SFC raises feeble safety net for high-risk trading
SFC chief executive Ashley Alder said the commission would issue a consultation paper this year to re-examine local regulations that ensure only professionals are allowed to partake in the riskiest investments.
SCMP, February 24
Here is a twist of irony for you. The reason that unsophisticated savers are plagued with dubious investment 'products' is precisely that we give the professionals a free hand to play with these things.
Take for example the 'accumulators' on which many people lost money during the last big market crash four years ago. Simply put, these time bombs offered you stock in a reputable company, at a discount from the market price, provided that you continued buying that stock in regular monthly instalments at a set price for up to two years.
And just to make it truly lethal, the people on the other side of this bet reserved the right to buy you out of the deal if the market price of the stock went up instead of down. It was a classic example of 'heads, I win; tails, you lose'.
The reason they created these convoluted things was to balance their own risks. For various reasons they chose to hold, or were required to hold, large amounts of stock on which they could lose a great deal of money if the market crashed. They thus created an instrument that would make them money in a crash and so hedged their bets.
Accumulators mostly afflicted wealthier investors but Lehman 'minibonds' were directed at smaller targets. They offered you a decent interest rate of the sort you used to get on deposits before central banks around the world started cheating savers by forcing interest rates down.
But, innocent as they looked, they depended on the solvency of a troubled investment bank, Lehman Brothers. If Lehmans were to become insolvent, you would lose everything. And, of course, Lehmans at the time was on the brink of insolvency - a fact the people who issued these minibonds knew well.
They were hedging their own exposure to Lehmans by pushing their risks onto small investors.
They did not have to tell outright lies or make false claims to do this. All they had to do was offer a high rate of commission on sales of minibonds to the public. Hundreds of thousands of securities salesmen around the world instantly jumped to the bait. If lies had to be told or truth avoided to get the minibonds sold, these salesmen would do it. The issuers were insulated.
But did the Securities and Futures Commission (SFC) stop anyone from selling accumulators or minibonds to the unsuspecting public?
No, they did not. Our regulators did not even realise what was happening until it was too late and then could only make noises of regret, much of it directed at shifting the blame to other government agencies.
They did, however, stop the investing public from buying shares in a Russian aluminium producer, Rusal, on the grounds that it was a risky investment.
It was true. All the risks were fully described in the prospectus and in public discussions. Nobody who looked at the stock could be in any doubt of the potential threats to Rusal's profits and the pricing of the stock fully reflected these.
And this introduces a question: If the market has been made fully aware of the risks, is there any role for a securities regulator to rule the investment as unduly risky?
It can only be so if the price does not take the risks into account. At a low enough price, however, the potential rewards counterbalance the risks and the investment is effectively 'risk neutral'.
An investment prospect that might otherwise be considered virtually risk-free could actually be riskier if its price is too high. The risk may be small but the reward is even smaller.
How will a regulator know at what price the risks balance the rewards? The fact is that no one knows. It is why we have financial markets; they balance out risks and rewards through the inputs of millions of investors who decide to buy, hold or do nothing. No other opinion can carry as much weight.
But I doubt that the SFC really understands the distinction. It is my belief that its campaign against risky investments will be against investments in which the risk is already reflected in the price. Meanwhile, the professional rats of the market will continue to devise poisonous derivatives to which our regulators remain oblivious.