FSS Conducts Full Investigation of Securities Firms Selling Hong Kong ELS with 'Principal Loss'

H Index Hits 10,000 in Early 2021... Now Dropped to 6,000
High Risk of Principal Loss for Products Maturing from January Next Year
H Index ELS Balance in Securities Firms at 3.5 Trillion Won, Less Than Banks

The financial authorities, which had been investigating only five major securities firms related to Hong Kong H Index equity-linked securities (ELS), have recently switched to a full-scale investigation. It is expected that there will be a high possibility of principal loss for H Index ELS products maturing from January next year.

According to the financial investment industry, the Financial Supervisory Service (FSS) previously investigated the ELS sales status of five major firms?KB Securities, Mirae Asset Securities, NH Investment & Securities, Samsung Securities, and Korea Investment & Securities?and then requested written data from small and medium-sized securities firms. The FSS reportedly demanded these firms submit key business details such as ELS balances and upcoming maturities. While the issuance scale of ELS sold by banks and the amount maturing in the first half of next year have been confirmed, the scale of ELS issued and sold by securities firms, the amount maturing in the first half, and estimated loss amounts have yet to be aggregated.

According to data submitted to Yoon Han-hong, a member of the People Power Party, by the FSS, the outstanding balance of ELS based on the H Index reached 20.5 trillion KRW as of the end of August. Of this, 16.2 trillion KRW was sold through banks, and 3.5 trillion KRW was sold through securities firms.

As of the end of June this year, the amount of derivative-linked securities (ELS, DLS, etc.) that have triggered knock-in events was estimated at 7 trillion KRW. This accounts for 7.3% of the total derivative-linked securities (96.3 trillion KRW), and all knock-in events occurred in ELS. Yoon Han-hong’s office pointed out, "Due to the weakness of the Hong Kong H Index in 2022, knock-in events mainly occurred in ELS linked to the H Index, and 85.6% of these will mature in the first half of 2024."

The financial authorities have launched an investigation into the actual conditions of ELS due to growing concerns that losses on H Index ELS will materialize. ELS are derivative products whose returns depend on the stock prices of the underlying indices or stocks. Typically, the price of the underlying asset is evaluated every six months, and if it maintains a level above the promised threshold, early redemption occurs at a predetermined return rate. However, if the price falls below the promised level, principal loss occurs. These products are designed to maximize returns when the index or stock is expected to continue rising or is judged to be at a low point. They are generally issued with a three-year maturity.

ELS are divided into ‘Knock-In’ and ‘No Knock-In’ types. Knock-In types are products where the underlying asset index falling below a certain level (usually 50%) can result in principal loss. No Knock-In products return the agreed principal and interest at maturity if the index is higher than 65% of the level at subscription, regardless of how much the underlying index falls.

The H Index refers to an index calculated by selecting 50 leading Chinese state-owned enterprises listed on the Hong Kong Stock Exchange. On January 4, 2021, the H Index was 10,722.99, but after breaking below the 10,000 level in the second half of the same year, it continued to decline. As of the previous trading day (November 24, 2023), it had fallen to 6,041.15. The index maintained the 10,000 level until the first half of 2021 (July 7). If the index remains at the current level or falls further, principal loss will be confirmed.

The FSS is also reportedly examining whether there was any mis-selling. However, in the case of securities firms, since a large portion of sales are non-face-to-face and the customer profiles differ from those of banks, the possibility of mis-selling is considered low. A securities firm official said, "Most customers who subscribe to ELS products at securities firms are risk-tolerant and have experience investing in products like ELS that carry the possibility of principal loss, so there are unlikely to be many cases of mis-selling."

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