Regulators split over response to Lehman bankruptcy

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Structured products underwritten by Lehman Brothers were the most direct means by which retail investors were exposed to the collapse of the US investment bank 12 months ago. Regulators in many regions have demanded providers exercise greater caution in transactions with this client segment, or in some cases stop them altogether.


A global study recently published by law firm Allen & Overy on changes to market practice following the Lehman collapse shows that the environment for issuing structured products to the retail market has changed in 11 out of 18 countries. “Regulators have historically been somewhat divided as to whether retail investors should be given access to these products… the issue seems to be whether people are or are not stupid when it comes to investment,” says the report.


Of note is the divergence of response from regulators and providers. In Asia, the collective financial authorities’ decree that banks would have to buy near worthless Lehman Minibonds back from clients was not mirrored by the Monetary Authority of Singapore. Instead, MAS released a very prescriptive set of rules on structured products, including a ban on the phrase ‘capital protected’ (see news). Market participants are sceptical about the future success of the edicts, as financial engineering tends to swiftly either outwit or outpace rules-based regulation in ways that it cannot with principles-based supervision.


Equally lengthy pronouncements have been absent from the European marketplace so far, which has instead seen a discreet handful of provider-led buybacks and some more minor alterations. The US regulators have been silent throughout, a vacuum swiftly filled by lawyers now trying to claim compensation on behalf of investors. In the Middle East, the most extreme response has been the recent curt memo from the Central Bank of the United Arab Emirates, which forbids sales to retail clients without its individually granted exemption.


Whether obligatory or not, most product literature now carries a more patent disclosure of credit risk. “Most of these transactions have risk warnings as long as your arm… not unnaturally, these dire warnings have been intensified and made more prominent,” notes the report. Despite this obvious change, paradoxically most providers disagree that this means their previous literature did not highlight credit risk seriously enough.


Nonetheless, if literature did provide some warning about credit risk, no matter how perfunctory, judgments about whether mis-selling took place are now increasingly concerned with the advice given in each individual case. The UK Financial Services Authority has just allowed the Ombudsman to resume its investigations for specific complaints, for example. But unless specific records have been kept of the precise advice disclosed, the Ombudsman will find it difficult to prove which party is to be held accountable for the eventual losses.

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