KFTC’s Notification on Illegal Use of Derivatives as Debt Guarantees

On April 23, 2025, the Korea Fair Trade Commission (the “KFTC”) issued the “Notification on Designation of Types of Illegal Conduct Applicable to Business Groups Subject to Cross-Investment Restrictions and Related Criteria” (the “Notification”), which specifies the types of illegal uses of derivatives as debt guarantees, as well as their assessment criteria.

The purpose of the Notification is to enhance the effectiveness of the Debt Guarantee Restriction System^[1]under the Monopoly Regulation and Fair Trade Act (the “MRFTA”) by preventing business groups subject to cross-investment restrictions (“Relevant Business Groups”) from misusing derivatives (e.g., Total Return Swaps (“TRS”)^[2]) as a means of debt guarantees between affiliates.

The key details of the Notification are as follows:

Assessment Criteria for Illegal Use of Derivative Products as Debt Guarantees

According to the Notification, if a company that is part of a Relevant Business Group – whose underlying assets (e.g., debt securities) are issued by another domestic affiliate within the same group – trades derivatives with a financial institution, such activity has practically the same effect as providing debt guarantees to the other domestic affiliate. Accordingly, it would be deemed illegal.

The existence of a practical debt guarantee effect will be determined for derivatives based on the following three underlying assets that are subject to the Notification:

TRS with debt securities (e.g., corporate bonds, convertible bonds) as the underlying asset;
Credit-linked securities (i.e., securities that transfer a certain company’s credit risk, such as default on debt, in exchange for financial payments) as the underlying asset; and
Credit Default Swaps (“CDS”) (i.e., contracts to transfer a certain company’s risk of full default on debt (e.g., due to bankruptcy or insolvency) in exchange for financial payments) as the underlying asset.

More specifically, the KFTC’s position is that the transfer of only credit risk (changes in the value of underlying assets due to changes in the creditworthiness of the underlying assets, such as corporate credit ratings) – rather than the transfer of market risk arising from the underlying assets (changes in the value of underlying assets due to changes in market conditions) – has practically the same effect as debt guarantees. Thus, such transactions would be deemed an illegal use of derivative products as debt guarantees.

Meanwhile, considering that Relevant Business Groups sometimes indirectly trade the above mentioned derivatives with financial institutions through special purpose vehicles established by financial institutions, the Notification covers both financial institutions and special purpose vehicles they established as relevant transaction parties.

Specific Examples of Acceptable Uses and Illegal Uses of Derivative Products as Debt Guarantees

To provide predictability for companies, the Notification also provides specific examples of both acceptable and illegal uses of derivatives as debt guarantees.

The illegal uses of derivatives regulated under the Notification are as follows: (i) when an affiliate within a Relevant Business Group purchases TRS with bonds (e.g., corporate bonds, convertible/exchangeable bonds) issued by another affiliate of the same Relevant Business Group as underlying assets from a special purpose company established by a financial institution, and (ii) when a financial institution obtains bonds issued by an affiliate within a Relevant Business Group, and another affiliate of the same group purchases derivatives that compensate for the former affiliate’s default on debt (e.g., due to bankruptcy) from the financial institution.

However, for example (i) mentioned above, the Notification provides exceptions in the following cases, where the substance of the underlying assets is deemed to have been converted from debt securities to equity securities: (a) when convertible bonds (the underlying assets) have been, or will definitely be, converted into shares prior to the maturity date under the derivative contracts, or (b) when convertible perpetual bonds (the underlying assets) have been, or will definitely be, converted into shares on the early redemption date under the derivative contracts.

Following a one-year grace period, the Notification will take effect on April 24, 2026, and will apply to transactions involving derivatives (including TRS) based on contracts executed after the effective date.

Through the Notification, the KFTC intends to proactively prevent the use of derivative products as a means to circumvent debt guarantee restrictions under the MRFTA. Therefore, affiliates within Relevant Business Groups planning derivatives-related transactions among themselves will need to pay close attention to the scope and details of the Notification.

For more details, please refer to the full text of the Korean version of the Notification (Link).

^[1] According to Article 24 of the MRFTA, a domestic company belonging to a Relevant Business Group is prohibited from providing guarantees to another domestic affiliate belonging to the same group in connection with credit (loan, guarantee or assumption of company debts) provided by a domestic financial institution.
^[2] A TRS is a type of derivative, which is a contract under which a party exchanges the total profit generated from an underlying asset for a certain agreed-upon interest at regular intervals.

[Korean Version]

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