"High-Risk Financial Products Like ELS Must Consider Whether Consumers Fully Understand Them"

Korea Institute of Finance Report
How to Strengthen the "Suitability Principle" for High-Risk Financial Investment Products
"Proper Assessment of Product Comprehension Needed"
Separate Suitability Evaluation Required When Selling at Dedicated Bank Counters

There has been a suggestion that when selling complex financial products such as equity-linked securities (ELS), it is essential to consider whether consumers fully understand these products, given their complicated structure. The fundamental reason why investors often fail to recognize the risks is pointed out to be their low level of product comprehension.

According to the financial industry on September 23, Lee Kyubok, Senior Research Fellow at the Korea Institute of Finance, expressed this view in his report, "Recent Strengthening of the Suitability Principle for High-Risk Financial Investment Products and Future Tasks." After the 2021 case of incomplete sales of Hong Kong H Index (Hang Seng China Enterprises Index, HSCEI) ELS, financial authorities introduced measures to improve the sale of high-risk financial products. The main points include: separating bank sales branches and counters, enhancing the substance of the suitability principle, and strengthening the duty to explain. In particular, last July, the authorities announced amendments to the Enforcement Decree of the Financial Consumer Protection Act and supervisory regulations, further strengthening the "suitability principle."

The suitability principle is a regulation that prohibits financial product sellers, such as banks, from recommending a product to a consumer if, after checking and considering the consumer's information, the product is deemed unsuitable for them. Specifically, it requires sellers to first explain the types of consumers for whom the product is not suitable, and if a consumer still wishes to purchase an unsuitable product, a detailed report assessing the product's inappropriateness must be provided to the customer.

Lee assessed that this revision makes a meaningful contribution to strengthening the suitability principle. First, the process and evaluation system for confirming consumer information have been reinforced. The amendment mandates that six essential pieces of information must be identified and reflected in the evaluation. In particular, loss-bearing capacity is now assessed in more detail. The previous four-tier evaluation standard has been expanded to six tiers (seeking principal preservation, tolerating up to 10% loss, up to 20%, up to 50%, up to 70%, or being able to bear total loss), allowing for a more precise understanding of the consumer's risk tolerance.

He explained, "The significance of this amendment lies in its ability to identify investors with a principal preservation tendency and fundamentally exclude them from being solicited for high-risk products."

"Need to Reflect Product Comprehension"

However, he emphasized that in order to properly strengthen the suitability principle, it is also necessary to accurately assess consumers' understanding of the product. This is because, for high-risk financial products, the fundamental reason for insufficient risk awareness stems from low comprehension levels.

Currently, the standard investment principle form includes questions about financial knowledge and understanding. However, these questions rely on the investor's subjective self-assessment, which has limitations in truly gauging their actual product comprehension. The questions are structured as follows: no investment experience; partial understanding of the structure and risks of widely known financial investment products such as stocks and bonds; deep understanding of structure and risks; or understanding of the structure and risks of most financial investment products, including derivatives.

He evaluated, "With the current method, it is difficult to properly determine whether an investor truly possesses the knowledge necessary to understand the product."

Lee also raised the need to improve sales methods at banks. Currently, high-risk products are restricted to being sold only at separate counters within main branches, but in practice, the suitability assessment is duplicated. He stated, "At general counters, the basic suitability assessment for identifying risk grades should be conducted as before, but for customers classified as active investors who want high-risk products, it is necessary to conduct additional product-specific questions and evaluations at the separate counter."

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