[Inside Chodong] Gray Rhino 'ELS'... Investor Protection Must Be Thorough

The Higher the Risk and Complexity,
the More Thorough the Measures Needed to Prevent Consumer Damage

The term "Gray Rhino" refers to situations where the possibility of a certain risk occurring could have been sufficiently anticipated, yet it was overlooked, resulting in an inadequate response to the risk. This concept contrasts with the "Black Swan," which denotes events that are extremely unlikely and difficult to predict or prepare for but cause tremendous shock once they occur.

"Gray Rhinos" often appear in financial markets. A representative example is the subprime mortgage crisis that occurred in the United States in 2008. At that time, institutions such as the Bank for International Settlements (BIS) and the Federal Reserve (Fed) sufficiently warned about the instability of the financial markets, but the parties involved avoided responsibility and failed to implement proper measures. Ultimately, major global financial firms in the U.S. went bankrupt, spreading the crisis to international financial markets.

Concerns are growing over large-scale losses in equity-linked securities (ELS) products based on the Hong Kong H-Index. ELS are derivative financial products that pay a predetermined interest on the principal if the underlying assets, such as individual stocks or stock indices, maintain a certain level until maturity.

The market turmoil caused by the COVID-19 pandemic was significantly influenced by the aftershocks of ELS exceeding 100 trillion won at the time. Despite warnings from most experts, securities firms rushed to issue ELS one after another. When overseas futures exchanges saw the underlying asset prices plummet, they requested additional margin payments from domestic securities firms. Those without trillion-won scale liquidity issued commercial papers (CP) and sold asset-backed securities from specialized credit finance companies, drying up the market's liquidity.

The Gray Rhino of ELS is approaching. The outstanding balance of ELS based on the Hong Kong H-Index exceeds 20 trillion won, and a large-scale loss event is inevitable due to the sharp decline in the index. This is because many investments were made when the index was at its peak. With the index's recovery uncertain, avoiding principal losses is difficult.

When issuing, selling, or investing in ELS products, one must always keep the emergence of Gray Rhinos in mind. Although the purpose of managing derivatives is divided into risk hedging and profit seeking, they generally carry high risks, often described as "High Risk, High Return."

ELS issuing companies should devise strategies to increase the likelihood of profit repayment so that ELS can form a virtuous cycle where early redemption leads to reinvestment. This is necessary for the ELS market to grow stably without large-scale losses. Additionally, they must thoroughly inform subscribers of the product risks to ensure consumer protection. Otherwise, it constitutes incomplete sales. The Financial Supervisory Service is currently investigating banks and securities firms for incomplete sales, including whether they sufficiently explained the possibility of losses in advance.

Despite the precedent of the Hong Kong H-Index plunging 49% within a few months in 2016, the fact that a large volume of high-risk products was sold makes it difficult to avoid criticism for neglecting investor protection. Considering the product's extreme volatility due to factors such as China's real estate market conditions and the precedent of principal loss criteria being triggered in ELS, sales should have been more cautious. Nevertheless, the fact that one bank sold more than the combined sales of dozens of banks and securities firms ultimately proves negligence in investor protection. Financial Supervisory Service Governor Lee Bok-hyun also sharply questioned whether investors were properly informed and advised before investing.

The higher the risk and complexity of a product, the more meticulous the preventive measures against consumer damage must be, and sales should comply with the Financial Consumer Protection Act. Investors need to fully understand the risks of derivatives and carefully consider how to invest. This is because Gray Rhinos are always looming in the market.

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