[Inside Chodong] Hong Kong ELS Facing Compensation: Responsibility of Financial Supervision

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Lee Bok-hyun, Governor of the Financial Supervisory Service (FSS), bowed his waist at a 90-degree angle. Immediately after the open discussion titled ‘Open Debate with Individual Investors’ on the improvement of the short-selling system, he apologized by bowing when questions arose during an unscheduled back briefing regarding the dispute mediation standards for Hong Kong H-Share Index (Hang Seng China Enterprises Index·HSCEI) equity-linked securities (ELS), and then continued to answer.

"We apologize for causing pain and inconvenience due to the supervisory authorities' failure to thoroughly address incomplete sales. We also regret that the trust in banks and securities firms was damaged because we could not present clear standards," he said. It is known that this apology was made without prior consultation with the FSS staff or the Financial Services Commission. Immediate evaluations followed, describing it as a responsible attitude as the head of the financial supervisory agency.

Why did Governor Lee take such a sudden step? Two days before his apology, the FSS announced the results of inspections conducted over two months since early this year targeting banks and securities firms. The core of the extensive on-site inspections and complaint investigations, which were extended in duration, was ‘incomplete sales by banks.’ The FSS then presented a ‘dispute mediation standard’ that adjusted the basic compensation ratio by investor factors, based on voluntary compensation by the sellers.

Coincidentally, four hours after the FSS announcement, a press conference marking the 100th day since Jo Yong-byeong’s inauguration as Chairman of the Korea Federation of Banks was held. Like previous chairmen, it was planned as a usual meeting to share the direction of the banking industry, but attention focused on the Hong Kong ELS compensation issue. Chairman Jo expressed regret over the Hong Kong ELS incident in response to the barrage of reporters’ questions and evaluated that “the announcement of the dispute mediation plan is a starting point for communication among the market, consumers, and authorities.” Regarding whether banks would continue selling high-risk products such as ELS, he stated, “We need to supplement the shortcomings so that customers’ choices are not narrowed.”

[Image source=Yonhap News]

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A subtle sense of discord intersected between the FSS’s announcement and Chairman Jo’s remarks. While Governor Lee revealed problems in banks’ internal control systems and regulations on the sale of derivative-linked products such as ELS during the inspection period, the FSS clearly stated that banks bear collective responsibility in advance. This was interpreted as a thoughtful response from the head of the supervised institution’s association.

Immediately afterward, concerns were continuously raised within the banking sector that accepting the standards proposed by the FSS as is could lead to ‘breach of trust’ issues becoming a stumbling block. There were also criticisms about the uncertainty surrounding the plan to use the results of voluntary compensation implementation as grounds for leniency in various sanctions such as fines and disciplinary actions against institutions and management.

Subscribers and civic groups such as the Financial Justice Solidarity raised their voices, calling the compensation plan a regression compared to the past, saying, “It is a compensation plan that favors financial institutions with an absurdly high number of subscriber faults, and the FSS and banks are shifting responsibility.” There were even sharp views that it is inappropriate for the FSS, which neglected financial accidents, to act as a judge.

The ‘Mobius strip’ of chronic major financial accidents caused by moral hazard in financial institutions and delayed responses by supervisory agencies was reaffirmed. Domestic and international trust collapsed once again. Contrary to the FSS Governor’s wish who apologized abruptly, various disputes and conflicts are expected to inevitably spread during the upcoming process of compensating losses and preparing recurrence prevention measures for the Hong Kong ELS.

The number of accounts subscribed to the Hong Kong ELS product at the end of last year was 396,000 accounts worth 18.8 trillion won. Among them, first-time ELS investors accounted for 6.7% or 26,000 accounts, and elderly investors aged 65 or older accounted for 21.5% or 84,000 accounts.

“It was a financial product continuously sold since early 2021, and including products with confirmed losses, the estimated loss amount for this year alone is 5.8 trillion won.”

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