A screen shows the Hang Seng China Enterprises Index at Exchange Square, Hong Kong, August 18. Reuters-Yonhap
Banks may face series of lawsuits from individual investors
By Lee Yeon-woo
A 58-year-old man, surnamed Kang, recently filed a complaint with the Financial Supervisory Service (FSS) as he faces the risk of losing half his assets after investing in equity-linked securities (ELS) tied to the performance of the Hang Seng China Enterprises Index (HSCEI).
Kang contends that the bank recommended high-risk financial products without properly assessing his asset status, and that he was not provided with any documentation while receiving only brief explanations about the products for only 10 minutes. Additionally, he claims that the bank did not try to contact him despite substantial fluctuations in the index over this period.
"My retirement funds are like my life itself. I don't even have hope to make interest payments. I wish to recover at least my principal," Kang said.
A significant number of others facing similar losses are also coming forward. They accuse banks of misleadingly claiming that the product is safe "unless Hong Kong perishes," and recommending it to elderly customers who are unfamiliar with the basic concepts.
An ELS is a type of fixed-income financial instrument that derives its investment returns based on the performance of certain equities, such as stock indexes or a group of selected stocks. A principal loss is expected if the index falls by 35 percent to 55 percent at expiration.
The ELS product in question is derived from a selection of 50 companies among Chinese firms listed on the Hong Kong Stock Exchange. This encompasses numerous prominent enterprises, including Tencent Holdings, Alibaba Group and Xiaomi.
A man waves the Chinese flag in Hong Kong in this July 2022 file photo to celebrate the 25th anniversary of the city's handover from Britain to China. AFP-Yonhap
Although ELS is a high-risk derivative product, it gained popularity among investors during periods of low interest rates. Particularly with index-based ELS products, there were hardly any long-term losses until the pandemic. The returns were also 1 to 2 percentage points higher than savings deposit rates, attracting wealthy investors as well as retirees to invest substantial amounts.
"During periods of low stock volatility, consumers may have perceived knock-in ELS products — which offer higher interest rates and a shorter maturity period — as akin to a high-interest deposits," an official from the banking industry said.
However, the investment risk associated with ELS products increased dramatically as the global stock market plunged, driven by rising interest rates and China's economic recession.
Most of the three-year-maturity ELS products were sold in 2021, when the index peaked at around 12,000 points. Since then, the index has halved to about 6,000 points as of the end of November.
Derivatives worth over 8.4 trillion won ($6.4 billion), sold by the country’s top five lenders — KB Kookmin, Shinhan, Hana, Woori and NongHyup — are set to reach maturity by next June. Among these banks, KB Kookmin has the largest share, accounting for over half of the total.
The combined losses of investors are projected to reach 3 trillion won in the first half of next year, if the index fails to rebound by the time of maturity.
Should the losses escalate, the likelihood of class-action lawsuits against banks and brokerages becomes substantial.
Currency traders watch monitors at the foreign exchange dealing room of Hana Bank headquarters in Seoul, Nov. 10. AP-Yonhap
Following these concerns, the FSS has launched a comprehensive investigation to determine whether the involved banks and brokerages sold the products irresponsibly.
"There are significant concerns about the suitability of selling these complex, high-risk derivative products to elderly clients. We will investigate this issue thoroughly," FSS Governor Lee Bok-hyun said during a National Assembly meeting last month.
The issue is particularly concerning to the country's top lenders. They are facing a rapid increase in non-performing loans, where neither principal repayments nor interest payments are being made, along with a rise in delinquency rates. Market watchers anticipate that such economic ripple effects will occur primarily in the first half of 2024.
Furthermore, the pressure from financial authorities on these lenders to pursue "mutual growth" with the public could intensify, incurring further losses.
However, banks claim that there is hardly any possibility of mis-selling.
They argue that, following past crises, such as Lime funds, financial regulations have been tightened. In this case, banks say they have taken steps to ensure thorough sales practices, such as recording sales processes and verifying customers' understanding of potential principal loss risks through either handwritten signatures or audio recordings.
"It's important to distinguish between damages and financial losses among fund customers. If lenders mismanage funds, as was seen in the cases of Lime and Optimus, these are damages. However, if a product like ELS is sold and managed properly, it should be considered a financial loss, not damages. The ultimate responsibility for financial investment rests with the investors themselves," an official from the banking industry said.
