Top bank executives may face penalties for improper derivative sales

The Financial Supervisory Service is considering penalties for top financial executives over alleged misconduct related to the sale of Hong Kong-linked derivative products.

Investors in Hong Kong-linked derivative products hold a rally in front of the Financial Supervisory Service office in western Seoul on Dec. 15 ahead of their imminent maturity. [YONHAP]

The Financial Supervisory Service (FSS) is considering levying penalties on top executives at financial firms over alleged misconduct related to of the sale of Hong Kong-linked derivative products.

Korea’s financial watchdog suspects that there has been an organized effort among banks to encourage incomplete or improper sales of high-risk investment products, including the troubled equity-linked securities (ELS) tied to the Hang Seng China Enterprises Index (HSCEI), according to a source within the agency.

“We have discovered that ELS products were sold in large quantities during a specific time frame and at a certain branch,” a high-ranking official at FSS told JoongAng Ilbo, an affiliate of the Korea JoongAng Daily, suggesting that “it is proof that banks have been involved in a coordinated effort to drive up sales of ELS products.”

ELS are a debt instrument on which investors' returns are linked to the performance of an underlying equity.

The FSS uncovered instances of managers encouraging ELS sales through performance evaluations and failing to “keep” documents related to the deals during an inspection from November to December of last year. Following the investigation, the financial regulator initiated an on-site probe into banks and brokerage firms that sold the Hong Kong-linked ELS products. The first round of the probe was launched in January, followed by an additional round in February, which was completed on Friday.

The HSCEI plunged to half of its 2021 peak in the latter half of 2022 and has continued to hover at that level since. More than 10 trillion won ($7.58 billion) worth of products will mature in the first half of 2024.

As probe launched in February wrapped up on Friday, the FSS will come up with a compensation plan that may demand that banks and financial firms incur some of the losses incurred from Hong Kong-linked ELS products on Monday.

The upcoming announcement, however, will only address that compensation plan, with details on penalties to be determined later.

If the FSS holds banks accountable for the improper selling of ELS products — such sales made without proper explanation to investors — executives are likely to be subject to penalties, as current law mandates that financial firms establish an internal control system.

“While there are some cases where those who are responsible [for the sale of] ELS products are still holding executive positions at their firms and some that are not, penalties can be imposed regardless,” said the source from FSS.

“The problems with ELS products are not only about incomplete sales, but also about a lack of internal control systems evidenced by the violations of the Trust Act and the performance evaluation system [that encourages ELS sales],” said Lee Hyo-seop, head of the financial industry division at the Korea Capital Market Institute.

As the upcoming compensation plan will require banks' buy-in, the FSS may offer reduced penalties in return for their voluntary participation.

Meanwhile, banks denied the existence of an organized effort to engage in incomplete sales and added that the sales' improper or incomplete nature has yet to be determined.

“As external board members’ approvals are needed to proceed with voluntary compensation, the boards of directors are not likely to agree with that in order to avoid penalties on executives considering the risks of being accused of malpractices,” said a source from the financial industry.

BY KIM NAM-JUN, SHIN HA-NEE [shin.hanee@joongang.co.kr]