July 13, 2020

Brokerages on risky structured bets to take quick breather

PUBLISHED : March 25, 2020 - 16:35

UPDATED : March 25, 2020 - 16:40

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South Korea‘s brokerage houses are expected to take a breather from financial woes, triggered by the recent rout in risky structured products that placed their heavy bets on foreign stock benchmark indexes. With parts of policy prescriptions to cure financial markets hit hard by the novel coronavirus across the board, local brokerage houses suffering liquidity crises are expected to heave a sigh of relief.

The financial authorities on March 24 vowed to inject 5 trillion won ($4.1 billion) to help securities firms deal with the stress, as part of a package of 100 trillion won. Under the measure, the Bank of Korea’s 2.5 trillion won will be used to issue short-term bonds like repurchase agreements, while the rest will be used for loans.

Analysts said the “beyond-expectations” measure will remove the imminent financial strain.

“The measure has reaffirmed (the government‘s) willingness to stabilize the domestic short-term money market,” Han Kwang-yeol, an analyst at NH Investment & Securities, wrote in a note Wednesday.

Securities firms’ exposure to illiquidity stems from their risk-hedging efforts in structured investments tied to foreign assets, mostly foreign stock indexes that were considered safer than those of emerging markets before the coronavirus outbreak.

In a calm market, such structured products, including equity-linked securities, act like safe assets that deliver moderate gains.

Backed by investor appetite for higher yield, the annual issuance of equity-linked securities and equity-linked bonds rose 28.4 percent to 99.9 trillion won in two years to 2019, according to data from the Korea Financial Investment Association. Throughout, those tracking foreign stock indexes accounted for over 70 percent.

The risks in the instruments, however, came into the limelight as their underlying indexes in Europe and the United States are seeing severe fluctuations due to coronavirus fears.

Eurostoxx 50 -- one of the most favored assets tied to the structured products according to the Korea Securities Depository -- fell 24 percent over the past month through Tuesday.

The S&P 500 and Hong Kong‘s Hang Seng China Enterprises Index slid 21.8 percent and 13.2 percent, respectively.

The nose-dives dragged down the asset values to hover just above the “knock-in barriers,” or the thresholds that determine whether investors lose the original investment or not.

In the meantime, brokerage houses began to carry out their hedging strategies for the structured investments. In order to do so, the securities firms were in aggressive search of short-term borrowings to address the massive margin calls.

“As the underlying assets fall closer to the ’knock-in barriers,‘ brokerages will be short of capital when ’delta-hedging‘ the risks on their own,” Kang Seung-gun, an analyst at Hi Investment & Securities, wrote in a recent note.

The brokerages turned to short-term fundraising through commercial papers, which acted like a financial clog in the financial market, according to Yoon Won-tae, an analyst at SK Securities.

But they will be less likely to rely on the commercial papers with the state-led financial support, he noted Wednesday.

Eyes are now on whether the market volatility could be eased before the maturity dates of the products. They usually have two to three years of maturity, but the monthly issuance of ELS and ELB saw a sharp uptick in December 2019 to 21.6 trillion won, with over 60 percent of them having less than one-year maturity.

Market watchers are wary of the possibilities that investors in the structured products will not be able to get their money back on the maturity date, or will even lose their principal.

As of end-February, the outstanding investment from either ELS or ELB came to 69.7 trillion won, according to data from the Korea Financial Investment Association.

Six out of 10 are tied to Eurostoxx 50, according to Kim Go-en, an analyst at Meritz Securities. Their knock-in barrier could be anywhere from 45 to 60 percent lower than the prevailing prices.

”Every product has set the different knock-in barrier, but we assume that investors will start losing their original investment if Eurostoxx 50 falls below 2,000 points,“ Kim wrote in a recent note.

By Son Ji-hyoung (

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