Proposal for Resolution of Mini-bond Issue
Around 43,700 Hong Kong people invested HK$15.7 billion in products issued or guaranteed by Lehman Brothers, as distributed by banks (mainly) and brokers. Most of these products were called 'mini-bonds', although they were not bonds but complex and high-risk structured products. When Lehman collapsed on 15 September 2008, many of these products became worthless or nearly worthless. Over 16,000 investors have made complaints to the Hong Kong Monetary Authority (HKMA, the banking regulator), and some to the Securities and Futures Commission (SFC, the regulator of brokers). The Legislative Council has opened an enquiry into the mini-bond affair.
How did such risky products come to be sold in such quantities to retail investors? Regulations are in place in Hong Kong to prevent this:
Firstly, the product has to be approved or authorised by the SFC;
Secondly, intermediaries (whether banks or brokers) who sell investment products need to abide by the SFC Code of Conduct which requires them to consider the suitability of the investment for their client and to make proper disclosure of the risks to their client. Failure to abide by these regulations constitutes mis-selling.
Thirdly, the SFC is responsible for supervising the investment selling activities of brokers and the Hong Kong Monetary Authority (HKMA) is responsible for monitoring the investment selling activities of banks in accordance with the SFC Code of Conduct. The two regulators cooperate under a Memorandum of Understanding.
What went wrong? In the event, each of the above links in the regulatory chain failed to function effectively.
The mini-bond prospectus was authorised by the SFC under the Companies Ordinance provisions applicable to debentures. In such case, the main requirement is for the prospectus to make full disclosure (i.e. disclosure-based regulation), and not for the SFC to consider the suitability of the product for the investor (i.e. not merit-based regulation). Nonetheless, the mini-bonds were clearly aimed at retail investors, and were to be distributed in the non-transparent over-the-counter market where the investor would have little access to other information about the product (e.g. secondary market prices, or information on Lehman). The name ‘mini-bond' was also misleading, in that the product was not a bond and did not perform like a bond. The SFC could perhaps have regarded the mini-bonds as investment products under the Securities and Futures Ordinance. In such case the SFC would probably have had stronger grounds to consider suitability and merit, and might well have required modification of the product and communication materials, or even rejected the product altogether. In any event, the SFC's authorisation of mini-bonds for distribution to the general public appears highly questionable.
The banks (and a few brokers) concerned reportedly sold the mini-bonds aggressively to their clients. It is questionable whether the banks had due regard for the suitability of the investment to the client's needs and risk appetite. In at least some cases where the minibonds were sold to elderly unsophisticated investors, it seems rather likely that the banks concerned mis-sold the minibonds.
The HKMA seems not to have focused on the selling practices of the banks. (Review of the HKMA's website reveals little if any material on investor protection or which is intended to educate investors about risks - in contrast, the SFC's website has plenty of such material and the SFC's annual report and mission statement emphasise investor protection.) The HKMA claims to have issued an alert letter to the banks, but it is not clear that this was followed up by effective regulatory audit or review. At any rate, the banks continued selling the mini-bonds to large numbers of clients.
Perhaps almost of more concern than these lapses is the fact that when summoned to Legco, the heads of the two regulators denied that their respective institutions had done anything wrong.
Existing remedies for investors
Mis-selling is a regulatory misdemeanour. It is possible for the SFC to investigate the complaints and prosecute the intermediaries concerned. The SFC is known to be conducting an investigation - although it may take a considerable time. But even if intermediaries are found to have mis-sold and are punished, this will not of itself provide compensation to investors.
The main remedy that would be available to investors is for them to sue their bank for misrepresentation, breach of contract, negligence, as appropriate depending on the circumstances of their case. But this is easier said than done. The investor has to engage lawyers and prepare the case, which takes money and time which many of the affected investors do not have. The investor may lose, in which he has to pay not only his own costs but those of the bank - a daunting prospect for most individuals. And there are many thousands of aggrieved investors. Hong Kong does not have class action rights under which large numbers of individual plaintiffs can sue collectively. Nor does Hong Kong have contingency fees.
The Consumer Council is understood to be marshalling representative cases for a possible suit, in the hope that a favourable judgement would make it easier for other investors to follow. But the process appears likely to be very patchy and incomplete. Meanwhile the banks are identifying and settling the most egregious cases so as to reduce the likelihood of a successful suit.
The HKMA has arranged with the Hong Kong International Arbitration Centre (HKIAC) for a mediation and arbitration service, available to qualified candidates under which the HKMA will pay half the fee and the bank concerned the other half. To qualify, an investor has to have made a complaint to the HKMA and the HKMA reviewed it and referred it to the SFC for consideration; or either the HKMA or the SFC has made a finding against the bank or bank officer concerned.
This mediation and arbitration service may have merit. However, it may take a long time for the HKMA to process all the cases, and also a long time for the HKIAC to process them thereafter. It seems doubtful that the existing 16,000 complainants, not to speak of the entire 43,700 investors concerned, can be handled within a reasonable time frame. Moreover, the process is dependent upon the voluntary compliance of the banks.
Firstly, on the face of it, all parties bear some share of the blame for the scandal:
The intermediaries concerned appear to have acted irresponsibly in selling the minibonds to retail investors. Quite possibly they are guilty of mis-selling, in which case they should be the firms and the officers concerned should be prosecuted and if found guilty punished by withdrawal of licences, suspension, etc, as appropriate.
The SFC's authorisation of the minibonds for distribution to retail investors appears highly questionable.
The HKMA appears to have failed to properly supervise the selling practices of the banks.
The Government has failed to ensure that a proper regulatory arrangement was in place. As the crisis unfolded, it has failed to provide leadership to resolve it.
Finally, investors themselves bear some responsibility. Even an elderly and not-well-educated investor should wonder why a product is paying a return much higher than the rate of deposit interest (e.g. 5.5%, compared with perhaps 1% or 1.5% on deposit accounts).
Secondly, there is no adequate existing mechanism for resolution of the crisis.
Thirdly, the crisis should not be allowed to drag on too long, given the delicate state of the global financial market and the likelihood of Hong Kong falling into recession. A near-term resolution is highly desirable.
In order to arrive at a settlement in a reasonable period of time, the following are necessary:
The cases must be assessed and categorised, and then dealt with in batches rather than individually.
There must be active management of the process by the authorities.
While ultimately, both banks and investors have the right to take their disputes to court, reasonable incentives can be applied to encourage the parties to take part in the settlement process. The incentives are, on the investor side the prospect of a part recovery of their money (depending on the merits of their respective cases) within a relatively short time, and on the bank side, the prospect of clearing the issue at a reasonable cost and keeping their reputations intact. Banks that refuse to take part in the settlement process could expect to receive more attention from the regulators in future. And as a further incentive, the Government could consider making a legal aid budget available for investors to sue non-cooperative bank, although it is very much hoped that the banks would be persuaded to agree to a settlement without contest.
In accordance with the above principles, the Foundation recommends that the Government appoint and fund an independent tribunal with appropriate resources (i.e. staffing, premises, IT equipment, legal support, etc) to examine all the cases and provide an indicative opinion on their merit. Given the volume of cases, the tribunal would have to divide them into batches according to their characteristics. The tribunal's opinion could then be used in negotiation with the banks with a view to arriving at a reasonable settlement for all affected investors. There might be a role for the HKIAC in the latter process.
It is clear that the present regulatory structure is not working. In the medium term, the following reforms should be considered.
Dividing responsibility for supervising intermediaries' conduct of business between two regulators has manifestly failed. Consideration should be given to allocating responsibility to a single regulator. One possible model is the integrated regulator approach, under which all financial services are regulated in all aspects by a single regulator. A second possibility is the 'Twin Peaks' model adopted in Australia, under which one regulator (the Australian Securities and Investment Commission) is responsible for supervising conduct of business, the other (the Australian Prudential Regulatory Authority) for supervising capital adequacy.
A statutory cooling off period should be introduced to safeguard investors after making investments.
There should be mandatory disclosure of commissions in the sale of investment products.
Consideration should be given to establishing legal mechanisms to enable consumers or investors to assert their legal rights, e.g. class action mechanism and contingency fees.
Consideration should be given to whether it is appropriate for banks to utilise their customer information to make targeted sales to those customers. Possibly there should be some form of Chinese wall, or even complete separation of mainstream banking and investment sales functions.
Policy Committee, Hong Kong Democratic Foundation
Reproduction of this paper is permitted with proper attribution to the Hong Kong Democratic Foundation
- 迷你債券招股章程是由證監會根據適用於公司債券的公司條例規定授權的。 在這種情況下，主要要求是對招股說明書作出充分披露（即以資料披露為本之監管），而不是證監會考慮該產品對投資者的適合性（即不以利弊為基礎之監管）。然而，迷你債券顯然是針對散戶投資者，並分發給在非透明的櫃檯市場令投資者將很難獲得關於產品的其他資訊（如次級市場價格，或關於雷曼兄弟的資料）。該「迷你債券」的名稱也具誤導性，在於該產品不是債券，並沒有如債券一樣的業績表現。證監會或許根據證券及期貨條例把迷你債券看作投資產品。在這種情況下，證監會可能有更強有力的理由考慮適合性和利弊，並且很可能需要修改產品和宣傳材料，甚至完全拒絕接受該產品。在任何情況下，證監會對迷你債券分配給一般公眾的授權，看來是非常值得懷疑的。
- 金管局似乎沒有把重點放在銀行的銷售方式。（金管局網站的審查顯示，幾乎沒有任何保護投資者或教育投資者風險的資料 - 相反地，證監會的網站上有大量這樣的材料，以及證監會的年度報告和使命聲明強調對投資者的保障。）金管局宣稱已向銀行發出警告信，但目前尚不清楚，這是否有有效的監管性審計或審核跟進。無論如何，銀行繼續出售迷你債券予大量的客戶。
- 最後，投資者自己承擔一些責任。即使是長者和未受過良好教育的投資者亦應該懷疑，為什麼一個產品可以有遠高於存款利息利率的回報（如5.5 ％與存款帳戶或許1 ％或1.5 ％的相比）。