"Already Halved... Is the Principal at Risk?" Hong Kong ELS Bomb About to Explode?

Full Survey of Banks Selling 'H Jisoo ELS'... In-depth Investigation into Incomplete Sales

As large-scale losses in derivatives products linked to the Hong Kong H-Share Index (Hang Seng China Enterprises Index) are imminent, financial authorities have launched an emergency fact-finding investigation.

Hong Kong Stock Exchange
Photo by Getty Images Bank

They plan to focus on whether banks and securities firms sufficiently explained the possibility of losses and the volatility of the H-Share Index when selling related products.

According to financial authorities and the financial sector on the 26th, the Financial Supervisory Service (FSS) began a near-comprehensive investigation on the 20th targeting banks and securities firms that have sold equity-linked securities (ELS) based on the Hong Kong H-Share Index as the underlying asset (performance benchmark) over recent years.

At KB Kookmin Bank, which has a large sales volume, an on-site inspection by the FSS Bank Inspection Division 1 is ongoing. This field investigation is scheduled to continue until the 1st of next month.

Written investigations have also been planned for major selling banks such as Hana, Shinhan, Woori, and NH Nonghyup. Among securities firms, 5 to 6 companies including the largest sellers Mirae Asset Securities and KB Securities are included in the investigation.

The reason financial authorities have launched a simultaneous investigation is that the possibility of losses for subscribers of H-Share Index-linked ELS becoming a reality from next year is increasing.

The H-Share Index, composed of blue-chip Chinese state-owned enterprises listed on the Hong Kong Stock Exchange, reached 10,000 to 12,000 points in early 2021 but has since plummeted to 6,000, only 40 to 50% of its previous level. Given the current Chinese economic situation, a clear rebound is difficult to guarantee.

If losses are confirmed one after another starting next year, the issue of 'incomplete sales' is expected to become a key point.

Although ELS are high-risk products whose structure is difficult even for experts to understand and principal is not guaranteed, many investors perceive them simply as deposit products that can expect 'market interest rate + α.' Since sales have reached several trillion won, there are concerns that complaints and disputes claiming 'the risk of principal loss was not properly disclosed' will surge.

Financial authorities are also gathering related data and circumstances with the possibility of incomplete sales in mind from the investigation stage. While the banking sector is flustered by the large-scale ELS losses caused by the unexpected sharp drop in the H-Share Index, they emphasize that unlike past fund scandals, this is unrelated to illegal acts such as incomplete sales.

Due to repeated incomplete sales incidents involving financial products in the past, regulations to protect investors have become stringent. They argue that the possibility of incomplete sales is almost nonexistent.

KB Kookmin Bank currently records the sales process when selling ELS in accordance with relevant regulations. In particular, for elderly investors, even the investment propensity analysis process must be recorded.

Understanding of the risk grade of the subscribed product and the possibility of principal loss is also confirmed by obtaining handwritten or recorded consent from customers. Most customers subscribe to ELS through digital forms, reducing the possibility of missed confirmations, and banks provide a 7-day cooling-off period after confirming the final subscription intention.

The bank headquarters calls all ELS subscribers to recheck their subscription intention and whether the sales staff provided explanations. However, even within the banking sector, the prevailing view is that it will be difficult to completely avoid controversy over incomplete sales related to H-Share Index ELS.

In the securities industry, about 80% of ELS sales channels are 'non-face-to-face channels,' which is a variable. Securities firms claim that since incomplete sales mainly occur during explanations by branch staff, ELS sales conducted mostly through non-face-to-face channels are exempt from this issue. However, there remains room for debate on whether it is too easy to subscribe to high-risk products.