Greed is the name of the game

‘ we brought nothing into the world, and we cannot take anything out of the world. But if we have food and clothing, with these we will be content.But those who desire to be rich fall into temptation, into a snare, into many senseless and harmful desires that plunge people into ruin and destruction.’ (1 Timothy 6:7-9)

The recent disclosure of huge trading loss by a giant US bank shows how prevalent it is amongst the financial institutions to resort to “all about risk-taking” to generate profits. New and complex trading instruments are ‘created’ for trading purposes, and their trading positions can be so huge (to make that razor-thin profit margin) that they can cause turmoil in the financial markets.

The ex-head of equity derivatives business of another US giant bank, revealed publicly why he decided to quit his job. The interest of the client is often sidelined as the firm thinks more about making money. The culture which centred on teamwork, integrity, humility has vanished. The view of doing what is right for the clients even it may mean less money for the firm is no more popular. As long as you make big money for the firm is all it matters, and that guarantees your promotion to an influential position and fat pay checks.

Here is how a financial firm do it and do it fast by rippling the clients: Persuade the client to invest in the stocks or other products that the firm is trying to get rid of. This would help the firm to get rid of risks that no one want by selling those risks to someone else who does not know enough to know they should not want them. Another practice is get your client to trade whatever it will bring the biggest profit to the firm regardless of whether the clients are sophisticated or not to understand these products. The emphasis is on ‘short-cuts’, not 'long- term' business relationships. The mammoth monetary rewards encourage such practices.

Complex financial products are gaining popularity in Asia. Examples of some of these are Reverse Convertibles, Super Track Notes, Accumulator and Principal Protection Notes. Whatever names they may give to these products, they are essentially structured products and carry high risks. Take for example, the Accumulator, which is a contract that obliges investors to purchase a security, currency or commodity at regular intervals at a fixed price. This obligation lasts throughout the term of the contract, normally one year. Perhaps the most attractive feature of this product is that the fixed price is set at a significant discount to the prevailing market price. The trick or 'poison pill' is that if the security price drops, investors remain contractually obliged to purchase the underlying security, even the prevailing market price is lower. The contract typically has a clause which terminates the contract if the stock reaches a certain level, which is usually set slightly higher than the initial price. So the gain is capped in that sense. However, the investors could be required to double down on purchases if shares dropped, hence, the losses piled up with each purchase.

Investors apparently have not learn a thing or two from the financial crisis in the past. In fact, seeking to accumulate wealth by buying structured products is an unwise move. No companies issue securities to help investors. They do it for a single purpose-to raise capital at the cheapest cost possible. So if a security carries a high yield or potential future return, inevitably it entails a high level of risk, even if one can't identify the risk. If you cannot fully understand the products, then walk away from them, don’t invest. By the way, the complexity of the product is intentional so that if you understand the product, it is likely that you won’t buy it.