FSS to Inspect Securities Firms' Bond-type Wrap and Trust Operations... "Will Correct Wrong Practices"

The Financial Supervisory Service (FSS) announced on the 3rd that it is inspecting the bond-type wrap accounts (wraps) and specific money trusts (trusts) operations of securities firms.

This inspection was initiated after large-scale redemption requests occurred in bond-type wraps and trusts due to liquidity tightening in the money market at the end of last year, raising suspicions that some securities firms compensated customers' investment losses through so-called 'bond rollover'.

Customers subscribed to bond-type wraps and trusts to manage short-term surplus funds, but some securities firms used a 'maturity mismatch management strategy' by incorporating and managing long-term corporate commercial papers (CPs) with low trading volumes.

Securities firms are required to present incorporated assets and expected returns that match customers' investment objectives and fund needs during the sales process, but they designed and sold products that included CPs with long maturities (1 to 3 years) or low liquidity to achieve the targeted returns.

Furthermore, during the management and redemption process, it was revealed that securities firms compensated customer losses through delinquency and replacement transactions.

In the management process, securities firms must select and replace assets that match investment objectives and fund needs through one-on-one contracts. However, some securities firms continuously held low-liquidity and long-maturity assets and, at contract maturity, sold them at book value to other accounts under management to prepare redemption funds.

During the redemption process, securities firms must pay redemption proceeds by selling incorporated assets in the market at the maturity of wrap and trust contracts or return funds through maturity extension or contract termination. Some securities firms transferred losses of customers whose maturities had arrived to other customers through linked and replacement transactions between customer accounts or purchased customer assets at high prices using the securities firms' proprietary funds.

The use of proprietary funds by securities firms involved purchasing CPs incorporated into wraps and trusts at high prices with proprietary assets, and the target customers were mostly large corporations and investors.

The FSS viewed these business practices as undermining the 'investor self-responsibility principle.' They operated performance-based products like wraps and trusts as if they were fixed-rate products and violated the investor self-responsibility principle by compensating losses using proprietary assets.

There were also criticisms that risk management was neglected due to maturity mismatch management. Long-term bonds with low liquidity have high price fluctuation risks and require thorough risk management, but some securities firms neglected risk management even as the valuation losses of held assets accumulated due to interest rate hikes.

The FSS pointed out that internal control and compliance monitoring functions did not operate properly, as securities firms did not perform replacement transaction monitoring or abnormal transaction price control and engaged in loss compensation using proprietary assets.

In addition to the securities firms inspected this time, the FSS plans to select additional securities firms suspected of violations and inspect the appropriateness of their operations.

An FSS official stated, "We will strictly take action against the violations confirmed through this inspection to correct market order and prevent the continuation of improper practices," adding, "For securities firms with inadequate risk management and compliance monitoring systems, we will enhance internal control functions."

This content was produced with the assistance of AI translation services.