The Fine Print is Enlarged, But Will Investors Read It?

The Fine Print is Enlarged, But Will Investors Read It?

By JONATHAN CHENG
As governments around the world rewrite banking rules after the financial crisis, Hong Kong's regulators are moving to tackle the biggest local fallout from the crisis here: lax rules on how banks sell financial products to mom-and-pop investors.

On Friday, Hong Kong's Securities and Futures Commission unveiled rules that will enlarge the fine print on complex structured derivatives and restrict banks' and brokers' use of free trinkets and baubles to sell financial products.

The relatively narrow scope of Hong Kong's post-crisis overhaul reflects the limited damage dealt to this city's financial system over the past two years. Banks' conservative balance sheets and a long-time ban on "naked short-selling," among other things, insulated Hong Kong from having to rewrite the rule book.





Protesters demonstrate in Hong Kong in February 2009. More than a year later, few investors are asking about risk.
But Hong Kong's response is telling, too: this city's retail investors were burned by some pretty complicated financial products during the pre-crisis bull market, many of them sold by offering shopping vouchers and other perks along with their structured derivatives.

The product that got the most attention, so-called Lehman minibonds, promised juicy returns while relegating complicated risk warnings to the fine print. The minibonds were tied to well-known Asian conglomerates and issued by a subsidiary of Lehman Brothers Holdings. When the U.S. investment bank collapsed in September 2008, minibond investors were virtually wiped out.

With Hong Kong investors camped outside bank headquarters and old grannies complaining about losing their life savings, regulators brokered a deal under which banks here bought back the minibonds at 60 cents on the dollar.

Government officials promised to re-examine whether sufficient safeguards were in place to govern how complex structured financial products were sold.

The exercise is far from academic. By all accounts, Hong Kong's public hasn't lost its appetite for risky financial products. Bank branch windows hawk currency-linked derivatives with annual returns of 55.21% and 62.8%, and investment seminars dominated last year by concerns about principal protection are focused again on juicing returns.

"After the Lehman incident, a lot of investors were very scared of risk, but now no one asks me about this any more. It's like they've all forgotten," said Ricky Tam, chairman of the Hong Kong Institute of Investors. At one investment seminar he conducted last Wednesday before an audience of more than 100 investors, many of them teachers, risk was hardly an issue, he said.

Mr. Tam welcomed the SFC's new regulations, in particular a "cooling-off period" that allows investors to mull over their purchases and seeks refunds within five working days. The SFC also will require banks to differentiate between those with some financial savvy and those without, and to tailor sales pitches accordingly. Words like "minibonds," which aren't traditional bonds, are out.

Financial products will require five-page "key fact statements" that clearly introduce the derivative and their risks—filling a gap between what SFC Chief Executive Martin Wheatley described Friday as "a 200-page prospectus that nobody ever reads and a one-page flyer with a pot of gold on it and a lot of fine print."

As in the U.S., hitting the right regulatory balance is tricky. Hong Kong banks rely heavily on sales of structured products as a revenue driver, and have resisted further regulation.

At the same time, public anger remains high. Twenty months after Lehman Brothers' collapse, disgruntled minibond investors continue apace with their protests outside the downtown offices of Citibank and other minibond vendors.

Alan Ewins, head of the regulatory practice at Allen & Overy LLP, said regulatory fixes take time to prove their efficacy. "You are going to have to wait and see overall how the market absorbs the regulations," Mr. Ewins said, adding that the cooling-off period and the identification of unsophisticated customers were relatively new ideas.

Regulators will be up against products geared towards Hong Kong's risk-hungry mom-and-pop investors, like ones being offered now by HSBC PLC and Citic Bank International.

HSBC is promoting a structured derivative called "Deposit Plus" that allows investors to reap annual interest-rate returns of 13.5% in a foreign-currency account—provided currencies moves don't sour.

The derivative promises "greater wealth appreciation potential" for customers and enters investors into a "lucky draw" for round-the-world airplane tickets. A disclaimer notes that the derivative isn't a traditional deposit account, despite its moniker, and offers prominent and clearly written risk warnings.

But at no point does the bank warn investors that, should currency movements turn against them, their entire investment could be substantially wiped out. Instead, HSBC lays out three reference scenarios. In one, the investor earns the maximum possible annual interest rate of 13.5%, and in another, the investor would come out just better than even. In the worst scenario presented, the investor is down 0.006%.

Had an investor followed the referenced scenario over a three-month period rather than the brochure's 14-day example, investing HK$300,000 in an Australian dollar-linked "Deposit Plus" account on March 5, he would be down about HK$24,000 today — a loss of about 8%, with a few more days to go.

Bruno Lee, HSBC's Hong Kong-based regional head of wealth management, said in response to questions that "we strive to be transparent in the communication of our products," and that HSBC engages in thorough discussions with customers to guide them to appropriate solutions "rather than pushing a particular product." Mr. Lee added that HSBC welcomed efforts to enhance investor protection and would comply with regulations.

Citic Bank International, controlled by China's state-owned Citic Group, offers a similar "currency-linked deposit" that promises "infinite possibilities with foreign currency investment." Citic dangles the promise of 24.18% annual return, compared to 0.01% with a plain-vanilla fixed-rate deposit. In the four scenarios laid out by Citic in its "pay-off table," the investor makes money or breaks even in the first three scenarios and loses 3.75% in the case of an significant downturn in the New Zealand dollar against the U.S. dollar.

In response to questions, Citic said using the word "deposit" was "in line with market practice" and that the derivative has many elements of a traditional deposit. Citic also says that its risk warning section is adequately clear and that, in any case, if a customer were to sustain a loss, the customer could opt to hold onto its investment in hopes of a rebound.

Citic adds that it has enhanced its assessment of a product's suitability for its customers, that it makes audio recordings of the selling process and that it now physically separates investment services and general banking services in its branches.

Write to Jonathan Cheng at jonathan.cheng@wsj.com