[Edaily Marketin Reporter KIM YEON-SEO ] Amid allegations of improper sales of JTBC corporate bonds, some observers are calling for higher barriers to entry in the sub-investment-grade corporate bond market. However, corporate bond market experts unanimously agreed that regulating issuance itself could only stifle funding for sub-investment-grade companies and reduce market liquidity, and that investor protection should instead be strengthened at the sales stage.

According to the financial investment industry on the 7th, controversy over the mis-selling of JTBC bonds is spreading, centered on whether investor protection mechanisms functioned properly during the sale of the bonds to retail investors. The joint legal team representing victims of Joongang Group’s bond issuance has raised allegations that, although JTBC was effectively in a state of complete capital impairment at the time of the bond issuance, the lead underwriter and the selling firm sold the product without adequately disclosing the risks.

In light of this controversy, there are calls to tighten the requirements for corporate bond issuance—such as reinstating the net asset value threshold that was in place before the Commercial Act was amended—to ensure that issuers’ financial conditions and repayment capabilities are scrutinized more rigorously.

In fact, prior to the 2012 amendment to the Commercial Act, Article 470 of the former Commercial Act stipulated that the total amount of corporate bonds issued could not exceed four times the net assets shown on the final balance sheet. Consequently, companies with eroded net assets faced significant restrictions on issuing corporate bonds, and it was virtually impossible for companies in a state of complete capital impairment to issue new corporate bonds. However, with the implementation of the amended Commercial Act in 2012, this provision was abolished, shifting the structure so that corporate bond issuance limits are determined not by statutory restrictions but by market credit ratings and investor demand.

High Reliance on Sub-Investment-Grade Bonds and Retail Investors… “Concerns Over Market Contraction if Regulations Are Tightened”

Corporate bond market experts have advised that any move to reimpose stricter regulations on corporate bond issuance should be approached with caution. This stems from concerns that tightening issuance regulations, as was done in the past, could simultaneously constrain the ability of low-credit-rated companies to raise funds and reduce market liquidity.

A credit bond analyst at a securities firm, who requested anonymity, stated, “The financial market can only develop if a funding market for non-investment-grade companies is established,” adding, “If issuance is significantly restricted simply because a credit issue has occurred, the polarization in funding between investment-grade and non-investment-grade companies will become even more severe.”

He continued, “Restricting corporate bond issuance for companies with debt-to-equity ratios above a certain threshold will reduce funding channels for non-investment-grade companies and make it harder for them to access capital markets,” emphasizing, “Given the lack of secondary market trading for low-rated bonds, the approach should focus on thoroughly managing disclosures and investment warnings rather than blocking retail demand.”

Sub-investment-grade bonds are structured such that issuers bear higher interest rates, while investors accept the associated credit risk in exchange for higher returns. Consequently, the market view is that it is difficult to apply separate issuance restrictions or special regulatory measures exclusively to sub-investment-grade bonds based solely on the insolvency of individual companies.

Kim Sang-man, an analyst at Hana Securities, said, “It is difficult to prevent corporate bond issuance at its source,” explaining, “High-risk companies issue bonds with low credit ratings and high interest rates, while investors expect high returns in exchange for assuming the risk.”

Kim explained, “In the U.S., a high-yield (speculative-grade bond) market has been established covering ratings from Double-B to Single-B and Triple-C,” adding, “While issuance becomes more difficult and higher interest rates must be offered as the debt-to-equity ratio increases, whether an issuance ultimately takes place is determined by the interplay between interest rates and investor demand.”

“Adequate Explanation Needed on the Risks of Investing in High-Interest, Low-Credit-Rated Corporate Bonds”

However, for the market to function according to its own principles, it is essential that the risks of the product be fully explained to investors. In particular, it has been pointed out that when selling corporate bonds to individual investors through mobile trading systems (MTS) or home trading systems (HTS), issuers must clearly disclose the potential for principal loss due to credit rating downgrades and default, as well as the risks associated with low priority in repayment and liquidity.

Consequently, a key point of contention has emerged: whether the losses incurred by JTBC bond investors should be viewed as “damages” resulting from a breach of the duty to explain during the sales process, or as “investment losses” stemming from the investors’ acceptance of credit risk. The argument is that if evidence of mis-selling is confirmed, the selling firm should be held liable; however, if investors made their decisions after receiving sufficient explanations, they should bear the risk of loss inherent in high-interest-rate investments.

A bond market official stated, “While we cannot rule out the possibility of mis-selling regarding the JTBC bonds, whether investors can prove this specifically is a separate issue,” adding, “It is also possible that they made an optimistic investment decision based on the high interest rates and the Central Group’s reputation.”

The official continued, “In the absence of clear evidence supporting mis-selling, investment losses should, in principle, be borne by the investor,” adding, “In particular, since hybrid capital securities—though classified as bonds—are recognized as equity and have a lower priority in repayment, investors must accurately understand the product’s structure and risks.”

In the market, an alternative being discussed is to implement pre-sale education and investor comprehension verification procedures for corporate bonds rated BBB or lower and hybrid capital securities, rather than blocking their issuance. This approach would involve standardizing the display of information on sales screens—such as whether the issuer has negative equity, its priority in repayment, credit rating changes, and liquidity risks—and immediately notifying holders in the event of a credit event.

An official in the financial investment industry stated, “Rather than imposing blanket restrictions on the issuance of or investment in non-investment-grade bonds, the priority should be to fully disclose the risks and potential for loss associated with these products,” adding, “Sales procedures must be revised so that investors can make informed decisions based on disclosed information.”