INSURANCE SECTOR & INVESTOR PROTECTION FUND

After addressing a seminar on risk management, arranged by the Emirates Insurance Association in Dubai a few days back, I was intrigued by a fairly extensive and absorbing Q&A session; much of which centred on how the insurance sector can work with the banking sector.

From a product development and de-risking perspective, clearly the banks appear reluctant to share the reward to the same extent that they would like to share / transfer the risks. This is the classic historical syndrome of wanting to have the cake and eating it too. However carrying the analogy further, what may be appropriate, is atleast that the icing on the cake is shared in such a way, so as to incentivize the insurance sector to come up with innovative solutions. All these become particularly relevant in the context of the new Basle Capital Accord; now slated to come into force with effect from 2006. Time is running out and the financial sector domain that includes banks, insurance companies and other financial institutions, ought to gear themselves up indeed, in terms of risk mitigation and distribution.

Much financial engineering has been achieved by the derivative specialists; many of whom are in the non-banking financial industry. For instance, the credit default swap, now a huge multi-billion phenomenon, has been able to transfer credit risks, while retaining relationships and much of the front-end fees!

Similarly, in a different context, the export credit agencies such as ECGD, Coface, Hermes and Exim have successfully provided political and commercial insurance or other guarantees. There was an interesting report last week that Dr. Mohammed Khalfan Bin Kharbash is leading a delegation, along with the UAE Central Bank Governor, to the U.S., to consider an appropriate investor protection foray; as part of an overall trade and investment talk / joint commercial framework.

Investor protection has always been a critical factor in cross border commercial activities, and insurance companies can play a vital role.  Similarly, investor protection, at a domestic level, is another area that the UAE and the GCC region can consider; with a view to strengthening the fledgling asset management and capital market activities. In some countries, upto US$ 100,000 investments are protected against fraudulent and other factors such as execution failures or mis-selling. In the U.S., the Securities Investor Protection Corporation (SIPC) was created by the Congress in 1970; with a view to compensating investors upto US$ 500,000, if the losses were suffered on account of the factors mentioned above and including breakdown of the dealer-broker settlement.  Interestingly, SIPC is designed as a non-profit organization and therefore, administers a fund accumulated from contributions made by its members.

In most parts of the world, there are depositor protection funds, which run on similar lines i.e. intended to compensate retail depositors upto a certain specified amount of their balances with banks. So, this is particularly useful, whenever there are banking bankruptcies.  Of course the jury is still out, as to whether such arrangements create hazards i.e. especially if the state governmental funds are used to set up such deposit investor protection facilities. However, if fiscal measures are not used to support and this was more an industry-contributed arrangement, then the question of moral hazards, that for instance, the IMF often faces, when it bails out sovereigns with governmental-contributed monies, does not arise.

One of the objectives behind the investor protection fund can be investor education. Using the corpus to highlight risks, enhance greater understanding of the markets and the methodologies of dealing with it, as well as valuation trends etc. can be beneficial. Another objective would be to build up sufficient comfort factors among retail investors; so that they voluntarily participate and assume risks with appropriate downside protection.

By default, we are now finding that guaranteed funds and investment schemes are popular, It is wrong to blame the investors for wanting to place a 'floor' to the losses that they can sustain. Similarly, while institutional or informed investors, especially of the high net worth variety, do not either deserve or seek such protection, the retail investors on the other hand, cannot be expected to do the necessary due-diligence or scrutiny of what are presented to them. Sometimes, some institutions irresponsibly dazzle or mis-sell or misinform; driven by competitive pressure.

It is in this context, that when the chips fall down, all in the insurance industry are affected by the general breakdown of investor appetite and the loss of credibility. The regulators should therefore, encourage industry participation to pool in and create such a corpus, and ensure that this is administered with a view to supporting best / sound market practices.

It was heartening to read that the Securities and Exchange Board of India (SEBI) in India has found an ingenuous way of creating such an Investor Protection and Education Fund (IPEF). They have used unclaimed dividends of mutual funds of about IRS 700 crores (AED 50 million) to structure a 'safety-net' for participation in the capital markets. The Fund is being designed to protect participants in the market from losses caused by the shortcomings on the part of market intermediaries. For instance, the Unit Trust of India (India's largest mutual fund company) is estimated to hold over IRS 500 crores of unpaid / unclaimed dividends.

Any such framework that facilitates easy access by investors to the market place and controls the offerings by credible players, are in itself an indication of regulatory efficiencies. Market regulators need to be made accountable and any laxity on their part or failure to build pillars of strength to support the market place, must reflect poorly on them.  They ought not be allowed to play God; given that the devil is often in the details, in terms of how the regulatory practices deepen and broaden the market place.

Some stock exchanges have also set up such investor protection funds to insulate the risks arising from default by its members. In the UAE, the secondary markets for stocks and bonds and the exchanges have now emerged out of the limbo that lasted until 9/11. Suddenly, overseas money is also being attracted; especially from Kuwait, through the likes of the placement of EMAAR shares.

Before there are steep rises and falls that dent customer confidence, it is necessary that the authorities proactively put in place, such risk mitigation mechanisms; with a view to sustaining confidence and feel-good factors. This is what will create liquidity and an equity and bond culture, but will underpin the economy in addition to a robust banking system.
 
The author is General Manager of Emirates Bank.  However, the views expressed in this article are not necessarily shared by the Bank.

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