The Financial Onslaught in Singapore
The Monetary Authority of Singapore (“MAS”) classifies investors into 3 classes under the Securities and Futures Act – “accredited investor”, “expert investor” and “institutional investor”. There is no classification for retail investor specifically, and generally all other types of investors fall under this classification. The banking sector has been hit hard all around the globe, including Singapore. However, a key difference in the drama in Singapore’s financial sector from other countries’, is not due to bank closures but to individuals (retail investors) losing their life savings by investing in an instrument that was one thought to be untouchable by any market downturns –Lehman Brothers Bonds that were rated A1 by credit-rating agency Moody’s as late as July 2008. Who were the victims of this onslaught and how were they exposed to these instruments in the first place? Are there other investments that the same investors are exposed to and are they aware of the risks of those investments? How can the MAS find the middle ground it needs to prevent something similar from happening again, without over-regulating the financial system in Singapore?
Mr Tharman Shanmugaratnam, the Finance Minister of Singapore was recently quoted as saying ‘The MAS approach is one that balances regulation with responsibility on the part of the institution and the investor. All three play a part, and in all three areas, I’m sure there can be improvements, coming out of the recent problems.’
The Issue
The Monetary Authority of Singapore said about 9,700 people had bought Lehman-linked structured notes worth over S$500 million, and due to the recent Chapter 11 bankruptcy filing by Lehman Brothers, investors in these notes would lose most of their investments. Recently, about 600 investors in Lehman-linked derivatives held a public meeting in Singapore to protest about the way banks sold them the investment products and to discuss ways to get compensation, according to news sources. The problem with Singapore’s financial system is the way financial instruments are being sold and the way sales people are trained and motivated to sell them.
Quoting from the same source:
‘They never told me the issuer was Lehman and I told the manager I was afraid of American banks,’ said Ms Lin Ling, who bought S$60,000 worth of Lehman-linked ‘Minibonds’ from a Singapore finance firm that had marketed the structured notes as a safe alternative to fixed deposits.
‘I didn’t know it’s Lehman. There’s no Chinese explanation,’ said a lady in her 60s who identified herself as Madam Lee. ‘I don’t want interest, I just want my deposit back.’
Observations and Lessons Learnt
Passing the buck to another is always a convenient way out of trouble and that appears to be the route taken by many of the investors hit by this Lehman debacle. There should never be a doubt that there is a risk in every investment. By law, all financial advisors (“FA”) in Singapore are required to sit for and pass a number of Code of Ethics exams before they are allowed to give any form of financial advice. Without diverting this discussion into the effectiveness of the syllabus of these exams, we assume that passing these examinations shows the FAs’ abilities to understand the concept of risk, client classification and the different investment goals of different clients. There is no requirement for these FAs to be able to identify a high risk/return investment product before being let loose on the streets to peddle their products. What does this implicitly tell anyone aspiring to be a FA? Simply, it defines the minimum standard that these FAs need to fulfil, which is their knowledge of the law that governs marketing financial products in Singapore. Armed with this knowledge, FAs then gradually pick up product knowledge from their supervisors and colleagues, many of whom took the same path as them years ago.
What is the role of a FA? No matter how one argues, the FA’s role is to sell. It is not to “help clients manage their risk” or to “help clients save for a better future” – it is to “reach the sales quota to get paid”, “get on the millionaires’ roundtable to be seen and admired by your peers”, “be the first to sell a million contracts and win a holiday to Europe”, etc. Psychologically, FAs are not cultivated to be risk-adverse, they are by the nature of their motivation driven to take more risks, resulting in them advising their clients to take on more risks.
A Linear Solution to an Exponential Problem
Currently, FAs are paid a basic salary (terms and conditions apply) and a bonus based on the amount of sales generated by them. Any good salesman with little or no education would be able to fulfil this role. Alternatively, imagine if FAs were rewarded by how much money their clients made, this would immediately motivate them to do a few things:
- Get a proper financial education;
- Learn the concept of portfolio management and learn the instruments and how they can work for/against an investor; and
- Think twice before selling an investment product.
Relate this to fees made by professional fund managers. Fund Managers are paid a basic salary (management fees) derived as a percentage of assets under management. When they make money for their investors (clients), they are rewarded a certain amount of performance bonus. Should they lose money or break-even for their clients, they would only be given their management fees which are sufficient to keep them in the business but not enough for them to retire on a 20-ft yacht. MAS should conduct a survey on all the FAs in Singapore, the result of which should tell the employers of FAs (Financial Institutions, or “FI”) how they can structure the basic salary of FAs in order to keep them in the business, based on their demographics. Analysing this information with past client data, FIs can then also structure a rewards table for FAs whose clients perform well. Without tagging the reward of FAs to clients’ portfolio performance, it is unfair to blame FAs for the recent losses of Singaporeans who invested in the Lehman bonds, since FAs were not rewarded for any gains derived from investing in these bonds either.
Summary
In conclusion, the recent financial turmoil in Singapore defined as individuals losing their live savings rather than financial institutions closing down, is a clear indication of a weakness in the regulatory system. This weakness is caused by a psychological problem – motivation of Financial Advisors in Singapore – rather than by a technical problem in the financial system. The solution to this is for the Monetary Authority of Singapore to conduct a survey on every Financial Advisor in Singapore, and release the results of this survey to all the Financial Institutions who are licensed to sell investment products to retail clients. MAS should also issue Guidance to these Financial Institutions on how they should revamp their reward structure, the result of which would improve the entire financial advisory industry in terms of knowledge and monetary reward.
Felix.
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