FSS issues strong warning to brokerages of possible mis-selling of ELB, DLB

FSS [Photo by Lee Seung-hwan]

South Korea’s top financial regulator has issued a warning to securities companies as competition to sell their high-interest equity or derivative linked financial products is intensifying, raising risk of mis-selling of exotic financial products that could cause massive losses to investors.

According to sources on Monday, the Financial Supervisory Service (FSS) recently requested securities companies to explain their credit rating, liquidity, and solvency capacity to investors when selling derivative-linked bonds (DLB) and equity-linked bonds (ELB), which are corporate bonds restricted based on the credit of securities companies and are exposed to the financial risk of the issuer.

The latest warning came after the regulator warned investors last week of possible losses from investing in DLBs and ELBs that do not guarantee repayment of the principal and interest in a worst-case scenario, like a bankruptcy of the issuer.

DLBs are broadly the same as ELBs, but they differ in the underlying asset structure. Because of the product structure of these products, it is easy to think that the stability of the underlying assets is associated with the possibility of repayment, but there is no relationship between the two, and whether to repay principal and interest is purely determined by the issuer’s credit rating.

In other words, the payment capability for ELBs or DLBs is determined by the solvency of the issuer, and the underlying asset is only a condition for offering a higher interest rate.

However, as the guarantee of principal and interest has been highlighted in marketing campaigns, small securities companies increase the issuance of such products, using them as a major source of financing to make up for their insufficient funds.

There are concerns that such products could trigger volatility in the money market when something goes wrong due to oversupply. According to the Korea Securities Depository, the issuance of DLBs between October and November of this year came to 8.23 trillion won ($6.33 billion), a nearly 450 percent jump compared to the same period last year.