[Hong Kong ELS Compensation] What Are the Differences from Past Standards? ...Conflicting Evaluations

Considering Factors by Seller and Investor Combined... Compensation Ratio "0~100%"
Final Compensation Ratio for DLF Incident is '20~80%'... More Detailed and Strict
Experts Say "Helpful for Dispute Resolution, But Compensation for Experienced Investors is 'Socialization of Loss'"
Subscribers and Political Circles Criticize "Insufficient Reflection of Incomplete Sales"

Lee Bok-hyun, Governor of the Financial Supervisory Service, is announcing the dispute mediation guidelines related to the large-scale losses of Hong Kong H Index-linked ELS at the Financial Supervisory Service in Yeouido, Seoul on the 11th. Photo by Kang Jin-hyung aymsdream@

The dispute mediation standards for Hong Kong H Index (Hang Seng China Enterprises Index·HSCEI) equity-linked securities (ELS) released by the Financial Supervisory Service (FSS) have become more detailed and stringent than those applied during past derivative-linked fund (DLF) compensations, by comprehensively considering both 'seller-specific factors' and 'investor-specific factors.'

Experts expect that the FSS's new compensation standards, which include adjustment factors such as sales channels, investment experience, and investment amount, will effectively influence the dispute mediation process. However, they also expressed concerns that the FSS’s proactive and excessive segmentation of adjustment items might instead increase the potential for disputes between sellers and investors. Evaluations from the political sphere, investors, and the financial sector were somewhat divided.

The compensation standards for Hong Kong ELS announced by the FSS on the 11th were designed differently from those applied during the Lime, Optimus, and other incidents, including the DLF, which was sold privately with a total value of 795 billion KRW in 2018-2019. The standards took into account that Hong Kong ELS is a relatively standardized and popular product compared to the highly complex structure of DLF. Hong Kong ELS has been continuously sold since February 2003, with a total sales volume of 18.8 trillion KRW as of the end of December last year. It was sold through public offerings, and investors tended to be older with a high reinvestment ratio.

Accordingly, unlike the DLF incident where the final compensation ratio was determined within a 20-80% range, the FSS removed the upper and lower limits for Hong Kong ELS by reflecting adjustment factors even when a basic compensation ratio is set. Theoretically, this means the final compensation rate can be calculated within a 0-100% range. This implies that even subscribers through banks might receive no compensation.

The compensation ratio for internal control failures by sellers has also decreased compared to the DLF incident. During the DLF incident, the maximum compensation ratio for internal control failures was 25%, but in the current standards, it has been reduced to a maximum of 10%. The FSS explained that compared to the DLF incident, the Financial Consumer Protection Act has been implemented, strengthening sales regulations, which has been substantially reflected in the new standards. Lee Se-hoon, Senior Deputy Governor of the FSS, stated, "We believe that formal legal obligations such as basic explanation duties and recording obligations were largely complied with during the actual sales process," adding, "It is difficult to see internal control failures as severe as in the DLF incident, so a relatively lower standard was applied."

Since the compensation standards have become stricter than before, the average compensation ratio is also likely to decrease. While the compensation ratio during the DLF incident mainly ranged between 40-80%, the FSS analyzed that the Hong Kong ELS compensation ratio is likely to mainly range between 20-60%.

On the 30th, a petition from the Hong Kong Index ELS Victims' Group to be sent to members of the National Assembly was placed at the National Assembly Communication Office. Photo by Hyunmin Kim kimhyun81@

Mixed Expert Evaluations: "Helpful in Dispute Mediation Process... Difficult to Accept Compensation for Experienced Investors"

Experts generally evaluated that the new dispute mediation standards would help frontline financial institutions resolve disputes but viewed the trend of strengthening financial product design and sales regulations after this incident as undesirable.

Kang Sung-jin, Professor of Economics at Korea University, said, "Compared to the past DLF incident, there is evidence of thoughtful consideration," adding, "Basically, investors also bear responsibility, so 100% compensation is difficult." However, regarding improvements in financial product sales systems, Professor Kang said, "Since Korea already has strong financial regulations, if the direction is further regulatory strengthening, it is not desirable," and added, "If improvements are too stringent, the development of the financial industry itself could be hindered, so sellers should voluntarily restrict sales to elderly people, etc."

An economics professor at a university who wished to remain anonymous said, "It is regrettable that the measures came late after sales of 18 trillion KRW had already occurred," explaining, "Since the product has a large proportion of public offerings, the more detailed standards presented than before are expected to help the dispute mediation process between financial companies and investors."

Concerns were also raised about whether the FSS can properly fulfill its role as a 'mediator' given that it preemptively set arithmetic adjustment criteria for qualitative items. Seo Ji-yong, Professor of Economics at Sangmyung University, said, "While there is evidence that the FSS struggled to prepare guidelines, it is regrettable that they excessively clarified items such as deduction factors without clear grounds like the number of ELS subscriptions," and criticized, "With strong opinions from banks and customers, it is questionable whether the FSS can properly perform its role as a mediator."

There were also criticisms that compensating investors with investment experience socializes losses. Kim Sang-bong, Professor of Economics at Hansung University, said, "For corporations or investors with investment experience who subscribed to ELS, it is unlikely they were unaware of the possibility of principal loss, yet compensating them is tantamount to privatizing profits and socializing losses," adding, "It is appropriate to prohibit banks from selling such derivative products in the future."

Subscribers and Political Sphere: "Insufficient Consideration of Mis-selling"... Financial Sector: "Significant Time Expected Until Final Compensation After Legal Review"

Subscribers and the political sphere still maintain the position that 'mis-selling' was not adequately considered. Banks positively evaluated the authorities for paying attention to detailed aspects but anticipated that it would take time until the final compensation plan is released due to legal reviews.

A victim, Mr. A, who subscribed to a 600 million KRW product in January 2021, said, "Isn't it wrong to compensate depending on the degree of fraud?" He added, "I believe principal compensation is necessary, followed by compensation for (mental) damages."

Some subscribers expressed incomprehension about the criteria for judging investment experience and product understanding. Mr. B, who subscribed 34 times since 2015 with the depositor insurance payout limit of 50 million KRW each time, argued, "I thought it was a deposit or savings, so I was more cautious and paid attention to the depositor insurance limit, but reducing the compensation ratio because of many subscriptions is nonsense." According to the adjustment criteria presented by the FSS, subscribing to ELS 34 times results in a 5 percentage point deduction in the compensation ratio, based on the judgment that experienced investors were sufficiently aware of potential investment losses.

Mr. B also added, "There were past delayed repayments, but I was only told 'It's okay, just wait,'" and "Since it was a 3-year maturity anyway, I thought it was no big deal and let it pass." Having delayed repayment experience is evaluated as a higher understanding of ELS products, resulting in an additional 5 percentage point reduction in the compensation ratio.

In the political sphere, which has continuously paid attention to the Hong Kong ELS incident, voices have emerged calling for full compensation if mis-selling is recognized, especially for elderly subscribers. A staff member from a lawmaker's office who wished to remain anonymous said, "For victims such as subscribers aged 65 or older or dementia patients where mis-selling is clearly recognized, 100% compensation should be provided," adding, "This incident appears to have more definite mis-selling than the DLF loss incident, so if the compensation plan is not better than that time, victims will find it difficult to agree."

The banking sector, as the party involved, is taking a cautious stance. While positively evaluating the possibility of detailed adjustments unlike the past DLF dispute mediation plan, they judged that swift mediation would be difficult because the number of subscription accounts reaches 396,000, including 84,000 accounts of elderly individual investors. A banking sector official said, "During the DLF incident, the minimum and maximum values were set uniformly and adjusted autonomously accordingly," and evaluated, "This ELS dispute mediation standard allows very detailed adjustments and case-by-case approaches considering both sellers and customers, which is favorable."

However, despite the announcement of the mediation plan, they stated that legal review is necessary, so it will take some time to finalize compensation. Another banking sector official said, "Looking at the mediation plan announced today, there are so many diverse cases per subscriber that additional legal review will be needed for each case."