Rules of the game
While 'gaming the system' is legal, investors need to look beyond official announcements before making investment decisions based on such data
Financial regulations often begin as guidelines set down by intelligent people to codify best practice. Too often, they end up being used by clerks instructed to tick boxes to ensure form rather than substance.
In Hong Kong, we have developed turning regulatory guidelines into law as an art form, but it is a sad fact that it is how all governments administer. And those that are subject to the regulations will game their behaviour to suit the ticking of those boxes.
This gaming of the system, where institutions and individuals find loopholes for their own advantage, is legal, but as we saw in the global financial crisis, bending the rules got people into a lot of trouble.
Banks lent irrationally, companies and people borrowed heavily, the US Federal Reserve kept interest rates low. All this happened within a tightly regulated financial system. Banks have so far been fined US$130 billion to settle allegations of misdemeanours from that time, such as money laundering, mis-selling, market fixing, lapses of compliance or assisting tax evasion.
This fining process itself is a gaming of the system. The regulators hold the threat of damaging the bank's reputation by exposure in the press. The banks want to pay to make the problem go away.
In a fair market, either the allegations should be proved in a court of law or the bank is blameless. Yet the game at present is for banks and regulators to get the shareholders and customers to bear the fines incurred by an institution and its directors.
It is governments that do the most gaming of all.
During the crisis, then US treasury secretary Henry Paulson knew Congress would never bail out rich directors of profligate banks. His plan, which Congress passed, was to buy illiquid toxic assets using the US$700 billion Troubled Asset Relief Programme (Tarp).
Except that instead it was used to support the banks directly - the very thing that Congress would never have agreed to. Paulson claims he did not intend this to be the result, but it worked.
Organisations on the mainland are particularly good at gaming the system, because there are so many, often contradictory, rules and regulations. If you are at all active in business and finance, you may well break some rule, even unwittingly.
The way to get things done on the mainland is to treat the system as an errant computer. You fool it into doing something different from what it expects in order to get what you want.
This is best illustrated by the recent exposé by CCTV accusing Bank of China of using unapproved techniques to move money outside the mainland in an alleged violation of strict cross-border currency controls.
The state-owned bank claims that the process was legal. The state-owned media company claims it was against the spirit, if not the letter of the law.
The spat might, perhaps, herald a new game on the mainland whereby some issues are argued out in public rather than behind closed doors. Perhaps the authorities feel that the banks will be more stung by adverse press comment than by private admonishment.
The financial markets need to rely on official government announcements and statistics in making their investment decisions, without any form of gaming of those figures.
Investors frequently sense, on the mainland and elsewhere, that published inflation figures seem too low to be true, or growth figures seem too high to be verified by other data.
Governments are supposed to be providing the level playing field, but in the West it is common for them to spin verifiable economic statistics their way.
In emerging markets, investors usually just see the bald announcement, with little transparency as to how the figures were calculated.
The behavioural finance lesson here is for investors to keep both eyes open - one eye on the official announcements and the likely reaction of the market if they deem the figures to be credible, and one eye on how the market will react if the numbers turn out to be less than credible.
Investors who look at economic or statistical figures must always be aware of the phrase, "trust but verify". Only junior analysts put the first number off the wires into their spreadsheets.
Richard Harris has been involved in the investment management industry in Asia for 35 years and is chief executive of Port Shelter Investment Management in Hong Kong