ANZ: an equity finance timeline

Ian Rogers

Incompetence rather than malfeasance wears the blame for the losses and management distractions created for ANZ by the losses on equity finance arrangements with Opes Prime Stockbroking and Primebroker.

One equity finance client, Opes Prime (a firm to which ANZ was one of the largest financiers), failed in March 2008, sparking the present controversy. Primebroker Securities failed last month.

ANZ on Friday published the review of securities lending.

Five people formed the review committee: Mike Smith, ANZ managing director; David Crawford, a director of Westpac; David Hisco, managing director of Esanda; Chris Page, head of risk for Asia Pacific; and Bob Santamaria, group general counsel.

The key conclusion of the report is that “the differences between equity finance and other types of securities lending were not fully understood and appreciated by most ANZ staff involved in those products.”

The report also concluded that “the business posed unacceptable reputational and financial risks to ANZ and these were not properly identified. Those risks were compounded by the lack of a proper control environment with respect to the equity finance business.”

The report states that ANZ believes it entered into equity finance relationships with brokers “on a strong legal foundation and in good faith” though these conclusions are one of the points of contention in the numerous court cases in which aggrieved customers of Opes Prime sued their broker’s banker.

Four ANZ committees score a mention in the securities lending review published by ANZ on Friday.

One is the Credit and Trading Risk Committee, which is more or less the executive committee augmented by a few extra risk managers. A second is the Wholesale Credit Risk unit.

A third is the Securities Lending Oversight Risk Committee, established in April 2006 and comprising line and risk management representatives. The fourth is ANZ Market Risk.

The following timeline derives from the narrative (which is not linear) in the review of securities lending published by ANZ on Friday.

•    Equity finance emerged as a new business line for ANZ in 2001, an outgrowth of the more conventional securities lending that ANZ Custodians took responsibility for in 1999 (but which was a business line managed by a different part of the bank for more than a decade).

•    ANZ’s Wholesale Credit Risk unit published a policy on securities lending in June 2002. The authors intended the policy to apply only to standard securities lending and not to equity finance.

•    The review found, however, that the policy “did not exclude equity finance clearly [and] was interpreted by ANZ Custodian Services and the ANZ Securities Lending unit as permitting equity finance.”

•    At the time, in mid 2002, ANZ estimated its exposure to equity finance at $33 million.

•    The review shows that over the three years to early 2005 management of ANZ Custodian Services gave “freedom and encouragement” to the securities lending unit to grow the equity finance business.

•    At this time (in early 2005) ANZ estimates its financial risk to equity finance at $771 million.

•    Few outside ANZ’s custodian business were aware of the initial growth in the equity finance business, though this changed in March 2005. By this time, internal audit and management knew that the equity finance business lacked an appropriate control framework.

•    The most critical failure cited in the report is that there were no credit limits for brokers and nor was there any process to assess or manage counterparty credit risk.

•    This issue was escalated to the Credit and Trading Risk committee in May 2005, which appears to have determined that credit limits must be set.

•    But in most cases credit limits were not set by subordinate risk management committees or by line management. A limit was set for only one broker client in 2005 and for the rest only in mid 2006.

•    The review says that ANZ’s financial exposure to these other brokers more than doubled between the internal audit report of March 2005 and the setting of these limits in mid 2006.

•    In February 2006 the equity finance business adopted a risk model that accepted any listed security and that did not limit exposure to individual securities.

•    Given marketing by brokers’ clients during what is now known to be the last phase of the long equities boom this model fostered high concentrations of holdings in illiquid securities, and often companies with low market capitalisation. Flaws in the security model fostered a situation in which ANZ accepted more of these securities for broker clients to which the bank had the largest exposure.

•    In April 2006 a senior risk officer decided that, for internal reporting purposes, the bank would classify credit limits on the basis of “potential exposure risk”, which in this instance the bank resolved to treat as being 10 per cent of the face value of the funds made available.

•    By about the same time, or May 2006, the bank’s Wholesale Credit Risk unit adopted an updated version of the policy on securities lending that explicitly catered to equity finance.

•    In July 2006, ANZ Market Risk developed a revised model that addressed the defects with the method of working out loan to valuation ratios in equity finance. Final implementation of this did not, however, occur until March 2008, only days before the demise of Opes Prime.

•    ANZ ultimately advanced $2 billion in cash and securities to brokers at August 2007 (the beginning of the credit crunch, though then still three months shy of the peak in world stock markets). Reports to senior management and the board, however, showed this exposure as being $200 million.

The review notes that following the internal audit report of March 2005 the issues identified “were not then addressed effectively or in a timely manner”. There was also poor compliance with controls introduced at the time.

This theme echoes through the review.

Responsibility for many decisions, and follow up on agreed actions, rested with committees and not with individuals: “management by committee” is the report’s term.

Line management also procrastinated over whether to invest in the business or to pull out altogether.

Risk management did not report “relevant issues” to the chief executive or the board.

As a result of this affair eight staff of ANZ lost their jobs late last week. Among them are Peter Hodgson, group head of institutional banking since June 2007. Hodgson used to be head of group risk. Also out the door is David Stephen, the current head of group risk.

Chris Page, the head of risk for ANZ covering Asia Pacific and a former executive of HSBC, will take over as head of group risk. Alex Thursby, the head of ANZ Asia Pacific, will also look after institutional while the bank seeks a replacement for Hodgson.

ANZ’s provisions to date in relation to Opes Prime are a little vague but appear to be small (though the compliance costs and litigation costs since then may be substantial).

The review cites a provision of $70 million in connection with the bank’s loan to Primebroker.