Changing of the guard

With the departure of SFC chief Martin Wheatley, will the watchdog revert to a lighter touch on regulation - or maintain its rage, asks Jasper Moiseiwitsch

As Martin Wheatley leaves this week as the chief executive of the Securities and Futures Commission (SFC), Hongkongers might be wondering who and what are coming next.

The relevance for investors is clear: the new chief will be the last line of defence between the public and another Lehman minibond type of disaster.

The role of the regulator is especially important in Hong Kong, where individuals form a large part of the market, and poor corporate governance is common among listed firms.

"The volume of trading in warrants and futures of the Hong Kong public market is well above the participation seen anywhere else. A strong regulator is the only person who can provide checks and balances to this kind of market," says Alex Duperouzel, a managing director of ComplianceAsia, a consultancy that helps intermediaries comply with SFC regulations.

The commission provides a recent example of how things can go wrong. The SFC on May 24 published the results of a "mystery shopper" survey, in which the commission sent its own people into banks and brokerages, pretending to want to invest. The purpose was to see how well the products were explained.

In the survey, the commission found that, in 12 per cent of cases, sales agents failed to ask about a client's risk appetite when pitching an investment.

The commission also found examples in which sales staff would coach shoppers on risk-profile questionnaires to prod them to take a higher risk rating.

And in the cases when a salesman recommended an investment to a mystery shopper, 16 per cent of the time the agent failed to properly explain the investment, according to the SFC.

The SFC said its mystery shopper campaign showed sales agents failing to understand or explain basic features of the products they were selling. In one example, a shopper posing as a 74-year-old woman with HK$1 million in fixed deposits was advised to invest in leveraged futures and options, with the suggestion that this was a way the woman could avoid risk.

Although the survey shows just small ways in which investors might be vulnerable, the bigger danger is low corporate governance - particularly where management strips cash from listed firms, effectively robbing investors.

The Lehman minibond default was the defining event of Wheatley's tenure. It obliged the SFC to take a more forceful approach to regulation.

The question for investors is, as the Lehman affair fades from memory, will the SFC revert to its tendency towards light regulation?

There are those in the industry who argue that investors would benefit from a looser regulatory touch.

For example, the SFC has made it sufficiently difficult to sell equity-linked notes (ELNs) to public investors that this market has slowed significantly, issuers say.

ELNs are notes embedded with a put option on equities. The SFC's new rules requiring a cooling-off period on investments (in which individuals may change their minds after agreeing to buy it) have affected the instrument.

Issuing banks need to hedge their positions when they sell the instrument. If investors decide during the cooling-off period that they do not want the investment, the bank has to unwind that hedge.

The effect of the new rules is that many banks have since decided that ELNs are not worth the trouble, which largely explains why the product has gone quiet.

ELNs have long been a staple of Hong Kong's structured products market, thanks in part to their simplicity. But now, as they thin out, complaints have arisen that investors are being deprived of a useful instrument.

Investors are also complaining about the amount of paperwork recent SFC reforms are forcing them to complete to invest in certain products.

Fidelity did a survey of investors in February and found that many individuals declined to buy a mutual fund because the process of determining a person's suitability for the investment could take up to two hours.

The survey found that 38 per cent of investors believed the new procedures took too much time, and 27 per cent said they did not add value.

Perhaps most strikingly, the survey reported that 32 per cent changed from investing in mutual funds to other products to avoid the process.

"A high number said they would rather go into individual stocks than do all the procedures required to buy a fund. Or they will buy IPOs, foreign exchange or bonds," says Kerry Ching, Fidelity's country head in Hong Kong. "The unintended consequence of tightened regulation is that investors may buy something that is a higher risk than a mutual fund."

Todd James, head of wealth services for the private bank BSI, says: "I know investors are very frustrated by documentation. They are overwhelmed."

The regulator, therefore, faces a damned-if-you-do, damned-if-you-don't dilemma. It was pilloried during the recent financial crisis by minibond investors, who asked how the commission could permit such a product to be sold to the public. Now it's getting complaints about being too intrusive from the financial services sector.

In between these parties is the government, which will appoint the next head of the SFC as it tries to promote Hong Kong as a financial centre in light of growing competition from Shanghai.

The SFC has to balance all these interests and not always with the independence it would like.

"Hong Kong needs someone who also has the necessary tact to navigate a set of key stakeholders, including the government, stock exchange, mercantile exchange [and] mainland regulators," says Christine Loh Kung-wai, the chief executive of Civic Exchange, a public policy think tank. "It is not an easy job because there are so many vested interests."

jasper.moiseiwitsch@scmp.com