TEMASEK'S SCHOLARS CONNED BY AN OVERGROWN KID IN SHORT PANTS

In the 1980s there was a company called Colour Touch (S) Pte Ltd whose principal business was wholesaler in carpets. It appeared on the scene sometime 1985 and within 2 years became the biggest carpet wholesaler in town. Soon it took on massive financing and many banks rushed in to provide loans upwards of S$20m. The boss sat in an oversized office fit for an international conglomerate, adorned with display pieces in gold. The company had about 6 sales executives (not managers) all provided with BMW cars. I was working in a bank and I wondered what sort of business a carpet trader can attract that kind of loans and bear those overheads. I narrate this with full authenticity as I had close relationship with people in the trade who knew the folks at Colour Touch. To my query what sort of margin is there in carpet trading that can support such loans, I was told it was a competitive market. The modus operandi was Colour Touch imports at a certain price, sells to a separate company at good discounts, said company was then able to outbid competitors at big projects. Colour Touch chalks up huge losses, bank sues company to bankruptcy, owners walk away with huge profits from the related company. The opulent office and the BMWs, and of course fine wines and diners, all out to impress bankers. The oldest con in the business, and it worked. Often.

Take away the complicated technology, high sounding literature of the crypto world, the boast of block-chains that mystifies even seasoned investors, then left in the Emperor's clothes, the collapse of crypto exchange FTX is not much different from Colour Touch.

Much has already been written about how FTX collapsed. I shall limit myself to the investment of Temasek.

Back in the days when I was in banking, we used to quip that in every big corporate failure, we will see Societe Generale right up there amongst the biggest lenders. Kenneth Jeyaratnam wrote eloquently about banana skins of investments and of Temasek's uncanny ability to find every one in the room and slip up on it.

Everyone is an expert with the wisdom of hindsight. Investment carries risks and all investors have to make a call on what they wish to invest in. Since outcomes are never deterministic, we cannot criticise Temasek as long as there was due diligence and investments made within their framework of risk and authorised investment parameters. That said, what is open to criticism are weaknesses in risk management system and when red flags prior to investment decisions were apparent but ignored or missed.

The only thing that we Singaporeans should have a say, policy wise, is whether we prefer reserves to be invested in the old-fashioned traditional 60-40 way and in solid assets. Or do we want Temasek to continue it's journey into equity fund management, a world of huge employee compensation, high risk assets of venture capital, often in early seed funding, huge unlisted portfolio, build concentrated equity with no board seats, offices all over the world, and lastly into leveraged investments. It all boils down to the risk-returns conundrum. I feel this is a national conversation we ought to have.

As for leverage, Temasek has been taking on debt since 2014, rising from S$9b to S$90b as at 31 Mar 2022. In 2022 debt increased by S$8.5b. I believe these are USD bond issues. The era of cheap money is over. With the Fed taking an aggressive stand against inflation, the USD interest rates are rising. Every 50 basis point increase is going to see a S$450m increase in Temasek's interest expense for the year. It's going to be a challenge just on debt servicing.

For those that kpkb Temasek does not perform due diligence, or forever dragging Ho Ching into the picture for responsibility based on the investment timeline, this isn't helpful. Temasek statement shows a 8 month process due diligence work into areas most laymen won't even know about --licencing, AML, KYC, sanctions, cybersecurity, etc, across many jurisdictions. Of course they did interviews, legal advices and technical specialists' inputs, the whole works.

There are only 2 things I am curious about the due diligence work. Temasek said:
- "..we reviewed FTX’s audited financial statement, which showed it to be profitable."
- "Separately, we also gathered qualitative feedback on the company and management team based on interviews with people familiar with the company, including employees, industry participants, and other investors."

Apparently Temasek was satisfied with the people and the financial statements they saw. Did Temasek review a different set of financials and vetted a different group of people or what? If you were to go look up various interviews of Sam Bankman Fried or SBF, beyond the technical gobbledygook of crypto-talk, he had been caught tongue-tied and displayed naivete and lack understanding in running a huge financial operation.

John Ray III has been brought in as new CEO to sort out the mess in FTX. Ray had vast experience in sorting out the mess of the Enron bankruptcy. This is what he had to say :

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”

This is a complete annihilation of Temasek's opinion on FTX financial status and personnel. However, I give myself an escape path. Perhaps by now their accounts have been totally messed up due to the upheavels of the past few weeks as FTX tried to prop up Alameda with fraudulent transfers. Perhaps months ago during Round B and C funding when Temasek was doing the due diligence, the accounts were in order.
 
On the issue of fraud regarding funds that went missing and transfers to Alameda Research, Temasek had this to say:

"Reports have since surfaced that customer assets were mishandled and misused in FTX. If these statements are true, then this amounts to serious misconduct or fraud at FTX."

Of course we cannot pin post-fact events on Temasek. However, in their due diligence, Temasek may have failed to appreciate Alemada - FTX link. FTX is a crypto exchange, Alemada is a giant crypto trader. Both are owned by SBF and Alameda is a price maker for FTT-USD, the native token issued by FTX. Both companies have insisted they deal with each other at arms length (very familiar term to Singapore Inc). In financial markets, the exchange is always separate from the market makers. This prevents trading against their own customers and price fixing. It is this relationship that brought the house of cards down.

The woes of FTX stems from liquidity problems at Alameda. Over extension of resources by Alameda into venture capital plays and counter-party credits took a heavy toll, especially from loans extended to Voyager Digital, another cypto platform. To support Alameda, FTX fraudulently transferred customer deposits to the latter.

The market has always suspected Alameda's big play is on FTT-USD, playing against their own customers, plotting the token price up. This was revealed when Coindesk.com got hold of a secret document of Alameda's financial status. On Nov 2 Coindesk published an article to reveal Alameda's bulk of assets as well as net capital, was nothing more than FTT-USD tokens that FTX issued from thin air. This report confirmed the lines between FTX and Alameda are blurred and suggests the trading giant may be insolvent. On Nov 7 Binance liquidated its holding of US$530m worth of FTT-USD tokens with Binance CEO Changpeng Zhao making a public tweet. This started the dowward spiral of the price of FTT-USD. As its token tanked, customers of FTX rushed for the exit door resulting in a run on deposits which the exchange no longer have.

If you want to take a whip against Temasek, it is this inability to see the FTX-Alameda link in their due diligence. FTX had super-charged to propel itself to the 2nd biggest crypto exchange in a matter of 1 year. How much of their transaction volume is fictitious? The industry is known for at least 70% of volumes to be 'wash trading', which is fictitious buy and immediate sales by same entities. Since FTX is a centralised exchange, transactions would not have been individually done on-chain and thus not transparent. Data analytics would have not been able to determine the wash trading. However, the trades are recorded on some order books, an examination would have revealed wash trading by Alameda. Temasek obviously failed to audit the order book which is inexcusable.

Temasek explained the nature of their technology investments :

"Our venture building efforts have been focused on programmable money, digital assets tokenisation, and decentralised identity and data."

This is at odds with the FTX exchange which is a centralised platform. The two biggest crypto exchanges FTX and Coinbase are both centralised technology. The centralised exchange is a model based on protection of private keys and then make lots of money charging fees on transactions. It works against the promise of blockchain technology and a reversion to something akin to the legacy banking systems that crypto and delfi want to replace. This is what Vitalik Buterin, founder of Ethereum, had to say about centralised exchanges:

“I definitely hope centralized exchanges go burn in hell as much as possible”...Vitalik Buterin 2018

 Temasek's investment in FTX is like promoting sustainability investments and then going out and fund a coal mining project.

Perhaps the most critical big picture of Temasek failure came from a high level insider who once explained there is no risk committee at board level. He said with reference to Temasek : “Every commercial organization of any reasonable scale, and in particular financial institutions, simply must have a dedicated risk management committee of the board that is fully independent of management. To not do so is simply playing Russian Roulette and is inexcusable in today’s volatile era and in light of the recent financial crisis ”.

To sum up, FTX collapse is the unraveling of the cascading effect of the Terra-LUNA eruption back in May, its destructive forces is still rumbling throughout the crypto ecosystem. The fall of Terra-LUNA pulled down the Singapore registered crypto hedge fund 3AC or Three Arrows Capital, which brought down Voyager Digital, which in turn caused huge problems at Alameda, causing the collapse of FTT-USD token price and a run on deposits at FXT. The legacy banking system has been heavily criticised for assets that are packaged and repackaged into derivatives and repackaged yet again, until risks becomes blurred and contagion effect occurs when one counterparty in the system goes bust. It is the same exact situation in the crypto world.

We trust our sovereign wealth funds navigate this complicated investment world with eyes wide open and especially be extra cautious with overgrown kids in short pants asking for a $ billion to burn. The investment environment may have changed, but the con is still the same.


My related blogs :
Temasek Tracking - making sense of risks
Will Temasek by played by the deep pocket syndrome

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