There is a tremendous daily market of discounted bank instruments like SBLC, Bonds, MTN, BG, etc. involving issuing banks and long chains of what are called “exit-buyers”, which include huge financial institutions, Pension Funds, etc. in an exclusive Private Placement Program arena.
These activities on the bank side are done as “Off-Balance Sheet Activities”, which allow the banks to benefit in many ways. So, what are “Off-Balance Sheet Activities”? Basically, they are contingent liabilities and assets, where the value depends upon the outcome upon which the claim is based, similar to that of an option. These “Off-Balance Sheet Activities” show up on the balance sheet merely as memoranda items. When they cause a cash flow, they will show up as a debit or credit on the balance sheet. Since there is no deposit liability, the bank does not have to consider binding capital constraints.
So, what is the difference between private placement programs and normal trading?
Since all Private Placement Programs involve trading with discounted debt instruments (notes) and can only be done on a private level in order to bypass legal restrictions, these types of trades are different from the highly regulated “normal” trading. Said another way, these Private Placement Programs are done and restricted on a private level only without all of the restrictions that are present in the securities market.
What is “normal trading”? It is what the majority of the public is aware of and is known as the open market (or spot market) under which bids and offers are used to buy and sell discounted instruments. Kind of like an auction.
To play here the traders must have full control of the funds, if they don’t, they cannot buy the instruments and sell them to others. Also, there are no arbitrage buy-sell transactions in this market because all players have a clear view of the instrument and its price.
There is also something called a “closed, private market” where an inner circle exists and is made up of a restricted number of “master commitment holders”. These are basically trusts with large amounts of money that agree (through contracts) to purchase a specified number of fresh-cut instruments at a set price during a set period of time. Their purpose is to sell these fresh-cut instruments on, so they contract sub-commitment holders, who contract with exit-buyers they find.
Because all of these programs all based on arbitrage buy-sell transactions with preset prices, the traders do not have to be in control of the investor’s funds. But in order for a program to start, there has to be enough money behind each buy-sell transaction. That’s why the investors are needed. The involved banks and commitment holders are not permitted to trade with their own money unless they have reserved enough funds on the market, and that money belongs to the investors which is never used, and never put at risk.
These Trading Banks can lend out money to the “traders” usually at 1: 1 0 ratio, but under certain conditions, they go as high as 20: 1. That means that if a trader can “reserve” $100M, then the bank can lend out $1 Billion. This is accomplished through a line of credit based on how much money the trader (the commitment holder) has, since the banks don’t lend out that much money without collateral.
Any trader that requires he be in control of the investor’s fund, is not one of the major players, but rather plays in the open spot market where lots of different instruments are traded.
Now if the trader only has to reserve the client’s funds without being in control of those funds, he is participating in this private market of private placement programs.
Since many bankers and others in the financial arena are exposed to the open market but are not allowed into the private market, they find it difficult to believe that a private market exists and that is often the reason they think private placement programs are scams.
As my grand pappy used to say, “Ignorance is a voluntary misfortune”!!!