Thursday, June 30, 2022

The Wirecard Book

Dan McCrum - the Financial Times journalist - has released a blockbuster finance book - the story of Wirecard.

The book is called Money Men: A Hot Startup, A Billion Dollar Fraud, A Fight for the Truth

Wirecard is - I think - the biggest fraud by dollar value and scale ever conducted in Europe.

Whatever: just buy the book. It is really good fun. I do not agree with all of Dan's perspectives - or even some of the analysis - but it is a great story about bad accounting, worse sell side analysts and completely awful regulators.

It is also a story of Libyan and Austrian secret agents, guys who run night clubs, pornographers and fraud. Oh, and guys who turn up in Syria with the very best body armour money can buy only to be told by the cool heads that that body armour marks them as a high-value target and the snipers would shoot them dead so they better leave it behind.

Dan also tells a story about how he looked - for work - at several thousand porn sites - and how he even spent some of the Financial Times money using a credit card to buy porn.

And yes - this was a perfectly legitimate work activity. Not like when the SEC did it

It is above all a story about how surprising (and often nasty) the world is.

Some background

I once thought of Wirecard as a simple fraud. This was about 2009-2013. What I saw was a payments processor with three red flags:

a. it was a reverse merger into a totally bullshit EASDAQ listed company. 

b. It did "high risk" payments in the Philippines and other places, and

c. The accounts did not quite make sense.

I did one check - described below - and found that the acquisitions did not make sense.

High Risk Payments

High risk payments are payments that normal banks do not want to process. Some come with administrative troubles (eg lots of high cost charge backs). Some are likely magnets for stolen credit cards. Some come with the risk you will find yourself on the wrong side of a DOJ indictment.

Examples include:

  • Porn sites that get your credit card and then systematically loot it by putting a recurring charge on. These obviously come with chargeback risk.
  • Clearing money for online casinos - especially in jurisdictions such as the US where online gambling is illegal. 

Even the porn sites, though legal, can get you into bad trouble. Nobody has found a foolproof way for instance to use a computer to separate legal pornography with actors over the age of 18 from child abuse material. 

If a financial institution is found to clear payments for child abuse material and that is discovered by the DOJ then the CEO is unlikely to have a good day at the office. (Example - look what happened to Westpac - a large Australian bank - when it accidentally cleared a handful of payments involving child exploitation...)

The number one sin in the Visa/Mastercard network if you clear payments is mislabelling a payment. To take an extreme example - if you cleared payments for a porn site in Central Luzon and labelled it as a flower shop in London you may reasonably be thought of hiding something.

Anyway Wirecard did this. And yes - for work - I spent enough time looking at bad porn sites to work this out - and then I stopped - because I did not want to go there. 

I also found out - via online gambling chat boards - that Wirecard cleared payments for online casinos. 

That was enough hanging around bad websites for me. I never proved comprehensively that Wirecard did child abuse material - and I did not want to. Well actually I would have loved to have nailed the company - but I did not want to go down that rabbit hole. 

But whatever - I thought there was enough to get them into really bad trouble. 

Putting this business in a public company did not make sense

The idea of embedding high risk payments in a public company did not make sense to me. 

There were two main reasons.

  • public companies have more scrutiny and if you are doing that sort of thing it is best to be under-the-radar,
  • If you are someone who is clearing high risk payments you are taking a real risk of prison - and in exchange you are getting paid really well - the cut is high. But there is no logical reason you would take all this risk and share the profits - but not the risk - with distant shareholders.
Bluntly being a mafioso is highly profitable and highly risky. You don't want to put it in a public company have lots of scrutiny and share the profits but not the risks with say CALPERS. Calpers do not deserve that.

But the accounts showed big profits

Back in 2014 the accounts showed quite a bit of cash generation - a margin considerably higher than I would expect.

It also showed acquisitions in markets that you might do high risk processing in - notably Dubai and South East Asia.

The acquired companies were also clearly very profitable - much more profitable than a simple merchant acquiring business should be. So - at best - they were other high risk processors.

Now the owners of high-risk processors are - for the reasons outlined above - likely to be mafioso. And lots and lots of money was being paid for them.

So I had two theories.

a). The profits were fake and the fake profits were used to by rubbery acquisitions or 

b). You were going to find a lot of organised crime at the bottom of this.

To some degree I found both - and stopped looking. Why stir that hornets nest? 

That said we did quietly look a little.

A trip to Jakarta

A friend of mine (now publicly disclosed to be Alex Turnbull) visited a company that Wirecard had acquired in Jakarta. Alex speaks the language. He winds up at a non-descript office up a dusty road full of what look like illegal enterprises controlled by the Indonesian military. There was no way this was worth what Wirecard claimed was paid for it.

We stopped looking. But we were pretty sure there was a lot of fraud here - and the company would blow up.

Alas it did not blow up. The stock went up and up some more.

In frustration I told other short sellers. And I told Dan McCrum.

I stopped looking at Wirecard - but maintained the short for years figuring that it would blow up eventually.

Long standing and big frauds

Sino Forest was a major fraud with billions of market capitalisation and billions of debt which ostensibly processed 30 million tonnes of woodchips per year. It was the bluest of Chinese blue chips.

It was very hard to see it was a fraud and it fooled lots of highly reputable fund managers.

However if you go back to the beginning it was pretty obviously a fraud. It owned a large amount of forest - but in the late 1990s the annual reports showed no property plant and equipment other than forests. The company did not own a truck, or a chainsaw, or a fire lookout tower. It was a blatantly obvious scam.

As time went on the scam got better and better - and eventually it took a really savvy operator (in this case Carson Block) to spot the fraud. 

Well Wirecard was that on steroids. The people running Wirecard became seriously competent and experienced fraudsters. And they were not afraid to break laws and spend money in the investigation of their fraud.

In their last year they spent almost 50 million euro on lawyers to obstruct investigation, spies to follow their critics, even high-class hookers in Mayfair wine bars to entrap critical journalists. (I also think they broke into one critics house, installed a camera to spy on the computer and used that information to track other critics - though Dan does not take that line and even doubts the house was broken into.)

Against 50 million per annum in expenses, and a cluster of world class crooks was a small team of journalists led by Dan McCrum and Paul Murphy at the Financial Times.

It was a roughly even fight. And boy was it a brawl.

You learn that your conversation with a night-club owner might be bugged, and that the Financial Times is incompetent at filming something with a camera hidden in the button of a female journalist.

You find out that German regulators are stupid enough to criminally charge English journalists for telling the truth. (They also - but not in the book - blamed the Wirecard stories on an Anglo-Jewish conspiracy rather than on Austro-German dishonesty. It is a bad look when German regulators falsely accuse Jews of running global financial conspiracies.)

You learn that there are "shops" where thousands of fictional companies are manufactured in England, with people recruited from the local pub to be named as directors. And they front for porn companies and online casinos. And you learn the tricks journalists used to uncover this network. 

You find yourself in the company of Russian agents, and people who clear money to pay mercenaries in Africa. 

It is all amusingly improbable and real. Like a good spy novel except that it is true.

But the laughter turns to angst when someone (who happens to be a friend of mine) had her internet disabled at work, the local security cameras disabled and then was assaulted as a warning. That made it real.

This book is fun. But it is funny, strange and scary at the same time.

Just buy it.


PS. As advice for short-sellers: if you ever get this entrapped in a story like this you are doing it wrong. There are lots of ways to make money in the market - and being chased by ex-Libyan agents and guys who (plausibly) have the formula for Novichok is one of the ways to make money - but it is not a very good one.

As a journalist however this is exactly the way to do things. This is the rollicking story of a lifetime. A journalist if they are lucky gets one story only half this good in their career.

PPS. People will ask where I disagree with Dan McCrum. Well I will give one example. Dan comments disapprovingly of Fraser Perring when Fraser was accused of market manipulation by South African regulators. His tone seemed to say that was a definitive judgement on Fraser's character. This was discombobulating at the end of a book where German regulators had falsely criminally charged the author with market manipulation. At the end of this it story it should have at least occurred to Dan that the South African regulators (and not Fraser) might have been wrong.  (Disclosure: I think the South African regulators are wrong here.)

PPPS. I looked at my files. I did not save a single Wirecard Annual Report after 2014 - though I had them all from 2003 onwards. I had worked out it was a fraud and was just waiting for the denouement. This book explains why it took so long.

Tuesday, May 10, 2022

Swedish Match: how not to behave when you are kissed on the dick by a rainbow

There are confirmed rumours that Swedish Match, a Swedish company focussed on oral nicotine delivery (snus, chewing tobacco and most importantly "modern oral") is in advanced merger talks with Philip Morris.

I am furious.

Swedish Match is about a ten percent position for my fund - and a core holding. We own about 1 percent of the company. 

The management lucked-in when they came up with what is in my opinion the best nicotine product ever invented and hence founded the whole category of "modern oral". The product gives maximum nicotine hit (think supercharged coffee) with substantially lower health risks. It is however extremely addictive.

As a dirty capitalist out to make money for my clients this is a nirvana. A product that attacks an enormous brand-loyal and addictive market with a superior product. 

Oh, and did I mention the product has strongish patent protections?

This is the stock in the portfolio I have the most hope for the future.

Here is the Swedish Match shipment volumes for Zyn from the last results presentation.

It is a pretty good growth stock and the runway is tremendous.

And it is massively cash generating.

Okay, that is all wonderful. But the management is not. 

I do not normally want to talk negatively about the management of one of my core investments, but this time I am furious.

To be blunt the management might be kindly called dull plodders.

When riding this Zyn tiger they proudly talked about their capital management because all their plants were running at 100 percent capacity. Sure they couldn't supply (hence addict) all the customers who wanted their product, but look at that capital management...

But the plodding management do not stop there. Swedish Match own the biggest lighter and match business in the world. It is not much of a business, returns are merely okay, and volume falls every year because most match volume is driven by (ever falling) cigarette consumption.

But hey, this business has a distribution channel into almost everywhere in the world where cigarettes are sold. Pair that with a decent vape product and you would immediately have one of the world's biggest vape business. I wrote about that opportunity here.

Anyway this utterly unimaginative management team look like they are just going to take the bid from Philip Morris and I am disgusted.

I gave a florid quote to the Wall Street Journal expressing my feelings:

The management team are uninspiring utility execs whose dick got kissed by a rainbow. They are busy selling the rainbow.

They should all be fired for considering this deal.

We own 15.1 million shares.

Anyway, if there is a bid there should be an overbid. I think you can make a PE deal work to 175 (deal looks to be about 100).

And to help you out I have attached a note I wrote a few years ago explaining our Swedish Match position. Enjoy.

And if other angry shareholders want to talk my DMs are open on twitter.


Swedish Match takeover rumours

There is an article just out that Swedish Match is in advanced merger talks with Philip Morris at a price of about USD15 billion.

At Bronte we own 15.1 million shares in Swedish Match - or about 1 percent of the company.

We believe the future for Swedish Match is considerably better than the price reflected and we are not happy with this offer.

We will consider our future actions.

John Hempton

Tuesday, April 19, 2022

Mr Big Wells gets popped by the SEC but somehow escapes criminal charges.

On Friday 14 August 2009, that is more than twelve years ago, I wrote a little blog post about a fraudulent oil company run by Mr. Massimiliano (Max) Pozzoni. The name translated from Italian roughly as "Mr Big Wells".

You can find that blog post here

I was sure it was a fraud because they claimed in press releases that renowned petroleum engineer Dr. Daulat Mamora had consulted for them. This was an easy check - I emailed the Good Doctor, and he replied that he had never heard of the company. 

I sent those details to the SEC to test how fast they would react.

I posited that Mr Big Wells was likely a fictional person - but my blessed readers did find the real Max Pozzoni. 

The blog post was titled: Mr Big Wells and the new faster SEC. 

I guess they have demonstrated their speed because - after more than twelve years UK-resident Ronald Bauer and various combinations of his associates, Craig James Auringer, Adam Christopher Kambeitz, Alon Friedlander, Massimiliano ("Max") Pozzoni, Daniel Mark Ferris, Petar Dmitrov Mihaylov, and David Sidoo face civil charges.

Yes, Massimiliano ("Max") Pozzoni has been charged by the new faster SEC.

Parallel criminal charges have been filed, but only against Bauer, Auringer, Ferris, and Mihaylov.

Mr Big Wells has escaped criminal charges.

It appears that the SEC is faster than the Justice Department.

Praise be the new faster SEC.


Friday, October 22, 2021

How not to apply for a job - L'Oreal edition

I accepted an invite on LinkedIn from a finance student at an Australian University.

Nothing unusual about that.

Said finance student then decided to pitch me a short idea in this case in the hope of getting an internship.

Again nothing unusual. Indeed this is how about a third of our employees joined us.

Just that this one was funny. So here goes.

Finance Student (FS): John, you gotta give me an interview. I have the short to end all shorts!

Me - John Hempton (JH): lets chat, though there are plenty at the moment

FS: Okay great John. The ticker is EPA:OR - L’Oreal. Truly a terrible company.

JH: ha ha. What makes you think that?

FS: John, are you pulling my leg? Surely it is obvious. If you are being serious I can explain.

JH: Please do. What phone number?

JH (later): I am expecting to call you. What number?

FS: John, I only have one shot at this so please give me some time to put my thoughts/thesis together. I will be in touch early next week if that’s okay?

JH: Okay. But I genuinely suspect that you are mad.

The big area of disappointment at L'Or├ęal is the hair dye business over the past fifteen years.

So I guess explaining what the business is and how it went wrong is a key.

FS: I think after you hear my explanation you will truly realise what a disaster of a company this is. Perhaps even elements of fraud going on.

JH: I am intrigued.

But the hurdle here is high. Company has generated 2-3 billion of free cash per year for a very long time. The business smells very profitable.

You are betting against female vanity - and that is not normally a good bet.

FS: John, sorry, I’m pitching this idea to Jim Chanos from Kynikos in the coming days, are you familiar with him and his fund? Unfortunately this means I won’t have time to pitch it to you, but let’s circle back if he doesn’t go for it.

JH: I know Jim well, but I am deeply skeptical. I am almost certain you are wrong.

Give me 15 minutes as a pitch if you want. If you can get past that it will help with Jim.

If you can convince me I will be deeply surprised

FS: Look, John. Let me have a chat to Jim about this first. I don’t want you front running him and soaking up all the alpha in the trade. If he gives it the green light, I will speak with you first. The last thing yourself, Jim and I would want is a ‘Herbalife-eque’ activist campaign happening on any of either 3 of us hold as result of bad-blood.

Will be in touch.

One thing I must say though, John - I have had MANY girlfriends, all of whom use hair products. I am also a European native, so I am afraid I am beginning with a head start on this one.

JH: I am European and I have had girlfriends might be the height of arrogance...

FS: John, I understand you may be upset... but that doesn’t mean I am wrong

JH: No. But you have already proved that you know nothing about the business. By suggesting that your girlfriend is the target market for hair dye.

That is unlikely to be true unless your girlfriend is 45+.

Genuinely you come across as pig ignorant.

FS: You must know there is a certain something I relish in a 40+ year old Italian woman. They are like nothing else, John ­čĹî

May I ask, do you think L’Or├ęal is at fair value, under valued or (dare I say it) under valued?

JH: It is not cheap.

But 6x sales is the new normal

Nothing here is cheap.

L'Oreal is 6.8x revenue

Biggest competitor Estee Lauder is 7.4x revenues

Key suppliers

Givaudan - 6.7x revenue

Croda - 7.9x revenue

But telling us that these companies are pricey is not worthy of analysis.

Whatever, see if you can answer the big question - which is why hair dye  has  been problematic for 15 years?

It goes on. Dear graduate students - this is not how to apply for a job. But it is quite amusing...


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 Wirtschaftspr├╝fer (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


Wirtschaftspr├╝fungsgesellschaft [Orginal German version signe by:] gez. Bauer  Wirtschaftspr├╝fer gez. G├Âller  Wirtschaftspr├╝fer

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.


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