[Q&A] "Compensation Ratio Possible from 0 to 100%... Most Cases Are 20 to 60%"

Sehun Lee, Senior Deputy Governor of the Financial Supervisory Service (FSS), said on the 11th regarding the compensation ratio for losses related to Hong Kong H Index (Hang Seng China Enterprises Index·HSCEI)-based equity-linked securities (ELS), "since the unilateral responsibility of the parties or sellers cannot be excluded, the compensation ratio could range from 0 to 100%."

Senior Deputy Governor Lee attended a press briefing held at the FSS headquarters in Yeouido, Seoul, in the morning and stated, "In most cases, the compensation ratio is expected to be distributed within the range of 20 to 60%."

Lee Bok-hyun, Governor of the Financial Supervisory Service, is attending a meeting of research institute heads held on the 28th at the Kensington Hotel in Yeouido, Yeongdeungpo-gu, Seoul. Photo by Jo Yong-jun jun21@

He said, "Compared to the overseas interest rate-linked derivative-linked fund (DLF) incident, ELS is a public offering product, so related regulations have been largely observed. Also, since it is a structured product well known to investors, it is difficult to apply incomplete sales liability as much as in the DLF case," adding, "Therefore, it is unlikely that the compensation ratio will be higher than in the DLF case."

The following is a Q&A session with Senior Deputy Governor Lee and other FSS officials.

- Since the issues arising during the sale process of Hong Kong H Index-based ELS can be seen as violations of the Trust Act, is there a possibility of sanctions such as revoking trust business licenses?

▲ Most ELS were sold through bank trusts, and potential violations of various regulations are expected to be one of the issues. We will also examine whether there were breaches of the trustee’s duty of care and duty of loyalty under the Trust Act. However, at this stage, we are setting responsibility standards for the sales phase. Sanctions or institutional improvements based on illegality will be discussed later when reviewing overall institutional improvements.

- In the past DLF incident, the compensation ratio for internal control failures was up to 25%, but this time it has been reduced to 10%. What is the reason?

▲ Compared to the DLF incident, the Financial Consumer Protection Act (FCPA) has been implemented, tightening sales regulations, which has been largely reflected. Formal legal requirements such as basic explanation obligations and recording obligations during the sales process have been substantially complied with. It is difficult to see internal control failures as significant as in the DLF case, so a relatively smaller standard was applied.

- Is there a possibility of adjusting the responsibility ratio for cases before the enforcement of the Financial Consumer Protection Act?

▲ There are differences in legal regulatory levels and obligations before and after the enforcement of the FCPA. The part announced today is a recommended compensation standard to promote voluntary agreements between parties. It is separate from legal sanctions and liabilities. There is room for consideration depending on whether the violation occurred before or after the FCPA enforcement when recognizing compensation responsibility.

- Was there any prior consultation or opinion gathering with financial companies?

▲ There was no prior opinion gathering.

- Are CEO disciplinary actions being considered?

▲ Our current focus is to quickly resolve private disputes to eliminate legal uncertainties. Sanctions and institutional improvements are separate issues to be reviewed. Since on-site inspections are still being completed, sanction procedures have not started. It is difficult to comment on the level or existence of sanctions at this time.

- What are the specific compensation standards?

▲ We will explain and deliver how to technically apply the compensation standards to the sellers. Since dispute mediation committees will be held for representative cases in the future, the compensation standards are expected to be specified through those procedures.

- Were there any financial companies without incomplete sales?

▲ It is not appropriate to mention incomplete sales status by individual sellers. However, the incomplete sales cases announced as inspection results are not individual deviations of some sellers but are cases commonly applied to most sellers such as banks.

- What is the direction for future institutional improvements?

▲ It is too early to explain specific directions for institutional improvements. When full-scale discussions on institutional improvements begin soon, there will be another opportunity to explain.

- Governor Bokhyun Lee theoretically said that compensation from 0 to 100% is possible, but reconstructed cases show a maximum of 75%.

▲ Since the unilateral responsibility of the parties or sellers cannot be excluded, the compensation ratio could range from 0 to 100%. However, since a full survey was not conducted, it is difficult to say there are specific cases. The 75% compensation ratio presented in the materials does not mean an upper limit at all.

- You mentioned that generally a compensation ratio of 20 to 60% will be recognized.

▲ Based on on-site investigation results, most cases are expected to be distributed within that range. During the DLF incident, compensation ratios were mainly distributed between 40 and 80%, but it seems difficult to apply a higher compensation ratio for this ELS incident.

- Even if it is the seller’s unilateral responsibility, there have been no 100% compensation cases before. Does this mean that theoretically 100% compensation for incomplete sales is possible if it is the seller’s unilateral responsibility?

▲ Regarding 100% seller responsibility, I would like to point out that cases where only one party’s responsibility is recognized cannot be excluded. However, no specific cases have been confirmed yet.

- The common weighting is divided into 10% for banks and 5% for securities firms. Based on inspection results, are the financial companies subject to common weighting fixed? If there is no possibility of internal control violations, can they be excluded from common weighting?

▲ Regarding common weighting factors, the difference in sales channel structures between banks and securities firms caused the rates to be measured differently. This ratio applies only to sellers where incomplete sales factors are confirmed. If no illegal factors are found, the ratio is not applied. It is applied differently by seller, but as mentioned earlier, it is not the stage to discuss the situation of each seller. For banks, common factors were found in most sellers, and for securities firms, due to differences in sales channel structures, common weighting factors are less than those for banks.

- Regarding investor responsibility, during the DLF case, even an elderly dementia patient in their 80s was applied a 20% self-responsibility principle, but this time it was not applied at all. Also, reinvestment up to 20 times was not considered a mitigating factor. Could this be criticized as undermining the investor responsibility principle?

▲ In the DLF case, there was a 20 to 80% upper and lower limit, but this time the compensation ratio is selected without upper and lower limits, ranging from 0 to 100%. This does not mean that self-responsibility is not recognized at all. Elements recognizing the investor’s responsibility are included depending on investment experience and understanding. It is not mechanically derived based on scientific evidence but can vary relatively. It should be understood as a difference in relative importance rather than an absolute standard difference.

- After the DLF and Lime incidents, institutional improvements under the Financial Consumer Protection Act were made, but incomplete sales continue to occur. What does the financial authorities see as the fundamental reason for the periodic occurrence of incomplete sales? There is a concern that even with institutional improvements, it might happen again.

▲ We regret and feel sorry for the repeated occurrence of such situations. A more detailed cause analysis is needed to diagnose whether the repeated occurrences stem from institutional aspects or whether business practices or cultural factors play a larger role. It is difficult to be confident that all problems will be solved by improving institutions. However, since the FCPA has been implemented and various systems have been established, showing gradual progress compared to the past, if supplementation or institutional improvements are made in this area, we can expect the establishment of a financial order closer to consumer protection.

- Will the plan to “completely ban banks from selling ELS,” mentioned by Financial Services Commission Chairman Juhyun Kim at the National Assembly in January, also be considered?

▲ At this point, it is difficult to speak with a specific direction regarding sanctions or institutional improvements. We plan to hold a separate session for further explanation. Prohibiting the sale of high-risk products could be discussed as one of several options. However, there is no confirmed decision on the direction.

- The inspection of seven securities firms that entertained KB Kookmin Bank has been completed. Are additional sanctions being pursued separately from this incomplete sales issue?

▲ Since related investigations or inquiries are ongoing, sanctions or penalties are expected to proceed separately according to related procedures.

- You said there was no prior coordination with sellers, but is there a possibility that banks might oppose or reject it?

▲ Saying there was no prior coordination means there was no unofficial communication. Various opinions were exchanged through official channels. Last Friday, there was a session explaining dispute mediation standards, and there were several meetings for general communication on the overall progress direction. Whether to proactively settle disputes based on compensation standards or wait until confirmation through litigation is a responsible decision each seller must make; it is not for the financial authorities to suggest. However, from the sellers’ perspective, the concern is less about whether they are responsible or not, but more about whether a third party confirms the responsibility or they acknowledge it themselves and proceed with compensation. Since legal uncertainties can last long and social costs can be too high if proceeding through lawsuits or legal procedures, we tried to create reasonable dispute mediation standards to minimize this. We expect disputes to be resolved promptly according to the standards by sellers and investors.

- It seems difficult to motivate banks only by considering a reduction in fines. Are there any additional compensation measures?

▲ Regarding fine reductions, in principle, voluntary compensation by banks should not be mechanically considered during the imposition of fines under the FCPA. Private dispute mediation and legal sanctions do not necessarily have to be linked. However, during sanctions, active post-remedial efforts by violators can be taken into account as a mitigating factor, so it may be actively considered in future sanction procedures.

- ELS is a popular public offering product. From the public offering perspective, the seller’s responsibility can be considered large, but from the popular product perspective, investor responsibility also exists. You explained that the compensation standards are stricter than in the past DLF case, but considering the 45% adjustment factor for investor elements, it might seem generous. Why was 45% reflected? Is this compensation standard generous or strict from the investor’s perspective?

▲ The numerical part represents relative importance, not an absolute level. Compared to DLF, since it is a public offering product, regulations applicable to public offerings have been largely observed, and since it is a structured product well known to investors, it is difficult to apply incomplete sales liability as much as in the DLF case. Therefore, I said it is unlikely that the compensation ratio will be higher than in the DLF case. The 45% is not an absolute number. When applied to individual cases, there will certainly be cases where favorable investor factors are applied up to 45%. In most cases, the compensation ratio is expected to be distributed between 20 and 60%.

- Loss amounts are expected to increase. What is the outlook for the recovery of the H Index?

▲ It is difficult to comment on market outlooks. Regarding stock market forecasts, some are optimistic about the global outlook, while others see many uncertainties, so it is hard to make a uniform forecast. There is also a variable whether the H Index will follow the global stock market or not. At this stage, I can only mention the loss scale if the current index remains unchanged; the outlook is difficult. However, considering the structure and knock-in reference points by sales period, if the index remains unchanged, the product structure has a lower loss rate.

- From the consumer’s perspective, they are curious whether they will be compensated. Since the 0 to 100% range is very wide, the key is whether it applies to their case and how to verify it. When representative dispute mediation cases are confirmed, will consumers be notified? If they want to prove incomplete sales further, do they have to prove it themselves?

▲ Even if consumers do not file complaints, banks or securities firms will present an amount based on certain standards to consumers, and if consumers find issues with that proposal, there will be a process of mutual claims and proof. After the dispute mediation committee concludes, detailed information will be released. Please refer to that part.

- Financial consumers lose assets every time. What is the standard for authorities to intervene and lead? Some abroad question, ‘Why does the Korean government take responsibility?’

▲ If authorities do not intervene at all, sellers and investors must resolve disputes through litigation. It would be resolved by seeking court judgments such as civil damages, but if many victims’ cases all go to court, social and economic costs cannot be ignored. Many complaints can be resolved through dispute mediation procedures legally established outside court trials, and this procedure is being conducted accordingly. It is not direct intervention by financial authorities but support for prompt resolution of private dispute mediation to minimize social and economic costs. The government or authorities cannot compensate for individual losses. We strive to uphold the principle of self-responsibility and investment responsibility.