The KTM got involved in a discussion with Mr Tan Kin Lian on the question of the regulation of financial institutions w.r.t. "questionable" financial products at TOC. This entry is a short summary of the crux of the exchange. The KTM is hoping to continue the discussion on the regulation of financial products with Mr Tan here. :-PMr Tan said in the article that “(MAS presumably) should disallow financial and insurance products that have excessive charges and offer unfair terms to consumers”, which seems to imply that MAS should start playing the role of HSA for financial products. Would such regulation be prudent and how should it be done?The KTM disagreed with this statement because he is of opinion that if the Govt tried to regulate, it’s probably going to screw it up - because MAS won’t be able to do it right. However, the KTM could most certainly be wrong if there’s indeed some way of regulating the industry, which is why Mr Tan's views on “how” the regulation should be done were sought.The following question was posed to Mr Tan:Imagine. Just imagine that the Government agrees with you that we should regulate more and you are appointed the Director at MAS in charge of the regulation. In addition, you have a small army of analysts at your disposal to help you with your work. My question: what is your directive to your army of analysts w.r.t. what should be considered “questionable” products?Obviously there are many factors, e.g. liquidity, maturity, etc. etc., but at the end of the day, it’s all about the tradeoff between rate of return versus risk. So what are you going to do? Are you going to say that only products with a minimal “effective” (nett of fees) rate of returns of say 5% can be sold? How would you even begin to quantify the risks and are you going to make decisions on behalf of the people w.r.t. their risk appetites?Since you were from the insurance line, so perhaps we can do a simple case study for insurance products that typically have two components - guaranteed and non-guaranteed. What sorts of conditions would you impose on them? People surely haven’t forgotten the recent episode where AIA zeroed the bonuses (because investments didn’t do so well)? When insurance companies sell their products they always have this dunno what projected returns. If they cannot meet how? Should MAS keep track and fine them?? If MAS passes such a law, the KTM is sure you know the reaction of the insurance companies. As we know, NTUC Income is a major player in the financial sector in Singapore and since NTUC is a co-operative, which means that it is supposedly owned “by the people for the people”, how is it possible that NTUC will come up with “questionable” products, which seems to be what you are insinuating as you sweep the financial landscape with your broad strokes?Now suppose the KTM has misunderstood, and NTUC Income is flush with lots and lots of “good products”, then isn’t the solution simple? Government can just tell the people, “Let’s buy NTUC. NTUC will take care of all your retirement needs!”. In any case, if NTUC Income is “doing the right thing”, wouldn’t it already be exerting competitive pressures on the other financial institutions to fall in line?Mr Tan said that he would like the regulator to require the product issuers to answer a few key questions:what are the charges levied on the consumerwhat benefits is being provided by the product issuerwhat is the best estimate cost of the benefitsThe KTM was frankly quite surprised at this 'cos he thought that there were already rules on disclosure. Mr Tan also cited an very interesting example of a product meant to skim consumers:A structured product is being introduced to give a capital guarantee at the end of 5 years. If the yield on government bonds is 4% per annum, the product can earn 20% from this investment. If the charges taken away for the marketing, issue expenses and the profit to the issuer is 15%, the product is likely to return 5% for 5 years or 1% per year. To hide this miserable yield, the issuer invest the remaining 5% in an option. Many of these options expire without value. The investor is likely to get back the original principal - nothing more.The KTM then responded as follows:Your cited example is interesting - but it is still not clear that regulation (in the sense of banning such products) is necessarily the only way. You seem to have described a problem of misrepresentation. My question on your 5%-gamble-on-option product is the following: how does/can a financial institution get away with it?Even a naive investor will ask the question: how much can he expect to get after 5 years, above and beyond the capital guarantee? Surely the bank rep must cough up a number and the expected returns must be more than you regular bank savings rates for him to invest in the structured product. Are you suggesting that there a problem in that number? In your example, the bank rep should have said 1% p.a. right? If not, then shouldn’t MAS simply take action against misrepresentation?Frankly, the KTM has no issues with MAS requiring financial institutions to make full (or what’s deemed “sufficient” ;) disclosure of financial products (but he thought this has already been done what no?). Where the KTM disagrees quite strongly with you is the statement that “(MAS should) disallow financial and insurance products that have excessive charges and offer unfair terms to consumers”, because the terms “excessive” and “unfair” are highly contentious (and he was basically seeking to understand where in your opinion is that threshold separating “reasonable” from “excessive” and separating “fair” and “unfair”).If there’s is no misrepresentation and it’s a case of willing buyer/willing seller, why should we stop people from buying/selling? You seem to be implying that your invest-5%-on-option instrument is bad. Perhaps you are right, but there is this organization called Singapore Pools and they sell this thing called 4-D. Is buying 4-D necessarily better or worse than investing 5% on options?Now the question about NTUC Income was not random (and neither was it a personal attack - merely an unfortunate coincidence that Mr Tan was former CEO of NTUC Income). The point very simply is the following: NTUC Income is a subsidiary of the NTUC, a national co-operative under the control of the Government. And hor, co-operatives aren’t usually supposed to be making tons of money since they are supposedly “by the people for the people”.The answer to “questionable” financial products thus seems pretty obvious (or perhaps not): if NTUC Income is doing its job and coming up with quality products, it should be hard for other financial institutions to sell their “questionable” products. All NTUC Income has to do is to take up ad’s side-by-side with these “questionable” products with accurate information and let these products sell themselves. Of course, this might not eliminate “questionable” products completely, but it should make these products relatively unpopular if the uptake isn’t high enough. So ends the KTM’s logic. :-)This argument could however be flawed since the KTM is not sufficiently familiar with the financial landscape to see where the underlying assumptions might fail. Addendum:Mr Tan replies:The product issuer tells the financially naive investors that their money is invested in certain combination of shares or bonds that will give certain yield under certain circumstances in the future.The ordinary folks have no way of calculating the probability of the “happy events” occuring. As a financial expert, I will not be able to calculate this probability as well, but I guess that the chance is very, very small.What happened? Most of these “happy events” did not occur. The investor is likely to get his principal back. In some cases, they lose part of their principal - as they were not aware about the risks.I understand that some of the structured products are invested in CDOs. They have not matured yet. Let us see if the investors can get back their principal.As the so-called MAS director of regulation (if I ever get appointed), I will never allow this type of “rip-off” to happen. It will not be possible for the product issuer to answer my (b) and (c) questions, so the product will never get approved by me.Why did the government regulate gambling? It is to ensure that the consumers are not “rip off”. They should be given a fair game of chance, and may pay some loading to cover expenses.Sadly, this kind of protection does not occur, when financial products are concerned and reputable, trusted banks are involved.And the KTM responds:Wah, isn’t it somewhat extreme to issue disclosure requirements that are not satisfiable?While the KTM still doesn’t understand completely what you mean by (b) and (c), he does not believe that your requirements are impossible to satisfy. It is just not plausible for MAS do something like that. In fact, let’s imagine that you are the MAS Director and KTM is CEO of the imaginary KT Income, and you issue this new directive. This is what the KTM will do:KT Income will kwai kwai follow your instructions and submit the data to you as required. Whatever PhDs you have, the KTM will also similarly employ to spit out the numbers you ask for. Throw in the partial differential equations, Black-Scholes, kitchen sink and all. Somehow, there will be these magic numbers all backed up nicely with data and charts. :-PThat’s not it. The KT Income will not be submitting just one product for approval, but a whole range of products (10?) ranging from almost riskless bond-like products to the high-risk products. Why? The KTM is merely probing your system. You cannot possibly be blocking the bond-like products. The question will be: where is your threshold and how do you actually do the regulation?If your threshold is too low, the KTM will complain to the Finance Minister that you are killing the financial sector and Singapore can kiss it’s pipe dream of becoming a financial services hub goodbye. :-P And it’s not just a complaint letter. The complaint will be a big stack of documents demonstrating to the Minister in no uncertain terms that MAS has disallowed a product that is comparable to products available in other major financial centres like New York or London - and you can go figure how to explain to Minister. The KTM’s numbers will be correct (’cos they will be generated by this army of PhDs in the back room). :-)Ding-dong enough and something will eventually get through ‘cos KT Income has the resources to play this little game with the MAS bureaucrats. And what happens after that? Two things:(i) What is submitted to MAS for approval and what is printed in the marketing brochures are not exactly the same. There no lies of course! By why the omissions? “Aiyah, not our fault. We did try to print (b) and (c) in our earlier versions, but we found out that the customers couldn’t understand and didn’t find it useful. We want to help the customers understand and so we only print useful information in the product description.” Actually hor, you want us to print also never mind, since like you say, nobody understands anyhow.(ii) There will always be risks - and if the product tanks, whose fault? Well, MAS has already checked and approved, so KT Income cannot accept responsibility. MAS’s approval means that we had already done our due diligence. Any losses arising are an act of God (or MAS’s failure in its checks. Complacency?)!Be aware that an approval process will have the unintended side effect of implicit endorsement. There is no reason why MAS would in its right mind want to accept responsibility for the downside of a financial product. It might not be MAS’s fault, but will the people understand? :-) Damned if you do; damned if you don’t.Frankly, the KTM does not disagree with the spirit of your proposal. Surely, protecting the people cannot be wrong. He just doesn’t believe that there is a practical implementation of what you’re proposing. Addendum 2:The KTM was thinking through this problem and he suddenly realized that there's probably an easier way to regulate financial products. This is perhaps what MAS can do: inform all financial institutions that it is not adverse to making a public announcement if customers complain and it discovers that a product is "questionable" - and don't define "questionable". :-)Frankly, then MAS doesn't have to do much and life goes on. After a while, some fellas will think that MAS is sleeping? Good for them and they try something funny - and someone gets conned essentially and complains to MAS. MAS verifies the complaint and makes a big story of this case, call in the press, have reporters do sob stories on how some poor folks have lost their life savings, yada yada. Stock price of the offending institution takes drastic beating and everyone falls in line thereafter because they know that MAS means business? Sounds plausible? :-)