Growing pains in Asia

For almost all of us it’s become impossible to ignore the daily reports in the media on the biggest financial calamity the world has seen since The Great Depression.

The impact of the global financial crisis has been felt in almost all walks of life, but it’s likely the greatest havoc has been wrought in the very broad industry we know as financial services. It’s times like these that reshape the landscape and we are seeing that across the globe.

As an ex-pat now in Hong Kong after 25 years in financial services in Australia, I’m in the front-row seat to watch the changes being thrust upon financial institutions in Asia, especially those that deal with the retail consumer.

Many of you might know that the regulations on the sale of financial products in this part of the world are much more relaxed than those we currently follow in Australia. The most notable exception is Singapore, which stands out as the most similar to the Australian model. Hong Kong too has developed its advice regulations in the past few years with changes similar to ours.

However, recent events associated with the financial crisis and the boom times of the last few years are set to change much more of the Asian landscape than these two cities.

After being both an observer and actively involved in the development of the retail advice regulations in Australia, it came as quite a shock to find how wide and varied the regulations regarding the sales of financial products are in Asia.

Of course, you’d expect that virtually nowhere in the world is as regulated as Australia, yet the unbelievable pace of growth of financial services in many of the countries here has created a wealth of problems that were masked in the bull market run of the past five years, only to be shown to all in the current environment.

As Warren Buffet is fond of saying, “You find out who has been swimming naked when the tide goes out”. With a rapidly emerging middle class in countries such as China and the penchant for investment by the more sophisticated consumer in Hong Kong and Singapore who wants a piece of the action, retail banks in particular were keen to meet the demand.

As is typical of long bull runs, many investors left their timing until late in the cycle to invest. To meet the huge demand for higher return investments, many of the retail banks in Singapore and Hong Kong offered a structured investment from Lehman Brothers.

These were sold as ‘minibonds’ via bank staff to everyone from high-net-worth individuals to mum and dad investors and retirees with a few or many thousands to invest. If you accept the media’s view of events, bank staff represented these as low-risk investments similar to a bank bond.

In Hong Kong, 43,700 individuals invested over HK$15.7 billion in the minibonds from Lehman. In hindsight, it could be argued that minibonds were indeed low-risk instruments since they were backed by Lehman Brothers, which until just months before its collapse was a venerable member of Wall Street with high credit and investment ratings. Indeed, many banks accepted minibonds as collateral for loans and credit facilities. The subsequent default of Lehman Brothers was totally unexpected.

The Hong Kong Government has proposed a plan to buy back the investments at their current estimated value, which would allow investors to partially recover some of their losses by the end of the year. Hong Kong chief executive Donald Tsang at the time insisted that local banks respond swiftly to the Government buy-back proposal as the Monetary Authority had received more than 16,000 complaints. However, the parties involved could not agree on the arrangements and repayments to investors stalled.

In Singapore it was a similar story and in both cities street demonstrations were held. To this day you will find round-the-clock demonstrators outside various retail bank headquarters calling for justice.

In the latest development, all parties have agreed to a repayment proposal that will see 70 per cent of investors’ money refunded. For some this is still not enough.

This episode has had deep repercussions on the banking industry here, where misguided investor sentiments have become hostile to both wealth management products and the banking industry as a whole. Under intense pressure from the public, all political parties have come out in support of investors, further fanning distrust of the banking industry.

In other countries that don’t have as many sophisticated investors, the rapidly growing middle classes still wanted a way to participate in the strong returns they saw in their local stock markets. The insurance industry found a way to do just that by offering insurance-based mutual funds, much like our insurance bonds in Australia during the 1980s and 1990s.

This was manna from heaven to the rapidly growing legions of newly-recruited insurance agents and fast-expanding bancassurance operations of local banks, which were looking for something other than risk products to sell and hoping to tap into the new retail investors' appetite for investing their disposable income.

Called variable universal life policies, and known locally as VUL policies, under the promise of better returns than a bank account but with 'almost' the same risk, they took off with spectacular rates of sales growth. No country in Asia missed this opportunity; therefore, when returns linked to the performance of the stock markets started to dip in the second half of 2008, many first-time investors found, to their anger, a falling fund balance on their statement.

With the spectacular growth in agent numbers over the past four years, many agents had never experienced a downturn and were poorly equipped to explain to their clients why returns were heading south. Even less experienced were the bank staff who were on the front-line of sales within banks across the region that had expanded their services to include insurance and investments.

In China, the insurance regulator has forced many insurance companies and banks to repay funds to local investors who clearly didn’t understand what they were investing their hard won yuan into and the volatility associated with their products. Unfortunately, this is an all too familiar a story in the journey to maturity for retail financial services and Asia is no different to the trails and tribulations we have all seen in the West.

These events have set in train a vast array of changes to the regulation of retail financial services across Asia. While some countries are planning changes that are similar to Australia's regulations, others have or are moving to more extreme measures such as audio taping all investor conversations within bank branches.

There is no doubt the retail investment landscape in Asia is undergoing considerable change, and not without commensurate industry pain.