Report on the Lehman-related Securities (5)

II. Dissecting the ‘Piggybacked Structure’

The ‘piggybacked structure’ is made up of two separate and independent components. They
are intended to operate in tandem, but independently. They carry risks of different kinds and
of different magnitude.

The majority of Lehman-related securities are labeled as ‘minibond’ while others are
variously named as ‘equity-linked note’ and the like. The label is less important than the
structure because the scam is based on using one component to conceal the other. The former
performs the function of a façade in order to hide what is underneath. It is apt to characterize
that component a façade because prominence is given to it by the fraudsters in the marketing
materials.

The façade component (the ‘façade’) could be a first-to-default credit-linked note (the ‘CLN’)
featuring a few corporations well-known to the public of Hong Kong. It is intended to
provide the reassurance that the product is safe and solid.

By purchasing a CLN, the investors run the risk of losing part or all of their investment if any
one of the specified reference entities (that is, the well-known corporations) suffers a credit
event as defined in the prospectus. Because an issuer of CLN can be a special purpose entity
(a company without substantive business or asset but was created solely for the purpose of
issuing structured notes), it will use the fund received from the investors to purchase
collateral in order to enter into swap arrangement with another party (known as ‘swap
counterparty). The swap is intended to be a mutually beneficial exchange whereby the CLN
issuer is likened to an insurer underwriting the financial health of the reference entities. In
exchange for this protection, the swap counterparty agrees to pay at regular intervals a fixed
or variable sum to the CLN issuer just as an insured would do in paying premium to its
insurer. The collateral serves to protect the interest of parties to the swap agreement by
ensuring that fund for the performance of their respective obligations is readily available.
Given this ‘safety net’ function, the parties to a swap agreement normally select sound and
solid assets whose value is likely to remain stable during the term of the agreement as
collaterals.

.....to be continued.
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"