The battle for the Libyan Investment Authority

Euromoney, April 2012

You are a country emerging from a bloody revolution that has ended 42 years of stultifying dictatorship, and you have one crown jewel: a sovereign wealth fund, fed with national oil wealth, with perhaps $60 billion of assets. So where do you go, in these liberated but uncertain times, to find the right man to run it? In Libya in 2011 you went, it turned out, to the University of Nottingham Business School.

Mohsen Derregia became chairman of the Libyan Investment Authority in April 2012 following a process he describes today as “totally a freak accident.” Indeed, the appointment of an academic, who had left Libya to become a research fellow at Manchester Business School in 2001 before shifting to Nottingham in 2006, puzzled some in the MENA investment community, and continues to do so today. “He’s a professor of accounting,” says someone formerly close to the LIA. “He hasn’t got a clue about finance.” But those who knew him before his move to the UK recall instead a successful entrepreneur in Libya, and not such a strange choice: no investment expert, sure, but a safe custodian for a vital institution.

“A friend of mine called and said: we like your CV. We’re asking for people in senior positions in Libya, and we want some new people to join,” Derregia tells Euromoney from Tripoli. After some cajoling, and on the condition that he would only consider supervisory part-time roles, he expressed interest. First he was proposed as a trustee member on the LIA’s supervisory board; then Libya’s cabinet insisted he would be more useful as a director, involved in LIA’s management. Next he ended up on a committee of three executive directors with the power of a board. “And then people started withdrawing, having seen the amount of work required,” he says. “I ended up being the only remaining person on this committee of three. “ And hence, in April 2012, he became chairman of the LIA, almost by default, and then CEO in May. “I remember the Prime Minister calling me,” he says. “He said: it’s down to you. We can’t all walk away. Somebody has to take responsibility. Somebody has got to do this in the new Libya.”

And so he did. But, 11 months on, after an exhausting glut of frozen assets, entrenched interests, obstruction and opacity, he must wish he hadn’t bothered: three days before Euromoney’s interview, and after months of speculation, he received word from the government informing him that he was to be replaced at the helm of the LIA. He is challenging the legality of his removal, but is resigned to leaving, with a bitter sense of progress lost. “I want the government to understand that in the new Libya, even if you have the power, you must act within the boundary of law, of rules and regulations,” he says. “Otherwise, we shouldn’t have gone out on the 17^th of February and deposed Gaddafi. Because it’s going to be exactly the same.”

*

The LIA took shape in stages between August 2006 and April 2007 following the lifting of UN, European and US sanctions against Libya in 2003-4. It was backed, from the outset, by Seif al-Islam, Muammer Gaddafi’s second son, and his shadow would remain over the institution long after the revolution and his arrest.

It has become commonplace to depict the LIA at this early stage of its development as a bunch of oil-rich buffoons, corrupt and uninformed and unaccountable, but the true picture was far more nuanced than that. From the outset, there were senior, experienced people at the LIA, among them Mohammed Layas, the LIA’s first chairman, who had been chairman and general manager of the Libyan Arab Foreign Bank; and Hatim Gheriani, who became CIO (or at least was given that title, if not the responsibility and freedom that might infer) in April 2007. Gheirani was an experienced ex-Commerzbank investment banker who had worked with Layas and has since gone on to HSBC.

There were also highly regarded external advisors. “What gave us confidence,” says one early recruit, “was that we arrived on day one and on day two Ernst & Young turned up. They were hired to build a structure and develop internal manuals. It made us feel they were serious about doing it properly.” Next Mercer was hired to advise on asset allocation and corporate governance, putting together a suggested structure that would yield average annual returns of 7%, and offering use of its best-in-class fund manager database. At one stage the LIA even hired a PR firm, Financial Dynamics, to help with disclosure policy. “I know this will sound funny to you,” says one former staffer. “But our role models were Norway and Singapore.”

Still, there were early signs of authoritarian interference. The other key early hire was Mustafa Zarti, who worked alongside Layas as deputy head; his main qualification appears to have been that he met Seif Gaddafi while studying for his MBA at Webster University in Vienna.

LIA was in a hurry. Early arrivals found their first priority was to buy themselves chairs and computers, yet the urgency for quick investment was palpable. “I went to see the Prime Minister and tried to explain that it took the Norwegians five years between the decree [to form the sovereign fund] and investing their first dollar,” recalls one former employee. “A lot of homework has to go into this: work on asset allocation, a public debate in parliament, the infrastructure, passing law, setting objectives. He said: you start now. The Qataris are buying islands off Libya.”

Still, a balance was struck between the heady optimism of the state and the more cautious approach of the senior executives, who spent as much of their time attempting to slow things down as to get things moving. Investment began across a broad range of asset classes. Fund managers who pitched Libya through this period – and most did, despite a certain residual uneasiness at dealing with Gaddafi money – recall Layas’s delight that suddenly international bankers would fly in to Tripoli on private jets to see him. “We were inundated,” recalls one former LIA employee. “There was always pressure: do this, do that.”

There was a mixture of enthusiasm and incapacity. While working in the Middle East, fund manager Douglas Hansen-Luke, now managing director of HLD Partners, secured a mandate from the LIA. However, having won it, he then flew to Libya, and found himself meeting summer interns because the head of the LIA at the time had been summoned into meetings with politicians. In the end, the mandate was never funded. “The LIA had some of the best procedures and principles, but were frequently unable to follow them through due to lack of strength and depth in their team and resources,” he says. “For example, their advisory board and council had the likes of Lord Rothschild and other expert investors on it, and they used outside consultants like Mercer. But actual implementation never occurred.”

It would later become clear that many of the mandates that were seeded during that time would have been far better left unfunded. As one former staffer says: “The financial crisis was a godsend for Libya, really. Otherwise they would have invested even more money. Despite some of the very poor investments made during that time, the LIA was still basically 85% in cash. We preserved our funds and outperformed almost any other sovereign fund almost by chance.”

Other moves were widely admired by the world investment community, notably the establishment of Dalia Advisory Limited as the LIA’s UK arm. It still exists in premises on Mayfair’s Upper Brook Street, around the corner from the Dorchester and the US Embassy. “The purpose was a vehicle to recruit the talent that we lacked,” recalls one former staff member. They went so far as to hire two headhunting firms, give them the organisation structure Ernst & Young devised, then “identified five or six key positions without which you don’t have a sovereign wealth fund.” To which he adds: “And we still don’t.” By December 2009 the original team considered their asset allocation work complete, but by then, some had already become disillusioned about the authority’s commitment to a properly-governed, well diversified institution. “We were chasing a mirage,” says one. “They were never going to do it properly.”

January 2010 brought a new CEO, Sami Rais, with different ideas and backers; Rais was a protégé of the then central bank governor, Farhat Bengdara. Depending on whom you talk to, Rais was either a new broom seeking to improve governance and returns and correct past errors, or someone who simply binned all previous efforts in order to implement the will of the central bank. In rare interviews he has said that he, too, struggled to get long-term ideas past senior management. Either way, this was a moment of transition; Gheirani swiftly left, though Layas stayed.

One of Rais’s most significant decisions was to employ another top management firm, KPMG, to conduct an audit on the LIA’s holdings. Two of KPMG’s reports – or internal management reports compiled with KPMG’s assistance, stating the asset position of the LIA as of June 30 and September 30 2010 – found their way out of Libya and were leaked to Global Witness, a London-based campaign group.

The leaking of these reports opened a window on what the LIA had been invested in all this time. The attached article examines these documents in detail, but several conclusions leap out: one, that the LIA was miles from its intended target allocation, though enormously overweight cash; two, that it dramatically favoured Italy as an investment destination; and three, that there had been some terrible investments in structured products, in particular through SG, Goldman Sachs, Millennium Capital and Palladyne. While this is not explicitly stated in the documents, it is believed Goldman Sachs lost $1.4 billion for the LIA (another report says it lost 98% of $1.3 billion), and SG, about $700 million. Both banks declined to comment to Euromoney.

Still, by the time these reports became public in 2011, Libya had other things to think about.  On February 15, 2011, protests began in Benghazi, leading to civil war, the establishment of the National Transitional Council, and eventually revolution. Shortly after the beginnings of the Benghazi uprising, the United Nations Security Council froze all Gaddafi and state assets, including the LIA.  The institution entered limbo until Gaddafi was overthrown and the time came to recruit a new chairman to take stock.

Which is where we meet Mohsen Derregia.

*

Derregia had some sense of what to expect when he started work in April 2012. “It was known to be badly managed. It was known that it didn’t even adhere to the investment strategy it developed with the help of consultants,” he says. “There were decisions made by phone calls on behalf of the board for powerful people like Seif Gaddafi and his dad; all kinds of ad hoc investments that did not really fit the profit of the LIA.”

He concluded: “It was a big, big problem. And fixing the problem is not something you are going to do in one or two years.”

In particular, the picture was blurred by those mysterious subsidiaries that show up in the KPMG report. “The way the LIA was created was as the umbrella and owner of various other funds like the Libyan African Portfolio”, he says, referring to one of the most notoriously secretive institutions in Libya, run pre-revolution by Gaddafi aide Bashir Saleh Bashir, who has vanished with knowledge of the whereabouts of an estimated $7 billion. “So you ended up with hundreds of companies doing all sorts of activities,” says Derregia. “Anything you could name could be in the portfolio, whether through the LIA or, mostly, the subsidiaries the ownership was transferred to. It was a huge mess.”

So where to start? “The first priority was to see where the assets are, and approximately how much they are worth so we know what we have,” he says. “We started off with bonds and shares: easy things to identify. Then major assets, and then down to smaller assets. We took an inventory which, if not an accurate one, was at least 90% accurate.” It’s common to cite the LIA as having $60-70 billion in AUM; is that right? “The accurate figure is not done yet, but there was never 70 billion. Sixty is closer to reality. But it’s all subject to asset valuation: what you have is the book value of many assets, in Africa and so forth.” There may be instances, as in Egypt, where true value is understated in the books, but more frequently the reverse is likely to be true. This has become a steadily more pressing problem as other nations, particularly in Africa, have taken advantage of Libya’s paralysis in transition: Zambia has been accused of appropriating Libya’s stake in the mobile carrier Zamtel by nationalising it, for example, while Niger has also nationalised a phone business it had been in the process of selling to the LIA.

Yet another international consultancy firm, this time Deloitte, was recruited to help with the asset valuation process, which was projected to take nine months to a year. “Then we started looking at some urgent problem files, such as alternative investments that went belly up very soon after investing in them.”

This clearly refers to the investments named in the KPMG report, detailed in the accompanying article. Working out what had happened – “the record keeping was not exactly ideal” – and what was worth claiming took time, but “we basically identified four names, rather than products. Some had a mixture of some products that were good and some that were bad, and we identified the very bad ones as potentially litigation areas.” He says a lot of time was spent finding law firms who would be prepared to take on the cases without having a conflict of interest around the major banks involved. “We had to identify firms that would take on and seek resolution to what we believe are unfair deals. Hopefully amicably, but possibly with court action.” Derregia was about to sign two firms when the process of his ousting began.

Asked which four names he is referring to, he says: “The investments that went bust very quickly, so Goldman, SG, Millennium.” He doesn’t name a fourth. It’s not just about the performance of investment, he says. “There were other issues with high fees.” Already some firms have offered to reduce or reimburse some of the high fees, but not the losses incurred, he says.

So was there a fraud involved, or did banks simply get the financial crisis wrong in the products they sold? Stories abound of Goldman’s top Middle East rainmaker Youssef Kabbaj being sent to Tripoli to explain to Mustafa Zarti how his bank had lost about 98% of the LIA’s investment; the story goes that Kabbaj was so nervous he hired bodyguards. But he does appear to have convinced Zarti (and by extension the Gaddafis) that Goldman simply stuffed up rather than committed any fraud.

“That’s exactly the problem you face,” Derregia says, asked about distinguishing between malfeasance and a bad call. “To me it looks like these products were designed, not to fail, but…  the people LIA dealt with created financial products and sold them to LIA with a lot of opaqueness there. Were they signed in a fair way? How many toxic elements were there in these products? These are questions you could not answer without a subpoena. You have to get them on the record, and to get their records of their calculations [in the products when they sold them]: of implied volatility, pricing of options. You have to check whether, at the time, it was reasonable to price at the level they priced at.”

In a rare statement on February 29, the LIA said it had entered into cooperation with the US Securities and Exchange Commission in relation to the SEC’s examination of Goldman’s dealings with the LIA prior to the revolution. “In this regard, LIA has appointed legal counsel to advise it in relation to potential claims arising from the significant losses suffered on its structured notes investment portfolio,” the statement said.

Asked about these investments, someone who was involved at the time insists that corruption was not a part of the problem, but rather bad decisions. “The LIA was the cleanest institution ever in Libya,” he says. “For anyone to suggest that Layas or Zarti was on the take, I would find it impossible to believe. I don’t see any suggestion of them doing these deals for personal interest.” This individual was opposed to the Goldman deals, arguing they made no sense in the market conditions of the time, and says the SG deal fell apart because of a structure SG put in place to hedge currency risk, which would have worked if SG’s price had not fallen far further than almost anyone had predicted.

Derregia also had plenty else to deal with. One was setting up a board to get things moving. “There were several delays, but these were due to internal politics rather than anything else,” he says. “Unfortunately the idea of ‘conflict of interest’, and selecting a board that was conflict-free, was not really well understood. People in conflicted positions would try to delay decisions. Some of the decisions we have to take involve liquidating or merging some investments, and invariably some people will lose because of that as an individual, but the Libyan people will gain. These people would resist very hard, in unimaginable ways.”

And beyond all this was the fact that almost everything the LIA has is frozen. The UN sanctions are, largely, still in place, and initially Derregia not only accepted this arrangement but asked for its extension. “I initially asked the government to keep the sanctions until I took stock of at least the fairly liquid assets to make sure we knew where they were.” That part of the job was complete by the end of July 2012, he says, upon which he asked for an end to the sanctions. But they’re still there.

Then there is a second level of freezing, which involves so-called attachment orders, where courts have imposed shackles on Libyan investments. “I found $20 billion of assets were subject to attachment orders when I took over,” Derregia says. “$1.6 billion of them were confiscated by courts to compensate third parties.” Instances like this have taken up a great deal of the LIA’s time since the revolution, with some successes: bolstered by Shearman & Sterling and DLA Piper, among others, the LIA has successfully sought the release of stakes in Unicredit Bank, Finmeccanica and Eni, all of which had been seized because of a claim that they belonged to the Gaddafi family.

Then there are the other far-flung Libyan assets. Take, for example, the case of 7 Winnington Close, a GBP10 million house in Hampstead that belonged to Saadi Gaddafi, another son, and which the London High Court ruled last March belonged to the Libyan state because it had been purchased by diverted Libyan state funds. It was, typically, bought through a British Virgin Islands company called Capitana Seas Limited. “The structured products with big name institutions like SG and Goldman may have performed badly but they’re relatively straightforward to find and identify,” says Robert Palmer, a campaigner at Global Witness. “But then there is a much more difficult set of assets to identify and recover. A number of investment funds were rolled into LIA subsidiaries and there is a lot less information in the public domain about where their assets are, and the control structures for them. The way our financial system is set up, it is easy to hide your assets behind complex webs of shell companies and nominees and straw men.”

So how much of the LIA’s total wealth is still frozen? The answer, well after the second anniversary of the uprising, is a shock. “We have 95% still frozen,” he says. Oddly, the order to freeze didn’t cover the Libyan African portfolio. “The cleaner companies were frozen,” Derregia says. “That was an oversight.”

Not everyone has a problem with the continuing freeze. “Personally I’m glad it’s still frozen until they can find a competent person with relevant experience and core competencies,” says one senior Libyan professional. “The opportunity cost is huge. But it’s better than taking it back and squandering it.”

In such circumstances, any talk of asset allocation, external manager use or long-term targets is clearly superfluous, but Derregia had intended to follow the Mercer model for the time being. “There’s no point changing the asset allocation when you have to restructure,” Derregia says. “You have to decide where you are going to be active and where you are going to stop being active. Then you make a new asset allocation plan. It goes in tandem with the organisational restructure.”

But now Derregia won’t be around to see that through.

*

The axe took a month or two to fall.

Derregia says he has had four meetings with prime minister Ali Zeidan during his time at the LIA. “Every time I saw him, he acted in a different way,” he says. “In the first one he was very supportive and appreciative. In the second, he was weary.” And it appears to have gone downhill from there, as on February 28 2013 Zeidan – who is also head of the board of trustees – announced in a press conference that he had ordered the appointment of a new head of the LIA. This had been rumoured for a month beforehand, but was still something of a shock to Derregia, who had received a letter informing him about his replacement on February 10 (the Libya Herald was quoting from it verbatim within days) but was not contacted about the handover process until March 15. “I can imagine he’s been busy with other things,” notes Derregia dryly.

He says he had heard rumours of a political deal involving his replacement some time ago, and senses he is a victim of a power struggle above his head. He is contesting the decision on legal grounds – “I cannot hand over to a single person. It’s not because I want to stay” – but has contacted all subsidiaries, bankers and business partners globally to ask them for a financial statement and valuation by the end of March so he can pass it on. He has also asked the National Audit Office to review all transactions under his tenure; he says LIA assets went up $1 billion under his watch.

It appears the person he will be handing it to is Ali Mohamed Salem Hibri, the deputy governor of the Central Bank of Libya, who has been appointed as chairman and CEO until a permanent appointment is made. Once more, the central bank has effective control of the LIA.

“I’ll be glad not to deal with this unusually tough job,” Derregia says. “Dealing with people working against you, continuously trying to stop what you are doing, even though what you are doing is not a personal thing but what needs to be done to make the LIA a strong institution. It needs five to seven years. I don’t understand what basis there is for wanting to change what happened in the last year. This is going to be lost effort: not to me, but to LIA, and to Libya.”

So now what? Is the LIA even running? Derregia says the headcount is 90, plus more in subsidiaries, and that some recruitment has taken place, but it’s clear the institutional knowledge has been enormously depleted in recent years. Euromoney tried to contact 10 advisors, executives and portfolio managers who were active at the LIA at least as recently as 2010; all 10 appeared to have gone.  “The institutional memory now is almost zero,” says one former staffer. “The best people left. They invested so much time and effort and now they want nothing to do with the LIA.”

Locally, emotions run high over the future of the institution. This is Libya’s money, and its people need it to be run professionally, transparently and successfully. “In 42 years of Gaddafi, the worst thing he destroyed was integrity,” says one Libyan professional. “Corruption was a way of life, but it wasn’t corruption: it was survival. It is going to take a long time to change this engrained mentality in Libya.” This professional believes the government should go overseas to find people for its key positions, including the LIA. “If you can’t find them in Libya, find them from all over the world. We need a cultural infusion of senior people.”

And Derregia has this message for whoever takes over in the long run. “They must continue with asset valuation and organisational restructuring. There is no alternative to that.”

BOX: The KPMG reports

When two management reports from 2010 audited by KPMG leaked to the campaign group Global Witness and were released on-line, the world was given a remarkable insight into where the LIA had invested. And since all its assets have been frozen since early 2011, it is very likely still accurate.

On September 30 2010, the market value of the LIA was US$64.18 billion, $24.7 billion of it in an opaque category called ‘subsidiaries’. The rest broke down as more than half cash and deposits, then around 10% apiece for “equity: non strategic”, alternatives and “others”; and just under 10% apiece for bonds and “equity: strategic”, followed by a small amount in real estate. The document sets the portfolio breakdown between actual assets – which is where the figures above come from – and “LIA Assets allocation”, which appears to suggest a target allocation. If it is, the LIA was absolutely miles from its benchmarks: bonds were meant to account for almost 40% of the portfolio, with non-strategic equity about 25%, cash and deposits 10%, alternatives 10%, strategic equity 10% and real estate about 8%.

Europe dominated. Among bond and equity holdings, 53% were denominated in euros, 68% of total assets were in Europe, and 75% of all equities: dramatically higher than any comparable sovereign wealth fund. Only 19% of the fund was in North America, 14% in North American equities, and only 33% in dollars – the bulk of that in deposits and bonds.

In particular, the fund was very heavily invested in Italy: in equities, about 15 times higher than the benchmark, accounted for about 30% of the stock portfolio. Unicredit and ENI were the biggest holdings – Unicredit’s book cost was US$1.326 billion – followed by a more typical blue-chip mix including Siemens, Pearson, Repsol YPF, General Electric and Allianz.

In 2010, and probably still, the Central Bank held a great deal of the LIA’s assets: on September 30, $17.3 billion was on deposit there (notably, HSBC also had just over a billion in a liquidity account). Other interesting disclosures are that Nomura, Western and BNY managed external bond portfolios for the LIA, between them holding a market value of $1.543 billion in 2010, all of them in global government fixed income mandates for one to three years with a minimum rating of A/A2.

But the real meat of the report comes in the section around alternatives, which accounted for $4.5 billion of assets in September 2010, and which KPMG was recommending be reduced to $2.4 billion. It is notable that more than half (54%) of the alternative portfolio at that time was not in the common sovereign wealth staples of hedge funds, private equity or infrastructure, but in structured products.

In a damning set of slides, the management then went through several of the individual holdings. One was Notz Stucki, with which the LIA had invested $300 million, a figure that had dropped by 18% since by September 2010, an underperformance of 15% versus the MSCI world index, in exchange for $5 million of fees. “High fees for no added value,” noted the report. Next up was Permal, which also received $300 million, and had lost 40% of it in exchange for $27 million in fees. “Very high fees for no value. Very poor structure and management,” it said. Next: Palladyne, also $300 million. “To date we have paid in excess of $18 million in fees, for losing us $30 million.” Then BNP, down 23% after $18 million in fees. “High fees have been directly responsible for the poor results.” Credit Suisse, down 29% after $7.6 million. “Structure means we are paying CS, Pimco and Duet for adding no value.”

In conclusion, the report noted: “Market up by over 25% since Jan 2009, funds have registered a decrease in the same period. Our funds have scarcely moved and therefore if they did not increase during the last 2 years it is unlikely they will perform in times of uncertainty.” KPMG recommended liquidating funds immediately to guarantee capital preservation and reduce expenses.

And that wasn’t the worst of it. KPMG then turned to Millennium Global Investments, with which the LIA had invested $100 million apiece in three funds: global natural resources, high yield and emerging credit.  By the time of the KPMG report, one of these – apparently the emerging credit fund – had gone bust completely. It’s clear that this relationship had turned nasty. “When the team met with James Guiang and Zarko Stefanovski to discuss the issue of fee rebate and reduction going forward, the team was struck by the lack of cooperation by the company, with both rebate and reduction in fees being rejected,” the report says. “The team strongly recommends that with such evident problems and a company in disarray that our investment is not safe.”

It seemed that everywhere the LIA alternatives team put money in 2009 and 2010, it met disaster. A $300 million Lehman Brothers CPPI investment also appeared to vanish from the books following Lehman’s own demise, while a Soc Gen strategic equity fund holding went from a market value of $566.4 million to $286.5 million in the space of a single quarter. An ironically named “Commerzbank outperformance note” lost 26.61% in three months.

Worse by far was a series of externally managed equity derivatives mandates, held at a book cost of $2.246 billion, which had fallen in value to just $311 million by September 2010. It is understood that the Goldman Sachs investments referred to in the main article were within this category. Unlike the rest of the alternative book, there was no accompanying commentary on this. Looking at the numbers, there really wasn’t any need.