CJ used derivative financial instruments in an attempt to rescue its struggling subsidiary but was caught by the Fair Trade Commission and fined 6.5 billion won. CJ acquired 65 billion won worth of perpetual convertible bonds (CB) issued by the struggling subsidiary through a roundabout method along with CGV. The Fair Trade Commission determined that this behavior supported an affiliated company that had difficulty raising funds and restricted competition in the market.
On the 16th, the Fair Trade Commission announced that CJ and CGV had used total return swap (TRS) contracts as credit enhancement and payment guarantee instruments to support CJ Construction (now CJ Logistics) and Simulain (now CJ 4D Flex) in issuing perpetual CBs at a low interest rate. It then ordered corrective action and imposed a penalty surcharge of 6.541 billion won on the four companies.
A total return swap (TRS) is a transaction in which counterparties exchange cash flows promised in advance, such as capital gains or interest from underlying assets. A perpetual CB is a bond that can be extended indefinitely while providing the right to convert into stock.
According to the Fair Trade Commission, CJ and CGV entered into a TRS contract with financial companies on the condition that they would acquire perpetual CBs worth 65 billion won issued by CJ Construction and Simulain. The financial company bought the perpetual CBs of CJ Construction and Simulain, and CJ and CGV entered into the respective TRS contract. As a result, the financial company transferred the risk of loss associated with the acquisition of the perpetual CBs to CJ and CGV. The Fair Trade Commission concluded that this act effectively turned the TRS contract into a means of credit enhancement and payment guarantee.
The TRS contract may have been entered into with the expectation that the value of the perpetual CBs issued by CJ Construction and Simulain would rise in the future. However, the Fair Trade Commission noted that during the TRS contract period, the financial company was restricted from converting the perpetual CBs into stock and that CJ and CGV had no intention of realizing their profits. The Fair Trade Commission concluded that CJ and CGV only assumed the credit risk of the perpetual CBs through the TRS contract. The TRS contract allowed CJ Construction and Simulain to save 5.281 billion won in funding costs.
At that time, there were objections within the CJ board that the TRS contract constituted a guarantee for struggling subsidiaries and was a betrayal of trust. Concerns were also raised regarding the potential losses arising from the bankruptcy or repayment incapacity of CJ Construction and Simulain, leading to the rejection of the agenda once.
The Fair Trade Commission stated, "As a result of the support actions of CJ and CGV, CJ Construction and Simulain secured significantly favorable competitive conditions compared to competitors, hindering fair transaction order in the comprehensive construction and 4D cinema equipment supply markets." It further noted, "CJ Construction artificially improved its financial structure and avoided the credit rating crisis," adding, "Simulain also avoided the risk of market exit and excluded potential competing businesses."
However, the Fair Trade Commission deemed that CJ's entry into a TRS contract regarding 50 billion won worth of perpetual CBs from CJ Foodville, under the same structure, was not a legal violation. The commission found it difficult to judge whether the actual issuance interest rate was significantly favorable compared to normal rates or whether internal funding was impossible at the time of the support action.
Choi, the Fair Trade Commission's Corporations Monitoring Bureau Director, stated, "This is a case where actions that concealed the fact that the company was essentially providing credit enhancement and payment guarantees to its affiliates as derivative investment products were sanctioned." He added, "It is significant in confirming that even if a financial product appears to be normal in form, it may constitute a legal violation if it is abused as a means of supporting specific affiliates."
CJ stated, "The TRS is a legitimate financial product chosen by many corporations as an alternative to paid-in capital increases," adding, "We are concerned that sanctions against it could negatively impact the capital market and corporate management." CJ plans to review future response measures, including filing an administrative lawsuit after receiving the Fair Trade Commission's decision document.