SCMP:Cleaning up the mess after a big player falls

15 July 2009

In the last part of a series, Enoch Yiu examines proposals on how to deal with future financial failures. The Lehman Brothers minibond crisis showed just how ill-prepared Hong Kong is for the collapse of a new breed of hybrid investment products.

Bank deposits are insured up to HK$100,000, which may soon be raised to HK$500,000. Consumers can recoup up to HK$150,000 in the case of a failed broker, although the investments themselves are not covered. And the insurance industry is considering its own compensation fund in the case of failures.

But crossover products have left consumers without protection. Ten months after Lehman collapsed, leaving behind HK$20 billion in now virtually worthless minibonds, customers are still awaiting a resolution.

Regulators are trying to negotiate compensation. The government is mulling the creation of an ombudsman. Meanwhile, banks are rehearsing ways to handle any collapse, and other industries are looking on with interest.

Many Lehman minibond investors, frustrated at the lack of compensation, criticise the lengthy negotiations with the minibond sellers and the lack of clear guidelines from the regulators about handling their complaints.

They are even confused about where they should take their case - the Hong Kong Monetary Authority, which regulates banks, or the Securities and Futures Commission, which regulates the securities market.

"I did not know where to file my complaint, so I ended up contacting the Democratic Party to help me out," said investor May Chan.

The quick answer: Investors who bought minibonds from banks should go to the HKMA; those that bought them from brokers need to go to the SFC. But the whole process has left investors confused and angry.

In its negotiations with financial institutions, the SFC has so far only been able to prod full compensation for investors out of Sun Hung Kai Financial (HK$85 million) and KGI (HK$1.6 million). The SFC wanted the same compensation from banks but failed. Banks are negotiating with customers on a case-by-case basis.

Bank of China (Hong Kong) reportedly suggested compensation at 60 per cent of the minibond investment. But SFC chief executive Martin Wheatley told legislators last week that it was unacceptable, because banks should pay the higher value of the principal investment.

Permanent Secretary for Financial Services and the Treasury (Financial Services) Au King-chi said the government would consult soon about whether Hong Kong needed to set up a new agency, a financial services ombudsman, to handle complaints and negotiations between banks and customers in disputes like that over the Lehman minibonds.

"The SFC has asked for the power to compel compensation, while the HKMA has not," said Ms Au.

The government will consider the experiences of financial services ombudsmen in Britain, Singapore, Australia and Canada.

But legislator Kam Nai-wai believes an ombudsman would have little effect. "What we need is a real super-regulator that has the power to add tough regulations on banks and brokers that sell investment products to investors. We do not need another complaint channel," he said.

There is also the question of what mechanism should exist to deal with the collapse of a large investment bank or broker. Banks have already held rehearsals. In 2006, Hong Kong introduced its deposit protection scheme - initially set at HK$100,000, with a proposed rise to HK$500,000. A year later, it conducted its first annual rehearsal to deal with failed banks. Another rehearsal was conducted at the end of last year.

"Such an exercise cost several million dollars and a whole week, but it is all worth it," said Raymond Li Ling-cheung, the chief executive of the Deposit Protection Board. "The rehearsal makes sure we have a group of contracted providers, such as accountants, lawyers, cheque printers and PR firms, that are prepared for the worst. This will allow us to give cheque payments to the depositors within 14 days of a bank collapse."

Hong Kong Stockbrokers Association chairman Kenny Lee Yiu-sun said such rehearsals could be expanded to the securities market.

"It is worth it for the SFC and the related regulators to have similar rehearsals to inform the public about the impact of the collapse of a giant player like Lehman," he said.

When Lehman collapsed on September 15 last year, the SFC banned the exchange clearing house from taking the cash and stock of Lehman to settle the trades it made on the previous trading days. The clearing house was thus forced to trade in the market to settle the transactions.

Since the market fell 1,052 points that day, the trades were executed at prices lower than had been agreed upon. The result was a loss of HK$160 million, forcing the exchange to make a provision.

Legislator Chim Pui-chung said the restrictions on the Lehman settlements were a mistake. In previous cases, the clearing houses took stock and cash from the collapsed firms to make settlement, which was international practice in the Lehman case.

"Luckily, Lehman did not have a large volume of unsettled trades in Hong Kong," said Mr Chim. "The clearing house would go bankrupt if the SFC imposed curbs on collapsed brokers with unsettled trades valued at HK$20 billion or HK$30 billion."

Mr Chim urged the SFC to confirm it would not repeat the practice.

However, the SFC argued that the powers of the commission to issue a restriction notice are set out clearly in the law, although it agreed to learn from the Lehman experience. "Based on the experience with Lehman, we have been working closely with the Hong Kong exchange to establish internal guidance as to how future restriction notices will be dealt with," the commission spokesman said.

The collapse of a giant player like Lehman is rare. Nevertheless, it exposed a range of problems in the financial regulatory system - loopholes in the law, gaps in the regulatory system, inadequate investor protection and a lack of preparation in the event of the failure of a large firm. The question is whether the government is prepared to fix the problems before another giant goes down.