Focus: Hong Kong - Banking & Finance – SFC warning to issuers in the midst of global financial crisis
28 October 2008
In brief: The recent collapse of Lehman Brothers has rendered its 'minibonds' almost worthless with angry investors alleging that they were marketed to them as a low-risk product. It later transpired that the 'minibonds' were not bonds but derivatives designed for professional investors, not for retail investors. As a result, many investors are asking whether the banks fully disclosed the risks pertaining to that investment or were the banks in breach of any law or regulatory codes of conduct? In this context, the Securities and Futures Commission has issued circulars reminding issuers of investment products of their obligations to investors. Senior Associate Mun Yeow and trainee solicitor Brian Chen look at the circulars and their implications.
How does it affect you?
- Regulated persons, including licensed corporations and banks, should review their investment-selling procedures against the relevant legislative requirement and the codes of conduct, guidance notes and the circulars issued by the Securities Financial Commission (the SFC) and the Hong Kong Monetary Authority (the HKMA).
- Licensed corporations and banks should ensure that they have adopted specific client due diligence and risk disclosure measures in accordance with the legal and regulatory requirements when giving investment advice and selling investment products.
Background
Lehman mini-bonds
Despite the wide press coverage on the allegations of mis-selling against the local banks, it remains very much an unknown as to what these mini-bonds actually are. According to some experts in the industry, these mini-bonds or derivatives were designed by specialists and were so complex that they could not be understood by the ordinary frontline people working in the industry, let alone the consumers and the public at large.
The Hong Kong Monetary Authority has received about 8,000 complaints of mis-selling of the mini-bonds and other products issued or guaranteed by Lehman Brothers. The investors allege that they were misled into believing that the mini-bonds were low-risk at the time of the selling. In fact, it turns out that the mini-bonds were high-risk, credit-linked derivatives. It is also rumoured that the mini-bonds were not allowed to be sold to retailers in any country other than Hong Kong and Singapore.
The Hong Kong regulators have rejected claims of inadequate oversight in the banking and finance market. HKMA chief executive Mr Joseph Yam Chi-kwong, spoke at a special Legislative Council meeting saying, 'I personally think that if banks followed all the SFC and HKMA regulations, investors would have sufficient understanding of the risk. The problem is whether the banks followed all the regulations.' Mr Yam also said, 'Before the breakout of the sub-prime mortgage crisis, we rapidly issued guidelines. This is having foresight, not belated awareness.'
The SFC was criticised for permitting the product to be sold under the label of 'minibonds', which gave the false impression that the product was low-risk. Mr Martin Wheatley, chief executive of the SFC, replied that investors should not simply rely on marketing materials, but should ensure they understood the product. He said, 'The term mini-bond...has no regulatory meaning. It's just a brand name...Different firms use different brand names. I would be shocked if anyone bought a product based on the name of the product. The requirement is to understand the features...Anybody who is offered via bank staff a product that pays 6 per cent rather than half a per cent on deposit should be asking why?'.
The HKMA is considering a ban on banks selling complex investment products such as the mini-bonds. Banks have also accepted the Hong Kong Government's proposal to buy back the mini-bonds from retail investors at the current market value. However, the question remains as to how the terms of the actual buy-back are to be determined. The HKMA is also considering raising the minimum investment threshold in these products so they would not be promoted to smaller, more vulnerable investors. Banks have been selling the mini-bonds in lots of as little as HK$100,000, when these mini-bonds should, it is argued, have been sold with a much higher minimum threshold and/or to sophisticated investors or institutional investors only.
In Hong Kong, offers of securities including, for example, bonds, shares, stocks, debentures, funds, notes, rights and options, need to be approved by the SFC before they are released onto the market, unless otherwise exempted by SFC or under the law. Examples of exempted products are those sold to 'professional investors' and where a minimum subscription of HK$500,000 is required.
According to the Securities and Futures Ordinance (Cap. 571) of the Laws of Hong Kong, 'professional investors' include individuals with a total portfolio of HK$8 million as evidenced by an auditor's or certified public accountant's statement or more than one custodian statement.
The equivalent to a 'professional investor' in Singapore is an 'accredited investor', which includes individuals with a net worth of more than S$2 million or who have received income of at least S$300,000 in the past twelve months.
Requirement and commentary
Suitability of recommendation
Regulated persons are obliged under the SFC code of conduct to ensure the suitability of their recommendation or solicitation for investors. The SFC published a list of questions and answers and a circular on 8 May 2007 in relation to the duties of regulated persons in providing investment advice. Regulated persons should:
- know their clients' financial situation, investment knowledge, investment objectives, risk tolerance and capacity to make regular contributions and meet extra collateral requirements;
- understand the investment products they sell by conducting proper due diligence by developing a thorough understanding of the nature and risks of the investment products, the experience and reputation of the product's issuers and service providers, fees and charges, the relative performance and liquidity of investment products, lock-in periods, and unit pricing;
- provide reasonably suitable recommendations by matching the risk-return profile of each investment product with the personal circumstances of their clients;
- exercise extra care in advising elderly or unsophisticated clients on complex investment products, particularly those products with long maturity periods and hefty early redemption penalty charges;
- provide all relevant material information (including prospectuses and other documents relevant to the investments) to clients and help them make informed investment decisions;
- give clients sufficient time to evaluate the information and recommendations provided, and sufficient opportunity to raise queries;
- not use high-pressure techniques to force or entice any client into making a hasty investment decision;
- employ competent staff and provide appropriate training; and
- document and retain the reasons for each product recommendation made.
Investors' concerns and complaints
Regulated persons in distributing retail structured and credit-linked notes should play a more proactive role in addressing investors' concerns. They should take steps to investigate and respond promptly to complaints and where a complaint is not remedied promptly, give the client advice on further steps that can be taken.
Credit crisis and early redemption
Where regulated persons hold investment products on behalf of investors, in the event of a credit crisis or default resulting in early redemption, they should inform the investors of the date and amount of the early redemption.
Risk disclosure duty
The SFC circular of 3 October 2008 is directed to issuers of retail investment products, including retail collective investment scheme products authorised under section 104 of the Securities and Futures Ordinance (the SFO) and retail investment products where its offering documents and marketing materials are authorised under section 105 of the SFO or authorised for registration under the Companies Ordinance.
Issuers should make sure that the marketing material 'must be clear, fair and present a balanced picture with adequate and prominent risk disclosure in compliance with all applicable regulations'.
Issuers are also reminded to include in their marketing materials 'upfront, prominent and adequate warnings' of all risks, including 'new risks' emerging from prevailing market conditions. Issuers seeking SFC authorisation to market retail investment products are advised to 'revise their documents in light of the recent market events'.
Conclusion
The SFC has reiterated the importance of adherence to the standard practice of selling investment products by regulated persons and issuers. To regain investor confidence, regulated persons and issuers have the responsibility of making sure that investors are well informed and advised in their investment choices. If you need advice on this or any other financial services matter please contact us.
For further information, please contact:
- Robert FishPartner,
Ho Chi Minh City
Ph: +84 8 3822 1717
Robert.Fish@allens.com.au