Financial authorities have put the brakes on the practice of "captive sales," which mobilizes affiliates and in-house departments during corporate bond issuance. They judged that internal controls failed to function properly as independence between the underwriting department and the trading department was undermined.
According to the securities industry on the 21st, the Financial Supervisory Service issued four "management cautions" each on the 7th to six major securities firms, including Samsung Securities, Mirae Asset Securities, NH Investment & Securities, Korea Investment & Securities Co., KB Securities, and Shinhan Investment & Securities.
A representative reason cited for the sanctions on the securities firms was "captive sales." Captive sales is a method in which a securities firm secures underwriting mandates by mobilizing internal investors—such as its bond trading department or affiliates—to promise participation in book building. It artificially boosts demand to lower the issuance yield, and losses incurred during the bond underwriting process are then covered through allocation of underwriting fees or internal profit-and-loss adjustments.
The Financial Supervisory Service (FSS) judged that these acts damaged the "Chinese wall (information barrier)" between the underwriting (IB) department and the trading department. Accordingly, since last year it has been conducting audits focused on large securities firms with high market shares in corporate bond underwriting.
First, NH Investment & Securities was found to have the IB department cover losses of the bond sales department that took part in book building. Shinhan and Korea Investment & Securities Co. paid part of the IB department's underwriting fees to the bond trading and retail departments. KB and Shinhan Investment & Securities were found to have reviewed setting separate "special limits (such as strategy books)" so in-house departments could actively participate in book building.
The Financial Supervisory Service (FSS) called on the securities firms to strengthen independence between departments and to make sure information barriers function in practice. In particular, it ordered them to stop operating separate limits for managing corporate bonds they underwrite or acquire themselves, and to stop internally adjusting fees and trading P&L between departments. It also urged them to reinforce post-management by updating work manuals and internal control standards and systematically preserving related records.