Three years after the financial crisis and there are still lawsuits flying around the Middle East of allegations that wealth managers mis-sold complex products that lost their clients money. George Mitton reports.
It was not until the oil price collapsed that investors in the Middle East knew the financial crisis had hit. From an all-time high of $147 a barrel in July 2008, oil fell to $30 six months later. Gulf investors gritted their teeth.
At the same time, investors began receiving hedge fund statements revealing huge losses. To their anger, many people found they could not get their money back. “These things just shut down, you couldn’t get your money out, you couldn’t sell, you couldn’t do anything,” recalls one Middle Eastern investor.
Many in the region are still angry. Lawsuits are flying round accusing wealth managers of mis-selling complex products. Clients allege they were pressured into buying inappropriate products or misled about buyback facilities that dissolved in the crisis.
As client suspicion continues to be as high as ever, many say the wealth management industry must retreat to its old-fashioned values of trust and relationship building to restore its damaged reputation.
For some firms this could mean reversing recent behaviour.
“A number of the private bankers, particularly those linked to large investment banks, have clearly been used as product salesmen,” says Nigel Denison, head of wealth management at the Bank of London and The Middle East.
Many feel this impulse to sell new products came at the expense of providing care and attention that would have helped soften the blow when the crisis hit. And it is certainly not the right approach now, when investor appetite for innovative financial products has slumped.
Investors who might have been susceptible to buying exotic financial services in 2007 are now deeply suspicious of all but the simplest financial products. Instead of hedge funds, they want real estate, such as high-end property in London – solid assets that will hold their value.
“I’ve heard that lots of people are extremely unhappy that things that were sold as being liquid turned out not to be and the banks wouldn’t buy back the assets,” says Denison. “Private banking will have to shift away from being about product sales to being much more about relationships; what it used to be.”
It hardly helps matters that as the Middle Eastern wealth management industry is trying to build back investor confidence, political upheavals in the Arab world have, according to one wealth manager, triggered a new flight to safety. A trend to place more money offshore had already emerged after the crisis, but it seems to have accelerated, with many high-net-worth clients moving their money to bank accounts in Geneva, Switzerland, as an insurance policy in case the unrest in Egypt, Tunisia, Libya and Syria spreads.
A two-way process
Wealth managers could have done things a lot better. In the urge to compete and sell more products, some banks did not explain risks properly and gave clients bad advice, critics say. Commenting on the industy as a whole, Allard Lugard, Pictet’s head of private banking in the Middle East, says: “Clients were clearly overweight in risky assets. Some of them were highly leveraged. The whole structured products industry could have been better explained but also could have been more transparent. There were clearly clients with very concentrated portfolios and concentrated bets and the risk profile of clients could have been done better.”
The debate about the underlying risk attached to structured products is particularly heated. These products were popular in the Middle East and many clients feel they were misled about how safe they are, with wealth managers failing to explain that these products rely on derivatives. Another point is leverage; many clients believe they were not given enough explanation about the risks.
Lugard says that since the crisis, wealth managers have become much better at explaining these issues. “The whole use and explanation of derivatives and the underlying risk and leverage understanding has improved.” But he does not only blame wealth managers. Private banking is a two-way business. Wealth managers pushed their clients into risky positions because there was intense competition for business and clients wanted high returns. Indeed, Lugard says clients had unreasonable expectations of returns – many were demanding the high leverage that ultimately cost them dearly in the crisis.
So what is the solution? The general belief is that wealth management will only restore its reputation if managers work alongside their clients. Wealth managers must do a better job at explaining risk in their documentation and in the advice they give about derivatives and leverage. This is already happening, driven by regulation, compliance and internal controls. But they must also manage client expectations. Or, to put it another way, clients must be more realistic about the returns they want and the risks they are willing to take.
This may not be as hard as it seems. In the last two years, clients have adapted their perspective.
“Initially, there was anger, but as the dust settled people were a little bit more thoughtful about how they looked at it,” says one investor.
Many people say their disappointment lies with the investment instruments, the hedge funds and so on, not with the wealth managers. Some have learned the lesson that they should have been better protected.
Certainly, it is not true that the investors who closed their accounts are all angry with their private banks. Many were simply taking precautions at a time when the banks’ balance sheets were being questioned. In many cases, the reason people left Citibank and UBS, for instance, was because of credit risk, not because of their service.
Another reason for the numerous account closures in the past two years is that some wealthy people simply had too many private bank accounts. This is unwieldy and makes it difficult to manage an effective global asset allocation because there are too many providers. Some clients have consolidated their accounts for this reason.
Among the wealth managers, there are also some bullish voices and several who claim they kept their clients during the crisis.
“The investors lost trust in the markets due to the volatility and not in their wealth managers,” says Eddy Abramo, chief executive officer at Société Générale Private Banking Middle East. “The crisis had an impact on the split between liquidity or markets investments, not on the numbers of accounts closed. Our clients reduced their exposure to markets but they didn’t close their accounts.”
Another point is that not everyone in the Middle East put money offshore. Some investors brought money home to bolster corporate accounts or because it seemed safer to have the money close to hand during the crisis. Though there was a trend to favour international organisations with low credit risk, some local players benefited from this returning capital.
There is still plenty of money invested with Middle East wealth managers and although many clients continue to favour simple investments such as real estate, an increased focus on transparency may help restore appetite for more complex products. But wealth managers must not forget the importance of service and trust.
©2011 funds global