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In face of crisis's twists, old principles guide new solutions
WHEN the shockwave of Lehman Brothers' collapse hit Singapore 10 years ago, it sent the economy and markets reeling in unprecedented ways.
Those on the frontlines of dealing with the fallout told The Business Times that, when faced with unforeseen circumstances, they leaned heavily on sound principles to chart new paths - and lived to tell the tale.
"You had to have the courage to do something that may not be the norm in the market, but you knew that it was a good practice," Singapore Exchange (SGX) chief risk officer Agnes Koh told BT.
Ms Koh, whose role at the exchange in 2008 was head of risk management, said warning signs had been flashing as early as March 2008 when US investment bank Bear Stearns required a bailout from JP Morgan. Still, when the US Federal Reserve and the US Treasury let Lehman go under in September that year, the speed of the fallout caught many by surprise.
"I think the market had too much of an expectation of 'too big to fail', and there was such a shock to the market, and the crisis in confidence was at a scale that was unexpected...There was a sharp escalation of credit risk aversion, and I would say it came close to a financial market systemic collapse."
Fortunately for SGX and The Central Depository, the exchange had shored up its defences just before the weekend announcement of Lehman's bankruptcy. Importantly, SGX bucked what was usual practice at that time by asking Lehman and other US investment banks in Singapore to put up collateral for the cash market.
For SGX to demand cash from the investment banks while the balance sheets of those institutions were already under pressure was a move that was unpopular with those being targeted, Ms Koh recalled.
SGX persisted, although in acknowledging the banks' concerns, it sought to ensure that the amount of collateral it demanded would not tip the banks into default.
"We knew what their liquidity conditions were, and we imposed what was necessary to just ease us through the weekend and then we'll see what happens on Monday," Ms Koh said of Lehman. "And that came in really fine, because when we finished on Monday, when the announcement came out, we went into action with the process. Over two days, we crystallised all the losses, by Sept 16. The collateral we had from Lehman was more than enough and we were able to return to the liquidators.
"You never know when the next problem is, but you just need to make sure that you know exactly what you have to do when it happens to your market.
"Use your power that you have under the rules, be not afraid to use it, and then you put the market in a good state."
For Dymon Asia founding partner and chief investment officer Danny Yong, Lehman was a shock that came just a month after his macro-strategy hedge fund was set up.
Like Ms Koh, Mr Yong had already seen the early signs of trouble, and had bet that Asian central banks would loosen policy. It was the right call, but not all the trades were working as he expected.
What caught him by surprise was that the London Interbank Offer Rate, also known as Libor, moved up even after the US Federal Reserve cut the Fed funds rate.
"Libor is also a measure of what banks are willing to lend to each other at, right?" Mr Yong reasoned. "The price of lending. And at that point of tremendous uncertainty, the banks weren't willing to lend to each other at anywhere close to the Fed funds rates...
"In the past, I would say historically 99.9 per cent of the time, when the central bank cuts interest rates, the banks will lend to each other at a lower price. But in this case it didn't happen. So unusual outcomes were happening. and when you call the markets right but the unexpected happens, basically that's a sign that you should liquidate your portfolio, reassess and then start again."
Concerned about market liquidity and recognising that some of his assumptions may have been wrong, Mr Yong decided to liquidate all his young fund's positions. He said the fund lost about 7 per cent from Lehman.
"The key was always about liquidity and capital preservation, he said. "Now, 10 years on, we still have this 4 per cent monthly circuit breaker to allow us to stay in the game, because I think very often for investors who do well in a certain period in their career, the main risk is that you get over-confident. That you believe you will always be right, or that the markets will always come back in your favour, and then some end up going out of business. So the key is always understanding that anything can happen."
In hindsight, Dymon's willingness to pull back turned out to be the right move, because that gave it the firepower to re-enter the market later on and recover.
Dymon is today one of the largest Asia-focused macro strategy hedge funds in the world, and the firm has a 4 per cent circuit breaker that requires its traders to liquidate positions if they lose that amount in a month.
A decade after Lehman, Mr Yong is again seeing signs of trouble in the markets. In many markets, he said, positions are significantly larger than daily liquidity, which means that investors trying to get out of those positions if something negative happens will probably face huge losses.
"The key is something needs to be significant enough for everyone to wake up, just as the 14th of September 10 years ago, when everyone woke up," he said.
"When Lehman went bankrupt, they were like: okay, this is for real, and you really, really need to get out. The question is, what will that catalyst be? But I'm convinced that if and when such a catalyst makes everybody sit up and say, I need to get out, that there will not be enough liquidity to get out."
That catalyst could come from any number of sources. Unease in the Korean peninsula, a major cybersecurity breach and unforeseen inflation triggered by trade wars or monetary policy are all potential candidates in Mr Yong's assessment. Wherever and whenever the next crisis hits, however, he expects the unexpected.
"It's a very, very humbling experience sometimes," he said. "You may be right, or it may make a lot of sense, but the unexpected continually happens, and I think Lehman was the kind of very extreme example.
"I always operate, especially after the Lehman bankruptcy, on the philosophy that anything can happen."
- For videos of Ms Koh and Mr Yong, and other stories that examine the impact of Lehman Brothers 10 years after its collapse, please visit bt.sg/lehman