for assessing the Group’s ability to continue as a going concern. They also have the responsibility for disclosing, as applicable, matters related to going concern. In addition, they are responsible for financial reporting based on the going concern basis of accounting unless there is an intention to liquidate the Group or to cease operations, or there is no realistic alternative but to do so.

Furthermore, management is responsible for the preparation of the combined management report that, as a whole, provides an appropriate view of the Group’s position and is, in all material respects, consistent with the consolidated financial statements, complies with German legal requirements, and appropriately presents the opportunities and risks of future development. In addition, management is responsible for such arrangements and measures (systems) as they have considered necessary to enable the preparation of a combined management report that is in accordance with the applicable German legal requirements, and to be able to provide sufficient appropriate evidence for the assertions in the combined management report.

The Supervisory Board is responsible for overseeing the Group’s financial reporting process for the preparation of the consolidated financial statements and of the combined management report.

Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements and of the Combined Management Report

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatements, whether due to fraud or error, and whether the combined management report as a whole provides an appropriate view of the Group’s position and, in all material respects, is consistent with the consolidated financial statements and the knowledge obtained in the audit, complies with the German legal requirements and appropriately presents the opportunities and risks of future development, as well as to issue an auditor’s report that includes our opinions on the consolidated financial statements and on the combined management report.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Section 317 HGB and the EU Audit Regulation and in compliance with German Generally Accepted Standards for Financial Statement Audits promulgated by the Institut der Wirtschaftsprüfer (IDW) will always detect a material misstatement. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements and this combined management report.

We exercise professional judgement and maintain professional scepticism throughout the audit. We also:

//  Identify and assess the risks of material misstatement of the consolidated financial statements and of the combined management report, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinions. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls.

//  Obtain an understanding of internal control relevant to the audit of the consolidated financial statements and of arrangements and measures (systems) relevant to the audit of the combined management report in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of these systems.

//  Evaluate the appropriateness of accounting policies used by management and the reasonableness of estimates made by management and related disclosures.

//  Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in the auditor’s report to the related disclosures in the consolidated financial statements and in the combined management report or, if such disclosures are inadequate, to modify our respective opinions. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Group to cease to be able to continue as a going concern.

//  Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements present the underlying transactions and events in a manner that the consolidated financial statements give a true and fair view of the assets, liabilities, financial position and financial performance of the Group in compliance with IFRSs as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) HGB.

//  Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express opinions on the consolidated financial statements and on the combined management report. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our opinions.

//  Evaluate the consistency of the combined management report with the consolidated financial statements, its conformity with law, and the view of the Group’s position it provides.

//  Perform audit procedures on the prospective information presented by management in the combined management report. On the basis of sufficient appropriate audit evidence we evaluate, in particular, the significant assumptions used by management as a basis for the prospective information, and evaluate the proper derivation of the prospective information from these assumptions. We do not express a separate opinion on the prospective information and on the assumptions used as a basis. There is a substantial unavoidable risk that future events will differ materially from the prospective information.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide those charged with governance with a statement that we have complied with the relevant independence requirements, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, the related safeguards.

From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter.

Other Legal and Regulatory Requirements

Report on the Assurance in accordance with Section 317 (3b) HGB on the Electronic Reproduction of the Consolidated Financial Statements and the Combined Management Report Prepared for Publication Purposes

We have performed assurance work in accordance with Section 317 (3b) HGB to obtain reasonable assurance about whether the reproduction of the consolidated financial statements and the combined management report (hereinafter the “ESEF documents”) contained in the file that can be downloaded by the issuer from the electronic client portal with access protection, “” (SHA256-Hashwert: d577ebf4cbcbacfa 0e8f547d80d80f4ba50fd9aa1f0ff2f2232e8144354793ad) und “JALA.xhtml” (SHA256-Hashwert: ae60422dc28df11cf97b491817b5b5051fd515478007ecc79816ba9de33fc535), and prepared for publication purposes complies in all material respects with the requirements of Section 328 (1) HGB for the electronic reporting format (“ESEF format”). In accordance with German legal requirements, this assurance only extends to the conversion of the information contained in the consolidated financial statements and the combined management report into the ESEF format and therefore relates neither to the information contained in this reproduction nor any other information contained in the above-mentioned electronic file.

In our opinion, the reproduction of the consolidated financial statements and the combined management report contained in the above-mentioned electronic file and prepared for publication purposes complies in all material respects with the requirements of Section 328 (1) HGB for the electronic reporting format. We do not express any opinion on the information contained in this reproduction nor on any other information contained in the above-mentioned file beyond this reasonable assurance opinion and our audit opinion on the accompanying consolidated financial statements and the accompanying combined management report for the financial year from January 1 to December 31, 2020, contained in the “Report on the Audit of the Consolidated Financial Statements and of the Combined Management Report” above.

We conducted our assurance work on the reproduction of the consolidated financial statements and the combined management report contained in the above-mentioned electronic file in accordance with Section 317 (3b) HGB and the Exposure Draft of the IDW Assurance Standard: Assurance in accordance with Section 317 (3b) HGB on the Electronic Reproduction of Financial Statements and Management Reports Prepared for Publication Purposes (ED IDW AsS 410) and the International Standard on Assurance Engagements 3000 (Revised). Accordingly, our responsibilities are further described below. Our audit firm has applied the IDW Standard on Quality Management 1: Requirements for Quality Management in Audit Firms (IDW QS 1).

The Company’s management is responsible for the preparation of the ESEF documents including the electronic reproduction of the consolidated financial statements and the combined management report in accordance with Section 328 (1) sentence 4 item 1 HGB and for the tagging of the consolidated financial statements in accordance with Section 328 (1) sentence 4 item 2 HGB.

In addition, the Company’s management is responsible for the internal controls they consider necessary to enable the preparation of ESEF documents that are free from material intentional or unintentional non-compliance with the requirements of Section 328 (1) HGB for the electronic reporting format.

The Company’s management is also responsible for the submission of the ESEF documents together with the auditor’s report and the attached audited consolidated financial statements and audited combined management report as well as other documents to be published to the operator of the German Federal Gazette [Bundesanzeiger].

The Supervisory Board is responsible for overseeing the preparation of the ESEF documents as part of the financial reporting process.

Our objective is to obtain reasonable assurance about whether the ESEF documents are free from material intentional or unintentional non-compliance with the requirements of Section 328 (1) HGB. We exercise professional judgement and maintain professional scepticism throughout the assurance work. We also:

//  Identify and assess the risks of material intentional or unintentional non-compliance with the requirements of Section 328 (1) HGB, design and perform assurance procedures responsive to those risks, and obtain assurance evidence that is sufficient and appropriate to provide a basis for our assurance opinion.

//  Obtain an understanding of internal control relevant to the assurance of the ESEF documents in order to design assurance procedures that are appropriate in the circumstances, but not for the purpose of expressing an assurance opinion on the effectiveness of these controls.

//  Evaluate the technical validity of the ESEF documents, 

i.e. whether the electronic file containing the ESEF documents meets the requirements of Commission Delegated Regulation (EU) 2019/815 on the technical specification for this electronic file.

//  Evaluate whether the ESEF documents enable an XHTML reproduction with content equivalent to the audited consolidated financial statements and the audited combined management report.

//  Evaluate whether the tagging of the ESEF documents with Inline XBRL technology (iXBRL) enables an appropriate and complete machine-readable XBRL copy of the XHTML reproduction.

Further Information pursuant to Article 10 of the EU Audit Regulation

We were elected as auditor at the Annual General Meeting on 6 August 2020. We were engaged by the Supervisory Board on 18 September 2020. We have been the auditor of  GRENKE AG since financial year 2018.

We declare that the opinions expressed in this auditor’s report are consistent with the additional report to the Audit Committee pursuant to Article 11 of the EU Audit Regulation (long-form audit report).

In addition to the financial statement audit, we have provided to the Company and its controlled entities, respectively, the following services that are not disclosed in the consolidated financial statements or in the combined management report:

//  Reasonable assurance pursuant to ISAE 3000 involving specific audit procedures on leases of  GRENKE AG in Q4 2019 and Q1 2020

//  Agreed-Upon Procedures Report pursuant to ISRS 4400 on agreed-upon procedures on leases of  GRENKE AG in Q2 and Q3 2020

//  Issue of comfort letter for the update of the EUR 5,000,000,000 debt issuance programme.

//  Issue of a comfort letter for the hybrid bond of EUR 75,000,000.

German Public Auditor Responsible for the Engagement

The German Public Auditor responsible for the engagement is Christian Bauer.

Frankfurt am Main, May 17, 2021


Wirtschaftsprüfungsgesellschaft [Orginal German version signe by:] gez. Bauer  Wirtschaftsprüfer gez. Göller  Wirtschaftsprüfer

Appendix to the Independent Auditor´s Report: unaudited components and cross-refences of the combined management report

We did not audit the following components of the combined management report:

//  the corporate governance statement contained in the combined management report in section 9 and

//  the non-financial statement contained in section 4 of the combined management report.

The following cross-references in the combined management report that are not required by law and the information to which the cross-references refer, have not been audited by us: 

//  In the introduction to the combined management  report: berichte-und-praesentationen 

//  In section 2.7.5 “LIQUIDITY” of the combined management report https://www. investor-relations/fremdkapital/emittierte-anleihen

//  In section 9.5 “SHARE TRANSACTION OF GOVERNING BODIES” of the combined management report: www. corporategovernance/meldepflichtige-wertpapiere

//  In section 1.3 “MANAGEMENT SYSTEM” depicted key performance indicators.

Saturday, May 8, 2021

How big is this crypto boom?

Google Trends doesn't predict stock market rallies, well somtimes it does. But more likely it is coincident with them, the suckers at the end of the boom being the biggest (yet) wave of retail buyers.

Here is a five year trend for the phrase "how to buy stocks" for the USA.

It has two peaks, one at the height of the first COVID lockdown, and a second and bigger peak at the height of the "meme-stock" rally in January.

The meme stocks haven't gone away, but most of them are well off their Mid February levels.

Still I can't resist the comparison. Here is "how to buy stocks" compared to "how to buy dogecoin" - again in the USA.

It is not even close.

This should give you some pause as to just how much money might pour into this rally.

I am old - even decrepit - and I do not understand. So I am going to leave it to someone else to explain to you. (And please appreciate the Matt Gaetz reference...)


Friday, April 30, 2021

The tough task facing the Australian securities regulator

Australia has several jurisdictional issues that make it a haven for corporate criminals. These features are sometimes for better, sometimes for worse, but they leave the securities regulator with a task considerably harder than any similar sized country.

Feature one: compulsory privatised pensions (called superannuation)

Australians are forced to save almost ten percent of their salary into lock-box savings accounts that they cannot touch until retirement. 

Twenty year olds are locking up tens of thousands of dollars that they cannot see, cannot touch and cannot benefit from for decades. They naturally enough become disengaged from this money.

This is real money though - and collectively it adds up to over a trillion dollars.

Bluntly - this is the biggest pool of disengaged money on the planet - with large amounts of financial assets held by people of middling to no financial sophistication.

Financial institutions in Australia have been fattened on fees from these collected savings. I personally have been a beneficiary.

That said these savings have attracted fraudsters, sometimes on a grand scale. I was quite publicly the person who reported one of the biggest frauds - when organised crime looted hundreds of millions of dollars raised by a fund manager called Astarra/Trio. Privately I have reported other frauds some of which ASIC (our securities regulator) has acted on.

Feature two: very plaintiff friendly defamation laws

Australia has some of the most plaintiff friendly defamation laws on the planet. There is a reason why I will not tell you which other frauds I reported to ASIC. The perpetrators would sue me (and may succeed even though the client money is mostly gone).

So far the most prominent people who have successfully blown the whistle on Australian frauds publicly are American short-sellers who write a reports and then hide in America - safe behind the American First Amendment and their freedom of speech. 

Major frauds in Australia have been well known for years by market participants who simply could not say anything because of the enormous power of Australian defamation laws. For example Dominic McCormick knew about Astarra Trio for years before he tipped me off. And he said nothing in part because he was scared of being sued.

Feature three: a historically weak securities regulator (ASIC) and low sentences

You would be blind if you did not notice that ASIC has a poor record of prosecuting securities fraud. So few people have been to prison for what is straight theft it is laughable. When they do get a prosecution sentences are sometimes ludicrously low. Shawn Richard from Astarra/Trio for instance ran an entirely fake funds management company for many years which simply took client money and wired it overseas. He got some of it diverted to a Lichtenstein bank account. He got two and a half years. In the US he would have got over twenty.

The Newly appointed Securities Regulator chair

The Australian Government has just appointed a new chair of ASIC and I am scared.

The appointment is Joe Longo who actually worked when (much) younger at the regulator he now leads. 

Much more controversially he was a senior corporate lawyer at Deutsche Bank for seventeen years when Deutsche Bank was the most scandal ridden and blatantly criminal investment bank on the planet.

I am not saying anything particularly controversial about Deutsche Bank. They have paid over USD15 billion in fines

Joe Longo was a lawyer there through most of that.

I know nothing about him. For all I know he may have been trying to reform the bank from within. 

Or he may not have. I genuinely do not know and the case has not been made.

But Deutsche was so bad that a senior corporate lawyer would have spent years gasping for breath has he was immersed in one pool of pus after another. It was not pretty.

Appointing a Deutsche Bank in-house lawyer to run your securities regulator is - politely - a brave political appointment. Heroically brave. Far braver than I expected from Josh Frydenberg - the relevant Australian Minister.

Poacher turned gamekeeper

I am not totally without hope though. Many a poacher has become an effective gamekeeper.

The US has more of a tradition of noblesse oblige than Australia and sometimes US government appointments come from skimming the top of the barrel. The average Goldman partner for instance would have the skills to be a very good securities regulator and some former Goldman staff have become very fine public servants.

I genuinely hope Joe Longo, with his long history of swimming through Deutsche Bank's pools of pus, lives up to his promise. Because the costs of failure are high. 


PS. To illustrate the costs of failure - about 300 million dollars were stolen in the Astarra/Trio debacle. $200 million of that was compensated by government - the money effectively taken from other pensions/superannuation accounts. There is no reason why this cannot be ten times or a hundred times larger, and if the regulator fails it will be a hundred times larger. Refunding money stolen by organised crime is not where I want my taxes to go.

Monday, March 22, 2021

How big is the Greensill problem at Credit Suisse?

The franchise of Swiss Banks has historically been access to large numbers of seriously high net worth individuals and stuffing them full of "product".

The "product" is both third party and internal, but the internal stuff is where the profits are, but also where the conflicts of interest are.

And it is where the scandals are too. 

But it is a model that Credit Suisse has embraced. Famously Credit Suisse embraced the "One Bank" model on the basis that the private banking clients benefit from expertise over the whole bank. And at its best that is true.

And Credit Suisse have truly embraced it. 

When CS won Risk Magazine's Private Bank of the Year award in Asia last year they highlighted it. To quote:

In bringing value to local markets, Credit Suisse has another advantage, too: its ‘One Bank’ approach, in which the investment banking desk and the wealth management desk collaborate to a far greater extent than many other organisations. 

“Our success is defined by the degree of our collaboration,” says Cavalli. “And if you are a client, you feel this because you have the entire orchestration of the capability of the bank coming around you. This helps us to be early in identifying a client’s needs – when they are just starting their journey as an entrepreneur, and need structures for monetising illiquid assets – to when they are more established, and start having cash and liquid assets to manage.”

Embracing the synergies between the various divisions is what Credit Suisse is all about.

Until now.

Until Greensill.

To quote a Bloomberg article that had me falling off my chair:

Credit Suisse CEO Thomas Gottstein signaled he’d consider further separating the asset-management unit from the rest of the bank after the Greensill Capital collapse, as he steps up efforts to limit the reputational damage from the supply-chain finance scandal.

Making asset management an independent entity is “potentially part of the plan,” Gottstein said in a Bloomberg Television interview, days after the bank replaced the head of the business and removed it from direct oversight of the wealth management unit. “Having a holding company around that could be something we are pursuing,” he said, adding that the Greensill affair for Credit Suisse is primarily an asset-management problem.

Get this: over Greensill, a seemingly irrelevant trade finance firm, Thomas Gottstein will dismantle the classic model of Swiss Private Banking at Credit Suisse.

Like really.

If this were a billion dollar issue it is obvious what Credit Suisse would do. It would sign the check and move on. And blame previous management.

For this to the rational course of action (or even an action that warrants considering) the Greensill problem must be big. Really big. Like huge.

So let's have a proper disclosure. And start provisioning - because at this point Credit Suisse are talking down the issue (telling us Greensill is but a scratch) but simultaneously deciding to destroy their own business model to excise the cancer.

Like wow.


PS. Credit Suisse One Bank strategy is real. There are two problems with One Bank done with the consistency of Credit Suisse and they both apply to Greensill.

a). Every division assumes that the appropriate due diligence on Greensill (or any other client) was done elsewhere, with the effect that proper diligence never happens and

b). Every division of the "One Bank" will be implicated.

Thomas Gottstein, "One Bank" means you own this problem. Now it is time to be straight with us and your clients.


Friday, March 12, 2021

Greensill - who is holding the bag - part two

 Insurance Australia Group reacted to my last  post by stating that they carried no net risk. It was all reinsured to Tokio Marine (the big Japanese insurer).

Here is their statement in full:

In response to market enquiries relating to Greensill exposure, IAG clarifies it has no net insurance exposure to trade credit policies including those sold through BCC to Greensill entities.  

IAG sold its 50% interest in BCC on 9 April 2019 to Tokio Marine Management (Australasia) Pty Ltd with the result of eliminating net exposure to trade credit insurance.

BCC is an underwriting agency that was authorised to underwrite trade credit insurance on IAG’s behalf through Insurance Australia Limited (IAL), one of IAG’s two licensed insurance subsidiaries in Australia. 

As part of a transition arrangement after the April sale of BCC, new policies were underwritten by IAL from the date of sale up to 30 June 2019 and Tokio Marine & Nichido Fire Insurance Co. Ltd  (Tokio Marine) retained the risk for these polices, net of reinsurance.

In addition to extensive reinsurance placed by IAG, as part of the sale IAG entered into agreements with Tokio Marine for it to hold any remaining exposure to trade credit insurance written by BCC through IAL.

IAG thus say they have no "net exposure".

The summary of this press release is that Insurance Australia Group were once taking risks (on Greensill) that could kill them but they do not take them any more and any risk they have they have passed off to Tokio.

Teenagers (especially teenage boys) take risks that could kill them. Then usually they stop and they are okay. Sounds familiar. 

The IAG as stupid teenage boy now grown up meme is one that I could get behind. 

And I can't reasonably complain about it either. I was once a teenage boy and am familiar with the process of growing up.

The only problem with this statement is that Tokio Marine say they are not liable. There is an article in the Financial Times where Tokio do not think that these policies will impact them in any meaningful way.

The money quote though is this:

People with direct knowledge of Tokio Marine’s situation said the Greensill issue was dominating the attention of top management. They added that there was a working assumption that many of the questions being asked would ultimately be answered by expected litigation proceedings in Japan, Australia and possibly Germany.

Tokio Marine said it remained “ready to protect its interests in court as required”.

The highlighted section could be very nasty for Insurance Australia Group.

You could see a situation where the primary insurance is determined to be valid and Insurance Australia Group get a ten figure judgement against them. (After all the amount insured is many billions of dollars and the more we find out about Greensill the uglier it looks.)

Insurance Australia has to front the money, and they have a claim against Tokio. It may even be a valid claim, but Tokio may protect their "interests in court as required". That could be very ugly for Insurance Australia as they would be ten figures out of pocket until they win their claim against Tokio.

I am not sure how that would affect their regulatory capital situation. 

Whatever - methinks it is likely that IAG will (eventually) get out of much (probably all) of their BCC liability. I see little reason to doubt their statement that they have no net exposure - although they clearly have large, thinly disclosed gross exposure and some legal risk.

Credit Suisse

Credit Suisse according to the FT is still working on the assumption that the funds are insured. To quote:

A person briefed on Credit Suisse’s stance said the bank was “working under the hypothesis” that the insurance policies would pay out in the event of a default, as they had done in the case of NMC Health, the former FTSE company that collapsed last year. But they added: “This is one of the big questions outstanding.”

We are about a week into the speculation here, and as far as I can tell we still do not know who is holding the bag.

But my working hypothesis is that IAG will face large lawsuits with uncertain outcomes and where disasters are possible. The defining disaster being they are held liable on primary policies but the reinsurance policies somehow fail. The scale of legal risks however are large enough to threaten IAGs solvency.

But at the end of the day IAG will probably skate through, and meanwhile Credit Suisse will have to operate where they do not know whether the funds are insured or not - and will wind up having to take large provisions anyhow. 

So far the stock market thinks that this isn't quite as bad as it appears to me. But that is the difference between a bull market and a bear market. In a bull market nobody is carrying the risk and nobody gets marked down. In a bear market everyone is carrying the risk and everyone is marked down.


Monday, March 8, 2021

Greensill - who is holding the bag?

There has been much fabulous reporting in the lead-up to the collapse of Greensill, the eponymously named Australian domiciled but London headquartered supply chain financier. But if you want guidance start with anything by Duncan Mavin (from the Wall Street Journal) or Robert Smith sometimes with Olaf Storbeck (at the Financial Times).

The excellent work of these journalists is now on the front page above the fold. It is not everyday a globally significant financial institution fails, and it is rarer still that this collapse happens within a couple of percent of all time highs in markets.

There has been remarkably little coverage of where the losses (which will be enormous) will sit.

I do not know either. But I am a short-seller at heart and trying to work this out seems like a core task for me. 

I will start my speculations at home in Australia.

In late November 2020 I wrote a letter to the Australian Prudential Regulatory Authority (APRA) about the credit risk that Insurance Australia Group was taking on Greensill. Here is that letter (which given outcomes looks rather on point). 

This letter is slightly modified, correcting punctuation and having some redactions.

Greensill and Insurance Australia  Group 

First - you need to know what Greensill and Lex Greensill are.

Lex is a controversial and aggressive factoring/supply chain/trade finance financier. Possibly the most controversial one in the world.

He is an Australian - bought up on a farm near Bundaberg in Queensland - and the parent company is Australian domiciled and still has a Bundaberg address.

The enterprise however is vast - and - by far - the biggest company headquartered in Bundaberg. 

The official version piles on the humble origins.

The unofficial versions focus a little on the indulgences, the family jets etc. Though apparently (and according to one of the articles attached) he is selling the fleet of private jets (four of them) as he takes money from Softbank.


Greensill is controversial. They financed the fraudulent NMC Health. 

More publicly they were involved in the collapse of the GAM funds that was widely publicised.

In that case the fund manager Tim Hayward overloaded his fund with Greensill paper at valuations some considered questionable.

Since Hayward's fund collapsed there have needed to be new large-scale sources of finance.

The biggest of these is that Greensill bought control of a tiny (and failing) German bank, recapitalised it, took a huge pile of brokered deposits (by paying about 100-120bps over) and either bought Greensill receivables or pledged bank assets to get letter of credit capacity to support Greensill activities.

The annual report for the bank (alas in German) is attached. The bank assets are largely "insured" but we cannot tell who they are insured by.

What we can see is the Credit Suisse fund that has deep Greensill relations (and is also the subject of this excellent article in the WSJ -

I have attached a letter from the Credit Suisse Supply Chain Finance Fund. A good way to start would be to get EVERY letter and prospectus from this fund and any other Credit Suisse fund with a decent Greensill exposure.

The fund is USD5667 in size - as per this cut-and-paste.

Other than 10 percent US Treasury holding it is diversified as to the countries that the assets are from and the industries that they are in.

But it is not diversified as to the the source of these assets (Greensill, Greensill and Greensill as far as I can tell) or the source of the insurance on these assets.


It is 56.1 percent Insurance Australia Ltd as per the following.

Now that is USD3.18 billion in exposure - just through one fund. That is AUD4.4 billion.

That is just the Insurance Australia exposure I can find.

I am assured the bank assets are also largely insured - but I cannot find who the insurer is.

So you would think that this is a disclosable large exposure to a single controversial financier. But the only statement in the IAG annual report is as follows:

That is it. They say it is in run-off. They feel no need to disclose a multi-billion dollar exposure to a questionable credit/s.

The only problem is that no insurer (other than Tokio Marine) seems to insure for them any more and the amount insured is rising fast.

I think the insurance is written at a broker in Sydney:

This entity used to be owned by IAG and Tokio Marine - but IAG sold their bit to Tokio Marine. However the insured amounts keep going up (at least the bits I can find) even though IAG say the thing is in run-off.


I have some hypotheses. Either

a) An amount - at least 4.4 billion - but possibly much higher - is insured by IAG. Given the size (say 50 plus billion) and controversy of Greensill this is potentially a solvency risk for IAG.

b). Greensill is faking IAG insurance policies - and the amounts are not insured by IAG but Greensill says they are. In which case the German Bank (taking all those insured bonds) is facing solvency risk - and you should be talking to your German counterpart.

c). The Credit Suisse documents are fake. I think this unlikely but cannot dismiss it.

Either way it is one of the uglier situations I have seen lately.


APRA (and to the extent I talked to them the Australian Securities Commission) dealt with me professionally. I was originally not short any company mentioned, but I did not want to restrict my ability to trade. They asked me a few precise questions but gave me no indication as to whether they took these issues seriously or what they were thinking. I wanted no insight to their thoughts and they gave me none.

But Sarah Danckert in the Age has reported (quoting multiple sources) that APRA has been interested in the situation since November. So I  guess my letter had the desired effect although for all I know APRA may have already had the situation in-hand.

Anyway it is clear that IAG had a large and thinly disclosed Greensill risk.

The collapse of Greensill and the role of the insurers

Tom Braithwaite in the Financial Times (and others) have reported that the proximate cause of the collapse of Greensill was that these insurance policies were not renewed. This led to a chain of events whereby Credit Suisse funds stopped accepting Greensill assurances and BaFin (the German regulator) took over Greensill Bank.

The best bits of information however come from an Australian court case.

Late at night and in emergency sitting the Supreme Court of NSW (a first-instance court despite its title) heard an urgent after-hours application for an interlocutory mandatory injunction compelling insurer to issue a trade credit insurance policy. 

This was always a long shot. The policy terms require 180 days notice to terminate or the insurer might be forced to renew. 

The argument Greensill made to the court was that maybe 179 or 178 days of notice was given, not 180 days and that Insurance Australia Group should be forced to renew USD4.6 billion in credit insurance for which it had no reinsurance coverage.

Understandably at a last-ditch 7PM hearing a single judge wasn't prepared to bankrupt a major Australian insurer by forcing renewal.

You can find the judgement here.

Greensill duly collapsed as they told the Judge that it would.

That said, the question of whether Greensill can force renewal of those policies is still open and is still going to court. All the judge decided was that at short notice and on only an "arguable" case he wasn't going to issue a mandatory injunction. 

So there will be a court case to come. And the court case will reveal new details and make important decisions.

The alleged rogue underwriter and what is at stake?

Jenny Wiggins and Hans van Leeuwen in the Australian Financial Review tell a story about a fired underwriter who had exceeded his authority by binding insurers  to contracts insuring Greensill to the tune of about $10 billon. (From the context I read this as 10 billion US dollars rather than Australian dollars). The core quote is:

BCC director Toby Guy wrote to Greensill chief executive Lex Greensill and Greensill Bank director Markus Nunnerich on August 4, telling them that Mr Brereton had exceeded his authority in approving customer limits to Greensill between July 2019 and July 2020 when he signed numerous comprehensive trade credit insurance policies worth about $10 billion. He was dismissed on July 8, 2020.Many insurance policies have terms that require insurance companies to renew and there is complex law around this. I am neither a la

There are several things to observe here.

First BCC is that Sydney based insurance broker I mentioned in the letter to ASIC. It bound insurance policies for both Insurance Australia Group and Tokio Marine. 

Second the 10 billion dollars in policies are substantially larger than the policies disclosed in any  Credit Suisse documents - so I am guessing that they include the policies that purported to protect the assets of Greensill's German  Bank.

Third, and most importantly, the policies were written until July 2020. This is important because most insurance policies cover 12 months, and many credit insurance policies are longer. If BCC was writing  policies until July 2020 some of them are likely still in force.

If that is the case Insurance Australia Group and Tokio Marine are staring down the barrel of some very large losses.

Insurance Australia Group is a minnow. Large losses on this scale could reasonably bankrupt it. Tokio Marine is a relative giant and large losses will hurt but not mortally wound it.

Fortunately for Insurance Australia Group they sold their interest in BCC some time ago to Tokio Marine so their exposure may not be large.

That said  - if they are eventually forced to renew exposures on old policies (as per the argument Greensill put at the late night court case) then IAG may incur some very large losses, especially as they appear not to have renewed their reinsurance (as disclosed in NSW Supreme Court).

You may think I am drawing a long bow here, but Insurance Australia Group recently lost a major case on pandemic caused business interruption insurance and were forced to raise AUD865 million in extra capital to remedy their "mistake". The mistake  was contract wording.

That said it will be up to the courts (and most certainly not me) to work out the extent to which Tokio Marine and AIG are left holding the Greensill bag.

A plea for disclosure

Insurance Australia Group disclosure on Greensill has been appalling. There are exposures potentially large enough to bankrupt them that were undisclosed. Robert Smith, Michael Pooler and Olaf Storbeck in  the Financial Times describe the problem as a "rogue underwriter".  To quote:

One insurer has already laid the blame for the scale of cover it extended to the company at the feet of a rogue underwriter.

“This is similar to what blew up AIG in 2008,” says one person close to the brewing disputes, in reference to the complexity of the contracts involved.

A rogue trader can kill a bank as per Barings, but the situation with insurance is even more stark. Rogue underwriters crashed AIG - previously the largest market cap insurer in the world.

Given the scale of the issue and the fact that key details have been partially disclosed in court I think it is time for a more public airing than this blog post.

I do not know the disclosure rules in Japan (applying to Tokio Marine) but the continuous disclosure rules that apply to ASX rules seem to impose some duties on Insurance Australia Group and potentially its directors.

What if the liabilities for Greensill losses do not fall on insurers?

It is possible that insurers will duck much of the liability to make good Greensill losses. If policies were written as late as July 2020 (as per the above quoted financial review article) it is unlikely insurers will avoid all liability, but depending on what policy was written when, and depending on the wording of those policies they may duck most liability.

So then someone else may be left holding the bag.

I think there is a good chance that someone will be Credit Suisse Financial Group.

Here is the final letter to clients of one of the credit funds

Here is the core client pitch:

The fund seeks to generate stable and uncorrelated returns by investing in notes with a maturity of typically less than one year which are backed by buyer confirmed trade receivables/ buyer payment undertakings, supplier payment undertakings and account receivables (”Receivables”). The underlying credit risk of the notes is insured by highly rated insurance companies. The Fund aims for a target return of 1.50% p.a. above the 3-month USD LIBOR and a short term maturity profile.

The highlighted section is  a doozy. It says that the underlying credit risk of the notes is insured by highly rated insurance companies.

Well it either is or it isn't.

If it is insured Insurance Australia and Tokio are in a world of pain.

If it is not insured then one might expect extensive litigation and potentially large losses at Credit Suisse. 

GAM, who previously had a fund exposed to Greensill and has barely recovered.  Here is a ten year stock chart. The decline from 15 Swiss Franc to under 5 Swiss Franc per share is Greensill related.

So who is holding the bag?

Well, genuinely I do not know. It could be Insurance Australia Group or Tokio Marine. It could be German taxpayers (through the subsidiary bank) and Credit Suisse.

I figure I know the winners though. Lawyers. Lots and lots of lawyers.

And maybe a short seller or two if we pick the shorts right. You can presume I have some position in  most of the companies mentioned.


Saturday, December 26, 2020

Job Interview Questions: Plus 500

I gave someone a quick job interview today. It was kind of miserable except the kid was enthusiastic and came with a lot of (what he thought were) good ideas.

Chief amongst his good ideas was to short XRP - the crypto-currency associated with Ripple.

His case was primarily "have you read the SEC complaint?"

Anyway my concern wasn't that. It was how do I actually execute this trade? What broker would I leave my collateral with to do this and why should I trust this broker.

The problem is acute. I am most likely to win in this trade in the event of a collapse in crypto-currencies generally - and that is the time the broker is most likely to default and wind up not paying me.

I can imagine it being a really bad trade whatever the market outcome. If I am wrong and crypto just keeps going up I will lose money. If I crypto collapses I can't collect my winnings - indeed I just lose my collateral.

Okay - his thought - do it at a broker which is not crypto-dominated. He thought Plus 500 which he told me was ASIC regulated. (ASIC is the Australian securities regulator.)

The ASIC regulated status I was amused by. They have never been particularly good at hunting debacles before they happened. And beside Plus 500 is an Israel/Cyprus operation listed in London - and is rather hard for ASIC to regulate properly. I could just imagine the ASIC officer trying get a holiday in Cyprus on the public purse because he wanted to do a site visit...

Whatever - he was convinced.

And so I left him a task. Could he analyse Plus 500. It is a listed company. Could he tell me whether I should own the stock or whether I should trust it with my precious collateral.

The accounts are public after all.

Does anyone think this is a reasonable task for a job applicant?

Asking for a friend.


Thursday, December 17, 2020

Delusion, fraud and the role of the SEC - the General Electric long-term care case

Luckin Coffee just settled with the SEC for a fine which I guess will be paid by shareholders. Given that the whole thing is a massive admitted fraud being paid by "shareholders" is a pretty moot case. There is not much evidence that the shareholders have anything left. Other than any part of the fine that might be distributed to them I doubt the shareholders ever get a penny.

Whatever: this prompted a twitter debate about the fine paid by General Electric after their long-term-care debacle.

This tweet by Francine McKenna is where it started.

I disagree sharply. 

First let's explain what that $24 billion cost at GE was.

a). GE wrote a lot of business in now sold/closed insurers insuring against the need for people to go into nursing homes. It would pay for the nursing home if that unfortunate situation actually arose. This insurance is called "long-term care insurance".

b). Long-term care insurance has been a near universal disaster for the insurance industry. Almost everyone who touched it lost money. The reason is that people lived longer than expected, they lived more of those years in nursing homes than people expected and the cost of nursing homes went up more than expected. Insurers did not deliberately lose money in long-term care - but everyone lost money in the end. That is the nature of insurance - it is full of surprises - and the surprises are mostly negative.

c). GE had a keepwell agreement with (State) Insurance Commissioners that required that they keep the long-term care subsidiaries capitalised at 300 percent of statutory minimums. This meant that negative surprises at the subsidiaries caused a cash call on the parent company of 3x the negative surprise. 

d). The long term care companies were under-reserved by $8 billion - a mistake that was common in the industry - but in this case a pretty nasty mistake.

e). Because of the keepwell agreement the cost to the GE Parent company was $24 billion. If the book of business runs off as GE currently expects much of that $24 billion - will be returned over time. After all the bulk of it is agreed "excess" capital.

By constrast Luckin Coffee was a fraud from when it listed and was purely a device to extract money from shareholders.

The GE long-term care business was not a fraud from when it listed. Indeed they were blithely writing long-term care insurance in the expectation it would be profitable. So were many other insurance companies.

At some point they will pay out far more than they took in (and the business will not have been profitable). I am not even sure that line has been crossed yet - but as of a couple of years ago when GE took the charge it had not been crossed.

But at some point on that path it will become obvious to anyone who takes a dispassionate view that the line will be crossed someday in the near future.

There is a sequence here.

First there is an honest mistake (writing the business).

Then there is just error - not noticing the models that you wrote too are wrong by a large enough amount to cause problems.

Then the error - under-reserving - becomes delusion. After all it is very hard to admit a mistake even to yourself. I have held a stock way too long when I am wrong and most people who invest have done this. Error is human. And sometimes that error becomes delusion and that is human too.

But there is a nasty line here. Sometimes that delusion becomes fraud. It is fraud when you start to lie about it and know you are lying about it

Luckin Coffee was a fraud from before the IPO. To even equate it to the GE thing is to downplay how much malice was involved in the Luckin Coffee fraud.

Now GE did pay a fine. 

I have a strong view here. If the SEC could prove that certain GE execs crossed the line between human delusion and fraud they should have criminally prosecuted.

And if they could not prove that then they should have not fined at all (except maybe for insufficient financial controls). 

As far as I know they could not prove it. But hey - GE settled quickly on a civil case. 

I can see how this happens. The SEC has lots of powers and it sort of forces GE to settle. But this is not what should happen. 

Either the SEC has a case - in which case it should have been criminal - or they have no case at all - in which case the fine is inappropriate.

My guess here is that the fine is just inappropriate. It makes me respect the SEC less. 

So was the fine against Luckin' Coffee appropriate?

By my own logic the fine against Luckin' Coffee was not appropriate either - what should have happened is criminal charges.

But the SEC has a real problem. The real problem is that the malefactors are in China. 

And it is awful hard to criminally prosecute them.

They may want to come to the United States (or some country with an extradition treaty one day). So settling for a fine works for them.

Whether it works for America I do not know. Sure some money came back Stateside - and maybe that was all that was ever able to be recovered.

The SEC notes it is really hopeless. To quote the press:

“While there are challenges in our ability to effectively hold foreign issuers and their officers and directors accountable to the same extent as U.S. issuers and persons, we will continue to use all our available resources to protect investors when foreign issuers violate the federal securities laws,” said Stephanie Avakian, director of the SEC’s division of enforcement, in the regulator’s announcement on Luckin.

The SEC is nastier against GE because it can be

The Luckin case was criminal - and all it got was a fine. That was because the malefactors were in China.

GE was probably not even fraud - and they got a fine.

That is because they were American. Nothing more.

Yeah, it is not fair.

But that is the world we are in. 

Francine McKenna pontificating just exaggerates that unfairness. But whatever.


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