The Hong Kong branch of HSBC Private Bank (Suisse) has been fined a record sum of HK$400 million (US$51.2 million) after the Securities and Futures Appeals Tribunal upheld the regulator's disciplinary action against it for systemic failures in relation to the sale of derivative products.

The products in question were Lehman Brothers-related Notes (LB-Notes) and Leveraged Forward Accumulators (FAs) and the bank sold them to HNW investors in the run-up to the global financial crisis in 2008. The regulator has suspended HSBC Private Bank (Suisse) SA’s registration for Type 4 regulated activity (advising on securities) for a period of one year and partially suspended its registration for Type 1 regulated activity (dealing in securities) for the same period.

The tribunal said that the bank fell short of the standards set out in the Securities and Futures Commission's Code of Conduct and ancillary guidelines. The bank’s culpability was “extensive, putting many clients at unnecessary risk of loss and indeed resulting in substantial losses for many.”

Between January 2003 and December 2008, HSBC failed to understand each client’s true risk profile; ensure that every client had suitable products; and supervise/monitor sales processes in order to detect and avoid mismatches between risks. The tribunal implied that it was trying to make an example of HSBC by admitting that the fine was 'exemplary' and "provides a stern. warning.”

It added, in a rare regulatory admission of the way in which many banks think of regulatory fines, that "in future, penalties imposed for convenient avoidance of the requirements of the Code of Conduct will constitute something more severe than the mere ‘cost of doing business.'"

By the summer of 2008, HSBC was aware of decline at Lehman Brothers and was shying away from doing business with it.  Nevertheless, it continued to sell the LB-Notes to its clients until 3 September 2008, i.e. two weeks before the firm's catastrophic collapse, without telling the HNWs that Lehman had issued the notes or warning them about the increasing credit risk of those notes during the sales process. A total of 672 LB-Note transactions were outstanding as at 15 September 2008. More than 540 customers hold the outstanding notes; these involve a total nominal value of approximately HK$2.33 billion (US298 million).

In more than 80% of the outstanding LB-Notes transactions, there was a mismatch between each client’s risk tolerance level and the risk rating assigned by HSBC to the relevant notes, with clients who were categorised with 'low' or 'medium' risk appetites purchasing LB-Notes that HSBC was rating the riskiest. The bank did not keep adequate or proper records of justification for these mismatches.

Leveraged forward accumulators

In distributing FAs to clients between January 2003 and December 2008, HSBC Private Bank (according to the SFC) failed to implement adequate systems and controls to prevent clients from being overly exposed to FAs and to ensure that clients had enough financial resources to assume the risks of trading in FAs even though FAs were at the time assigned internally the highest risk rating.

The bank’s own in-house policy at the time dictated that no client should be advised to invest more than 10% of his portfolio held with the bank in any single structured product, or more than 5% of the portfolio if the investment was considered to be highly risky. The SFC’s investigation, however, found that this had gone by the board.