SCMP:The right rules, and the facts to invest prudently

23 July 2009

The proposed settlement brokered by the Securities and Futures Commission offers a swift and practical way to resolve the long-running minibond controversy. It will not settle all outstanding claims, but it is a realistic solution that should help most retail investors recover up to 70 per cent of their investments, and possibly more, depending on market conditions. No doubt some will still reject it, having clamoured for a 100 per cent refund. But those who want to put the stressful matter behind them can now do so on generally fair terms.

Banks responsible for selling the complex products stand to lose most. But in return for their agreement to settle, regulators will drop all investigations against them. The banks are more willing to settle now because recent market rallies have pushed up the value of the collateral tied to the products. That should help lessen their losses and recover more money for investors.

The deal, therefore, is a compromise that will hopefully bring this sorry saga to an end. But lessons need to be learned if we are to avoid a repeat. The episode has exposed cracks in the regulatory system and lax monitoring. It turns out that many complex financial products proffered by banks are not regulated by the commission or the Monetary Authority. Financial institutions need to be reined in by closing such loopholes. A strong argument can be made that complicated derivative instruments such as minibonds should not be sold to ordinary investors.

On the other hand, investors cannot be absolved of all responsibility. They cannot plead ignorance and demand a refund every time they lose their shirts. Without doubt, some elderly clients and victims of blatant mis-selling deserve to have all their money back. But the majority of minibond investors simply made a bad investment and should accept some losses. There needs to be more of a culture of risk awareness. If something looks too good to be true, it probably is. The latest offer is, nonetheless, an improvement on banks' original proposal to buy back the minibonds at their market value, which is a fraction of what investors paid for them.

The minibonds are just one of many types of derivative instruments being sold to ordinary investors that have caused catastrophic losses during the market downturn. The notorious "accumulators" have caused much grief, but because most who bought them were high-net-worth individuals, regulators have been unwilling to get involved. Already, buyers of so-called Octave Notes - complex derivatives that have gone bust like the minibonds - are demanding compensation. The minibond settlement may offer a template to resolve their dispute as well, and perhaps others. But the line has to be drawn somewhere. Only where there is evidence of abuses should compensation be paid.

Generally, there should be broader markets and greater choices for investors. However, financial institutions should not use this as a pretext to sell fiendishly complex derivative products to gullible investors. Forcing banks to establish better complaint channels for clients and disclose investment information in simple language are moves in the right direction. A strong regulatory regime must not allow problems to fall through the cracks - and ensure people have the information they need to make appropriate investment choices. Greater transparency needs to be enforced in banks' dealings with clients. The financial crisis has forced many jurisdictions around the world to reform their regulatory systems. Hong Kong too needs to follow suit - and make sure it gets it right this time.