The Fair Trade Commission has taken action against total return swap (TRS) contracts, which large corporations often use to help finance struggling subsidiaries. A TRS is a type of derivative financial product where a creditworthy affiliate indirectly aids the financing of a distressed affiliate. The structure of the TRS varies depending on how the contract is formed, and some methods are deemed to violate current laws, according to the Fair Trade Commission.
According to the Fair Trade Commission on the 28th, the commission has begun a thorough review of transactions that involve support for affiliates in indirect ways, such as total return swaps (TRS). The Fair Trade Commission plans to examine other large corporations that have provided affiliate support in similar ways, starting with the CJ Group case.
Recently, the Fair Trade Commission imposed a penalty surcharge of about 6.5 billion won on CJ Group for violating the Monopoly Regulation and Fair Trade Act with its TRS. CJ and CGV entered into a TRS contract with Hana Securities based on convertible bonds (CB) of CJ Construction (now CJ Logistics) and Simulain (now CJ 4Dplex), which were in a state of capital erosion. The Fair Trade Commission concluded that CJ Group's TRS contract exceeded the common level of TRS contracts entered into by other large corporations.
◇ If interest expense was significantly reduced compared to when there was no TRS, it is considered indirect support
What was the issue? The legality of a TRS is determined based on the difference between the normal interest rate and the actual issuance rate. The Fair Trade Commission explained that if the actual interest expense is significantly reduced through funding via a TRS contract, it may qualify as "unfair support."
For example, CJ Construction and Simulain were able to raise funds at lower interest rates than normal market rates thanks to the TRS, resulting in savings of tens of billions of won in interest expense. However, the Fair Trade Commission determined that CJ's TRS contract for 50 billion won of perpetual CBs from CJ Foodville was not a violation, as it was unclear if the actual issuance rate was more favorable than the "normal interest rate."
During the first investigation, the Fair Trade Commission viewed the normal interest rate as 'market reference rate + additional charge', and based on this standard, the amount saved by CJ Group was more than 5.2 billion won. However, in the final determination, the commission excluded the "additional charge" as excessive and only applied the market reference rate. Consequently, the interest savings effect was reduced, and the legal violation judgment was also adjusted conservatively.
A Fair Trade Commission official noted, "The decision not to include the additional charge in the normal interest rate follows past cases," and explained, "In the case of Hyosung Investment & Development, which provided unfair support to a personal company, the additional charge was not considered when determining the issuance rate, reflecting real estate collateral loan rates."
◇ If a guarantee was provided without charging a fee, it constitutes unfair support
Another key criterion for evaluating TRS contracts is the presence of guarantee fees between affiliates. If the credit-providing affiliate did not receive a legitimate compensation, it qualifies as "free support," according to the Fair Trade Commission. In the future, if companies with TRS contracts do not exchange guarantee fees, the Fair Trade Commission plans to consider it a legal violation.
In 2014, Korean Air entered into a TRS contract based on a 196 billion won exchange bond (EB) of Hanjin Shipping, receiving a fee of 1.5% of the par value (about 3 billion won). While a certain compensation typically accompanies standard transactions, CJ and CGV did not receive any guarantee fees from CJ Construction and Simulain.
In response, CJ and CGV stated, "We had no involvement in the TRS structure," adding that "the securities firm devised it independently." However, industry insiders counter that "securities firms do not typically conceive fee transactions," with one security firm official saying, "It is rare to offer free guarantees unless there is a relationship between a parent company and a subsidiary," stating that the CJ and CGV case is different from standard TRS contracts.
There are also similar precedents. In 2018, Hyosung Group processed 25 billion won worth of convertible bonds of its affiliate Gallaxia Electronics through a TRS contract with a financial company, but the company was imposed a penalty surcharge of 2.987 billion won for not charging fees. Hyosung claimed it was "a reasonable investment," but the Supreme Court sided with the Fair Trade Commission in 2022.
A Fair Trade Commission official commented, "If there are issues with TRS being interpreted as (indirect guarantees) in other companies, we will look into it," adding that "there are no legal concerns if transactions are conducted in a normal manner."
As the Fair Trade Commission judges the illegality of TRS contracts based on the presence of guarantee fees, there is also a possibility that issues surrounding the appropriate scale of fees may arise in the future. For example, there could be companies that try to evade responsibility by paying an absurdly small amount, such as 10,000 won, in exchange for guarantee fees.
The Fair Trade Commission has not yet established clear criteria regarding fees. A Fair Trade Commission official stated, "There can be discussions about whether the (guarantee) fee amount is appropriate," noting that "not receiving any compensation is certainly an issue."
Meanwhile, the Fair Trade Commission did not impose sanctions on Hana Securities, which designed the TRS structure. This is because the subjects of punishment under the Fair Trade Act are limited to 'the recipient of assistance,' 'the provider of assistance,' and 'the person who instructed this.' If Hana Securities did not instruct (teach) CJ and CGV to provide guarantees, it is not subject to punishment.
During the investigation process, both CJ and CGV stated that each proposed the TRS structure first to Hana Securities. The Fair Trade Commission concluded that "there is no evidence of direct instruction" and found that "Hana Securities' statements are more credible."