As the Hong Kong Hang Seng China Index (HSCEI) has experienced a sharp decline, it has led to substantial capital losses of over 40 percent in Equity Linked Securities (ELS) products based on this index. In response to the significant risks in the trillions of won facing HSCEI-linked ELS, the Financial Supervisory Authority (FSS) has initiated a comprehensive investigation into the banks and securities firms involved in the sale of these products. The investigation aims to determine whether there was sufficient disclosure to subscribers regarding the potential losses associated with fluctuations in the HSCEI and to assess the completeness of the sales practices.
According to financial industry sources on Nov. 26, the FSS is currently conducting on-site investigations into Kookmin Bank, the leading seller of ELS, and has expanded its inquiry to include all major financial institutions, including the top five banks and securities firms. Hana Bank is closely examining its ELS offerings as part of its ongoing routine inspection, while Shinhan, Woori, and Nonghyup banks have submitted relevant documents to the FSS and are undergoing written examinations. For securities firms, five to six entities, such as Mirae Asset Securities and KB Securities, two of the largest sellers, are included in the investigation.
Among the ELS linked to the HSCEI sold by the top five banks, a total value of 8.41 trillion won (US$6.44 billion) is set to mature in the first half of next year. Kookmin Bank holds the highest amount at 4.77 trillion, surpassing the others by half. Following are Nonghyup Bank with 1.48 trillion won, Shinhan Bank with 1.38 trillion won, Hana Bank with 752.6 billion won, and Woori Bank with 24.9 billion won.
ELS is a derivative product that promises a predetermined return if the underlying asset price maintains a certain level until maturity, typically three years. However, there is a risk of principal loss if the price falls below a pre-set level. The contract period for HSCEI-linked ELS maturing in the first half of next year was initiated in the first half of 2021. At that time, the HSCEI reached its peak at 12,000 points, but it is currently hovering in the early 6,000s. Without a significant rebound in the index, the likelihood of substantial principal loss becoming a reality is high.
ELS products are divided into “knock-in” and “no knock-in” types. Knock-in ELS involves the risk of principal loss if the underlying asset index falls below a certain level, typically 50 percent. On the other hand, no knock-in ELS allows investors to receive the agreed-upon principal and interest at maturity if the index at the time of maturity is higher than 65 percent of the index at the time of subscription, regardless of how much the index has fallen during the investment period. While it is considered a safer option compared to knock-in ELS, it is inevitable to incur principal loss given the significant decline in the HSCEI.
Estimating the extent of the principal loss in HSCEI-linked ELS depends on the subscribed product and the index at maturity, making predictions challenging. However, current observations suggest a potential principal loss of 40 to 50 percent if current HSCEI levels persist. In the case of HSCEI-linked ELS products sold by Hana Bank, there has been a principal loss of 8.3 billion won out of a maturity amount of 18.1 billion won from July to this month, resulting in a loss rate of 45.9 percent. The calculation indicates that applying a loss rate of this magnitude to the maturity amount of the top five banks’ ELS, which is 8.41 trillion won and maturing in the first half of next year, would result in a loss of 3.86 trillion won. Among the ELS reaching maturity in the first half of next year at Kookmin Bank alone, over 4 trillion won has entered the loss zone, signaling a knock-in scenario.
The FSS is planning to conduct a thorough examination of banks and securities firms to determine whether they adequately informed subscribers about the potential for principal loss. During a parliamentary audit last month, FSS Director Lee Bok-hyun expressed strong concerns, stating, “There is strong skepticism about whether it is appropriate for individuals who do not fully understand the products themselves to sell complex and high-risk derivative products to the elderly at bank counters.” This announcement signals an intention for an intensive investigation into the matter.