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HomeNewsWatchdog Says Bankers Misrepresented Risky China-Linked Notes to Korean Retirees

Watchdog Says Bankers Misrepresented Risky China-Linked Notes to Korean Retirees

(Bloomberg) — South Korea’s financial watchdog said a probe found that some of the country’s largest brokers misrepresented risky China-linked structured products to retail investors, and it is considering remedies including penalties and a ban on sales.

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Regulators plan to take action after reviewing compensation offers from the financial firms involved, the Financial Supervisory Service said on Monday. An investigation uncovered poor regulatory compliance and systematic failures regarding the sale of products linked to the Hang Seng China Enterprises Index, it said.

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“The misselling cases we announced today were not just a deviation by individual firms but were common among most banks that were investigated,” Lee Se-Hoon, senior first deputy governor at the FSS, said at a press conference. Losses are estimated to total 5.8 trillion won ($4.4 billion) this year at the index’s current levels, the watchdog said.

The potential losses will be the latest blow to the structured products market in Korea after the 2015 China stocks crash, the 2016 Brexit surprise, and the 2020 oil market slump. Authorities are trying to rectify practices used by financial firms when selling such equity-linked securities, which are particularly popular among middle-aged and elderly Koreans seeking extra income amid an insufficient pension system and rising living costs.

The investigation by the FSS looked at some of the nation’s most prominent retail lenders, including Kookmin Bank and Shinhan Bank, and brokerages such as Korea Investment & Securities Co. and Mirae Asset Securities Co. to see if they had violated any rules or misrepresented the high-risk equity-linked securities. 

While reactions from bank stocks were mostly muted, shares of brokerages dropped sharply after the probe results. Korea Investment Holdings, parent of Korea Investment & Securities, slumped 5.7% while NH Investment & Securities fell 2.3%. Mirae Asset Securities dropped 4.5%.

KB Financial Group Inc., the parent of Kookmin Bank, will have to spend roughly 700 billion won to compensate ELS investors based on the FSS guidelines and may see legal disputes with investors, according to an estimate by Seol Yongjin, an analyst at SK Securities. South Korea’s largest financial holding company posted a net profit of 4.6 trillion won in 2023. Its stock ended down 0.3%.

“The FSS’s compensation guidelines are stronger than expected,” Seol said, adding banks will have to compensate at least 30% of losses to the retail investors based on the guidelines. “If they are not allowed to sell high-risk products, their non-interest income will take a further blow.”

‘Self-Reflect’

Korea’s retail investors are known for their embrace of risky bets. Equity-linked securities promise bond-like coupons and early redemptions unless the underlying assets drop below a certain level.

In 2021, the China-linked ELS notes were sold with a three-year maturity, with about 22% of the accounts now held by people ages 65 or older. The HSCEI has since lost more than half its value on concerns about the growth outlook of Asia’s largest economy amid growing US-China tensions.

Of the outstanding balance worth 18.8 trillion won in HSCEI-linked notes as of December, about 1.2 trillion won was lost during the first two months of this year, clocking an accumulated capital loss rate of 54%, the FSS said.

Systematic breakdowns led to sales systems that prioritized firms’ profit-making at the expense of consumers’ interests, the watchdog said.

One bank relaxed internal risk management rules that would have mandated slower sales as volatility grew and hiked sales targets instead. One brokerage recommended the high-risk products to investors who said they wanted their principal protected. Another bank misrepresented the equity-linked products as having recorded no capital losses in the past 10 years, neglecting to disclose losses going back 20 years, the FSS said.

That was despite existing consumer protection rules shored up in 2021 following a series of scandals tied to complicated and risky financial products that preyed on retail investors. Those consumer protection tools did not operate well in this case, the FSS said.

“We, the financial firms, investors and financial authorities, should take this case as a chance to self-reflect,” FSS Governor Lee Bokyun said at a press conference.

Compensation

Banks are expected to draw up compensation for investors hurt by the products and reflect those losses in their first-quarter financial results, Choi Chunguk, an analyst at Hana Securities, said in a note Saturday. If the size of the compensation exceeds 1 trillion won, their stocks may see a short-term shock, Choi said. 

The FSS said it will oversee a conflict resolution process starting April.

Regulators intervened back in 2019 when retail investors stood to lose all their money in derivatives tied to German bond yields. This time, investors are likely to be compensated less given the differences in the products, the senior first deputy governor said.

The probe also checked into Hana Bank, NongHyup Bank, Standard Chartered Bank Korea, Samsung Securities Co., KB Securities Co., NH Investment & Securities Co. and Shinhan Securities Co. Earlier this year, some lenders halted sales of equity-linked securities on concerns about capital losses and regulatory crackdowns.

(Updates throughout)

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