The fiduciary duty of financial intermediaries

inSight

28 Feb 2002

The fiduciary duty of financial intermediaries

The main purpose of financial intermediaries is to channel savings into investments. A stable and efficient financial system depends on their not engaging in behaviour that conflicts with this purpose.

In these Viewpoint articles I have, whenever discussing the role of the financial industry or of Hong Kong as an international financial centre, often (and deliberately) used the somewhat technical term - financial intermediation. This technical term refers to the process of channelling savings into investments, a process that is vital for promoting economic growth and development. I employ the term in the hope that its repeated use will serve as a frequent reminder to all concerned - the regulators and the regulated, the providers and the users of financial services - of this fundamental purpose of the financial industry. More specifically to the providers of financial services, or financial intermediaries, it is - allow me to be direct - a reminder of the main purpose of their existence.

Very often financial markets present financial intermediaries with opportunities for profit that involve business strategies that may be questionable, having regard to the fundamental purpose of the financial industry. It is not possible to be precise or comprehensive about the characteristics, and to attempt the categorisation, of such business strategies, so that financial intermediaries might refrain from purposely getting involved, although this would obviously provide useful guidance for the industry. As regulators we prefer to leave this to the financial intermediaries, who are closer to the markets and who understand better the intentions and effects of particular market plays. We believe that they are capable of realising that it is in their long-term interest not to be engaged in business strategies that have the effect of undermining the general stability and effective working of the channels of financial intermediation for which they have been licensed as service providers. Indeed, when licensing them, the regulatory authorities have taken the view that they were fit and proper, and it goes without saying that, this includes, crucially, being able to act in accordance with this important fiduciary duty as a licensee.

But every now and then it is appropriate for regulators to provide such reminders, and I hope financial intermediaries do not mind my doing so. One by-product of the advance of information technology and globalisation of financial markets is that opportunities to profit at the expense of the general stability and effective working of financial intermediation channels have increased. For example, the ability to conduct financial deals through cyberspace and book them offshore has resulted in a serious lack of market transparency, which is conducive to market manipulation, which undermines the integrity of the market. The creation of large and complex international financial institutions has also presented considerable challenges to the management of such institutions, so that the importance of observing the fiduciary duty of financial intermediaries may not have received the attention it deserves at the working level.

I am sure readers are aware of popular market gossip, often reported in the press, of big market players operating in the market to push (or in colloquial Chinese "frying") the prices of particular financial instruments higher or lower. As someone with some responsibility for safeguarding the general stability and effective working of financial markets, I feel sad hearing this. The market discovers price. The more efficient this is done, the more reliable is the price and the more effective is the financial market in performing the all important role of financial intermediation to promote economic growth and development. Market participants should be price takers. They buy or sell at the market price in the hope of making a profit when the price moves in their favour. They should not buy or sell with the purpose of pushing the price in a particular direction so as to make a profit. There is a subtle, but awfully important, difference between the two. The former enhances the role of the financial market in performing the important role of financial intermediation. The latter, being blatant market manipulation, undermines it, and in my opinion financial intermediaries would be failing in their fiduciary duty if they facilitated it.

Let us consider the fiduciary duty of licensed banks in Hong Kong as a further illustration - although I should stress that there is currently no cause for concern. We consider it the fiduciary duty of licensed banks to conduct their business in a manner that does not undermine the general stability and effective working of the banking system. We do not expect, just as an example, that under the Linked Exchange Rate system banks should facilitate speculative attacks on the Link, which has the effect of undermining banking stability. The banking system has been, and will continue to be, an indispensable channel of financial intermediation that is crucial to economic growth and development. The long-term well-being of the community depends on the banking system in performing this role effectively.

 

Joseph Yam

28 February 2002

 

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