China makes progress into the world of western finance

MALAYSIA - The decision by China Merchants Securities (CMS), one of mainland China's oldest and largest securities houses, to set up a subsidiary in Britain marks another step forward into the world of Western finance.

With a focus on derivatives, this is a follow-up to CMS obtaining clearing membership from the Chicago Mercantile Exchange under its global strategy, said the South China Morning Post (SCMP).

Underlining the expansion in its global business is the huge demand from the mainland to hedge the commodities price risks globally on major exchanges, said SCMP, quoting Stephen Chan, chairman of the British unit.

Further developments are expected as CMS responds to the boost in demand for hedging from mainland China.

Although derivatives has come under global risk scrutiny, the case with CMS, at the moment, looks more like catering to hedging than speculative risks.

Among US banks, the current buzz is the finalisation of the Volcker rule prohibiting proprietary trading that involves making big trading bets with the bank's money .

Looking back, the disadvantages seem to outweigh the advantages in proprietary trading although Bank of America chief executive Brian Moynihan said it cost his bank up to US$500mil of revenue per quarter to exit this trading activity, said Reuters.

Among some of the steepest losses, Morgan Stanley lost US$9bil in 2007 on a massive bet related to mortgage derivatives.

A year later, Merrill Lynch lost nearly US$16bil and Deutsche Bank lost nearly US$2bil in bets on risky securities, said Reuters.

Major banks have been heeding the call to ban proprietary trading.

In January 2011, Morgan Stanley said it would spin off its proprietary trading unit Process Driven Trading, which had 60 employees around the world.

Goldman Sachs said it had shut down two proprietary trading desks by February 2011. And Citigroup has closed a loss-making unit that had traded stocks, said Reuters.

Under the risk reward structure, it may be worthwhile to disband certain trading activities that pose large systemic risks.

Even if they want to go ahead with these risky trades, banks have to operate under certain conditions that stipulates how they are taking care of matters such as compensation and provision of historical demand for any equities that they buy.

A new wave of mis-selling of products has hit Lloyds Banks which faces a bill of at least £100mil to compensate up to 700,000 customers of Lloyds, Halifax and Bank of Scotland.

These customers had bought products in a bonus-induced selling frenzy by staff of the newly merged bank, said Reuters.

In many instances the customers did not need the products but Lloyds paid bonuses to its staff, who faced demotion if they failed to hit targets, regardless, said Reuters.

This kind of artificially induced compensation does not last forever and once uncovered, can have disastrous consequences.

The scale of the fine - a record for the Financial Conduct Authority for such conduct-related issues - could lead to bonuses for past and current directors being clawed back, said Reuters. The earlier scandal involved payment protection insurance which also resulted in claims of mis-selling and consequent fines.

Columnist Yap Leng Kuen advocates a more genuine incentive structure for selling of bank products.