SCMP:Objections to new rules on minibonds look flimsy

23 November 2009
Hong Kong's banks are preparing to fight back against new regulations proposed following the Lehman minibond fiasco.

But although the forces at their disposal are impressive, their tactical position looks weak.

Towards the end of September, the Securities and Futures Commission published its proposals for stricter rules to govern the sale of unlisted structured products to the investing public. Interested parties have until the end of next month to comment.

Most of the proposed rule changes look eminently sensible. For example, the SFC wants to tighten up advertising standards. It wants to ban banks from offering "free gifts" to their customers as inducements to invest. And it plans to force banks to let buyers know if the value of their investment subsequently plunges because of adverse market conditions.

That all sounds reasonable enough, as does the SFC's suggestion that banks should check to see if their customers understand the products they are buying.

But two of the SFC's proposals in particular have raised hackles among Hong Kong's smaller banks: that they should be required to disclose exactly how much commission they stand to earn from the sale of each product, and that they should grant customers a minimum "cooling off" period after buying an investment in which they can change their minds.

Although it is still early days for the consultation period, Hong Kong's banks are already pushing back against the proposed rule changes, complaining that they are unfair, overly complicated and too expensive to implement.

Resistance to commission disclosure is coming from three angles. First, some banks are complaining that full disclosure would enable investors to shop around for the best deal. That, they fear, could lead to unhealthy competition, with banks attempting to undercut each other in order to win business, which they say would erode profits and undermine the stability of the banking system.

The second argument against disclosure is that it would unfairly tilt the investment playing field against banks and in favour of insurance companies, which are under no such obligation to come clean about their own commissions.

The final objection to commission disclosure is that it is simply too difficult. Where banks both structure and sell investment products, the banks claim it is impossible to separate income attributable to the structuring process from value added by the sales force. As a result, they say, they can't disclose their earnings from product sales.

Similarly, the banking sector is raising two major objections to the proposal for a cooling-off period, which is designed to protect impressionable investors against high-pressure sales techniques.

First the banks say the proposal would introduce a perilous element of moral hazard into investment decisions by allowing customers to back out of purchases if the market moves against them or if they decide they can get a better offer elsewhere.

Second, the banks argue that if they buy structured products back from their clients, they will be forced to unwind their hedges in the underlying instruments, which in illiquid markets is likely to be both a lengthy and prohibitively expensive process.

On examination, these objections look unconvincing. On commission disclosure, it is ludicrous to argue that improved transparency could cause unhealthy competition. Heightened competition would only benefit the customer, which is a very healthy thing.

Similarly, complaints that requiring banks to disclose their fees and commissions would unfairly penalise them relative to insurance companies don't stand up. Insurers will face the same requirement under the government's new regulator for the sector.

And contrary to what the banks say, deciding what proportion of income is attributable to origination and what to sales is straightforward. Banks should already do it internally on their departmental profit and loss accounts. If they don't, it is simple enough to determine, based on the commissions paid to third-party distributors.

Objections to the proposed cooling-off period look equally flimsy. If they want to back out, investors will have to pay an administration fee, so there will be little question of moral hazard. And complaints about the difficulty of unwinding hedges are nonsense.

Any cooling-off period is only going to be a matter of days, so it is highly unlikely the banks would actually invest the money raised from a structured product offer until the cooling-off window had closed.

In reality, the banks are opposed to greater transparency because it would reveal internal conflicts of interest.

If a bank salesman were pushing one investment product particularly aggressively compared with another, customers would only have to check which one would pay the more lucrative commission rate to find out whether the salesman was acting in their interest or solely in his own.

And the banks object to the cooling-off period idea simply because they are afraid that on sober reflection without a salesman breathing down their neck, customers may change their minds about buying structured products like minibonds and demand their money back. That would force the banks to surrender their commission income, something they are extremely reluctant to do.

As a result, the banks are preparing to fight back, mobilising their forces to resist the proposed rule changes. Whether they succeed or not will say a great deal about the state of investor protection in Hong Kong.