[News Terms] Hong Kong ELS Controversy over Article 17 of the Financial Services Act, the 'Suitability Principle'

Regarding the scale of losses in equity-linked securities (ELS) linked to the Hong Kong H Index (Hang Seng China Enterprises Index), which is swelling like a snowball, the 'suitability principle' is emerging as a key issue in determining the compensation scale by banks.

On the 30th of last month, a petition from the Hong Kong Index ELS victims' group, intended for members of the National Assembly, was placed at the National Assembly Communication Office. Photo by Hyunmin Kim kimhyun81@

The suitability principle is an investor protection measure that obligates financial investment companies to recommend investments suitable to the investor's characteristics identified through the Know Your Customer Rule (KYCR) or prohibits unsuitable investment recommendations. It is stipulated in Article 17 of the Financial Consumer Protection Act.

According to this provision, financial product sellers such as banks must first identify whether the counterparty is a general financial consumer or a professional financial consumer when concluding or advising on investment product contracts. After this process, if they sell guaranteed products and investment products such as variable insurance, as prescribed by Presidential Decree, or financial products with variable returns depending on operational performance to general financial consumers, they must confirm the consumer's investment propensity through interviews and questions.

At this time, the general financial consumer's financial situation, as well as age, experience in acquiring or disposing of investment products, loan status, and repayment plans, must also be identified to judge investment suitability. The provision also states that if, after such information verification, the product is deemed unsuitable for the consumer, it must not be recommended. For example, recommending a stock-type fund investing in venture companies or derivative financial products to retirees aiming to manage retirement funds stably for old age is likely to violate the suitability principle as it is not appropriate for their investment purpose.

The financial authorities view the suitability principle as a core issue in determining whether the Hong Kong ELS was sold incompletely because 30.5% of subscribers are elderly aged 65 or older. Since most subscribers are retirees, the authorities judge that it is difficult to consider that the suitability principle was observed if the sales did not match the acquisition purpose or financial situation of general financial consumers.

Meanwhile, according to the financial sector on the 13th, among the H Index-based ELS products sold by the five major banks, a total of 973.3 billion KRW worth matured from the beginning of this year until the 7th. Of this, the amount customers received back (repayment amount) was 451.2 billion KRW, resulting in an average loss rate of 53.6%. As the maturity of Hong Kong ELS totaling 15.4 trillion KRW this year and 10.2 trillion KRW in the first half approaches, if the H Index maintains its current trend, the total loss amount could swell to around 7 trillion KRW.