Greensill - who is holding the bag?

 There has been much fabulous reporting in the lead-up to the collapse of Greensill, the eponymously named Australian domiciled but London headquartered supply chain financier. But if you want guidance start with anything by Duncan Mavin (from the Wall Street Journal) or Robert Smith sometimes with Olaf Storbeck (at the Financial Times).

The excellent work of these journalists is now on the front page above the fold. It is not everyday a globally significant financial institution fails, and it is rarer still that this collapse happens within a couple of percent of all time highs in markets.

There has been remarkably little coverage of where the losses (which will be enormous) will sit.

I do not know either. But I am a short-seller at heart and trying to work this out seems like a core task for me. 

I will start my speculations at home in Australia.

In late November 2020 I wrote a letter to the Australian Prudential Regulatory Authority (APRA) about the credit risk that Insurance Australia Group was taking on Greensill. Here is that letter (which given outcomes looks rather on point). 

This letter is slightly modified, correcting punctuation and having some redations.

Greensill and Insurance Australia  Group 

First – you need to know what Greensill and Lex Greensill are.

Lex is a controversial and aggressive factoring/supply chain/trade finance financier. Possibly the most controversial one in the world.

He is an Australian – bought up on a farm near Bundaberg in Queensland – and the parent company is Australian domiciled and still has a Bundaberg address.

The enterprise however is vast – and – by far – the biggest company headquartered in Bundaberg. 

The official version piles on the humble origins.

https://www.greensill.com/about/meet-lex-greensill/

The unofficial versions focus a little on the indulgences, the family jets etc. Though apparently (and according to one of the articles attached) he is selling the fleet of private jets (four of them) as he takes money from Softbank.

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Greensill is controversial. They financed the fraudulent NMC Health. 

More publicly they were involved in the collapse of the GAM funds that was widely publicised.

In that case the fund manager Tim Hayward overloaded his fund with Greensill paper at valuations some considered questionable.

Since Hayward’s fund collapsed there have needed to be new large-scale sources of finance.

The biggest of these is that Greensill bought control of a tiny (and failing) German bank, recapitalised it, took a huge pile of brokered deposits (by paying about 100-120bps over) and either bought Greensill receivables or pledged bank assets to get letter of credit capacity to support Greensill activities.

The annual report for the bank (alas in German) is attached. The bank assets are largely “insured” but we cannot tell who they are insured by.

What we can see is the Credit Suisse fund that has deep Greensill relations (and is also the subject of this excellent article in the WSJ - https://www.wsj.com/articles/softbank-backed-greensill-looks-to-raise-fresh-capital-11602173906).

I have attached a letter from the Credit Suisse Supply Chain Finance Fund. A good way to start would be to get EVERY letter and prospectus from this fund and any other Credit Suisse fund with a decent Greensill exposure.

The fund is USD5667 in size – as per this cut-and-paste.

Other than 10 percent US Treasury holding it is diversified as to the countries that the assets are from and the industries that they are in.

But it is not diversified as to the the source of these assets (Greensill, Greensill and Greensill as far as I can tell) or the source of the insurance on these assets.

It is 56.1 percent Insurance Australia Ltd as per the following.

Now that is USD3.18 billion in exposure – just through one fund. That is AUD4.4 billion.

That is just the Insurance Australia exposure I can find.

I am assured the bank assets are also largely insured – but I cannot find who the insurer is.

So you would think that this is a disclosable large exposure to a single controversial financier. But the only statement in the IAG annual report is as follows:

That is it. They say it is in run-off. They feel no need to disclose a multi-billion dollar exposure to a questionable credit/s.

The only problem is that no insurer (other than Tokio Marine) seems to insure for them any more and the amount insured is rising fast.

I think the insurance is written at a broker in Sydney:

https://tbcco.com.au/

This entity used to be owned by IAG and Tokio Marine – but IAG sold their bit to Tokio Marine. However the insured amounts keep going up (at least the bits I can find) even though IAG say the thing is in run-off.

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I have some hypotheses. Either

a) An amount – at least 4.4 billion – but possibly much higher – is insured by IAG. Given the size (say 50 plus billion) and controversy of Greensill this is potentially a solvency risk for IAG.

b). Greensill is faking IAG insurance policies – and the amounts are not insured by IAG but Greensill says they are. In which case the German Bank (taking all those insured bonds) is facing solvency risk – and you should be talking to your German counterpart.

c). The Credit Suisse documents are fake. I think this unlikely but cannot dismiss it.

Either way it is one of the uglier situations I have seen lately.

John

APRA (and to the extent I talked to them the Australian Securities Commission) dealt with me professionally. I was originally not short any company mentioned, but I did not want to restrict my ability to trade. They asked me a few precise questions but gave me no indication as to whether they took these issues seriously or what they were thinking. I wanted no insight to their thoughts and they gave me none.

But Sarah Danckert in the Age has reported (quoting multiple sources) that APRA has been interested in the situation since November. So I  guess my letter had the desired effect although for all I know APRA may have already had the situation in-hand.

Anyway it is clear that IAG had a large and thinly disclosed Greensill risk.

The collapse of Greensill and the role of the insurers

Tom Braithwaite in the Financial Times (and others) have reported that the proximate cause of the collapse of Greensill was that these insurance policies were not renewed. This led to a chain of events whereby Credit Suisse funds stopped accepting Greensill assurances and BaFin (the German regulator) took over Greensill Bank.

The best bits of information however come from an Australian court case.

Late at night and in emergency sitting the Supreme Court of NSW (a first-instance court despite its title) heard an urgent after-hours application for an interlocutory mandatory injunction compelling insurer to issue a trade credit insurance policy. 

This was always a long shot. The policy terms require 180 days notice to terminate or the insurer might be forced to renew. 

The argument Greensill made to the court was that (maybe 179 or 178 days of notice was given, not 180 days and that Insurance Australia Group should be forced to renew USD4.6 billion in credit insurance for which it had no reinsurance coverage.

Understandably at a last-ditch 7PM hearing a single judge wasn’t prepared to bankrupt a major Australian insurer by forcing renewal.

You can find the judgement here.

Greensill duly collapsed as they told the Judge that it would.

That said, the question of whether Greensill can force renewal of those policies is still open and is still going to court. All the judge decided was that at short notice and on only an “arguable” case he wasn’t going to issue a mandatory injunction. 

So there will be a court case to come. And the court case will reveal new details and make important decisions.

The alleged rogue underwriter and what is at stake?

Jenny Wiggins and Hans van Leeuwen in the Australian Financial Review tell a story about a fired underwriter who had exceeded his authority by binding insurers  to contracts insuring Greensill to the tune of about $10 billon. (From the context I read this as 10 billion US dollars rather than Australian dollars). The core quote is:

BCC director Toby Guy wrote to Greensill chief executive Lex Greensill and Greensill Bank director Markus Nunnerich on August 4, telling them that Mr Brereton had exceeded his authority in approving customer limits to Greensill between July 2019 and July 2020 when he signed numerous comprehensive trade credit insurance policies worth about $10 billion. He was dismissed on July 8, 2020.Many insurance policies have terms that require insurance companies to renew and there is complex law around this. I am neither a la

There are several things to observe here.

First BCC is that Sydney based insurance broker I mentioned in the letter to ASIC. It bound insurance policies for both Insurance Australia Group and Tokio Marine. 

Second the 10 billion dollars in policies are substantially larger than the policies disclosed in any  Credit Suisse documents – so I am guessing that they include the policies that purported to protect the assets of Greensill’s German  Bank.

Third, and most importantly, the policies were written until July 2020. This is important because most insurance policies cover 12 months, and many credit insurance policies are longer. If BCC was writing  policies until July 2020 some of them are likely still in force.

If that is the case Insurance Australia Group and Tokio Marine are staring down the barrel of some very large losses.

Insurance Australia Group is a minnow. Large losses on this scale could reasonably bankrupt it. Tokio Marine is a relative giant and large losses will hurt but not mortally wound it.

Fortunately for Insurance Australia Group they sold their interest in BCC some time ago to Tokio Marine so their exposure may not be large.

That said  – if they are eventually forced to renew exposures on old policies (as per the argument Greensill put at the late night court case) then IAG may incur some very large losses, especially as they appear not to have renewed their reinsurance (as disclosed in NSW Supreme Court).

You may think I am drawing a long bow here, but Insurance Australia Group recently lost a major case on pandemic caused business interruption insurance and were forced to raise AUD865 million in extra capital to remedy their “mistake”. The mistake  was contract wording.

That said it will be up to the courts (and most certainly not me) to work out the extent to which Tokio Marine and AIG are left holding the Greensill bag.

A plea for disclosure

Insurance Australia Group disclosure on Greensill has been appalling. There are exposures potentially large enough to bankrupt them that were undisclosed. Robert Smith, Michael Pooler and Olaf Storbeck in  the Financial Times describe the problem as a “rogue underwriter“.  To quote:

One insurer has already laid the blame for the scale of cover it extended to the company at the feet of a rogue underwriter.

“This is similar to what blew up AIG in 2008,” says one person close to the brewing disputes, in reference to the complexity of the contracts involved.

A rogue trader can kill a bank as per Barings, but the situation with insurance is even more stark. Rogue underwriters crashed AIG – previously the largest market cap insurer in the world.

Given the scale of the issue and the fact that key details have been partially disclosed in court I think it is time for a more public airing than this blog post.

I do not know the disclosure rules in Japan (applying to Tokio Marine) but the continuous disclosure rules that apply to ASX rules seem to impose some duties on Insurance Australia Group and potentially its directors.

What if the liabilities for Greensill losses do not fall on insurers?

It is possible that insurers will duck much of the liability to make good Greensill losses. If policies were written as late as July 2020 (as per the above quoted financial review article) it is unlikely insurers will avoid all liability, but depending on what policy was written when, and depending on the wording of those policies they may duck most liability.

So then someone else may be left holding the bag.

I think there is a good chance that someone will be Credit Suisse Financial Group.

Here is the final letter to clients of one of the credit funds. 

Here is the core client pitch:

The fund seeks to generate stable and uncorrelated returns by investing in notes with a maturity of typically less than one year which are backed by buyer confirmed trade receivables/ buyer payment undertakings, supplier payment undertakings and account receivables (”Receivables”). The underlying credit risk of the notes is insured by highly rated insurance companies. The Fund aims for a target return of 1.50% p.a. above the 3-month USD LIBOR and a short term maturity profile.

The highlighted section is  a doozy. It says that the underlying credit risk of the notes is insured by highly rated insurance companies.

Well it either is or it isn’t.

If it is insured Insurance Australia and Tokio are in a world of pain.

If it is not insured then one might expect extensive litigation and potentially large losses at Credit Suisse. 

GAM, who previously had a fund exposed to Greensill and has barely recovered.  Here is a ten year stock chart. The decline from 15 Swiss Franc to under 5 Swiss Franc per share is Greensill related.

So who is holding the bag?

Well, genuinely I do not know. It could be Insurance Australia Group or Tokio Marine. It could be German taxpayers (through the subsidiary bank) and Credit Suisse.

I figure I know the winners though. Lawyers. Lots and lots of lawyers.

And maybe a short seller or two if we pick the shorts right. You can presume I have some position in  most of the companies mentioned.

John