[Why&Next] FSS Launches Captive Sales Inspection: Will This Time Be Different?

FSS to Review All Aspects of Captive Sales
Market Remains Skeptical... "Proving Wrongdoing Will Be Difficult"

The Financial Supervisory Service (FSS) has launched an inspection into the prevalent practice of captive sales in the securities industry. Although concerns have been raised in the past that captive sales disrupt the corporate bond market, no clear solution has been found, leading to growing dissatisfaction in the market. However, FSS Governor Lee Bokhyun has expressed a strong commitment to improvement, referring to the initiative as "Bond Market Normalization Season 2." Through this inspection, the FSS plans to conduct a systematic review and examine any illegal activities.

Planning_Yeouido Securities District, Park One, LG Twin Towers. Photo by Hyunmin Kim kimhyun81@

Captive sales refer to the practice where an issuer (whether listed or unlisted) promises that a securities firm will mobilize itself and its affiliated financial companies to invest in the issuer's corporate bonds at the time of issuance.

According to the financial investment industry on April 25, the FSS plans to conduct on-site inspections of Mirae Asset Securities and Samsung Securities until May 15.

It is common for issuers to want to issue corporate bonds at lower interest rates. Securities firms, focusing on this, engage in captive sales by mobilizing affiliates such as insurance companies or asset management firms to participate in demand forecasting at lower rates.

Industry insiders point out that captive sales disrupt the market. When affiliates participate in demand forecasting at low interest rates, price distortions occur. This is because, after issuance at a low rate, the bonds may be sold in the market at higher interest rates. As a result, although demand forecasting was introduced to enhance the fairness and transparency of corporate bond pricing, the price discovery function has been lost due to captive sales.

Such concerns have existed for some time, but financial authorities have rarely intervened. In 2023, controversy also arose regarding corporate bond demand forecasting. At the time, the FSS investigated the situation through the Korea Financial Investment Association and collected industry opinions. However, no clear solution was found, as the business environments and interests of large and small-to-medium-sized firms differ significantly.

This year, however, Governor Lee has spoken out directly, reflecting a stronger commitment from the authorities. After a meeting with securities firm CEOs in March, Lee stated, "Improving captive sales practices is 'Season 2' of normalizing disorderly practices in the bond market," and emphasized, "In the first half of this year, we will focus our inspection capabilities in the financial investment sector on captive sales." He added, "If there are unfair practices in the bond market, they must be improved."

Accordingly, the financial authorities are expected to take more decisive action this time. They plan to broadly investigate whether price distortions occur, whether there is price collusion, and whether there are any illegal aspects in the business practices. An FSS official stated, "We will examine the situation, and if it is not illegal but merely a customary practice, we will consider how it can be incorporated into the institutional framework and whether there are ways to improve the system. If there are clear violations of the law, they must be eliminated."

However, there are opinions that even this inspection may find it difficult to present a clear solution, as proving such issues is inherently challenging. Hwang Sewoon, Senior Research Fellow at the Korea Capital Market Institute, said, "Even if bonds are issued at low interest rates, it is difficult to prove that the pricing is wrong," and added, "It is necessary to consider various factors, including market liquidity and the situation of the issuing company, but obtaining such evidence itself will be difficult."

An official from a securities firm explained, "If a loss is incurred upon sale, those responsible would be held accountable, but it is not easy for that to happen. Even if bonds are sold at a lower price than the issuance price, internal guidelines and reporting procedures would have been followed."

There are also concerns that restricting the use of affiliate funds could actually contract the market. Hwang, the senior research fellow, said, "If an affiliate wants to invest in a certain corporate bond but is blocked by regulation, that itself could become a problem," and added, "It is difficult to see substantial benefits from imposing such regulations (on affiliate funds)."

Following Mirae Asset Securities and Samsung Securities, it is highly likely that the inspection will be expanded to other securities firms in the future. According to the Korea Financial Investment Association, in the debt capital market (DCM) league tables for last year, KB Securities ranked first with 52.3835 trillion won, followed by NH Investment & Securities (45.9663 trillion won), Korea Investment & Securities (33.7512 trillion won), Shinhan Investment & Securities (19.5709 trillion won), Hanyang Securities (19.0771 trillion won), Kyobo Securities (14.7800 trillion won), and Samsung Securities (12.1582 trillion won). Mirae Asset Securities was ranked 13th.