Hong Kong ELS turmoil Unfolds: Escalating Damages Surge Like an Avalanche

Three years ago, Kang Jong Hyun, 62, visited a major commercial bank with the intention of utilising the retirement savings he had accumulated through a lifetime of dedicated work. Drawing on decades of experience, he is striving to formulate an investment plan for a better old age life.

In an interaction with a banker, he revealed that despite clearly expressing a preference for safe investments, he was advised to consider Equity Linked Securities products linked to the performance of the Hang Seng China Enterprises Index.

"I told the banker I dislike risky investments like funds and prefer something safe," Kang said.  However, influenced by the banker's recommendation, he subscribed to ELS instead of opting for regular interest-bearing deposits. 

"The banker assured me this product was not risky and similar to a deposit. I fell into this situation simply because I trusted the bank. I can't even tell my family, and I can't sleep at night," Kang said.

According to the Financial Supervisory Service's investigation in January, three out of 10 bank ELS investors are 65 or older and often need help comprehending the complex structure of derivative products. Furthermore, 1 out of every 10 investors were first-time subscribers, indicating a need for familiarity with such financial instruments. 

The criterion for considering bank investors as elderly is set at 65 in South Korea, emphasising the heightened responsibility to exercise caution when advising and recommending investments to these senior individuals.

As of November 2023, the total volume of Hong Kong index-linked ELS products sold to investors amounted to 19.3 trillion KRW (around HK$ 11.3 billion). Among them, about 82.1% were sold by banks, according to the Financial Services Commission of South Korea.

As a derivative, the ELS product linked to HSCEI aims to pay customers with a fixed return based on the performance of the HSCEI.

If the HSCEI stays above a set level until maturity, investors are promised to earn the return; otherwise, they will lose the principal.

If the market falls sharply, investors will inevitably suffer losses, said Jason Huang, 44, a private equity fund manager who has worked in the financial industry for decades.

The weak performance of HSCEI occurred amid a slowing economy in mainland China.

“Although Hong Kong's stock market is relatively affected by the global economy as the capital structure is rich in sources, mainland China’s economic policies and circumstances have had a more significant impact as the proportion of mainland Chinese enterprises in the Hong Kong stock market has gradually increased these years,” Huang said.

Since 2021, mainland Chinese stock has suffered a sharp decline, which is the same time that the HSCEI decreased.

“The Shanghai Composite Index has fallen by more than 20%,” said Huang. "Similarly, it is normal that the Hang Seng China Enterprises Index also showed a large decline.”

Despite repeated claims by bankers about the reliability of Equity Linked Securities, the ongoing disputes over the ‘incomplete contract’ (a contractual agreement that lacks specificity or leaves certain terms open to interpretation, often leading to disagreements between involved parties) of HSCEI-based ELS have raised serious concerns and resulted in growing financial losses.

Investors who have been affected by these circumstances are actively engaging in collective actions, including organising protests.

One such investor, Park Jiyoung, 26, invested in equity-linked securities tied to the performance of the HSCEI.

Despite lacking a clear understanding of the distinction between a standard deposit and an ELS product, she proceeded to sign the contract by the banker’s persuasion. However, after three years, her investment incurred a staggering loss rate exceeding 50%. An analysis of her investment appetite revealed that ELS products were deemed "unsuitable."

"I believed I was entering into an investment similar to a regular deposit, but when reality hit, half of my funds had vanished. For someone like me who has recently started working, this money is too substantial,” she said.

However, Aaron Lee, 26, who works at one of the main banks in South Korea, argues that the responsibility for the ELS situation does not solely lie with the bank.

 "The proportion of customers encountering ELS products for the first time is quite low, and our bank-supplied ELS products have a track record of not incurring losses. Moreover, customers themselves directly completed the contracts. It is unfair to hold the seller accountable when individuals, as financial decision-makers, incur losses," said the banking official. 

This viewpoint emphasises the disagreement between financial institutions and investors regarding who should be held accountable for the losses resulting from ELS investments. The ongoing controversy has highlighted the importance of thoroughly evaluating sales practices, educating customers, and implementing regulatory measures in the financial sector.

South Korea’s Financial Supervisory Service is conducting on-site inspections of major Equity Linked Securities sellers. The procedure for proving incomplete contracts is set to commence at once. 

Meanwhile, at the National Security Council's full committee meeting on January 29, Financial Supervisory Service director Lee Bok-hyun pledged to launch an investigation into the losses related to Hong Kong H-Index ELS in the first half of the year.

 "It is true that it is a structure that requires detailed explanation unless you are familiar with derivatives. We have been monitoring the situation since last year, and inspections are ongoing, including examining head office sales policies and branch sales performance," Lee said.

Examining the quarterly breakdown, 10.2 trillion KRW (around HK$ 60.2 billion), or 52.7% of the maturity, is concentrated in the first half of 2024, with 3.9 trillion KRW (around HK$ 23 billion) in the 1st quarter and 6.3 trillion KRW (HK$ 37.2 billion) in the 2nd quarter. The Financial Supervisory Service said it is imperative to establish compensation criteria to minimise investor losses swiftly. 

As for measures to prevent a recurrence, "we expect to consider further regulatory considerations following the inspections," Lee said.