A view from the ground

Author: | Published: 1 Nov 2007
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Asia is an exciting and demanding region in all walks of life, and none more so than for financial institutions. Speak to an investment banker about prospects for growth of his or her particular business, and it is likely that Asia will be integral, and indeed will be the region where he or she sees the greatest potential.

The demand for all kinds of financial products has grown massively in the region in the last three to four years, and that has brought increasing sophistication across all industry participants – investors, product providers, distributors and service providers. Increasingly, Asia is dictating its own destiny, rather than looking across the globe to developments in the US and Europe.

However, this growth and sophistication brings its own risks and challenges, as shown by a number of responses in this poll of bankers' counsel. Never before has it been so crucial for all practitioners, whether in-house or in private practice, whether on the legal or the business side, to be on top of these challenges and adapt to the fast changing legal and regulatory landscape.

Increasingly innovative

So, what are the developments we have seen? It is beyond the scope of this article to look at each and every financial product, but it is impossible not to discuss the growth in the topical area of structured products.

Asian structured products are maturing rapidly, and we have started to see many products emerge in their own right (rather than simply replicating structures developed elsewhere). The market is opaque and can be difficult to analyse precisely, but examples of the deals Simmons & Simmons has advised on recently include India's debut CDO, which referenced 60 Indian foreign currency convertible bond issues across 18 industry sectors; the first long-short collateralised commodity obligation referencing 100 long and 100 short commodity-trigger swaps (where Asian investors bought a significant 30%), and a series of hybrid deals referencing a combination of assets, including commodities as well as credit. We have seen a shift away from mezzanine tranches of credit risk, and a focus on other parts of the capital structure, through structures such as CPDOs.

The key message from these deals is that they are originated and structured in Asia, and evolve at the same time as similar deals in Europe and the US – Asia is developing its own technology, with a distinct Asian focus (as shown by, for example, India's first CDO). Asian investors have a real appetite for the latest products.

Different countries, different risks

There is a danger, particularly from those who have not worked there, to treat Asia as one homogeneous region, and this could not be further from the truth. Asia is a multitude of different countries, each with its own legal and regulatory regime, each with its own culture, each in a different stage of the economic cycle, each with a different political system and a differing appetite for international financial products.

It is no surprise that China is at the forefront of everyone's minds, for a number of reasons. There has been a concerted regulatory effort in China to embrace international financial products, with an increasing level of coordination and strategic direction among the numerous regulators. This is seen in regulatory developments such as the QDII and QFII regimes (and, crucially, the relaxation of certain restrictions this year to encourage their use), the opening up of the derivatives market (underlined by, for example, the publication of an ISDA-friendly master agreement for Renminbi-foreign currency forwards and swaps in 2006, and a PBOC endorsed master agreement published in October this year), as well as developments in the securitisation market, as shown by the Pilot Measures (relating to the securitisation of credit assets) published in 2005, and the related China Construction Bank and China Development Bank securitisation projects in 2005 and the recent (September 2007) Shanghai Pudong Development Bank CLO, all issued within the framework of the Pilot Measures. China's new sovereign wealth fund further underlines this regulatory drive.

With growth comes risks

Mis-selling risk is highlighted in this poll, as well as the need for full and complete disclosure. Yes, products are more complex; yes, investors are more sophisticated. But do they really understand the risks associated with such products, and retail investors in particular? There is clearly a role here for legal practitioners, both in-house and private practice, to educate business and sales teams within banks as to the associated risks. These risks are more in the spotlight given the global credit crunch and the press coverage surrounding, for example, structured products.

A further risk highlighted by the poll is legal risk (and one can imply from this, a concern as to the lack of certainty as to the interpretation of laws, and how they will apply in the future). This is more of an issue than in the more mature European and US markets, and was demonstrated by the proposed measures on offshore derivative instruments issued by Indian regulator SEBI. They threaten, amongst other things, the significant offshore local access market for India and are a stark reminder of how the legal environment in emerging markets can change, almost overnight.

A global integrated market?

One of the key challenges, in our view, is for Asia to move forward in as an integrated way as possible with Europe and the US, rather than for differing market standards to evolve in different regions. Many of these products are truly global, originated by global institutions, and it can only be good that all markets move forward together. An example is the principles relating to retail structured products issued recently by five trade associations in Europe. It is initiatives like these that Asia must grasp. Similarly, legal practitioners must operate on a global basis as fully as possible, and the benefits of sharing legal technology throughout a global network are large, both for the lawyers and their clients.

Finally, a mention of the credit crunch. It is not for this article to give predictions, but it is fair to say that the acute pressures felt by the US and Europe are perhaps one step removed from Asia. However, one observation is the need for regulatory developments and industry initiatives (such as developments with regard to the role of rating agencies; efforts to improve transparency and valuation methodologies; and a focus on selling risks in the retail market) to involve the Asian market and all its participants, so that the market moves forward on a global basis, aspiring to a global market standard.