The Financial Supervisory Service (FSS) is overhauling its investor protection system for derivative-linked products to prevent a recurrence of the significant losses associated with Hong Kong's H-index equity-linked securities (ELS). The key changes include stricter criteria for selecting underlying assets during the product design phase and advance notifications to investors when the price of these assets approaches a loss threshold, allowing them to consider early redemption.
On August 5, the FSS unveiled its 'Improvement Plan for Investor Protection in Derivative-linked Products' during a meeting with executives from the Korea Financial Investment Association and ten major securities firms.
This plan is based on discussions from a task force (TF) operated by the FSS, the Financial Investment Association, and major securities firms from March to June. With the recent increase in the issuance of derivative-linked products and heightened volatility in domestic and international stock markets, the focus is on enhancing the self-responsibility of securities firms from product design to sales and post-management.
The most significant change involves establishing a new management system for underlying assets during the product design phase.
Going forward, securities firms will be required to create operational standards for underlying assets and establish a 'pool' of these assets. The underlying assets included in products will be selected from this pool, taking into account the characteristics of the products and market conditions. The operational standards will also include criteria for restricting the use of specific assets.
Additionally, the product design process will mandate the creation of a checklist. The manufacturing department must assess the recent volatility and price trends of the underlying assets, as well as any concentration on specific individual stocks. Even for the reissuance of previously approved products, potential new risk factors must be re-evaluated.
The authority of the product approval committee will also be strengthened. Consumer protection, compliance monitoring, and sales departments will be mandatory members, and the Chief Consumer Protection Officer (CCO) will have the authority to delay product launches if investor protection is deemed necessary. Any new selection or changes to the underlying asset pool will also require approval from the committee.
Post-investment management will see significant enhancements.
For high-risk ELS, if the price of the underlying asset approaches the knock-in barrier within 10 percentage points, investors will receive a 'knock-in proximity alert' for the first time. Previously, investors often missed the opportunity to respond to potential losses because they were unaware of the risks until the knock-in was reached.
The FSS expects that this alert will enable investors to make more informed decisions about whether to hold onto the product or opt for early redemption.
If early redemption is delayed or fails, securities firms must inform investors about the possibility of early redemption and the application process. Furthermore, investors who realize profits through early or maturity redemption will be separately informed of the risks associated with changes in underlying assets and market conditions to prevent automatic reinvestment in the same product.
Product explanatory materials will also be improved for better investor understanding. Warnings regarding derivative-linked bond investments will be prominently displayed, and both annualized returns and actual returns will be indicated. Information on whether the underlying assets have reached their highest or lowest prices, as well as key options like issuer calls, will be summarized for easier access.
Internal controls at securities firms will be strengthened. The self-inspection cycle for high-risk products will be reduced from once a year to once a quarter, and board reports will increase from once a year to twice a year. A management ratio for unsuitable sales, considering factors like sales channels and elderly customers, will also be systematically established.
The FSS plans to revise the self-regulatory rules of the Financial Investment Association in September to reflect these changes in each securities firm's internal regulations and to complete system improvements, including the knock-in proximity alert, by the end of the year through close communication with the Financial Investment Association and securities firms.
* This article has been translated by AI.
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