Hong Kong investors grapple with effects of Lehman collapse

Investors know that if it sounds too good to be true, then it probably is

Apart from the rollercoaster ride on the stock exchange, Asia’s economies have not taken as big a hit as those of the US and Europe. That is not to say they are safe.

They have experienced some nasty shocks to the extent that their banks bought into the toxic debt that brought on the rot in the West.

Take the Lehman Brothers mini-bonds sold in Hong Kong. Over 33,000 investors sank as much as US$1.5 billion in these esoteric and highly technical instruments without really understanding what they were purchasing.

This was part of the cycling of debt and cleverly crafted derivatives that promised extremely high returns but were not exactly transparent when it came to disclosing the associated high risks.

Savvy investors know that if it sounds too good to be true, it is probably too good to be true. Some will know instinctively that the old axiom “the higher the risks, the higher the returns” also works in reverse.

The problem arises when the buyer is blinded by greed and gets sucked into the false belief that confidence and the markets will keep rising.

The other problem is the apparent deception on the part of the sellers. A lot of the people who sell investments do not really understand the technical aspects of whatever they are selling.

You find a lot of young people, straight out of college, armed with a marketing degree walking into your office and waxing lyrical about these new wonderful financial products their great Wall Street investment bank has recently conjured.

They go on and on about the high returns, the special discounts available for a limited time only, which you will lose, foolish fellow, if you do not sign on the dotted line within 24 hours.

These aggressive young men and women anxious to boost their sales figures and secure their bonuses could not care less if you lost your life savings, as long as they get their commissions and bonuses, and a mention as salesperson of the month in the company newsletter.

They also prey on the elderly who do not understand any of the jargon and just want to hear “high returns”.

The scandal of the mis-selling of Lehman minibonds is one of the biggest talking points in Hong Kong today.

The authorities have lurched from one unworkable solution to another, urging compensation and claiming they should not be accused of failing to monitor Lehman Brothers.

Somewhere in the middle of all the acrimonious exchanges lies a serious question, which is, how can investors best be protected from the wolves and sharks in the financial world?

When banks like Lehman Brothers collapse, hapless investors are left holding on to worthless paper. Meanwhile the executives have been awarding themselves gravity-defying salaries and bonuses that, seen against the losses and bankruptcies now faced by investors, are nothing short of robbery.

I was talking to a Kenyan banker recently about the shenanigans that go on in the stock market today which I encountered on a recent visit to the country.

I found it quite bizarre that the power to trade on the stock exchange is monopolized by so-called brokers. They require investors to channel transactions through third parties, effectively disenfranchises them and places them at substantial risk when these third-parties, who seem to be poorly supervised as well, engage in illegal trading, which I understand has led to a collapse or two.

Such practice also props up an industry that is prone to moral hazard where vested interests take precedence and irresponsible risk-taking is rewarded. In more advanced economies, you can trade through a broker if you so wish.

The trend, however, is to empower people to effect their investments decisions themselves, almost invariably through the internet. Now, it may be that investors in Kenya need to be protected from their unfamiliarity with the market.

But it seems to me as though investor education, if there is any, should equally be concerned with protecting investors from unscrupulous middlemen, brokers and all sorts of self-seeking third parties. That certainly seems to be the issue in Hong Kong, and no doubt many other jurisdictions.

Regulators who should have scrutinised the increasingly innovative financial products on offer have defended themselves by claiming they ensured that the risks associated with minibonds were fully disclosed.

The public begs to differ, and believes that the de facto central bank seems to have slept on the job.

For the average investor who succumbed to what now looks like a case of mis-selling, it is not enough for the regulator to issue warnings that products are labelled properly, that is, as high-risk.

And herein lies the dilemma for a responsible regulator. What further role can they play to ensure that truly dangerous products are kept out of reach?

Regulators can refuse to authorise products if they jeopardise the financial system, or if they are fraudulent.

It makes you wonder, when regulatory authorities in supposedly advanced economies can barely keep up with the financial wizardry (and, sadly, disingenuity) emanating from bankers, brokers and what have you, what hope is there for investors in jurisdictions where the gatekeepers of the industry treat the whole business of investing as a game?

The way IPOs in Kenya have been handled, for example, does not augur well for stability when the effects of the global financial crisis begin to be felt.

Professor Ken Kamoche is an academic and a writer.