How not to build an investor safety net
If Warren Buffett lived in Hong Kong, his bank would have to ask him to bring along a relative or friend when making decisions about financial products. Buffett, you see, is over 65.
It is not clear whether this means that some of Hong Kong's best known but rather senior investors such as Li Ka-shing and Lee Shau-kee are to be trusted to take investment decisions all on their own, but this warning to senior citizens most certainly applies to lesser mortals like us.
This is because in the wake of the minibond debacle, bank failures and the stock market crash following the crisis of 2008, Hong Kong's financial institutions are busy shutting the stable door after the horse has bolted and, of course, working assiduously to cover their own backsides.
The advice that people over 65 or with an education level not exceeding primary school should bring along friends or family to assist them in making investment decisions is among a series of new requirements supposedly designed to ensure 'investment protection'.
The minibond saga revealed that complex financial products were being sold to customers (many of whom were elderly) who did not really understand what they were buying. The more recent launch of yuan sovereign bonds persuaded the Hong Kong Monetary Authority to remind banks demand for this product was likely to attract considerable interest from people unfamiliar with sovereign bonds and would therefore need to be properly explained.
Both the HKMA and the Securities and Futures Commission have issued guidelines for institutions selling financial products to retail customers that, among other things, oblige them to collect risk assessment data. In regulator's jargon, this is a 'suitability test'. Part of this test involves customers completing financial profile forms that allow banks and brokers to better understand the customers' risk tolerance and financial awareness.
This all makes perfect sense, but the problem is that banks seem to have taken a formulaic approach to assess investor suitability.
There is nothing objectionable about a formula that focuses on customer responsibility for their own actions, especially when it is accompanied by a host of other measures to ensure that banks properly explain risks. Recently, the HKMA announced that its undercover inspectors would check if bank branches are offering appropriate advice when selling financial products.
However, the best of intentions to protect investors are bedevilled by problems of implementation. The investor profile forms sent out to customers, in some cases replaced by verbal interviews, contain rather dubious questions aimed at producing a mostly meaningless risk profile.
For example, customers are asked how long they intend to hold their investments and how much loss they are prepared to tolerate. The latter question is to be quantitatively answered in terms of the level of percentage loss investors are willing to contemplate in a year. Then they are asked things such as how they wish their investment portfolio to be distributed in terms of categories such as equities, bonds, cash etc.
Anyone with even marginal investment experience knows these questions are unanswerable because the very essence of financial markets is that they change direction and investors need to adjust their aspirations and targets accordingly.
On receiving one of these forms, I told my bank I could not supply meaningful responses to their queries. I was told if my risk perception and investment objectives changed, I could regularly update the bank on these changes. This involved a level of inconvenience that did not seem appropriate.
It was then suggested that the best way to resolve this problem was merely to state investment intentions at the time of completing the form. What would that achieve, I asked. The bank official was unsure, especially when I pointed out that I had no idea where the markets were likely to be in two months, let alone in 12 months, and if I stated particular objectives at one time, they were unlikely to be relevant in the near future.
The compromise I suggested was that I would fill out the form and in all places where uncertainty reigned, I would write 'depends on market conditions'. The bank official was dubious about this and said my remarks would be referred higher up the decision-making tree. I have now received a computer-generated letter saying the form I sent back has not been completed.
So we have reached something of an impasse because the hotline operators do not know what to do with a customer who refuses to give the formatted answers. Meanwhile, I have been warned that certain accounts might have to be cancelled if the required information is not received.
This, then, is the problem of pro forma safety nets. On the other hand, the bigger financial institutions have hundreds of thousands of customers, some of whom make quite small investments. It is a massive task to fulfil the objectives set out by the regulators to produce a thorough investment profile of all their customers. Rather than trying to really understand the needs of each client, it is far simpler for these institutions to collect forms, put them on file and declare the job done, with the signatures to prove it.
At the end of the day, there is really no foolproof system of avoiding investor greed and eliminating risk. Establishing a network of safety nets is certainly better than doing nothing, but they provide a false sense of security. This is especially so when part of that network is heavily reliant on meaningless pro forma exercises that purport to evaluate individual investor's suitability for buying certain products but in reality furnish only marginally useful information.
The bottom line is that all investments are risky and anyone pretending otherwise is not to be trusted. Even those who keep cash stuffed under their beds are subject to the risks of fire and theft, so let us not pretend there is any catch-all solution here.