Taiwan's Financial Regulator Moves to Rectify Structured-Note Market

Following the revelation late last month of the huge trading fraud at Societe Generale, France's second-largest bank, the Financial Supervisory Commission (FSC) has resolved to bring order to the local structured-note market, which has been flooded with disputes in the wake of its rapid expansion in recent years.

For instance, the Societe Generale fraud sent a shock wave through local buyers of structured notes issued by the bank in Taiwan, totaling NT$50 billion in value.

The FSC immediately urged local investors not to redeem their structured notes in panic lest they incur unnecessary losses, noting that the French bank's finances remain sound and that the risk of its defaulting on its structured notes is slim.

The Societe Generale case has brought into focus the enormous scale of Taiwan's own structured-note market, which developed in recent years as structured notes became one of the most favored investment vehicles for the island's people.

With local banks aggressively promoting structured notes, the outstanding amount of such products has reached several hundreds of billions of NT dollars. Wealth-management specialists at local banks have been enthusiastic about them, thanks to commissions that reach 3-5%--or, in some cases, even 7%.

Insurance firms, too, have sold huge amounts of investment-type insurance policies associated with structured notes.

The Trust Association of ROC reports that by fourth quarter of 2007, Taiwanese investors had purchased NT$908.9 billion worth of structured notes through designated money trust accounts.

In general, structured notes account for 20-30% of the wealth-management portfolios arranged by local banks for their clients, compared with 40-50% for mutual funds and 30% for insurance. In the U.S. and Europe, the corresponding share of structured notes is only around 10%.

Numerous complaints have come from clients, however, following the losses they suffered as a result of the slump in global financial markets that was triggered by the U.S. subprime mortgage crisis.

Clients charge that bank salespersons have exaggerated the benefits of structured notes (such as principal or interest protection) while downplaying the conditions attached to the promised benefits. One source of the ire is the complicated nature of many structured notes, which are associated with various financial products including stocks, exchange rates, interest rates, futures, derivatives, precious metals, and subprime mortgage loans. In many cases, even the salespersons do not fully understand the nature of the products they flog.

The FSC has instructed the Bankers Association of ROC to map out improvement measures by March. Those measures may restrict the sales targets for some structured notes, especially those of a highly complicated nature.