SCMP:Regulators' reports raise more questions than answers

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13 Jan 2009
Enoch Yiu

The two regulators' reports on the Lehman Brothers minibond fiasco have raised many questions but failed to find a solution to prevent a recurrence of the problem.

The 83-page report by the Hong Kong Monetary Authority and the 76-page report by the Securities and Futures Commission have been dissected and analysed since they were published last Thursday.


The stakes were high - the government ordered the two to report on the issue after 43,000 investors suffered losses from minibond products issued or guaranteed by Lehman, which collapsed in September.

But White Collar is disappointed the reports offer too few effective solutions to prevent such events from happening again. In fact, they only raise the prospect of a power struggle between the HKMA and the SFC on how to regulate banks' selling of similar types of products in future.

For one thing, the reports show that the regulators have no intention of banning complicated products such as the Lehman minibonds being sold to retail investors, which White Collar believes is the core of the problem.

A key complaint about the Lehman minibonds was why such a product, which are derivatives of credit-linked notes, could be sold to a 90-year-old housewife or 88-year-old retirees through bank branches as an alternative to time deposits.

Under the current regulatory system they did not need any regulatory approval, just the SFC green light on the marketing material.

Both the HKMA and the SFC say such an approach is good enough as they claim it should be the intermediaries who should see to the suitability of the products for investors. The two regulators also argue that investors may mistakenly believe that products approved by the regulators are safe.

The regulators said this was in line with international practices but White Collar urges our regulatory friends to rethink.

Unlike markets in Australia, Britain or the United States, where retail investors invest through fund products, Hong Kong retail investors are trading all types of investment products. This makes Hong Kong different from other markets.

If the regulators relied on intermediaries to recommend suitable products for clients, it is tantamount to downward delegation and this paves the way for mis-selling.

Such a disclosure approach is only adopted in the stock market - all listed companies in Hong Kong must first get SFC and stock exchange approval for them to go public and sell shares to investors.

Why do other investment products such as Lehman minibonds or derivatives such as accumulators not need regulatory approval before being sold to investors?

Britain is consistent with the disclosure base regulatory philosophy adopted by the Alternative Investment Market (AIM) which allows companies to list without regulatory approval. They only need to disclose information and to have a sponsor support their listing. In Hong Kong, the stock exchange has rejected the AIM model during discussions to reform the Growth Enterprise Market, saying that many retail investors are not ready to move to such a model.

If they are not ready for a Hong Kong version of AIM, they are also not ready for minibonds or accumulators.

What the two reports will surely lead to is a power struggle between the HKMA and the SFC on how to regulate banks' securities departments.

The HKMA said it should be the sole regulator and should take over the SFC's power to investigate and punish bank staff involved in securities dealing.

But the SFC said banks should set up subsidiaries to handle investment sales and let the commission regulate it. Neither proposals are perfect.

If the HKMA proposal is adopted, then it is bound to be opposed by stockbrokers as the HKMA would no longer use the same standards that the SFC applies to brokers. What is more, how can the authority punish banks?

While the SFC can publicly reprimand, revoke or suspend operations of brokers and their staff, such actions would be difficult to impose on a lender as that would affect the public's confidence in the lender, which may well lead to a bank run.

If the government adopts the SFC model, then the HKMA would not have the full picture on all operations of the bank and there may be a danger that losses incurred in the securities subsidiaries may affect its parent banking group.

The two reports have raised more questions than answers.