Guideline on "Over-concentration"?

Yesterday SFC and HKMA announced that an agreement has been reached with Standard Chartered Bank (Hong Kong) Limited in relation to the bank's distribution of equity linked structured notes issued and guaranteed by Lehman Brothers (LB ELNs). Standard Chartered sold over HK$5 billion worth of LB ELNs between August 2006 and June 2008 of which HK$2.19 billion worth remains outstanding. The 2,515 outstanding LB ELNs are held by 2,234 individual customers.


Without admitting liability, Standard Chartered has agreed to make a repurchase offer to eligible customers holding an outstanding LB ELN distributed by Standard Chartered. The total value of the repurchase offer is estimated to be approximately HK$1.48 billion and will cover over 95% of the outstanding transactions in LB ELNs by Standard Chartered customers.


The repurchase offer is available to all retail customers holding outstanding LB ELNs who invested more than 5% of their Available Assets in not principal protected LB ELNs or 10% of their Available Assets in principal protected LB ELNs at the time of the purchase of the LB ELNs. The offer will exclude corporations (other than a corporation where the suitability assessment was based on an individual's circumstances rather than the corporation's, charities and not for profit organisations), professional investors, customers of the private banking division of Standard Chartered and those who did not purchase the LB ELNs from Standard Chartered.


Following an investigation by SFC and HKMA, both regulators were concerned that Standard Chartered may have exposed LB ELN customers to higher levels of risk than were suitable for them by not adequately considering concentration risk when assessing the suitability of LB ELNs for customers.


Under the repurchase scheme, Standard Chartered has agreed to make the repurchase offer at a price equal to the total value of each eligible customer's investment in outstanding not principal protected LB ELNs less 5% (or less 10% in the case of customers holding principal protected LB ELNs) of each customer's total assets held at or with Standard Chartered at the end of the month immediately preceding the date of the purchase of the outstanding LB ELNs or, the amount invested in LB ELNs (whichever is higher) (Available Assets).


The repurchase offer price will exclude the amount of coupons already paid to the customer but include an additional amount representing the interest that would have been earned if the amount invested in LB ELNs that is over 5% or 10% of the customer’s Available Assets (as the case may be) had been invested with Standard Chartered on a fixed term deposit instead of being invested in LB ELNs.


Under the repurchase scheme, Standard Chartered will also pay top-up payments to those customers with whom Standard Chartered has already entered into settlement agreements but would otherwise have been eligible to receive a repurchase offer to the extent that such payments are needed to ensure those customers are treated in the same way as other customers participating in the repurchase scheme.
In entering into this agreement under section 201 of the Securities and Futures Ordinance, SFC took into account that:

• the total value of the repurchase offers under the repurchase scheme that will be made available to eligible customers who invested in LB ELNs at levels in excess of 5% or 10% of their Available Assets;

• although LB ELNs were high risk products, they were less complex than Minibonds and likely to have been suitable products for most customers as part of a diversified portfolio;

• unlike Minibonds, there is no distributable collateral for the LB ELNs;

• as unsecured creditors there is little chance LB ELN holders will receive a substantial payment or dividend in the Lehman Brothers bankruptcy so the payments from Standard Chartered may be the only possible return for eligible customers.

• the repurchase offer will enable the vast majority of Standard Chartered's LB ELN customers to obtain a reasonable recovery without the costs and associated risks of separate litigation;

• the agreement will bring the LB ELN matter to an appropriate end for the benefit of Standard Chartered and its customers who participate in the repurchase scheme;

• a result on these terms could not have been achieved through disciplinary action by SFC against Standard Chartered and/or its officers and employees; and

• Standard Chartered has undertaken to engage an independent reviewer, to be approved by SFC and HKMA, to review its systems and processes relating to the sale of unlisted structured investment products, to report to SFC and the HKMA and will commit to the implementation of all recommendations of the independent reviewer.

In view of the repurchase scheme, SFC will not take disciplinary action against Standard Chartered and its current or former officers or employees in relation to the distribution of LB ELNs, save for any acts of dishonesty, fraud, deception or conduct that is criminal in nature. HKMA has also informed Standard Chartered that it does not intend to take any enforcement action against their executive officers and relevant individuals in connection with the sale of LB ELNs to customers who have accepted the repurchase offers or the top-up payments under the repurchase scheme, except for any acts of dishonesty, fraud, deception or conduct that is criminal in nature.



Jack's comment: This case highlights the importance of concentration risk in the suitability process, which seems to be a hindsight after the Lehman Minibond incident. This case implicitly delivers a regulatory message that "over-concentration" means above 5% (of Available Assets) for non-principal protected products and over 10% for principal-protected products. Are such percentages too restrictive? Also, the so-called "Available Assets" count only assets maintained by the customers with the bank, then over-concentration is almost inevitable. Seriously speaking, if SFC does not intend to take this case as a benchmark to define over-concentration, it should issue a guideline in this respect as soon as possible.