The Hong Kong Society of Financial Analysts (HKSFA) is the local chapter of the Association of Investment Management and Research (AIMR), and industry body for financial analysts all over the world. The industry Chan represents is under scrutiny as never before. He reveals the measures that the HKSFA and AIMR would like to happen to clean up the industry.
There has been a lot of noise recently about cheerleading research from investment banks in the US. Have the same things been going on in Asia?
Chan: In Asia we have the same problems. But for professional investors, they know that the research they get is not always objective, because interested parties influence the analysts. But professional investors always look at the research they get as reference material. Professional investors know they have a fiduciary duty to do their own research.
Is there less noise about tainted research in Asia because it is less available to retail investors here than it is in the US?
That might be the case. Professional investors do their own research and they have buy side analysts. They use the sell side report or talk to the sell side analyst for information, reference and ideas, rather than just believing whatever the recommendation is.
If investment banking and research are under one roof, will the research always be tainted?
Not necessarily, as long as all parties have a clear understanding of the role of analysts. When I was a research analyst in Canada for Prudential Bache, our head of research was very good, always defending us against whatever pressure might come to us from the corporate finance department. If analysts can be shielded from undue pressure from the corporate finance department, then having the two under one roof is not a problem. In fact, back in Canada, from time to time we worked with the corporate finance department because we analysts knew the industry better than the individual corporate financiers. Working together is not a bad thing, as long as analysts understand where the conflicts might come from and know when to hold their position.
AIMR, of which the HKSFA is the Hong Kong member society, recommends that analysts should be paid purely on the quality of their research, not from any investment banking revenues. Who should judge the quality of the research and wont that mean that analysts will have to be paid a lot less than they are now?
For the research people to be judged on their performance, you have to look at good recommendations. But this is not the only way. You should also look at the arguments, the depth and the thinking behind the research. But yes this is a very difficult thing to measure.
Basing pay on stock recommendations would seem very difficult as it means that analysts would become little more than traders.
That's true. And while it is one way to measure an analyst's performance, it is not the only way and it is not the best way to do it. You must look at their overall presentation and the arguments they use.
There are other steps that the AIMR has suggested that banks and brokerages adopt to improve the situation - for instance clearly stating conflicts of interest and having distinct reporting structures. Are these anything more than window dressing, failing to tackle the real failings of the systems?
It will improve the situation because a lot of companies are aware of the potential conflicts but do not enforce the proper procedures entirely. This is a matter of enforcement rather than of just knowing where the conflict is. If they adopt these standards, then they will be bound to enforce them and this should really improve the situation.
So you don't think the model needs changing? Or inversely do analysts still play a useful role?
Analysts still have a very important role to play. There is so much going on in the market every day. There's so much information out there, even for professional investors. It would be very difficult for investors to do their jobs if they have to start from scratch without any analysts. When analysts perform properly they perform an invaluable service.
Do you think there will be any increase in regulation of analysts in Asia?
There's a trend of more people asking for more regulation, and more guidelines for the profession. As you will have heard from Andrew Sheng of the SFC, Hong Kong has not really decided what to do, until they can see what will happen in the US or Europe. But I believe we should leave it up to the professional bodies like ours to handle this. AIMR has come up with standards, which they will require all CFA holders to adhere to. That should be sufficient as AIMR has real power over its CFA holders. If they do not comply with AIMR rules and fail to meet professional standards, AIMR can pull the CFA or make a public reprimand of an individual analyst.
So if an analyst does produce some tainted research, or changes a recommendation to win an investment banking mandate, they could have their CFA pulled?
Yes. Its like a lawyer having their license removed or being disbarred.
Is this enough to police the market?
I don't think it is quite enough to police the entire market because not every analyst is a CFA charter holder. If all analysts are CFA charter holders, monitoring can easily be done as anyone can report a research report with a hidden agenda to AIMR and they will investigate and start a hearing procedure when required. Enforcement and monitoring this will not be a problem. But it might not be enough for the whole market as not everyone is a CFA charter holder. If the government requires all analysts to get some form of professional qualification, then that professional body can look after this issue.
Do analysts get more pressure not to issue sell reports from investors or from companies?
To a greater extent it's the corporations that don't like sell reports. Investors sometimes need sell reports because they need to know when a share price is overvalued, or when the company is having some problems. But companies put the most pressure. When an analyst calls a company stock a sell, the company takes it very personally. They think analysts are telling the public that this is a bad company. But the analyst might only be saying that the share price is overpriced because there are too many buyers.
One of the AIMR proposals is to ban companies from punishing analysts for negative research. How can that possibly be enforced?
Good question. If Regulation Fair Disclosure is properly enforced then it is very difficult for companies to bar analysts and for companies to stop the flow of information. But now most companies are shying away from giving analysts more information because they might be accused of not being fair to the rest. So companies will only now tell analysts what they say in press conferences.
Is that happening in Hong Kong as well and the rest of Asia?
Yes, Hong Kong is being affected. We hear from a lot of analysts that when they ask companies for information they get a "no comment" in reply. Most companies are giving what is in stock exchange announcements or the press releases.
So in this era of greater transparency and disclosure, the rules that are designed to enforce it are actually reducing it?
Yes it is ironic. Regulation FD is something that is very difficult to handle.
How do you see the research industry evolving from this inflection point?
Analysts these days are under a lot of pressure. They have to be more professional and more ethical. There are so many scandals coming out all over the world and not just in the US. The market is heading towards a more regulated environment, which is kind of unfortunate. All parties û not just analysts û have to bear some responsibility for this. Analysts have to be strong enough in their position to withstand the pressure to make a wrong recommendation.
Are you seeing a drop off in numbers of people involved in the research business? Is it becoming a less desirable profession?
I don't think it's the case. If you look at the CFA examinations and enrolment figures, last year we had 6,000 candidates in Hong Kong. This year we have 7,000. It is still growing despite the scandals and economic difficulties. Without analysts doing their jobs it will be very difficult for professional investors to do their jobs.
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