The Last Look…

Last week’s column prompted a decent mailbag, which collectively made the point that we all know there is a recurring problem with TARFs, but raised the question, ‘what can be done to make things better?’

In terms of the symptoms, most of those providing feedback were agreed – in a world of shrinking spreads in the mainstream products, salespeople were getting ever-more desperate to hit revenue targets, and this was making them cut corners in deciding client-suitability.  I am not sure I agree totally with this, after all, I doubt FX salespeople are actually talking to retail clients – some of whom are reported to be caught up in this mess – but accept they are to the corporates involved.

It’s not clear, beyond banks doing the unthinkable and actually holding or reducing targets for salespeople (who will naturally, still expect increased comp), how this will change. A couple of people thought a good idea would be to actually limit the product’s availability to qualifying clients, but my argument here is define ‘qualifying’. Just look at the number of retail brokers who like to claim they are ‘institutional’, even as they push the more retail of retail products, CFDs.

I am also not sure how, or rather who, should establish the criteria. One suggestion was the Global FX Committee, but while this is focused on conduct and fair markets, individual product specifications are not, and should not be, within the GFXC’s remit.

A majority of correspondents arguing for a restriction observed that this would protect clients from themselves – they are seen as products that provide instant gratification, while pushing potential problems down the road for another day, and this is leading some to ‘overdose’ on them, as one put it.

Another argument for restrictions many of you made was that retail investors are definitely being mis-sold these products, mainly because, unless the salesperson highlights them, most retail punters would not even be aware of TARFs. This, as I noted last week, is a trickier area for banks to navigate, but again, one has to question if it actually a problem in the FX business itself, more likely it is something for the private bank/wealth management unit to deal with – and I am not sure they have a best practice document.

One thing that does seem to have been settled, in my mind at least, is that the disclosure/disclaimer in the UBS case was up-to-date and suitable. Someone who would know assured me this was the case, although I should stress I have not actually confirmed this with my own eyes. If this is indeed the case, then the issue comes down to a question of leverage.

I was taken with the response of a couple of correspondents, who pointed out that while risky, there are circumstances where a TARF can provide funding, but only as part of a larger hedge. They argued the ‘premium’ received would cover a chunk of the expenditure on more normal options hedging the bulk of the exposure.

Assuming the time horizon was sensible – after all, these clients are selling vol, and why do that in the current environment for any length of time? – then it really is a question of leverage. If a client is hedging a large proportion (one person noted that in the past TARFs have been used to over-hedge an exposure, which is madness), then one has to ask the question, what was the advice from the bank? If the bank was complicit in over-hedging, then it has absolutely mis-sold the product, these correspondents argued (and I am inclined to agree), and should face sanctions and pay compensation.

Again though, one has to check the correspondence with the client. If the latter demanded the right to buy more TARFs, what is the salesperson to do? They can check suitability and argue the client doesn’t qualify to do that, but it would take a lot in any environment to make that happen.

Perhaps it is here that the banks can help by introducing rewards for salespeople who actually protect clients from themselves? This would mean looking at criteria other than hard data, which is the opposite direction to that most banks want to travel, so can you see it happening? I can’t.

As always, in the latest case to hit the newswires, we need more information, but given how many correspondents were quick to observe that many more incidents occur that do not reach the light of day, we should be, perhaps, considering some high-level guidance on this. My first, and biggest question, is why an investor would be sold a product where they sell vol? This seems, to me, to be anathema to the concept of investing, which is about building a portfolio and assuring one’s future, rather than taking reckless risk.

I suspect that what we are witnessing is the latest instance of one division using products created by the FX desk, but taking on few of the suitability checks that an FX business would, or should, conduct

Perhaps then, we could start with a blanket statement from the world’s major authorities that TARFs and the like are not suitable for retail investors and at no time should be offered to them. That way, any banker has a ‘get out of jail free’ card and will not be tempted to sell them. I understand that not all jurisdictions will fall into line on this, but if, for example, the investor is buying these products from a firm regulated in an area few of us have heard of, then frankly they deserve all they get.

Where TARFs can have a role to play is in the hedging world, but even there, good practice should be to make sure they are hedging only a proportion of the exposure. That way, if it goes wrong the client will suffer a little, but will not be wiped out. Equally, if they then want to complain about being sold the product, the bank can argue, with just cause, that they explained the risks and ensured the client wasn’t over-exposed. It fulfilled its basic duty of care.

A final issue would be how, or if, we connect the dots between the end-client (in wealth management or private bank), with the core FX business that has created the products? I suspect that what we are witnessing is the latest instance of one division using products created by the FX desk, but taking on few of the suitability checks that an FX business would, or should, conduct.

Overall, it is a complex matter, and one that puts the reputation of the FX market on the line – rightly or wrongly if the products were not sold by the FX desks. It needs to be solved in some fashion, however, because this type of thing is happening too often. I remain of the view that caveat emptor should play a major role here, but accept that in some circumstances we need to look at how the products were sold. If a corporate is over-hedged, or a retail punter involved, point fingers at the bank. If those two criteria are not met, then I am afraid we need to look in the direction of the client.

Either way, this is a mess than needs clearing up.

colin@thefullfx.com