Monday, August 17, 2009

Private Bankers & Accumulators - Recipe For Disaster




If you have a private banker, and you have been sold on accumulators structured products, go and check your account thoroughly. Accumulators were all the rage in 2007 and 2008 as they generate good fees to the bank and private bankers. I have heard many cases of some CEOs in KL being victims of these structured products as well. Maybe its too embarrassing to bring this up in a court. Accumulators can be linked to shares or currency. This form of structured product has also caused Citic Pacific to potentially lose US$2 billion when the Australian dollar plunged against the US dollar recently. It has even been termed “I Kill You Later” in Hong Kong.

His lawyer, Kristi Swartz, who refuses to identify the investor or the bank, alleges US$20 million was invested in equity accumulators without her client being informed. An expatriate businessman is in a US$30 million (HK$234 million) battle with a foreign-owned bank in Hong Kong over losses from high-risk financial products.

The first he knew of it - along with the revelation that it had all gone horribly wrong - came six months ago when he received a legal notice demanding he pay US$10 million to the bank against losses on his investments. He is now trying to recover the US$20 million as well as avoiding being hit for the other US$10 million. Swartz, who claims to have won hefty settlements for other Hong Kong people burned in the financial meltdown, said the businessman opened the account with the bank some years ago to keep savings of US$20 million as an education fund for his two children, now aged 10 and 12.

His instruction to the bank when he opened the account, the lawyer claimed, was to make conservative investments. About five years ago, the man and his family moved to South America. But he kept the money in his Hong Kong account in the belief it would be properly managed by his bank and its financial adviser. He had enjoyed a "good relationship" with the financial adviser who he dealt with at the bank, Swartz said, so he allowed the bank to have discretionary access to his account.

According to Swartz, the financial adviser involved in the case was also an expatriate, but he left the bank and Hong Kong after the bubble burst. In turn, the businessman had been shocked to discover the financial adviser had used his money to subscribe to high-risk funds such as those invested in emerging markets, which tumbled dramatically amid the financial tsunami, Swartz said.

"When the financial adviser found he was losing his clients' money in one area, he tried to put more money in some other areas to see if he could get the money back - just like gambling," she claimed. "No one would expect the market would keep going down."

The lawyer said her client was now trying to have the bank hand over copies of all the documents he had signed so he could prove he was the victim of mis- selling or that the bank breached instructions. "Twenty million US dollars may not be his whole life's savings," she added, "but it is a substantial amount - possibly the hard cash he earned during his whole life. When he came to me, he said, `Now my kids don't have any guarantee."'

Swartz said she has been or continues to be involved in 10 similar actions, which involve local Chinese and expatriates who regard Hong Kong as their home. Amounts involved in each case run into tens of millions of dollars. "Even the most sophisticated businessmen can get taken in," Swartz said of her cases. Three have been settled, she added, with banks agreeing to repay between 20 percent and about 50 percent of losses. "The banks involved are usually those that are well known - banks we trust," she said. "Customers would expect such banks to monitor the sales of such products and, surely, to look after their bank accounts."

Swartz's latest case has been revealed just weeks after Chan Wai- yee, 77, who is represented by law firm Hastings, filed a writ with the High Court to sue Swiss-based investment bank UBS, alleging she had lost nearly HK$260 million on an equity accumulator package and other high-risk financial products she had not sanctioned. As of July 23 this year, her UBS account balance was only HK$1.6 million.

Chan alleged she did not understand the documents she signed because they were in English, and no one from UBS had informed her of the risks and nature of the investments.

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What is an Accumulator and how it works? The following illustrates how a typical Accumulator linked to shares work.

The key terms to know:

  1. Reference Share - The share that the investor is ‘accumulating’
  2. Strike Price - The price that the investor buys the Reference Share if the share price is lower than the Knockout Price
  3. Knockout Price - The share price that will trigger the the termination of the Accumulator contract. Usually just a few percentage points above the issue price
  4. Observation Period - The tenor or term of the contract

The figure below explains how the Accumulator works.

  • When the Reference Share price is higher than the Strike Price, the investor gets to buy the share (accumulate) at a lower price (the Strike Price) than the actual share price
  • When the Reference Share price is lower than the Strike Price, the investor buys at a higher price than the actual share price. The investor also has to buy 2X the number of shares as compared to when the share price is higher than Strike Price

In effect, the investor has Bought 1 Call option and Sold 2 Put option.

What is a call/put option?
A Call Option is the right, but not the obligation, to BUYa quantity of a financial instrument (eg stock, bond, commodity) at a specific price (Strike Price) within a specific time period.
A Put Option is the right, but not the obligation, to SELLa quantity of a financial instrument (eg stock, bond, commodity) at a specific price (Strike Price) within a specific time period.

What does buying or selling an Option mean?
Buying
an option simply means you Pay a premium in exchange for the right to buy (Call) or sell (Put) at the Strike Price.
Selling an option would mean you provide that right by COLLECTING a premium. You have to buy back (Put option) or sell (Call option) the instrument to the buyer.

How does all these work out?
In a Bull market, the investor is happy as he gets to buy the share at a lower price than what is in the market. However, the maximum benefit is limited by the Knockout Price. In a Sideway market, the investor is disadvantaged as he has to buy twice the amount of shares at a higher price than what is available in the market. Dollar Cost averaging does not work. In a Bear market, the investor is likely to make a substantial loss as he is forced to purchase twice the number of shares at above market rates at most if not all the time.

Who holds the risk?
The investor holds most of the risk. The benefit that the investor holds is limited by the Knockout Price. Once the Reference Share price hits or exceeds the Knockout Price, the contract will end, meaning that he will not be able to buy shares at below market price anymore. This also means that the maximum downside the bank (or another third party) is exposed to is limited by the Knockout Price. In fact, the banks could be doing a risk free business if they do not hold the Reference Share but is structuring the deal for a third party. By selling 2 times the number of Put options compared to buying Call options, the bank gets to collect the extra Put option premium. Even if the bank holds the Reference Shares, it can still be profitable to sell the shares at the Strike Price if the Strike Price has been set higher than the original share price that the bank paid for the Reference Share.


Some investors have leveraged their investments by borrowing from the bank. In such a case, they may lose more than the original principal during the current market. The bank can just collect the extra interest for the borrowing.


p/s photos: Huang Sheng Yi

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