by Eric Ellis
EuroMoney
October 04, 2017

This is the third year of the drama: as the government desperately tries to untangle its controversial fund before elections are called, Malaysians are asking who’s really paying to clean up the mess.

It was a revealing time to be a banker in Malaysia.

During the last week of July, word went around Kuala Lumpur’s banking circles that there could be a big government mandate in the offing, a deal to raise around $600 million, there for the taking for anyone up for the business. A $600 million transaction might not be especially large, but a deal is a deal, and even better if it’s for a sovereign, no? After all, the pickings have been a little slimmer for KL bankers ever since Malaysia was engulfed by the 1MDB corruption scandal in 2015, a saga that has rocked the ringgit, threatened Malaysia’s credit standing and plunged the country into chronic political and economic turmoil. At the centre of the scandal is Malaysia’s prime minister, Najib Razak, who received hundreds of millions of dollars via 1MDB, and who claimed the money was a donation from Middle Eastern supporters.

Two years on, the $12 billion debt drama at the Malaysian sovereign fund continues to reverberate at home and echo in regulators’ offices around the world, with investigations under way in seven countries – but notably not Malaysia. Given the suspicions of money laundering and embezzlement, investigators, some wielding indictments, are demanding answers to tough questions about important people implicated in the case.

“There was real damage here. 1MDB caused significant widespread reputational damage to Malaysia,” says the country head of a large foreign bank in KL.

Unsurprising then that such a toxic environment has made bankers in KL rather more discerning – let’s call it gun-shy – when it comes to doing business these days. After all, they are well aware of the fate of one their coterie, Tim Leissner, the former Goldman Sachs southeast Asia boss who was close to the ruling family at the centre of the scandal. The flashy Leissner raised billions for 1MDB through 2013, earning his bank a rumoured $300 million in fees.

When word filtered through the market at the time about Goldman’s 1MDB windfall, “I got my butt kicked by my bosses asking why we didn’t get the business,” one local banker tells Asiamoney. Today, Leissner is long gone from KL, and from Goldman Sachs too. Nor is he welcome in neighbouring Singapore, where the market regulator has banned him from banking for 10 years for 1MDB-related offences. Goldman and Leissner are also under investigation by the US Department of Justice over their roles in the 1MDB affair.

Deadline

But 1MDB continues to draw blood: as talk of this proposed deal got around, bankers remembered that July 31 was the deadline imposed by 1MDB’s erstwhile Gulf associate, the Abu Dhabi sovereign fund International Petroleum Investment Company (Ipic), for repayment of the first tranche – or half – of the $1.2 billion that it owes Ipic.

That payment is an important part of the Malaysian government’s painstaking unravelling of 1MDB, a sclerotic, credibility-straining process of asset firesales and debt restructuring.

For Najib, whose government faces elections next year, 1MDB has become a political liability. In a US lawsuit seeking to recover assets acquired with 1MDB cash, the prime minister was simply referred to as “Malaysian Official No. 1”.

Najib, who was 1MDB’s one-time chairman, has dismissed the scandal as a lapse in governance, while his government has tried to stifle dissent. But there are hints at the depth of public revulsion at what has happened at the fund.

At the Starbucks cafes in downtown KL, it’s common to hear customers giving the name “Malaysian Official No. 1” when the baristas take their coffee orders.

Roadside government billboards exhorting public integrity are defaced with graffiti, as are the advertisements for property developments that promise a “new generation of aristocratic demeanour”. (The ennobled Najib hails from a family storied in Malaysian cultural and political history.)

So, were these two end-of-July events, this sniff of a sovereign deal and the Ipic-1MDB repayment deadline, connected?

No one in Putrajaya, Malaysia’s administrative seat, could or would officially say, which indicated something to old KL hands. Indeed, that this crucial Ipic debt deadline was looming went largely unremarked in the mainstream Malaysian media, which is read more to divine the official line. But it was a different take online, where the 1MDB saga has mostly played out and, in these strange days in KL, that’s where bankers tend to get their news – and from sources.

All that made this particular week in late July problematic for KL bankers and financiers. As it progressed, various industry sources told Asiamoney what they were hearing about how 1MDB might make good Ipic’s $600 million. It was believed, as it turned out correctly, that 1MDB didn’t have that sort of money to hand. So to make the July 31 deadline, it might have to come from somewhere else and, crucially, be seen as market-appropriate in doing so.

There was speculation that Malaysia’s Employees Provident Fund, a respected institution boasting assets of $200 billion, might step up. The rumour in the market was that 1MBD’s masters in the finance ministry – where Najib has been minister since late 2008, shortly before he became prime minister in early 2009 – had approached the EPF.

Then there was talk that Kwap, the $40 billion state-run retirement fund for civil servants, had been sounded out.

The state investment house Khazanah Nasional was also mentioned as a potential source of funds, as was the Federal Land Development Authority, which answers to the prime minister. The state-owned oil company Petronas was cited as a possible player; so too the Tabung Haji, the government agency responsible for arranging religious pilgrimages.

None of these agencies responded to Asiamoney’s inquiries. But as each large government-owned institution was cited as a possible source of funds, the notion was similarly cast aside as being both unrealistic and politically problematic for Najib’s ruling UMNO-led coalition. Denying wrongdoing at 1MDB, Najib has tried to affect a ‘crisis, what crisis?’ air about the debt-laden fund, promising that no state agencies will be engaged to bail it out.

So by Wednesday, with the deadline looming, official operatives and go-betweens started sounding out bankers. Could they help? ‘We’ll make it worth your while,’ they apparently cooed.

“It was only five days to the payment,” one banker told Asiamoney. “They were facing a technical default, and they’d only started making calls. It just showed how disorganized they are at the top.”

By Friday and with the pressure on, financiers were suddenly remembering golf and family dates they’d curiously forgotten about. Calls weren’t returned; phones were switched off for the weekend. As one investment banker put it to Asiamoney: “It was a banker’s equivalent of collectively deciding that we all had to wash our hair that day.”

Credibility

As bankers in Malaysia note, there were powerful reasons to get the payment made, not least the financial credibility of two sovereign players in the international markets.

After long and often bitter negotiations, 1MDB and Ipic agreed last April that 1MDB would pay Ipic $1.2 billion in two stages. Backed by the Malaysian state, 1MDB also committed to meet all the interest and principal payments of two $3.5 billion 10-year bonds that Ipic had guaranteed in 2012 for 1MDB. Those bonds helped pay for two power companies that 1MDB was later forced to sell as the fund tried to unravel its debt mess.

In agreeing to make good its debt, 1MDB promised to meet its obligation via the “monetization of 1MDB-owned investment fund units.”

In Abu Dhabi, there is no appetite for further public embarrassment over how one of the emirate’s leading sovereign funds was managed.

Authorities have jailed the former Ipic managing director, Khadem al-Qubaisi, over his role in the 1MDB plot, and Gulf observers believe Ipic’s messy involvement with 1MDB was a catalyst for the state-led, $125 billion merger last January of Ipic with another Abu Dhabi sovereign investor, Mubadala Investment.

“The Emiratis are also very keen to get their money back,” notes a banker. But back in KL, progress on that front was taking time: July 31 came and went without 1MDB making good its obligation to Ipic, marking another technical default for a Malaysian sovereign entity. Then Bank Negara, Malaysia’s central bank, published details inviting investment in a Shariah-compliant 30-year government bond to be issued by August 4. The amount was RM2.5 billion, or nearly $600 million – curiously, the same amount owed by 1MDB.

Was this a coincidence, or was it to raise the 1MDB payment? And was the Najib government breaking its promise not to deploy state agencies to bail out the troublesome fund? As speculation swirled about who was going to bail out 1MDB, Najib told parliament that the missed payment was a “technical issue…and not because we are not able to pay back. We trust that it will not affect the confidence in the country’s economy.”

Bond markets started to wobble. 1MDB broke its silence to say it had requested a brief delay from Ipic to make good the debt.

Blaming the default on “additional regulatory approvals,” 1MDB claimed that funds that were due to be paid to it in July had “been delayed to August.” The widely followed Malaysia Insight news site reported: “The delay was caused by banks, both local and international, not wanting to handle transactions related to 1MDB.”

On August 8, when 1MDB missed Ipic’s five-day extension to pay up, the Emirati fund told the London Stock Exchange it had given 1MDB another extension. Now it was demanding that 1MDB pay $310 million of the debt by August 12, the rest of the first $600 million tranche by the end of the month, and bear any penalty interest arising from the late payment.

As for that Shariah bond offered for auction via Bank Negara, Najib’s deputy in the finance ministry, Johari Abdul Ghani, then chimed in.

“That bond has nothing to do with 1MDB”, he insists. “It is a normal government bond,” Johari claims its issuance was a normal part of government business: “Every year, we have a deficit budget and we need to finance government expenditure through bond issuance. That’s it. So whoever speculated that this bond will be issued to help 1MDB is making totally baseless allegations and they are factually wrong.”

1MDB says: “All payments due from 1MDB to Ipic will be made from the proceeds of the 1MDB rationalization plan.”

On August 11, 1MDB at last made good on part of the first $600 million tranche to Ipic, wiring $350 million from 1MDB’s account at Maybank, which was $40 million more than was due. Even though it was 11 days after the original July 31 deadline, 1MDB noted it had paid a day ahead of the new August 12 deadline.

1MDB refused to say why it had paid an extra $40 million than necessary, though most observers believe it was a penalty for late payment. Nor did it explain why it didn’t pay the remaining $300 million due as part of the first tranche.

On August 30, 1MDB announced it had paid a further $350 million owed to Ipic, saying: “All funds were paid from proceeds of the on-going rationalization programme.”

Now December 31 looms as the deadline for the next $600 million. Some 20 years after the Asian financial crisis, this is the new normal in Malaysia.

Sensitive

Few banks operating in Malaysia have been unsullied by the 1MDB mess. Indeed, the extent of local involvement is a sensitive subject and no bank has fully quantified its exposure.

AmBank, the one local known to have had exposure, is now in the throes of merging with RHB Bank to create Malaysia’s fourth-biggest bank – after Maybank, CIMB and Public Bank. JPMorgan Chase is advising AmBank and Credit Suisse is advising RHB.

The AmBank-RHB merger will also close a difficult period for big Australian lender ANZ, whose 24% stake will be diluted to an easier-to-offload 10% of the merged entity as ANZ ends its Asian adventures.

One bank that has dodged the 1MDB bullet is HSBC Malaysia. And that’s a considerable source of satisfaction for country chief Mukhtar Hussain, a Briton who has also run HSBC’s global Islamic bank out of in Kuala Lumpur since 2009.

“There were phenomena in the market that we were not involved in,” Hussain tells Asiamoney. “We chose not to be involved in them over a period of time, and what it showed us was the robustness of our own judgement in process.”

After eight years in Malaysia, Hussain doesn’t see any negative impact on HSBC’s franchise simply because it decided to steer clear of questionable business.

“We’ve survived, we’ve invested, we’ve prospered, we’ve been through the ups and down with this country,” he says. “But I think we’ve always been fairly conservative and cautious about who we do business with and what business we do. The important point to take away is (that) we wouldn’t do business just because it is commercially attractive. And that has served us well.”

Having a diversified customer base helps.

“We are not reliant on government-linked companies for business, on the public sector for our core business,” he says. “We are able to make dispassionate objective decisions about what we want to be involved with, and who we want to be involved with.”

Hussain points to the reminders he’s had put up inside the lifts at HSBC’s headquarters in Kuala Lumpur. When members of staff ride the elevators to their floor, they cannot avoid seeing the confronting posters stuck to the inner doors.

“Ask yourself. Is there a financial CRIME risk?” the signs say, listing “bribery, corruption, money laundering, organized crime, tax evasion, terrorist financing” as the issues to be avoid.

“Are there UNACCEPTABLE risks? Complex company structures, country-specific risks, customer conduct, non-tax compliance, regulatory or reputational risk.”

Indeed, some of these warnings displayed around HSBC’s head office sound as if they come directly from the 1MDB playbook.

“It’s every day in the lift, every day on your computer. You hear it, you read it, you see it, you learn it, you do it,” says Hussain. “It isn’t just for those who of us who sit on this (management) floor to believe it. We have a footprint across this country, so it’s no good having a head office that believes this stuff but nobody else practices it.”

Hussain says the questions the bank’s credit analysts ask themselves boil down to basic due diligence.

“We apply a fairly rigorous degree of analysis to make a determination as to whether a piece of business is what we want to pursue or not,” he says.

“What are the facets of the transaction that we need to understand? There are the reputational facets of the institution, of the sponsors. The very simple truth is, do we understand what the purpose of the transaction is? Can we get some sensible answers to the commercial and financial logic of the transaction? Is being done in a transparent way? Is it a public markets transaction?”

Unravelling

HSBC has been involved in the 1MDB matter, but as Hussain insists, only in the dealmaking that has marked its unravelling. “Where we have been, as an institution, is solving the problem, not helping create the problem,” he says.

He means HSBC’s role in advising the Chinese state-owned energy giant China General Nuclear Power Corp in its $2.5 billion purchase from 1MDB of Edra Global Energy, which owned the largest independent power stations in Malaysia, Bangladesh and Egypt.

HSBC Malaysia is also investing $250 million in a new headquarters at TRX, slated to be Kuala Lumpur’s new financial precinct. The ministry of finance took over the project from 1MDB: that transaction, bank insiders say, was painstaking in its due diligence so as to ensure it passed the “smell test” and that 1MDB was well out of the deal.

Still, bankers are divided over the medium-term impact of the 1MDB crisis. One player who’s been on the road with various deals over the last two years says no one is talking about it anymore, or asking questions, and it is not a factor in pricing or risk.

“1MDB has made Malaysia cheaper,” says one banker. “The ringgit has fallen and Malaysia is now short of its weighting in the MSCI indices. Foreign investors just look for value – up until recently, regardless of 1MDB, Malaysia was just too expensive.

Malaysia has big local funds and they are always in the market and the PEs [price-earnings ratios] get pushed up.”

Says a fund manager: “Malaysia is rebuilding, albeit from a toxic base.”

So why did banks like HSBC avoid the 1MDB mess?

“If you don’t know who they and their business partners are, why would you bank someone you don’t know? And where’s the substance behind these figures? What’s the story? Where’s the value-add?” says one banker who prefers to remain anonymous. “We couldn’t really get the answers to any of these questions to our satisfaction. It was basic discipline.

“We take it as read that is what we do, but what 1MDB shows is that our way of assessing things is clearly not market practice.”