Hong Kong: Minibond fix may prove a risky business

Minibond fix may prove a risky business
StephenKwok
Thursday, October 16, 2008

The worldwide financial turbulence has triggered widespread public concern over the marketing of retail structured products - in particular, minibonds backed by toppled investment bank Lehman Brothers.

Distributors of the minibonds include local and foreign banks, as well as brokerages.

From the investors' perspective, the concerns right now are twofold. Firstly, investors are claiming they were misled into buying the minibonds - believing they actually had bought "bonds" that were low risk.

As such, they have been demanding action against the intermediaries that sold them the products. Secondly, many are also demanding back the full amount or a substantial portion of their investments.

The financial regulatory authorities in Hong Kong, including the Hong Kong Monetary Authority and the Securities and Futures Commission, have launched investigations into the possible mis-selling of the complex financial products backed by Lehman. Part of the focus is on allegations that the full risks of the instruments were not fully disclosed and explained to the investors.

The pressure is growing for the government to bail out the investors, who are not satisfied with a government proposal for the distribution banks to buy back the minibonds at prevailing market prices so investors quickly get back their money, although not in full. The banks are considering the proposal.

Regulators have been blamed for lax oversight and there are now demands for them to strengthen supervision of the marketing and selling of financial products. This has resulted in discussions as to whether a ban on banks selling complex financial products should be imposed to protect unsophisticated investors.

However, that is not an appropriate move. Firstly, access to capital is vital for financial institutions. This is why once formidable investment banks such as Goldman Sachs and Morgan Stanley are transforming themselves into commercial banks.

Secondly, many of the retail banks registered in Hong Kong are part of global and/or regional financial institutions. These institutions should be well-equipped to provide the necessary training for staff to undertake the selling process.

If we consider restricting the business of selling financial products to participants such as brokerages or independent financial advisers, I do not see how they will do better than the banks without improvements to existing regulation. The solution is to strengthen supervision of the distributors of such products, especially the selling process.

From the distributors' perspective, whether they have adequate guidelines for selling the products, have provided sales staff with adequate training and monitored staff performance should be investigated.

Parties found to have committed wrongdoings should be penalized. These investigation areas should also form the basis for new regulations.

From the staff perspective, the selling process should also be investigated to identify if it has been in accordance with the institutions' own guidelines and in compliance with regulations. Staff should be held responsible for any wrongdoings only if they are found to have not followed regulations.

As investigations are ongoing, it is premature for the government to recommend banks buy back the minibonds at prevailing market prices. Part or full compensation for losses for investors should only be considered if investigations show that investors were misled by the bank or its sales staff during the selling process.

Compensation for minibond investors before any evidence of misleading sales is found is not the way things are supposed to work in a free economy such as Hong Kong.

If intermediaries are required to buy back the products before any malpractice is confirmed and just because investments in the product suffer losses, this will have a significant and long-lasting impact on all kinds of intermediary businesses, including property agencies and brokerages.

http://www.thestandard.com.hk/news_detail.asp?pp_cat=20&art_id=72938&sid=21014657&con_type=1