HUNGARY: Investors' nightmare continues

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Hungary's financial markets have rebounded from Russia's August 1998 Financial meltdown but for many local investors the nightmare will continue until 2006. Last month the Investor Protection Fund started to compensate the clients of bankrupt London Bróker, whose activities had been suspended almost a year ago. But since the Protection Fund does not have the money to pay the Ft2.4 billion ($8.9 million) in losses to thousands of small investors, it must spread the payments over the next five to six years.

While London Bróker is one of the biggest securities firms to go out of business, it probably will not be the last. "I think there are still a few more bad peppers in the pot," says Péter Farkas, head of the Protection Fund. The trouble is, if another broker goes under, hapless clients will not begin to see their money until after 2006. Sixteen brokerage houses have gone bankrupt in Hungary since the Asian and Russian crisis ripped through the country's financial sector and demolished people's confidence in the industry. The tempests came just when local investors were starting to view securities Firms as a legitimate outlet for their savings.

"Then the Russian crisis came and we travelled back in time," says György Jaksity, managing director of Concorde Securities in Budapest.

The bankrupt brokers are small by international standards, with losses of around Ft500 million each. But established players such as CA IB, Concorde and Raiffeisen Securities have had to deal with the consequences. They have laboured to improve investor Confidence in Hungary, where multinational brokers compete with street-side operations that sometimes lack modern trading systems and experience. Some of these brokers offered stock-based funds that promised unrealistic fixed yields. After the Asian and Russian crises deflated their capital, they were unable to keep their heads above water and finally the authorities shut them down.

Established broker Firms say they have to pay for the damage done by the collapsed Firms twice over. During the past three years they have been required to pay Ft8 million annually into the Protection Fund, well above the usual Ft2 million, to cover the losses of their peers. In addition, they have to spend more money to convince investors that what happened to London Bróker won't happen to them.

Confidence among small investors is especially important as brokerages need to move more deeply into the retail market to boost revenues. "We need to invest much more in acquiring new clients," says Jaksity.

The problems lie with the rules governing the brokerage sector, industry executives say.

First, since the state guarantees individual investments up to Ft1 million, and most Hungarians don't invest more than that, people have an incentive to look for the cheapest services, knowing they will get their money back if anything goes wrong. Second, the laws don't require brokers to raise sufficient capital, and they don't put enough onus on management to handle client funds wisely.

Changes are on the way. The finance ministry is drafting a new law for the financial sector that is expected to go into force by early next year. Laws were strengthened once already in 1997 before the Asian Financial crisis. Now the regulators themselves believe that further changes are required.

István Molnár, senior adviser to the president of the Hungarian Financial Supervisory Authority, which regulates the broker sector, says that the minimum start-up capital requirement needs to be raised to Ft50 million from the current Ft20 million. He defends his organization's handling of the brokerage sector, claiming that other European countries have a 100-year financial tradition compared with Hungary's 10 years.

Some analysts expect the government to raise the maximum investment guaranteed by law from the current Ft1 million to Ft3 million in order to conform with EU norms. This would put a further squeeze on the Protection Fund, and would necessitate raising the amount of annual contributions made by brokers to the Fund.

Some believe that more sweeping reforms are needed. Now any broker on the market automatically is covered by the Protection Fund. Some argue the Fund should evaluate new brokerages in the same way an insurance company evaluates whether to take on a new customer. Those brokerages that are taking on too much risk should not be allowed to join the Fund, and clients should decide at their own risk whether to invest their money. "Then clients could make up their mind whether they want a cheaper service or less risk," says Jaksity.

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HUNGARY: Investors' nightmare continues

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