Picture this: a man walks up to you and tells you he'll mug you at gunpoint because he's in financial need. That would be awful, but disclosing his motive and planned course of action upfront makes it okay, right?
While the image may be a little strong, that's the question the Monetary Authority of Singapore -- and other market regulators around the world -- should be asking about private-banking rebates. The island's central bank told Bloomberg News on Thursday that there's room to clarify the practice of offering economic incentives to wealth managers for selling high-risk bonds to their clients. An industry group under its umbrella is reviewing disclosure requirements, the MAS said.
That shouldn't be the discussion. The practice itself should be abolished.
To see how this works, let's take a step back.
Sometimes, to help a company sell bonds, banks offer wealth managers a rebate that may vary from 0.1 percent to 1 percent of their total investment. It's unclear who pockets the cash, but it's seldom the client (and in some jurisdictions, it's actually unlawful to give it to the final investor).
In Singapore, the highest rebates were typically paid on the riskiest bonds, some of which have now defaulted. That means high-net-worth individuals often subscribed for the lion's share of these sales. If any other fund managers were willing to buy the notes as well, most of the time they weren't paid such a refund.
It's at that point regulators should start asking questions. Why should there be different treatment for various investor classes? It stands to reason fund managers should be offered a rebate too.
Then there's the issue of conflict of interests. Yes, financial markets are rife with them -- ratings agencies are paid by companies, auditors get their fees from the firms whose accounts they scrutinize, the list is long.
However, in both those examples, one way to reduce the problem has been to establish flat payments for credit scores or statement sign-offs. A private-banking rebate on the other hand acts as a sort of performance incentive. The more bonds a wealth manager places, the more money he or she pockets.
It's easy to trace a parallel with mortgage brokers in the U.S. before the subprime crisis. They used to get paid according to the size of the loan they originated, which became a reason to push people into buying homes they couldn't afford. And that incentive was disclosed, by the way.
Eventually, U.S. authorities realized it wasn't just about telling a borrower how you got paid, and curbed the practice altogether.
MAS has the chance here to lead regulators in Hong Kong, Europe and Latin America, where private-banking rebates are also rife. Instead of requiring disclosure, it should just stop the system, period.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story:
Christopher Langner in Singapore at firstname.lastname@example.org
To contact the editor responsible for this story:
Katrina Nicholas at email@example.com