Rogue traders in Hungary

The EUR 1 bn scandal: history and lessons

Young financial market 150th anniversary of Hungarian stock exchange (2014) 25 years of modern capital markets (re-opening in 1990) Low general financial literacy (OECD, 2011/2012) Higher theoretical financial knowledge lower skills in practice No family budgeting More than half of the 10 million population doesn’t have any

savings and only ~5% put their money in investment products

Strong retail investor base at BSE: 25-30% of the equities turnover 40% of the retail flow is done through internet channels They hold 6-8% of the Hungarian listed companies

Young financial market in a few number

8% 9% 9% 9% 7% 5% 4% 4%

52% 52% 53% 52% 49%52% 55% 54%

29% 22%18%

19%27%

32%33%

34%

11% 16%20%

21%

17%

11%8%

7%

0

5

10

15

20

25

30

2008 2009 2010 2011 2012 2013 2014 Q1 2015

Breakdown of domestic investment products held by Hungarian households (values at end of periods, EUR bn)

OtherGovernment bondsMutual fundsShares

Source: NBH

10% 12% 17%

90% 88% 83%

0

5

10

15

20

Q4 2014 Q1 2015 Q2 2015

EUR

bn

Risk appetite of investors (retail and others): proportion of shares in the mutual funds of domestic fund managers

OtherShares

Source: BAMOSZ

BSE’s equity market in numbers: Average daily turnover: EUR 31 m Market capitalization: EUR 15 bn Yearly turnover velocity: ~55%

The importance of the stock exchange

0%

10%

20%

30%

40%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Equities' market capitalisation in proportion of the yearly Hungarian GDP

Source: KSH, BSE

Hungary’s place in the world (2014)

Source: World Bank, ECB, OECD, WFE 2014

-

20 000

40 000

60 000

80 000

100 000

120 000

0% 50% 100% 150% 200% 250%

GDP

per c

apita

(USD

)

Market Cap / GDP

CH

LU

US

NOR

AUS

CAN

UK

NL

JPN

B

FR

ESP

IRLDE

AUT

IT

GRSLO

MEXPL

TUR

CZSK

RO

HU

Saving structures (Q1 2014)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Other

Life and pensions insurance

Mutual fund

Quoted Shares

Other securities

Cash and deposit

Source: ECB

Scandal chronology 24 February – suspension of the license of Buda-Cash and its management is

taken over by National Bank of Hungary (NBH, the market regulator) 4 March – NBH revokes the license of Buda-Cash and initiates its liquidation 6 March – BSE terminates the exchange membership of Buda-Cash and NBH

partially suspends the license of Hungária Értékpapír 10 March – NBH partially suspends the license of Quaestor Értékpapír 16 April – New proposals (draft bill) to enhance Investor Protection Fund (e.g.

increased amount of compensation to EUR 100,000) 17 April – NBH revokes the license and BSE terminates the membership of

Quaestor Értékpapír 20 April – NBH revokes the license and BSE terminates the exchange membership

of Hungária Értékpapír 1 June – deadline of extraordinary contribution (EUR 4 m) to BEVA (Investor

Protection Fund) by members 5 June – deadline for victims of Quaestor to submit application for extraordinary

compensation (QKKA special fund) 23 June – amended version of Investor Protection Fund approved by the Parliament

Summary of the 3 brokerage houses

50

36

8 8 10 1

0

20

40

60

EU

R m

Assets Equity Assets Equity Assets Equity

Ranks by turnover at BSE’s markets

Equity Equity futures Index futures

FX futures

8 16 - 14 8 1

9 4 4 - 8 -

EUR 300 m EUR 700 m EUR 10 m

Value of assets ”stolen”

Number of victims

32,000 15,000 5,000

How could it happen? Why now? NBH overtook duties of Hungarian Financial Supervisory

Authority in 2013 New methodology introduced by NBH: banking supervisory

practice implemented

Spillover effects of Swiss National Bank’s decision (January) Immediate cause Domino effect

Wrong business policies and illegal activities

3 different cases revealed

Buda-Cash •EUR 200 bn of collateral disappeared •False trade confirmations to the clients for 10-15 years •Buda-Cash cleverly moved all money and other assets to show match with the theoretically correct numbers •In practice no one knows exactly what happened and where the missing money is

Quaestor •Promise of high returns on its corporate bonds •Illegal bond issuances (EUR 500 m) •Quaestor group had a diversified business portfolio the management financed long term investments from short term sources •In addition: corporate bonds were refund guaranteed •No one knows where the money is (similar to BC)

Hungária •Mysterious fraud with a lot of open question •It was a little, independent brokerage house with smaller damage (max EUR 10 m) •The firm has signed short term loan contracts (max 1 year maturity) with the clients for the last 20 years: 15-20% (or more) returns promised Hungária paid its clients from the payments of the others

Case of Buda-Cash

CCP CSD NBH

Mr. Karácsony Shadow back office

Clients Back office

Collateral

DRB

What it looked like on the surface…

How it really worked – the dark truth

execution

(fake) confirmations

orders

confirmation

Trade info

Case of Quaestor

NBH

Clients

CSD

Authorised Bonds

Unauthorised Bonds

EUR 200m EUR 500m

Quaestor Hrurira Ltd. (own equity only EUR 33k)

Mandate to organize bond issuance (no guarantee from Quaestor!)

PERMISSION

OFFICIALLY REGISTERED

IPF Indemnification for both types

Moral hazard?

Nobody cares if it’s under a Quaestor named firm

What’s happening now? Amended version of Investor Protection Fund (23rd June) to

enhance investor protection and facilitate the ongoing compensation processes The amount of compensation is raised to EUR 100,000 (5x raise) The operational management will be supported by the National Deposit

Insurance Fund of Hungary Members pay initial contribution + annual contributions + penalties Members may finance these contributions by loan

NBH to launch a new online web service: securities account holders can check their current balances (cash & securities)

Continuous liquidation and assessment of properties/damages Indemnification of victims

Impacts expected Decreased levels of investors’ confidence However, BSE experienced an increased activity of retail investors

(increasing turnover during the 1st trimester, while market share of retail investors went up to 30% from 23%) Fear of independent brokerage houses: retail investors may shift to bank backed

brokerage services (no sign of this at the moment) Tightened investor protection rules may enhance investors’ confidence

The way of indemnification process and the raised level of Investor Protection Fund may trigger moral hazard problems

More frequent on-site supervisions will be led by the NBH Consolidation of the brokerage industry Or worse: domestic brokerage houses may relocate their headquarters to

foreign countries because of the overregulated Hungarian market the excessive need of bigger compliance staff additional payment obligations to the Investor Protection Fund