[Essential! Financial Education] ① Even with Incomplete Sales Prevention Laws, Consumers Are Still Deceived... "Consumer Education Needed"

Financial consumers tend not to diversify investments or invest without understanding product characteristics, increasing the risk of incomplete sales exposure. From KIKO to Hong Kong H Index ELS, despite measures like the Financial Consumer Protection Act, issues persist. "Financial education is needed more than sales bans."

Editor's NoteRecently, the issue of incomplete sales of financial products has continued to occur, becoming a social issue. Naturally, the fault of banks and other financial companies that engaged in incomplete sales is the greatest. However, financial consumers are also at fault. If they do not understand financial products well, they should not subscribe, and if they do, they should properly listen to explanations and ask questions, but they often neglect to do so out of convenience. When significant losses occur, they blame everything on the financial companies' incomplete sales and take collective action on the streets. To avoid repeating such old habits, proper financial education from an early age is necessary. We examined the current state of financial education, overseas cases, and expert opinions to discuss desirable financial education.

#30-year-old Min-gi Lee was a young professional who had only been employed for three years since joining in 2019. After joining, he did not engage in other savings or investments but saved 30 million KRW solely through regular savings deposits. After the savings matured, when he was considering investments, he visited his main bank and subscribed to a product called the Italy Healthcare Fund with all the money he had saved. This product is an overseas fund that indirectly invests in Italian hospitals by prepaying medical fees that the hospitals should receive from local governments and then collecting the fees from the government to earn a profit margin.

Not knowing much about funds, Mr. Lee gave up listening due to many difficult terms even though the bank teller explained the product. Moreover, although there was a risk of loss, the employee did not inform him and explained that the investment could be recovered unless Italy defaulted. He thought of this product as a deposit and did not try to learn about it. However, from the end of 2019, repayments were delayed, and as it became a non-performing bond at maturity, the fund sales were suspended in 2020. Mr. Lee lost all 30 million KRW he had saved over three years.

#Mr. Sang-won Park, upon entering his 60s, sold the house where he lived with his children. He was contemplating how to manage the 500 million KRW secured from the sale. He was introduced to a financial planner and heard about the need to build an asset portfolio and diversify investments. He first put 200 million KRW into a fixed deposit and decided to invest 300 million KRW. Next, he began to consider his own investment strategy and discovered a service through a securities company application (app) that allows investors to build their own portfolios. After reviewing pre-configured examples based on investment and themes, he decided to mainly invest in the Korean stock market. Besides stocks, he diversified into funds, bonds, and gold. Among the funds were high-risk derivatives linked to overseas interest rates. Due to a decline in bond interest rates, Mr. Park, who invested 20 million KRW in such a product, suffered a loss of 10 million KRW. However, he was using 200 million KRW stably in fixed deposits and other savings, and the bond-type funds actually had higher yields due to the interest rate decline. Thanks to investing in various other products, he was able to minimize losses.

According to the '2023 Financial Consumer Financial Capability Survey' recently conducted by the Financial Supervisory Service, financial consumers lack basic financial knowledge such as the relationship between interest rates and bond prices and compound interest calculations. Most did not properly establish the principle of diversification in setting investment principles and understanding their investment tendencies, and the proportion of those who understood product characteristics before investing was somewhat low.

Due to such tendencies, consumers are easily exposed to incomplete sales by financial companies. Incomplete sales refer to the act of financial companies failing to properly explain major product details and precautions, such as the possibility of principal loss, when selling products. The controversy over the Hong Kong H-Index (Hang Seng China Enterprises Index, HSCEI) equity-linked securities (ELS) from last year to this year is also related to this. Since the 2007 KIKO incident, through the overseas interest rate-linked derivative-linked fund (DLF) loss incident, Lime and Optimus private equity fund (PEF) incidents, laws such as the 'Financial Consumer Protection Act' have been enacted to prevent incomplete sales, but there are still many limitations. Experts analyze that fundamental measures such as strengthening financial education are urgently needed.

"The Safest Deposit in the World" Introduced Hong Kong H-Index ELS

The case of the Hong Kong H-Index ELS, which caused large-scale losses from the end of last year to this year, shows the current state of financial consumers. According to the Financial Services Commission, as of last month, there were 170,000 accounts with confirmed losses at maturity among Hong Kong H-Index ELS accounts, and 4.6 trillion KRW, which is 44.2% of the principal of 10.4 trillion KRW in accounts with confirmed losses, was the loss amount.

Many subscribers said they were encouraged to subscribe to the product by bank tellers during their visits and did not receive proper explanations. Especially, many retirees or elderly people managing large sums joined this product. Mr. Ki-hyun Park (61) said, "The bank explained it as 'the safest deposit in the world' and just circled where to sign on the documents, finishing quickly," and added, "When I complained to the bank three months later, they said, 'Since you've waited this long, if you wait three more years, interest might accrue,' so I waited, but when I went in April this year, the person in charge had transferred."

Repeated Controversies over Incomplete Sales... From KIKO Incident to Lime and Optimus Fund Incidents

The controversy over incomplete sales is not a recent issue. Going back to the 1990s, incomplete sales of insurance products were problematic. Insurance agents sold insurance products to acquaintances without proper explanations, and many subscribers did not receive proper insurance payouts. In the 2000s, controversies over incomplete sales related to funds emerged. The 2008 KIKO incident occurred when financial companies sold currency hedging products to companies without properly explaining risks and precautions. Exporting small and medium enterprises subscribed during the period from 2006 to early 2008 when the won-dollar exchange rate was stabilizing downward, but after the 2008 financial crisis, the won-dollar exchange rate soared beyond KIKO's profit range, causing 723 companies to suffer losses of 3.3 trillion KRW. At that time, courts partially recognized the financial companies' responsibility for incomplete sales, and the Financial Supervisory Service also recommended compensation of 15-41% of the damages.

In 2013, the Dongyang Group commercial paper (CP) incident occurred. Due to Dongyang Group's management crisis, several affiliates issued corporate bonds and CPs, and as the group became insolvent, about 40,000 investors suffered losses of 1.7 trillion KRW. Dongyang Securities' failure to properly assess the group's financial situation and investment suitability during sales was problematic. The 2019 overseas interest rate-linked derivative-linked fund (DLF) incident is similar to the Hong Kong H-Index ELS incident. Despite being high-risk products with the possibility of total principal loss, banks did not properly inform customers visiting the bank and sold the products. In the second half of that year, global bond interest rates plummeted, causing principal losses in derivative-linked securities (DLS) based on US, UK, and German bond interest rates and the DLFs invested in them. The Lime and Optimus private equity fund incidents involved not only incomplete sales but also more problems such as manipulating returns during management or not investing in the originally agreed assets.

Financial Consumer Protection Act Insufficient to Prevent Incomplete Sales... "Financial Education Needed Rather Than Sales Ban"

The Hong Kong H-Index ELS incident that arose this year was similar to the DLF incident, rendering the government's recurrence prevention measures ineffective. After the DLF incident, the Financial Consumer Protection Act was enacted in 2020, and the Capital Markets Act introduced 'regulations on the sale of high-difficulty financial products' to prevent similar cases. Specifically, a non-deposit product committee was operated, sales inducement was prohibited through key performance indicators (KPIs), and recording procedures were established during product subscription. Nevertheless, in the ELS incident, incomplete sales such as violations of investment suitability principles and explanation obligations, as well as excessive sales encouragement at the financial company level, were repeated.

Simply banning the sale of high-risk financial products cannot solve the problem because it restricts consumers' choice of financial products. Although ELS is a high-difficulty, high-risk financial product with up to 100% possible loss, it has been continuously sold since its first introduction in Korea in 2003 because it can yield higher returns compared to deposit interest rates during low-interest periods. During his candidacy, Kim Byung-hwan, Chairman of the Financial Services Commission, responded to questions about restricting ELS sales to professional investors by saying, "Restrictions on sales targets must sufficiently consider financial consumer protection as well as consumers' choice."

Fundamentally, it is urgent to enhance financial consumers' ability to understand products or create their own investment principles, and there is growing recognition of the need for financial education to achieve this. Most experts assume that financial education alone cannot completely solve the problem of incomplete sales but believe that financial education that goes beyond simple knowledge acquisition to guide judgment direction is necessary. Go Seung-beom, Chairman of the Youth Financial Education Council, said, "If financial education is conducted from adolescence, basic financial literacy can be established." He added, "If basic education on financial product risks and the relationship between returns and risk rates is provided, it will form the foundation for professional financial product education and enable individuals to make various investment decisions in society."

Professor Eugene of Hanyang University’s College of Economics and Finance stated in his paper 'Financial Disputes and Investor Protection' that the main goal of financial education should be oriented toward emphasizing irrationality rather than enabling ideal and optimal financial decision-making. He said, "It is necessary to emphasize that financial consumers themselves tend to have excessive optimism or confidence, leading to irrational decisions," and added, "Consumers should be encouraged to think that decisions such as fund investments should not be made alone but with expert assistance."