HK-tied ELS sellers could face full compensation for investor losses

The Financial Supervisory Service (FSS) on Monday laid out a compensation plan for sellers of the Hong Kong-tied ELS, which has caused 1.2 trillion won ($910.5 million) in losses in the first two months of this year.

Financial Supervisory Service Gov. Lee Bok-hyun speaks during a press conference on a compensation guideline for Hong Kong-tied equity-linked securities losses on Monday at the agency's headquarters in western Seoul. [YONHAP]

Sellers of the troubled Hong Kong-tied equity-linked securities (ELS) may have to compensate up to 100 percent of individual traders’ losses depending on how well they informed customers of the risks of the financial products upon sale.

The Financial Supervisory Service (FSS) on Monday laid out a compensation plan for sellers of the Hong Kong-tied ELS, which has caused 1.2 trillion won ($910.5 million) in losses in the first two months of this year.

The financial watchdog conducted an on-site inspection of the sellers, which includes 11 banks and brokerage firms, from Jan. 8 to Friday.

“Through the latest inspection, we have found multiple occasions in which the basic principles [of the Financial Consumer Protection Act] have been violated,” said FSS Gov. Lee Bok-hyun during a press conference held in western Seoul, on Monday.

“In particular, some ELS sellers failed to properly manage sales limits on the products when the risks were growing high, and incentivized incomplete sales through performance evaluation measures,” Lee said. The Hong Kong-tied ELS is linked to the movement of the Hang Seng China Enterprises Index (HSCEI), of which the value has collapsed to half of its 2021 peak. Of the 2.2 trillion won-worth of securities matured as of the end of February, 1.2 trillion won has been lost, with a cumulative loss rate of 53.5 percent. The FSS estimates an additional loss of 4.6 trillion won this year if the index remains largely unchanged from the current level.

While the FSS expects the compensation ratio to generally range from 20 to 60 percent, the actual amount varies based on a number of criteria in individual cases, and therefore up to 100 percent or none of the losses may be covered. Given the guideline on the compensation ratio provided by the FSS, however, the maximum figure is forecast to stand around 70 to 80 percent. “We cannot rule out the possibility of an investor, or a seller, being found entirely responsible [for the investment decision], and that is why we suggested that the compensation ratio may range from none to 100 percent, but there is no actual confirmed case for now,” said FSS Senior Deputy Governor Lee Se-hoon during the conference.

The sellers may come up with compensation based on the latest plan provided by the FSS on a voluntary basis. The timing of compensation execution depends on the progress of negotiations between the involved parties.

Assessment criteria set by the FSS include an adequate explanation to the investors, the existence of an internal control system at the selling institutions and the characteristics of the traders, like their previous experience in ELS investment. The basic compensation ratio stands between 20 to 40 percent based on whether there have been incomplete or improper sales, and an additional 3 to 10 percentage points may be added for a deficient internal control system. The ratio may also vary based on whether the seller is a bank or a brokerage firm, and whether the sale was conducted in-person or online.

Moreover, up to 45 percent points may be added or subtracted based on the characteristics of the investors, such as any previous experience in trading ELS products and their age group, as well as whether there were procedural issues.

The FSS said it will swiftly proceed with the dispute settlement starting in April, and encourage the sellers to voluntarily issue compensation for the losses incurred. Specific details, such as the compensation ratio for each investor or the total amount, are yet to be determined, as Monday’s announcement “serves as a starting point of a dispute settlement,” said the regulator.

Potential penalties for the sellers are to be decided later as well. The FSS concluded after its investigation that there has been a company-wide organized effort within each seller to incentivize aggressive marketing of high-risk derivative products despite mounting risks for losses. The financial regulator said that it “expects the social and economic costs caused by possible legal disputes to be minimized with the sellers’ voluntary participation to compensation.”

KB Kookmin, Hana and NongHyup banks suspended the sales of all types of ELS following the mounting losses from the ELS linked to HSCEI.

BY SHIN HA-NEE, JIN MIN-JI [shin.hanee@joongang.co.kr]