HK not ready for more interventionist style of regulation, Wheatley says

25 May 2011 by Oliver Jones

While Hong Kong’s financial services sector has enhanced its “conduct process” on the heels of the 2008 mini bonds’ investment saga by making products simpler to understand, the city is deemed not ready for a more interventionist style of regulation, according to outgoing Securities and Futures Commission chief executive officer (CEO) Martin Wheatley.

After almost six years, Wheatley is set to leave the SFC on June 8 and take up a new role, on September 1, as managing director of the UK Financial Services Authority’s (FSA) Consumer and Markets Business Unit and CEO-designate of the Financial Conduct Authority (FCA), one of two successor bodies to the FSA.

In Hong Kong, “we have enhanced the conduct process. Financial service providers are focussing more on suitability of clients and providing information in short, clear and concise documents, giving investors a better chance (of being able to make an informed decision). The products are simpler but the sales process is slower.”

But he adds, “you still don’t resolve the agency conflict”: that investors don’t know whether or not the agent is acting in their best interests. There is still the potential that investors are not receiving good, independent advice. The conflict can be removed by banning commission rebates. By taking the view that, “if investors want financial advice, they have to pay for it. It is a different way to intervene for a cleaner relationship.”

Wheatley remarks that, “in the UK, we are moving towards a more interventionist style of regulation than I think Hong Kong is comfortable with.” He adds that Hong Kong’s financial services sector has evolved hugely over the last six years and is on the cusp of a very exciting period. The rest of the world is seeing growth prospects in Asia and issuers, investors and institutions are deciding that they need a presence where they are comfortable with the legal system and the market structure.

He also notes that one can design products with no risk, but that they will offer no return. “If a car manufacturer was tasked with designing a car with no risk, he would design a car that goes at 3mph to eliminate risk for the driver”, but then he would still need to address the question of risk for pedestrians. The issue is the balance of risk.

In the UK, the regulators are taking on the additional role of forming a judgement as to whether a product is good or bad for investors. But by taking on that role there is the potential of building up the perception that, if a product is not banned by the regulator, then it is implicitly being approved.

In his last formal public speech as the chief executive officer of Hong Kong’s SFC, Wheatley outlined “Regulatory developments in Hong Kong and globally” at a professional development seminar organized by the Hong Kong Securities Institute on May 23.

“I don’t think I could have gone back to do that job without the experience gained in Hong Kong,” remarks Wheatley. Starting at the SFC in September 2005, he witnessed the listing of three of China’s big four banks before Lehman Brothers’ bankruptcy in 2008 and subsequent focus on “cleaning up the mess created by mini-bonds and other products.”

“I understand quite a bit (about product complexity) given what we’ve gone through in Hong Kong,” he notes. In a low interest rate environment, people wanted better returns and, after the dot.com bust, capital protection. Normal products could not deliver both and, “over the last decade, we moved into a world of product complexity.”

The transition to more complex products required trade-offs - such as including capital protection but at the cost of giving up some return – and a combination of debt, equity and derivatives. But the more derivatives are used in the product, the more difficult it is to understand.

Wheatley adds that he was returning to the UK at a very interesting time, and that – while the regulators in the UK are charged with similar objectives, of consumer protection and ensuring that the right information is provided by financial service providers, the approach in the UK will be very different to Hong Kong’s.