Regulators accused of ignoring warning
Alarm raised five years ago about complex derivatives, but 'nobody seemed to care'
A stock exchange research report five years ago warned of the lack of oversight of the sale of complex derivatives to small investors, the Democratic Party has revealed. It wants to know why financial regulators did not heed the report.
Had the alarm been raised and problems it identified been addressed, investors in minibonds might not be facing billions of dollars in losses, the party said.
Democratic Party chairman Albert Ho Chun-yan, who has seen the report, said: 'Everybody involved, including Hong Kong Exchanges and Clearing, the Securities and Futures Commission and the Monetary Authority, should be held responsible because they have neglected their duties in monitoring the derivatives market.
'The alarm was sounded, but nobody seemed to care back in 2003. The government must give an explanation.'
Political parties who are helping thousands of minibond investors seeking to get their money back called on the government to tighten monitoring of the sale of such investments. The League of Social Democrats demanded that officials be held responsible for failures in monitoring.
Hong Kong investors have bought HK$15.7 billion of minibonds and other complex derivatives issued or guaranteed by now-bankrupt US investment bank Lehman Brothers. Some face losing much or all of their money. The investors complain they thought the products, marketed by banks as a proxy investment in well-known companies, were low-risk when in fact they are high-risk, credit-linked derivatives.
The internal report, drafted by the risk management staff of HKEx in August 2003, covered ways to prevent speculators attacking Hong Kong's financial market in the wake of the Asian financial crisis.
The report raised concerns that the proliferation of sales of 'equity-linked notes' and other so-called structured products through retail banking could become an alternative avenue for speculators to manipulate the Hong Kong dollar.
The report pointed out that structural problems had prevented regulators seeing the full picture of the value of such products sold to small investors over the counter.
Neither the SFC, which approves the issuing of such products, nor the Monetary Authority, which approves banks' sale of them, had full information about the extent of their sale.
The report made several recommendations for doing so, including the setting up of a taskforce with representatives from the HKMA, SFC and Insurance Commission.
HKEx management rejected the report after its completion.
A source familiar with the report said that, at the time, its drafters felt that regulators' failure to get a clear grasp of the derivatives market 'was just like a black hole', and tighter rules for approving the sale of such products in Hong Kong.
The source said HKEx should have warned the SFC and Monetary Authority about its findings.
A spokesman for HKEx said the problems involving minibonds 'are unrelated to risk management of exchange-operated markets'.
'HKEx has maintained frequent and effective communications with other regulators,' the spokesman said. He said the 2003 study was not officially authorised by HKEx.
A spokesman for the Financial Services and the Treasury Bureau noted that the financial secretary had asked the HKMA and SFC to submit a report on issues raised by the problem of Lehman Brothers minibonds.
The SFC said it was not aware of the 2003 report. The HKMA declined to comment.
