Appeal to MAS - regulate investment products

I am writing to all parties, from the MAS, MOF to the business times editor, in a passioned appeal for the MAS to act.

So far, all the measures that MAS has focused on are 1) training of sales staff, 2) labelling of products, 3) sales process, proper documentation etc.

However, the MAS has failed to address the root cause of all the mis-selling in the financial industry. They have failed to address the conflict of interest between the way the sales force is remunerated and the interests of clients.

Clients want good investment performance, within their proper risk profile. They want a diversified portfolio.

The sales force and the banks that set the score cards want to sell products with the highest sales revenues. The higher the sales revenue, often the poorer the investment performance for clients.

By allowing banks to sell products with upfront sales charges, the sales force have no incentive to conduct due diligence of the products. In fact, the sales force is incentivised to go for the products with the highest sales margins, often embedded in flow products, structured products and treasury products. These products often provide very limited upside but unlimited downside.

Flow products like equity linked notes and dual currency investments involve the clients selling put options for a fee. Often the spreads taken by the banks are 80%, while the client earns only 20%. Yet the spreads are not transparent. The client only knows what he has been quoted. Worse, the little fees that client earns from selling these options involve unlimited downside if the underlying equity or the currency being paired drops in value.

Sales people love such flow products because 1) they earn very high margins at expense of clients, 2) these investments are short-termed, often 1 month for an ELN and 2 weeks for a DCI, and they keep rolling the clients every time a contract expires until they customer gets converted. if the stock rises or the currency such as teh AUD rises, customer merely gets a small yield like 1% per month. But if the stock or currency falls, customer receives the underlying stock and currency. Hence, the return is asymmetric.

When the investment climate is favourable for equities, often the sales force would steer clients doing such flow products, which earn very little yields, when the clients are better off investing in mutual funds, ETFs, products that constitute a core portfolio.

There are also no controls on the spreads that a bank can take for bonds, convertible bonds, preference shares. They are quoted as bid ask with the spreads embedded. However, bonds, convertible bonds and preference shares provide much better returns to risk ratios than flow products and hence such spreads are often quite justified.

The banks cannot be relied on to treat customers fairly because they are under tremendous shareholder pressure to produce ever increasing revenues. Any one from senior management in a consumer bank will admit that their sales target rises 20 - 30% per annum, regardless of market climate. Hence, banks tend to veer towards selling products that generate the highest revenue at the expense of clients.

The only way is for MAS to legislate or control the spreads earned from flow products, unit trusts and all investment products. The banks will likely find other ways to make up for the lost revenue by implementing performance fees or wrap fees, which will align the interests of teh bank with the customers.

The MAS must take this financial crisis as an opportunity to take bold steps towards reforming the way investment products are sold by banks. Otherwise, I suspect more social harm will fall on the public. If the government is willing to take steps to control the rise in property prices recently, why not take equally bold steps to reform the financial industry?

Greg Wang