The Opes Prime Fiasco

Lost in the noise surrounding this debacle is the mechanics of what has actually happened, and more importantly, whether this can happen again. The scariest thing about what has happened is that Opes Prime's business model is not that uncommon, and is shared by many other perceived margin lenders.

During the remarkable bull market we have seen, borrowing money to buy shares has become an all too common practice due to the combined forces of cheap debt and rising stock prices. The most common way to do that has been through margin lending (which many subscribers use), and it has long been an investment tool we have advised subscribers to be careful of. Margin lending is, in summary, when you borrow money to buy shares, and the shares are used as collateral for the loan. The advantage of this is that if the shares go up, your gain will be magnified and the disadvantage is the reverse. When stocks go down, margin lenders will require their clients to maintain a certain loan to value ratio (LVR), which essentially means that the value of the collateral (cash and shares) is substantial enough to cover the loan amount. The LVR can be maintained by either giving more collateral (cash or shares) to the margin lender, or by selling some shares. This has been one of the causes of the massive sell-off we have seen, as leveraged investors have wound down their stock portfolios by forced selling.

The difference between the ordinary margin lender (such as Leveraged Equities) and Opes Prime is subtle yet very significant. With the ordinary margin lender, once you borrow money to buy shares, the shares are held in your name and you effectively owe the margin lender what you have borrowed, and they hold the shares in trust as collateral against the loan. Opes' business model is, or rather was, that it lends as a finance broker on commission on behalf of its lenders (in this case, ANZ and Merrill Lynch) and takes full ownership of the shares provided as collateral. It then lends that stock to short sellers for a fee. ANZ and Merrill Lynch lent money to Opes and the lenders have the stock (now owned by Opes) as security. This is in direct contrast to the stockbroking clients of Opes, who in effect become unsecured creditors to the company. Effectively the clients are lending money to Opes as well to gain exposure to particular shares (much like CFDs) but rank behind the primary lenders. It seems amazing that clients can actually lose their equity in a situation where they either had no or minimal debt but it looks like all clients have lost their money and it appears many (if not most) were not aware of the structure.

What has caused Opes to become insolvent is still unclear, but further investigation will shed light on that… but now that Opes is in receivership, its secured lenders, ANZ and Merrill Lynch, now effectively own all of the shares that had been put up as collateral, and theoretically are free to sell these shares to recover their secured loan amount. What is left over from the sales will be distributed to those creditors ranking behind ANZ and Merrill Lynch (Opes' clients), and theoretically anything left over after that will go to equity holders of Opes (clearly not going to happen).

Some of the stories we have heard are terrifying. For example, we heard of an investor who bought $1m worth of shares through Opes, of which $250,000 was borrowed. The entire $1m has now been lost and the investor has become an unsecured creditor of Opes Prime, and unlikely to get much back (if any at all). So that person will lose $750,000 in assets simply through the mistake of using Opes Prime as a broker and lender for a third of that amount.

The moral of this story is to be aware of the risks of borrowing money to buy shares. Any subscribers who have done so should immediately look at the financial services guide (FSG) they signed when opening an account to make sure ownership of the shares remains in your name. If that means consulting a lawyer to walk you through it, we think that is a small price to pay for peace of mind.