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The SFC circular was issued on October 3, but fund houses are still interpreting the circular and coming up with measures to comply. Executives at fund houses and other industry practitioners say it hasnÆt been easy to interpret what the SFC wants because there has been no clear set of guidelines issued in support of the circular.
The circular was issued in response to the public concern over the marketing of retail structured products triggered by the collapse of Lehman Brothers, which, as SFC chief executive Martin Wheatley notes, has affected ômoms and popsö in Hong Kong.
The circular directs issuers of all retail investment products to make sure marketing materials issued ômust be clear, fair, and present a balanced picture with adequate and prominent risk disclosureö. ThatÆs already an existing requirement, but the SFC says itÆs not enough that the information materials contain the risk disclosures. In most cases, the risk disclosures end up at the bottom of the document or in fine print.
The SFC says the risk disclosures, from now on, must be ôupfront, prominent and adequateö. The risk disclosures must also contain ônew risksö arising from the current market conditions.
ôWe have been quite careful not to impose new requirements. What we have tried to do is clarify them,ö Wheatley said at an AsianInvestor conference on Wednesday. ôPost-Lehman, we are in a new situation where counterparty risks that were not really taken account of before have become a much more pressing issue. Global failure is a much more prominent issue. What are trying to get them to do is to rethink whether the disclosure they have in place today is still adequate given whatÆs going on in the world.ö
Effect similar to cigarette packet warning labels
What the fund houses are working on now is the creation of a uniform warning label to be placed prominently in information documents of new funds being launched or portfolios that are being re-launched. Some industry players have compared the planned fund warning label to cigarette box warning labels.
In Hong Kong, cigarette warning labels are written in English and Chinese. There are several versions of these warnings in Hong Kong, including ôsmoking killsö, ôsmoking causes lung cancerö, ôsmoking harms your familyö, ôsmoking causes peripheral vascular diseasesö, ôsmoking may cause impotenceö, and ôsmoking can accelerate aging of skinö.
One industry player says the label warning on funds wonÆt be as dire as the ones found on cigarette packets, ôbut the effect will be the sameö. The fund houses, through the Hong Kong Investment Funds Association, are still in the process of finalising the structure, content and actual wording of the warning.
ôWe have sent out a circular where we said, 'look the worldÆs moved on so you better make sure that the words you are using take account of the fact that, post-Lehman, we are in a different environment',ö Wheatley says.
ôWhat we are basically saying is 'remember your duties in terms of risk disclosure'. We are not mandating that they say investing can kill you or anything like that. It is how they are interpreting our circular. People have to work through in their own mind how they respond to our circular,ö he adds.
In the meantime, fund houses are experiencing delays in getting approval from the SFC for their fund products. This has been a huge source of frustration among fund houses that want to capture what little is left of risk appetite by offering bond products, for example. The delays are largely due to the fund houses' failure to comply with what some describe as an ôaggressive interpretationö of the requirements for more prominent and adequate risk disclosures by case officers at the SFCÆs investment product division.
The requirements include disclosure on specific risks involved in investing in the fund, including any counterparty risk and detailed and specific risks in relation to the portfolioÆs investment strategy.
While there have been fund applications that have been stalled, the SFC says it has authorised 79 new mutual funds and unit trusts û which have met the disclosure requirements û since the collapse of Lehman in mid-September. Many of those products have not yet been launched, however, and this is mainly due to expectations of poor demand due to the current aversion to risk.
SFC to send letter to fund managers soon
Managers of SFC-authorised funds should expect to receive a letter from the regulator in the next few days containing guidance on the disclosure on marketing materials, particularly for the issuers. Key disclosures required will include what the product is all about, what it covers, and the specific risks involved, especially counterparty risk. Fund houses will be told to make a balanced presentation of benefits, returns and risks.
It is unlikely that the letter will contain very specific and detailed descriptions of what is expected of fund houses, however, because the SFC tends to take a principle-based rather than a prescriptive disclosure approach.
For his part, Wheatley says the prominent and adequate risk disclosures are required even in marketing materials because there has been a tendency for retail investors to gloss over voluminous fund prospectus documents and other official paperwork in favour of marketing materials.
Wheatley notes investors around the world have lost money on complex structured products backed by Lehman Brothers (of which the Minibonds are a branded product line) or through other credit-derivative exposures. He says the SFC and other securities regulators around the world are trying to understand how so many retail investors became exposed to complex financial products.
ôDisclosure doesnÆt solve the problem,ö he says, noting that the SFCÆs regulatory regime covers three key issues: disclosure, suitability, and informed investors.
The SFC ensures that a product and the marketing materials of that product should have sufficient information to allow a reasonable person to make a good judgement, he says. In terms of suitability, he says the selling agent û whether itÆs a tied-agent, bank or broker û has the absolute responsibility to ensure that the product is understood and the matching of the risk profile of the client and the fund profile is suitable given the clientÆs characteristics. He says that in todayÆs environment, it is important to note that investors are not always making informed decisions.
ôIn many cases, investors werenÆt asking sensible questions,ö he says. ôLate cycle is really about lax risk awareness. People come in late into the investment cycle without asking too many questions. They just feel like they have got to get on the bandwagon. ThatÆs a fairly common thing.ö
In cases where there has been mis-selling, the SFC has taken action occasionally and has reprimanded people and firms involved, but it has never seen anything in the scale of the Lehman Minibonds.
ôThe last big case we had was Towry Law, where we forced a settlement from Towry Law. Nothing we have dealt with in the past is as huge as what we are dealing with now,ö Wheatley says.
In 2004, financial advisory firm Towry Law entered into a settlement with the SFC for more than $30 million to compensate investors affected by the collapse of two of its hedge fund offerings.
The SFC's real focus at the moment is getting compensation for investors involved.
ôWe want to make sure that the people who have been mis-sold products get their money back," Wheatley says, "or at least a portion of their money back."
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