Increasing Issuance of Derivative Bonds... Financial Supervisory Service Warns of Potential Investor Harm

Financial Supervisory Service Issues Investment Precautions for Derivative-Linked Bonds Such as ELB and DLB

[Asia Economy Reporter Myunghwan Lee] As the issuance and sales of derivative-linked bonds such as Equity-Linked Bonds (ELB) and Derivative-Linked Bonds (DLB) have increased recently, the Financial Supervisory Service (FSS) has provided investment precautions.

On the 15th, the FSS explained, "There is a risk of investor damage occurring during the issuance and sales process due to investors' lack of understanding of derivative-linked bonds."

According to the FSS, derivative-linked bonds are divided into ELB and DLB. ELBs are bonds that yield a predetermined return based on the price movements of underlying assets such as stock indices or individual stocks. On the other hand, DLBs yield a predetermined return based on the price movements of underlying assets such as interest rates, credit, commodities, or exchange rates, rather than stock prices.

However, derivative-linked bonds carry the inherent risk that principal and interest may be partially or fully unpaid. Although these products are principal and interest guaranteed types, they are not covered by depositor protection. Furthermore, the invested funds are not legally required to be separately deposited and are not segregated from the issuer's (securities company's) proprietary assets. Therefore, in the event of issuer bankruptcy, there is a risk of not recovering the principal and returns.

It is also important to note that the stability of the underlying assets and the possibility of principal and interest repayment are unrelated. Many derivative-linked bonds set the stock prices of high-quality companies as underlying assets, but the FSS explains that this has no relation to the ability to repay principal and interest on the derivative-linked bonds. Ultimately, the repayment of principal and interest depends on the issuer's payment capacity, the FSS emphasized.

Investors should also consider that redemption costs occur in case of early redemption (repayment). If early redemption is requested during the investment period of derivative-linked bonds, the amount paid to the customer will be the remaining amount after deducting the redemption costs calculated based on the remaining maturity at that time. Investors should be aware that such redemption costs may cause principal loss.

The FSS urged investors to invest only after fully understanding derivative-linked bond products. An FSS official advised, "Investors should carefully invest after thoroughly understanding the product's profit and loss structure, underlying assets, issuer's credit rating, liquidity risk, payment capacity, and soundness indicators through the prospectus and explanations from the sales company."

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