Read on Twitter
So... for a Friday afternoon break from actual work, I'm going to tweet out a thread about another large corporate entity financed from the Arabian peninsula that came to grief through absolutely massive option trades: Dubai International Capital which no longer exists. https://twitter.com/breakingmkts/status/1304456843713015809
In 2006, while I was working at Deutsche Bank on building the MENA equities business we were approached by DIC about investing in a fund they were going to create which would invest in 1-3% stakes in companies in the global 500 as researched by their staff of analysts.
The fund was structured as a hedge fund and it was going to charge us 2% % 20% as was the standard at the time. What's more, if we invested in the fund, we would be on the list of firms who would be able to engage in financing and options transactions related to these stakes.
This of course seemed totally preposterous to me. We're going to pay 2&20 to a bunch of guys who are going to somehow miraculously have better insight into the most thoroughly analyzed companies on Earth than the thousands of other analysts?
I could generate virtually the same return by picking 5 names at random from the S&P 500 and pay no fees. They were counting on our greed for the fees on these large transactions but we'd just wind up being both sides of the trades, it made no sense to me.
"But wait...." the cap-intro people say, "this is not full risk, all these massive equity stakes will be hedged with costless collars such that we can never lose more than 10% on any one name." Hmmm.... interesting.
What this really means, is that when they buy 1% of some company, they're going to instantly buy a 10% out of the money puts, and sell whatever strike call is necessary such that the price of the call and the put are equal so no cash goes out the door.
The practical effect of this is to turn the portfolio of stocks into a portfolio of call spreads, sound familiar? Obviously I am even less enthusiastic about investing in a portfolio of call spreads so, to the consternation of our sales staff, I laugh them out the door.
However, for some insane reason, other banks actually pony up billions of dollars, and the fund gets launched. https://www.difc.ae/newsroom/news/dubai-international-capital-launches-fund-management-company/
What's more, they actually went out and executed the plan, buying huge stakes in companies around the world and achieving the funds true purpose: making it look like Dubai had a sovereign wealth fund like Abu Dhabi and Qatar. https://af.reuters.com/article/hsbc-dubai/update-2-dubai-fund-buys-stake-in-hsbc-idUKL013896820070501
Something to notice here, the initial giant stakes that DIC bought were in financial services companies in the summer of 2007. https://www.oneindia.com/2007/07/13/dubai-international-buys-287-stake-in-icici-bank-1184310571.html
Then one night, in April of 2008, I'm working late and I get a call from a friend of mine whose brother works at DIC and who has been told that I know a lot about options. He asks if I can meet the DIC management team for a drink over near the Burj Dubai, curious, I go.
When I get there, the first 30 minutes are the standard go-go Dubai pitch. DIC is rocking the world the management team are the best, the smartest guys, and though they work for a state entity, they get personal points on the P&L (a much better deal than we got at DB.)
What's more, they're just getting started. They raised $10 billion and so far they've only deployed $2 billion. It's going to be a roller coaster to the moon for them. What's more, if I prove helpful enough, maybe I could join them for the ride... these hints were common in Dubai
So... down to business. Well, they have some issues with their derivative transactions and they want to know what they can do. Can I suggest changes in structure? The whole task of restructuring has been complicated by the fact that their PB has stopped sending them risk reports.
Hmmm... this is all very curious. So, where were the trades when they put them on. They tell me. Where are the shares now? Down about 30% from the highs (Bear Stearns had collapsed a few weeks before.) How long dated were the collars? 1 year, with 3 months left to run.
I look from one, to the next, and realize to my horror that they don't see it and I say: "Well gentlemen, that's your problem right there. The reason your PB is not sending you any risk reports, is that you no longer have any risk on...
"...your shares are so far below the put strike that you no longer have any exposure to the stock at all. It's as if you don't own it because one for one it's pledged to the puts." To which one of them replies, hilariously "But it's still our name on the shareholder register!"
To which I reply "Indeed it is, and it will remain there until three months from now when you exercise your puts and sell it 20% up from here to the firm that sold you the puts. In the interim, the presence on the shareholder register is the ONLY connection you have...
...you no longer have any economic interest in them, only a legal one. In short gentlemen, your money is gone. All gone." Surely there is something we can do about this, can we roll the puts? "Yes you can, but you're going to have to write a big check to do it, can you?"
They reply... why yes, it's a $10 billion dollar fund, and they're only down 20% at the time. "Wait a minute, did you say you're 20% down?" Yes. "And you're 20% invested?" Yes. "So you're down 100% of invested capital!?!" I guess that's a way of looking at it.
"Gentlemen, I'm certain that this is how Sheikh Mohammed, the owner of your GP will look at it. You have lost $2 billion of money that wasn't his to begin with but that he has been telling the world he has. My advice to you is to leave town."
This is also my advice to the people at Softbank running money for MBS with the same strategy.
