South Korea Probes Mis-selling of Hong Kong-Linked ELS

South Korean authorities have commenced a formal investigation into allegations of incorrect selling practices for equity-linked securities (ELS) based on the Hang Seng China Enterprises Index, predicting significant losses for investors starting from this month.

Financial Regulators Begin On-Site Investigations

Starting Monday, the Financial Supervisory Service (FSS) is rolling out on-site checks on 12 financial institutions. These firms are under suspicion of having breached regulations in their sale of ELS products that track the performance of the Hong Kong index.

An ELS is a complex financial derivative that produces returns based on the equity performance it is linked to. However, if a linked stock's price falls below a certain threshold, investors can face a total loss of their principal.

The Decline of the HSCEI

Although usually considered stable, the HSCEI saw a dramatic fall from its peak of 12,000 points in February 2021, plunging over 50% to under 5,000 by October 2022, with recent fluctuations around 5,600 points.

Initial Findings and Upcoming Examinations

A preliminary scrutiny between November and December uncovered several serious infractions, including lax internal controls during the sale of ELS in early 2021, undervaluing the volatility caused by China's economic woes and US geopolitical tensions.

Some banks were found to promote the aggressive sale of these risky products, tying ELS sales to employee performance evaluations. There were also instances of lost critical contract documentation.

The FSS plans to delve into the management systems of the financial firms and has scheduled further reviews of other major banks and brokerages throughout January.

Impact on Investors

Data from the FSS indicates that as of November, about 19.3 trillion won ($14.66 billion) worth of Korea's ELS products tied to the Hong Kong index were outstanding. More than half of this amount is due to mature in the first half of the year, with an additional 5.2 trillion won maturing later.

Retail investors make up the majority of the investment, with seniors over 65 holding 5.4 trillion won.

The financial watchdog has vowed to impose harsh penalties for any illicit actions, especially given past incidents where banks failed to protect client investments, such as in 2019's overseas interest rate-linked derivatives scandal.

New Task Force

A new task force formed in December is spearheading efforts to investigate and address the ELS misselling. A top FSS official has emphasized the urgency of the inspection due to anticipated continuing financial damages and the importance of establishing compensation guidelines promptly after resolving the misselling issues.

investigation, ELS, mis-selling