Private banks must disclose all 'conflicted remuneration'
THE recent wave of defaults in high-risk unrated bonds in Singapore has raised fresh scrutiny on how the bonds were sold.
Based on analyses by Bloomberg, bond issuers have taken to offering rebates of up to one per cent to private banks to sell their bonds, a form of remuneration that was apparently not disclosed to clients. It is estimated that at least half of some S$875 million worth of bonds that have defaulted since November were sold to private clients, including issuers such as Swiber Holdings, PT Trikomsel Oki and Pacific Andes Resources Development. To be sure, in a "lower-for-longer" rate environment, bonds have been a relatively easy sell to clients hungry for yield. Unrated bonds, in particular, offer an attractive coupon well in excess of 5 per cent. This appetite has helped to drive bond issuance to new highs. In the past five years, the average annual issuance of Singapore dollar bonds rose to US$23.8 billion, compared with US$16 billion in the preceeding five years.
Banks earn a spread from the sale of fixed income securities, typically well under one per cent. The offer of a rebate, however, is likely to come on top of the spread and exacerbates conflicts of interest issues. These conflicts are further magnified should a bank's investment banking division also serve as the arranger and/or underwriter for the bond. There is currently no explicit requirement for distributors to disclose the "sales concessions" received, although the practice is said to be under review. Under the code of conduct for private banks, institutions are to broadly "manage any actual, perceived or potential conflict of interest, including appropriate disclosures to the client under certain circumstances, to minimise any potential adverse impact to the client". Banks are also to ensure that advisers have a "reasonable basis" to recommend a product. The code also already provides for disclosure on fees, charges and conflicts of interest.
It is well known that product incentives drive adviser behaviour. Thus, markets such as the UK and Australia have banned commissions or, as the Australian Securities and Investment Commission puts it, "conflicted remuneration", which includes upfront or trail commissions and volume-based bonuses. The ban has cemented the advisory fee model where clients pay financial advisers a fee for advice. This model, however, is rare in Singapore where clients are accustomed to "free" advice and advisers earn product commissions. The latter, however, raises the question of alignment of interests. Whose interests do advisers represent if their income is paid by product providers? The issue is further complicated by leverage. By offering leverage, banks earn on the liabilities side of the client's balance sheet, even if borrowing to fund a high-risk investment may not be in the client's best interests.
For banks that take pride in quality advice, there is no question. Disclosure of all forms of remuneration, particularly those that may potentially skew advice, is a must, even absent any change in the code of conduct or regulation. There are, of course, safeguards in place such as the "balanced scorecard" framework for advisers, which refers to the use of performance indicators unrelated to sales. But ultimately, the key is to empower clients to make informed investment decisions. This is only possible if all relevant information including hidden remuneration is made known to clients. While it may not be possible to eliminate all conflicts of interest, disclosure goes a long in levelling the playing field.
