Hong Kong’s securities watchdog last week issued a circular warning of the risks that fixed-income products carry, and their obligations to investors while marketing such products.
The Securities and Futures Commission (SFC) sent the circular to its licensed corporations and registered institutions, which includes brokers, fund managers and banks. While it does not unearth anything particularly earth-shattering, according to one fund manager, it serves a “timely reminder”.
“In the current low interest rate environment, investors strive to achieve higher yield,” said the SFC in the circular. “Within this context, it is noted that fixed-income products being marketed and sold to clients include high-yield corporate bonds (which are generally below investment grade or are unrated), bonds with special features and funds investing in high-yield bonds,” it added, noting that such products carry additional risks that investors should be aware of.
An SFC spokesman declined to comment beyond the content of the circular, and would not say if it was prompted by concerns over the rush of perpetual bonds seen this year.
However, bonds have gained popularity and both perpetual and unrated bonds have hit record levels. Year-to-date, the total amount of perpetual bonds issued out of Asia, excluding Japan, has hit $9.5 billion while unrated bond issuance has reached $37 billion, according to Dealogic. This is roughly double the amount issued during 2011.
Not so long ago, the Monetary Authority of Singapore also sounded a warning of its own — when it cautioned investors that perpetuals do not have a maturity date, unlike vanilla bonds, after the city-state saw a raft of perpetual bonds.
In Asia, private banks have been particularly active in buying bonds — on leveraged accounts — particularly unrated and perpetual bonds. Many private banking accounts have eschewed stocks in favour of bonds as they are perceived to be safer. But bonds carry their own risk, as the SFC points out. The circular highlights that high-yield bonds are subject to a higher risk of default and also singles out “bonds with special features” as warranting particular attention.
These include bonds that are perpetual in nature or have extendible maturity dates and contingent write-downs or loss-absorption features, which mean that the bonds may be written off fully or partially upon a trigger event.
The SFC also warned that some bonds may not have an active secondary market, which would make it difficult or impossible for investors to sell them before maturity.
While the SFC circular did not target any group, it mentioned towards the end of the three-page circular that where intermediaries “receive benefits, such as rebates, for selling the products, they should disclose such benefits to the client prior to, or at the point of, sale”.
Private banking rebates have been a topic of contention within the industry. Such rebates incentivise private bankers to sell bonds to their private banking clients and, on some occasions, are passed on to clients, who tend to take the profit by quickly flipping out of the bonds.
Rebates allow new issues to move faster, but fund managers have criticised them in the past for inflating demand for new issues.
“Personally, I think private banking rebates should be abolished,” said Bryan Collins, portfolio manager at Fidelity. “I think it is a lose-lose situation. All that a private banking rebate does is artificially create demand, which then allows the pricing of a security to be tightened, concentrates the investor base and, ultimately, all investors — whether you are a private bank or institutional investor — lose out.”
“PB rebates around corporate perpetuals are something investors need to be especially wary of because corporate perpetuals are complicated instruments and there is a lot of variance in the structures, which takes time to analyse,” he added.