Controversy over SIA DLC shorts stems from risks caused by SocGen's untimely disclosure
THE decision by major structured products issuer Societe Generale (SocGen) to make a S$0.30 "goodwill" payment to traders who lost the entire value of their holdings in the 5x Short Singapore Airlines (SIA) daily leveraged certificates (DLCs) is a fair one.
The DLCs last traded at S$0.81 before they were suspended on May 6, after their value fell rapidly to zero when the underlying SIA shares surged more than 20 per cent upon trading ex-rights. The 5x Short DLCs would fall in value by 5 per cent for every one per cent rise in SIA shares.
Traders had argued that their losses stemmed partly from SocGen's shifting of the goalposts in a football game after the match had already begun. SocGen had adopted a theoretical ex-rights price (TERP) for SIA shares that was lower than what many believed to be appropriate, disadvantaging those who were betting on a share-price fall. SocGen also announced this pricing at 8.38am on the day that SIA started trading ex-rights - breaching rules requiring adjustments to be announced at least one day prior.
SocGen has maintained that it acted "appropriately and reasonably", given that SIA's rights issue is a complex one involving a simultaneous share and mandatory convertible bond (MCB) issue. It chose, however, to offer investors some compensation as it recognises the importance of making prompt notifications.
Pricing the MCBs
In a statement, SocGen said the goodwill payment was not related to its pricing formula. It added that a "range of views is possible" with regards to the theoretical value of SIA's rights MCBs on May 6, and that it was "logical and fair" that the MCBs would impact the price of the SIA DLCs.
SocGen had assumed a TERP of S$3.71. This was lower than investors' expected TERP of S$4.16, which was based on the formula used in SIA's offer document for its fund-raising exercise. Besides the issue of rights shares, SIA's exercise involved the issue of 295 rights MCBs for every 100 SIA shares held. Each of the rights can be exercised at S$1 for one MCB.
SocGen is of a view that rights MCBs are potentially dilutive, and adjusted for the potential dilutive effect. This approach is consistent with the one taken with respect of the shares rights. SIA's calculation, on the other hand, implied no immediate dilution arising from the rights MCBs. (see amendment note)
Yesterday, the first day of trading for the rights MCBs, saw trades matched at prices ranging from S$0.001 to S$0.019. Most sellers parted with their rights MCBs at S$0.006 apiece.
SocGen's TERP also assumed that the MCBs will be held to maturity and converted into shares, although this is only one out of a number of possible outcomes.
The MCBs are zero coupon bonds that SIA may redeem every six months. The redemption price rises over 10 years and the MCBs will only be converted into shares if they are not redeemed within that period.
In fact, analysts say that if business conditions improve SIA would be inclined to buy back the MCBs sooner rather than later.
Timely disclosure
Whether SocGen's assumptions are justified is up for debate. But its choice of a different TERP formula than what had been used in SIA's documents should have been communicated earlier to give traders the opportunity to exit their investment or hedge their bets.
The late notice resulted in a huge information asymmetry between traders and SocGen, which is also the designated market maker for the DLCs.
Traders want to trade on a level playing field. Timely disclosure is a basic expectation of any fair, orderly and transparent market.
SIA shares had languished ever since the rights issue was announced in March, and that trend has not changed. SIA shares fell S$0.29 or 6.76 per cent yesterday to close at S$4.00.
The exception to this pattern was May 6, when SIA shares reached an ex-rights high of S$5.04 within the first 23 minutes of trading. Though many factors were in play on May 6, it is probable that trading activity among 5x Short SIA DLC holders was one of them. The only way to cut losses once the DLCs had been suspended was to buy SIA shares.
In a move that may help recover some confidence in the structured products market, the Singapore Exchange (SGX) said on Tuesday that it has commenced investigations into the circumstances leading to SocGen's adjustment announcement.
SGX's regulatory focus is centred on ensuring timely disclosure, it said.
Affected traders must still stomach losses as SocGen's goodwill gesture is not meant to relieve them entirely of the risks they assumed in trading DLCs.
But the losses will be easier to take if they can be assured that steps are taken by both SGX and SocGen to avoid such confusion again.
Amendment note: An earlier version of this story said that SocGen's TERP formula implied a value of S$0.38 for each rights MCB. In fact, SocGen has clarified that it did not make any assumption on the price of the rights MCBs and such was not a factor in its adjustment.
