SCMP: Regulators have let down investors badly

http://www.pressdisplay.com/pressdisplay/showlink.aspx?bookmarkid=6DE4R4MQKSI5&linkid=2476115f-8279-4017-a03e-d00ea406b4cd&pdaffid=8HM4kDzWViwfc7AqkYlqIQ%3d%3d

4 Nov 2008
Frank Ching is a Hong Kong-based writer and commentator. frank.ching@scmp.com
Chief Executive Donald Tsang Yamkuen talked in his policy address of Hong Kong’s position as an international financial centre and spoke of “ optimising the supervisory framework” as though it were already very good. Alas, one can tell from the protests outside banks in recent weeks by investors complaining about being lured into unsound investments that the supervisory framework is far from satisfactory. In this connection, Premier Wen Jiabao
was much closer to the mark when he called on the Hong Kong government to “seriously learn the lessons” from the financial crisis and “analyse the problems with the structure of Hong Kong’s economy and regulation of its financial system”.

More than 43,000 people have lost money from investing in Lehman minibonds. Mr Tsang said that the Monetary Authority and the Securities and Futures Commission “will examine how to further strengthen the regulatory regime and enhance investor protection”. That is shutting the stable door after the horse has bolted. If banks had been under much tighter supervision, these tragedies could have been avoided.

The SFC, like its counterparts elsewhere, has a code of conduct for banks and other licensed or registered institutions. Its first general principle states that institutions should “act honestly, fairly, and in the best interests of its clients”. Can Hong Kong’s banks say, hand on heart, that they have acted in the best interests of their customers when persuading them to buy a risky product that investors did not understand?

One of the commonest complaints is that investors did not know what they were getting into because banks did not make adequate disclosure. This is in direct violation of General Principle Five, which says an institution “should make adequate disclosure of relevant material information in its dealings with its clients”.

Paragraph 5.3 is specifically about derivative products. This says that whoever provides “services to a client in derivative products” should make sure that “the client understands the nature and risks of the products and has sufficient net worth to be able to assume the risks and bear the potential losses of trading in the products”. Would Hong Kong be in this mess if the banks had abided by this provision?

General Principle Six warns against conflicts of interest. But in a system where banks pay their relationship officers bonuses for making a sale, these employees have a clear conflict between their own interests and those of their clients. What should be done?

According to General Principle Nine, “the senior management” should “bear primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures”.

The minibonds issue shows that banks sell risky products to retail customers not meant for them. Under the code, sophisticated financial instruments should only be sold to “professional investors”, a term that is carefully defined. This is a problem the SFC doesn’t seem to be sufficiently aware of. Its chief executive, Martin Wheatley, has been quoted as saying that investors should have ensured they knew what they were buying. If the responsibility is on the investor, what is the point of having a regulatory body?

Under the SFC’s code, a bank needs first to satisfy itself as to whether a client’s financial situation, investment experience and investment objectives make it appropriate to recommend a particular product. Such requirements are waived in the case of a “professional investor”.
Mr Wheatley seems to assume that all bank clients are professional investors. That is not the case. It is why the SFC’s code says banks cannot treat anyone as a professional investor unless he or she agrees in writing to be treated that way, and the client can withdraw from that status at any time. It seems that no one is regulating our regulators.