Saturday, November 01, 2008

Structured Products fiasco- What's reasonable, what's not 5 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
It is surprising that this storm has still not abated about one month after it initially started following Lehman's failure which ignited so-called "credit events" in many structured products offered around the world, most prominently in Hong Kong and Singapore (I wonder why these two countries in particular). With all due respect to the victims, my conclusion is that in Asia, money (and the loss of it) strikes at the raw emotions (and the corresponding activism) of people much more than anything else (eg. intangibles like democracy, politics, environment).

As this issue is covered almost every day in the papers, I cannot help but be saturated by all the reports. And I cannot help feeling that while there are obviously certain points that buyers of these Lehman minibonds/DBS Hi-Five/Merrill Jubilee notes (to name three of the most prominent) have strong reasons to be indignant about, there are other points that were raised which do not really hold any ground. I discuss a few of each below:

What's reasonable (ie. the investors have reason to be indignant about)

Terminology used: The misleading terminology used to market these products is one of their biggest bugbears, and rightly so. As I've said before, I never would have understood that there was a difference between capital-protected and capital-guaranteed until the shit hit the fan in the last two months. And calling the Lehman products "minibonds" certainly hints of an intention to lull the target audience into complacency. A rose by any other name is just as sweet (and the reverse applies for a pile of shit), but certainly the name is supposed to convey a certain first impression and underlying meaning.

Lack of understanding of products by sales personnel: For the level of complexity of the structured products which had even some experienced finance professionals struggling to comprehend the prospectus, it is highly debatable whether they should even have been made available to the masses. One thing is clear, and that is that many of the sales personnel were not equipped to explain their complexity to retail customers. There is anecdotal evidence on the part of the aggrieved customers, and partial acknowledgment of this fact on the part of the selling financial institutions. In my view, the caveat emptor principle is more valid when the investor is the one actively sourcing for investment targets to purchase; it is reasonable then to expect that he should do his own research. However, where the seller is conducting aggressive selling tactics, I feel it is their responsbility to explain the upside and downside of the product to their customer to give a complete picture. Most agree that it is doubtful that the sales personnel were even in an enlightened position to explain the risks of these products.

Poor financial advice: In the old days, the easy money was to be made in "widows' and orphans' money" --- it was easy to target the money of the most vulnerable. Anecdotal evidence suggests a key target for these structured bonds were the elderly looking for fixed deposits. This is not wrong in itself, except a key tenet of prudent investing --- diversification --- was ignored when a big part of these customers' money (several hundred thousand dollars for many) was eventually funnelled into one or two structured products. However safe a product might be deemed to be, surely it was unwise to put all the eggs in one basket? Perhaps the money could have been spread among several structured products?

What's not reasonable (ie. the investors shouldn't complain)

The yield and risk involved: Now this is one argument that I don't agree with. Some investors have pointed to the admissions of the banks that the structured products were risky ("probably a 8 or 9 on a scale of 10") as evidence that these were high-risk products that were mis-portrayed as safe products when they were marketed. Others claim that they had mistaken the products as being safe because they looked at the promised yields of 5% and thought that such low yields would surely mean that the products were low-risk ("high risk, high return" and vice versa). But people have to remember that at the time of issue, many of these instruments were rated AA or thereabouts, comparable to or even better than many emerging market sovereign bonds. The banks have a reasonable case that nobody expected then that the credit would deteriorate so fast. What the banks could have done better, though, was to regularly update their customers on the riskiness of these structured products, including any downgrades by the ratings agencies.

Role of the government: Some feel that our government has largely adopted a hands-off/passive approach to administering this issue and want them to offer more protection to the victims. Personally I feel the official reaction has already been quite active judging from the numerous comments from the authorities on the mass media, though people are apt to compare with other countries, notably Hong Kong. I don't really think taking too strong an official position on either side will be prudent, especially when one is wary of setting a precedent that could have implications down the road, or where it could cripple some financial institutions at a time of great crisis, and when our business reputation has always been built on fair governance without letting economic issues being corrupted by politicisation. For this issue in particular, it's really better to cross the river by feeling the stones.





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