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South Korea’s financial authorities have widened their investigation into banks and brokerages over the possible mis-selling of so-called exotic notes linked to Chinese stocks, following complaints from retail investors fearing heavy losses from the high-risk securities.
The Financial Supervisory Service said on Monday that it would probe 12 financial institutions this month to see if there were any illegal activities related to the sale of securities linked to a benchmark for Hong Kong-listed Chinese stocks.
“Investors basically invest at their own risk, but the financial firms will have to take responsibility for their acts if they neglected their duty of protecting customers,” said FSS governor Lee Bok-hyun.
Exotic notes that promise higher yields and are often linked to risky assets such as derivatives have long been popular among South Korean retail investors, despite frequent meltdowns in these products.
The FSS cautioned that massive investor losses could materialise as Won15.4tn ($11.7bn) worth of the equity-linked securities, or nearly 80 per cent of outstanding ELSs, are set to mature this year.
ELSs are fixed-income derivatives that promise bond-like coupons and early redemptions based on the performance of the underlying assets, but investors could suffer heavy losses if the underlying stock index falls below a certain level.
The Hang Seng China Enterprises index, a relatively stable gauge in the past, has been hit by a slow economic recovery from the effects of the Covid-19 pandemic and geopolitical tensions between Beijing and Washington. It has more than halved to about 5,450 points since peaking above 12,000 in February 2021.
The investigation will start with KB Kookmin Bank and Korea Investment & Securities, the biggest sellers of the high-risk notes, and then be extended to four other banks and six brokerages.
Following a two-month preliminary probe, the FSS said it had found some serious breaches of rules in the ELS selling process, such as a lack of internal controls and mishandling of key documents related to the securities contracts. It added that some banks encouraged staff to sell more ELS products despite the growing risks, in order to boost their non-interest income.
The FSS said it would punish institutions for any illegal activities as part of its efforts to strengthen regulatory oversight and investor protection following similar problems in 2019, when the agency ordered banks and brokerages to return up to 80 per cent of investors’ losses from high-risk derivatives linked to interest rates of foreign countries.
Regulators suspect the banks and brokerages did not properly explain the investment risks of the ELS products that were mostly sold in 2021, when interest rates were low. There are about 400,000 accounts for the products tied to the Hong Kong index. More than 90 per cent of the notes are held by retail investors, with nearly a third of the holders being over the age of 65.
