Pockets of the financial system are stabilising. Stock markets have appreciated rapidly in the past several months, with many equity benchmark indexes in the region back to levels reached prior to the collapse of Lehman Brothers in September last year. The 'fear gauge' Vix index, which measures expected 30-day volatility of the S&P 500, is trading in the 20-30% range, having fallen dramatically from its high of 80.86% on November 20, 2008.
Investment banks are again making money. Revenues from trading activities at financial institutions ranging from Barclays Capital to BNP Paribas and from HSBC to Goldman Sachs have stood up well during the first half of the year. Indeed, these investment banking revenues are often supporting other areas of business where growth prospects remain challenging and bad debts continue to rise. Meanwhile, banks that let go thousands of staff during the first two years of the financial crisis are once more in hiring mode.
Some of the high-profile disputes between investors and banks are also coming to an end. Hong Kong's two main financial regulators reached a deal with 16 distributors regarding their sale of credit-linked notes called minibonds to retail investors in July. The banks have agreed to buy back minibonds at 60% of the nominal value of the original investment for customers below 65 and at 70% for customers aged more than 65. There may also be some additional monies returned depending on recovery values associated with these investments. The agreement in Hong Kong follows an attempt to close the matter in Singapore in June (Asia Risk, July 2009).
Bank distributors in both jurisdictions will also need to improve their sales practices before they can offer retail structured products. And they are not the only financial institutions that should devote more time to improving internal practices.
With the pick-up in financial markets, dealers are once more pitching non-linear products to clients. One hopes they have learnt their lessons and are selling these instruments in an appropriate fashion. There is solid evidence that some leading investment banks sold highly leveraged option positions in 2007 to clients that were simply not in a position to price the options and fully understand the risks.
While the trade documentation may have legally been sound - and there are plenty of cases still going through the courts to test this - there is evidence many transactions were done in 'bad faith'. The trades took place in many cases despite objections by the banks' own internal risk control and compliance functions. Banks have made huge profits from their customers' mispricing options, but troublesome disputes look set to rumble on for some time to come.