The Financial Supervisory Service headquarters. [Herald DB]
The Financial Supervisory Service headquarters. [Herald DB]

The Financial Supervisory Service is significantly strengthening pre-emptive controls to protect investors in derivative-linked products. When the underlying asset price of a high-risk equity-linked security (ELS) approaches the knock-in barrier — the threshold at which principal losses are triggered — investors will receive advance notice. Consumer protection officers will also be empowered to delay a product's launch if they determine it necessary to protect investors.

The FSS held a roundtable Wednesday with the Korea Financial Investment Association and major brokerages to announce the reform package. The FSS, the association and 10 leading securities firms spent the past three months working through a task force to develop the proposals, with revisions to the association's self-regulatory rules planned for September.

The centerpiece of the overhaul is tighter internal controls before a product goes to market. Going forward, consumer protection, compliance and sales divisions will be required to participate in product approval committees. Consumer protection officers will have the authority to put a product launch on hold when they judge it necessary for investor protection. Products whose investment risk has grown materially since their original approval — due to changes in market conditions or other factors — will be required to undergo a fresh review.

Controls at the product design stage will also be tightened. Securities firms will be required to complete a consumer protection checklist when designing a product and to verify whether it is substantially identical to an already-approved product. Firms must establish operating standards and management frameworks for underlying assets to screen for concentration in specific securities and potential risk factors in advance, and any change to an underlying asset will require approval committee review.

The change investors will feel most directly involves early warnings. The FSS will require that investors receive a one-time advance notification when the underlying asset price of a high-risk ELS comes within 10 percentage points of the knock-in barrier. If an early redemption is delayed, investors will also be informed that mid-term redemption is available and told how to exercise it. The measure is designed to help investors decide for themselves — in a deteriorating risk environment — whether to continue holding a product or opt for early redemption.

Post-sale management will be strengthened as well. Prospectuses will be required to disclose notes on derivative-linked bonds alongside annualized and actual returns, and investors will be able to easily check whether the underlying asset has reached its highest or lowest price and review key options. The self-assessment cycle for high-risk products will be shortened from once a year to once a quarter, and the FSS plans to systematize management of unsuitable sales by factoring in distribution channels and whether the buyer is elderly. The FSS intends to revise the Korea Financial Investment Association's self-regulatory rules in September for incorporation into each firm's internal regulations, and plans to build an ELS knock-in proximity alert system before the end of the year.

The reforms follow the large-scale losses tied to Hong Kong H-index ELS products, which exposed gaps in selling firms' internal controls and consumer protection frameworks. A sharp drop in the Hong Kong H-index turned principal losses into reality, fueling widespread allegations of mis-selling centered on elderly investors, and financial regulators concluded that some firms' internal controls and consumer protection systems had been inadequate. The FSS said it intends to overhaul the management framework across the entire product lifecycle — from design through sales to post-sale management — to prevent a recurrence.


kacew@heraldcorp.com