Knock-in ELS sold as a deposit to a retiree
Kim, a 68-year-old retiree, invested 200 million KRW-about 80% of her retirement savings-in a three-year equity-linked securities (ELS) issued by a bank. The note pays a 6.0% annual coupon if the Euro Stoxx 50 is at or above 95% of its initial level on any semiannual observation date, and returns principal plus accrued coupon at maturity if the index is at or above 85%. A 55% knock-in barrier is observed daily. If the index ever closes below 55% and finishes between 55% and 85%, the investor receives principal with no coupon; if it finishes below 55%, the redemption amount is principal × (final index / initial index). The bank’s brochure shows “6% expected return” and “principal protection.” The index closed at 52% of its initial level at maturity, and had closed at 49% earlier. Kim says the salesperson called it “a deposit.” The bank’s product committee approved the sale to retail clients without a concentration limit.
1. Compute Kim's redemption amount at a final index level of 52% and explain how the payoff would differ at 80% and 86%.
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Payoff at final index 52%. The 55% knock-in was breached (the index closed at 49% earlier), and the final level is below 55%. Under the stated formula, redemption = 200 million × (52/100) = 104 million KRW. The investor loses 96 million KRW, or 48% of principal, and receives no coupon. The earlier 49% close does not change the final formula, but it confirms the knock-in.
If the final level were 80%, the result would differ: the index finished between 55% and 85%, and a knock-in had occurred, so the investor would receive principal of 200 million KRW with no coupon. If the final level were 86% and the knock-in had occurred, the investor would receive principal plus the accrued coupon (6% per year for three years, i.e., 18% simple, or 236 million KRW, assuming no compounding). The brochure's “6% expected return” is therefore conditional, not a promised return. The phrase “principal protection” is false for a knock-in ELS: principal is exposed once the barrier is breached.
2. Assess the bank's suitability, explanation, and product-governance conduct in this sale.
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Conduct assessment. The sale has three linked problems. First, concentration: 200 million KRW was about 80% of retirement savings in a single three-year note with daily knock-in observation. That is unsuitable for a retiree who may need liquidity, even if she signed a risk acknowledgement. Second, disclosure: calling the note “a deposit” misstates the product's legal nature and the absence of deposit insurance. Third, product governance: the committee approved retail sales without a concentration limit or elderly-client safeguard.
The bank must show that it explained the knock-in, the daily observation, the 55% loss threshold, and the possibility of losing principal. A signed form is not conclusive if the sales process contradicted it. The client's reliance on “deposit” language is central to causation. The bank should preserve the brochure, the sales script, the call recording, the KYC file, and the product approval minutes. The fact that the index had already closed at 49% before maturity also matters for any later communication: did the bank inform the client of the knock-in event?
3. What remedies and controls should follow? Distinguish automatic compensation from a case-specific mis-selling analysis.
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Remedies and controls. The client should file a complaint; if the bank's review does not resolve it, she can seek mediation. Compensation is not automatic, but a false “deposit” statement plus an 80% concentration creates a strong mis-selling claim. The bank should calculate the loss relative to a suitable alternative, not simply refund the full loss. It should also review all other clients sold the same note, especially elderly clients and those above a concentration threshold.
Controls: require a documented suitability score and a separate high-risk approval for clients over 65; set a maximum percentage of liquid retirement assets in structured notes; ban “deposit” and “principal protection” language unless the product is a deposit or has a genuine principal guarantee; record all sales calls; require a cooling-off period; and stress-test the note under a 50% index decline. The product committee should document why the barrier and concentration were appropriate for retail clients. Supervisors should test whether the sales incentive rewarded volume without suitability checks.