Banks sign agreement to buy back Lehman minibonds

The Securities and Futures Commission (SFC), the Hong Kong Monetary Authority (HKMA) and 16 distributing banks reached agreement this July on the terms for the repurchase of Lehman Brothers' minibonds from customers. Publicly, bankers say this is a good deal for the market and for the investors, but privately there is concern among bankers and lawyers that the deal will spell trouble further down the line, as well as being unfair.

"The banks are pleased to have reached this agreement with the SFC and the HKMA, which we believe will benefit Hong Kong as an international financial centre," said David Li Kwok Po, chairman and chief executive of the Bank of East Asia, in a statement on behalf of the banks backing the agreement. "It evidences our joint effort... to reinforce public confidence in Hong Kong's banking, financial and regulatory systems. This agreement demonstrates our unwavering commitment to the good of Hong Kong and the welfare of our customers."

Lawyers familiar with the agreement, however, suggest some parties were less happy with the arrangement. One says that since securities firms KGI Asia and Sun Hung Kai Financial in April agreed to pay back all monies lost by investors from their purchases on minibonds, it was expected other distributors would follow suit. But, since then, banks have dragged their feet. Not only did it take several months longer to reach an agreement, but the distributing banks involved will only buy back at 60% of the nominal purchase value.

"The decision on the agreement to buy back is by consensus, there is nothing in the ordinances that says (the banks) must," says one Hong Kong lawyer, who asked not to be named for reasons of proximity to the agreements. "Banks felt they didn't mis-sell, so were asking 'why should we buy back?'" One concern flagged up by a number of lawyers, all declining to be named, is that the deal might set a difficult precedent for the future. Bankers and lawyers are now concerned that every time retail investors lose money they will simply complain and ask for it back.

However, a spokesman for the HKMA said there was no concern at the HKMA about dangerous precedents being formed, adding "banks have to take into account the circumstances of each incident (of complaint)".

"It could be the case that the banks felt they just wanted to get back to making money... the retail market has ground to a halt," says the Hong Kong-based lawyer.

The pressure to sign up to the agreement has come directly from the Hong Kong Legislative Council (Legco), which responded to pressure from angry investors who took to the streets in protest at losing their money on minibonds - credit-linked notes linked to securitisations.

But lawyers fear the deal between the regulators and distributors effectively sidesteps the law. "This kind of thing is what the courts are for," says one lawyer. "We have to think about the rule of law in Hong Kong. (The attitude of Legco is) 'we don't care what those contracts say, here's what we want you to do'."

The suggestion by many lawyers is that the blanket approach of a mass buy-back is the wrong way to go, and that the only fair way to conduct the investigation is on a case-by-case basis as occurred in Singapore (Asia Risk, July 2009).

The minbond saga has highlighted a number of problem areas for retail investing in Hong Kong, which the regulators are now expected to try and change as the minibond difficulties subside. One focus area is that minibonds and some other structured products fall under the companies and debentures ordinance, but do not really get used as fund-raising vehicles, so lawyers are tipping a major change, where structured products are moved to sit under the securities and futures ordinance. A further area of discussion is the difficulty of having two regulators in Hong Kong, and the confusion this causes, with a possibility being that Hong Kong might end up with just one regulator.

The terms of the buy-back agreement are such that distributing banks will buy the minibonds at 60% of the nominal value of the original investment for customers below the age of 65, and at 70% of the nominal value for customers aged 65 or above. Once the banks are holding the underlying collateral, each will make a further payment of initially up to 10% depending on the recovery rates of the minibonds. If recoveries exceed 70%, the banks will pay the entire excess amount.

Banks will also have to enhance their complaints-handling procedures to resolve disputes and engage an independent party to review systems and processes relating to the sale of structured products. They are bound to carry out any recommendations made during this review.

The SFC will now discontinue its investigations into the sale and distribution of minibonds by banks. The HKMA has also informed the banks that it is not its intention to take any enforcement action against them in relation to minibond cases that involve eligible customers who accept the offer. The agreement also remediates the banks' systems and processes to meet the highest standards that will provide enhanced protection to the investing public in the future, and give the investing public an assurance that the parties are determined to ensure these events are not repeated.