The latest minibond resolution is likely to close the painful Lehman episode in Hong Kong, though it looks more like a political settlement than a thorough investigation into what really went wrong. The scandal shows that something has to be done to better protect investors. However, well-intended regulators may be hastening to correct the problem with the wrong tool.
Since the Lehman Brothers collapse, there has been a trend to introduce more elaborate procedures for selling financial products. The Securities and Futures Commission (SFC) will implement a new rule in June requiring licensees to classify investors by testing their knowledge of derivatives. This so-called 'investor characterisation' test will be requisite for anyone wishing to invest in both listed and unlisted products.
However, the selling requirements on pure derivative play traded on the stock exchange, like warrants or options, are more relaxed than those on unlisted products, such as mutual funds, which are managed by professional investment managers.
Investors averse to red tape may simply shun those unlisted conventional funds in favour of less regulated listed products. According to a March survey on investor protection by ACNielsen, nearly a third of investors may change their investment decisions because of the selling process. More alarmingly, many of them eventually end up investing in stocks (76 per cent), IPOs (25 per cent), foreign exchange (21 per cent) or even warrants and callable bull/bear contracts. Financial intermediaries may also be tempted to promote these listed products due to lower selling barriers.
This brings two problems. First, these alternatives are by no means less risky. Individual stocks are well known for their higher volatility, and trading foreign exchange on margin can be very risky. Warrants and callable bull/bear contracts are pure derivatives with potentially zero residual value.
Second, imposing a higher regulatory hurdle on unlisted products seems to violate the regulatory principle of maintaining a level playing field. It may wrongly signal to investors that listed products are more secure per se.
