Korea regulator calls for risk control as HSCEI losses bite

The balance of structured products reaching their knock-in level in South Korea increased by 280% to KRW1.1 trillion (US$850 billion) at the end of Q3 2022 compared with three months ago mainly due to the weak performance of the HSCEI, according to the report released by the Financial Supervisory Service (FSS) on 8 January 2023.

Nearly all the balance comes from equity-linked securities (ELS) while derivative-linked securities (DLS) contributed KRW4.4 billion.

The HSCEI, which comprises the largest and most liquid 51 Chinese securities listed in Hong Kong SAR, accounted for 63.3% of the balance through ELS, or KRW671.1 billion.

The Korean regulator noted that local securities houses, which act as the issuers and help providers to hedge their ELS activity, must strengthen their risk monitoring, particularly on HSCEI-linked structured products, in view of the knock-in volume surge during Q3 22.

As of 30 September 2022, the HSCEI stood at 5,914 points, down 22.9% from a quarter ago.

Although the size of knock-ins on products linked to the HSCEI increased, ‘it is possible to reduce the loss amount [for investors] or repay profits if the index recovers before most of the ELS mature in 2024,’ stated the Korean regulator.

Approximately 86.7% of the balance, or KRW923.3 billion, is set to mature in 2024 with KRW62 billion due in 2022, KRW25 billion in 2023 and KRW54.7 billion in 2025 or afterwards.

The weak performance of the HSCEI also led to a fall in demand for new ELS in Q3 22, besides the instability of global financial market, according to the report.

According to the regulator, Q3 22 saw KRW5.7 trillion and KRW 2.3 trillion worth of new non-principalprotected and principal-protected ELS, respectively. The amount represented a decrease of 35.2% and 20.5% compared with Q2 22, respectively.

For the combined issuance, the HSCEI accounted for KRW1.1 trillion, in line with the decline seen over the first two quarters of 2022, followed by the S&P 500 (KRW5.1 trillion), Eurostoxx 50

(KRW5 trillion) and Kospi 200 (KRW3.5 trillion).

There was KRW2.8 trillion issuance deployed with a knock-in option and full capital at risk were down from KRW3.7 trillion in Q2 22, but the proportion rose to 35.1% from 31.9% for the entire ELS issuance.

Specifically, low knock-in products, which are classified as ELS with a knock-in level of 50% or below the initial underlying level, contributed to KRW2.5 trillion, lower than the KRW3.5 trillion from Q2 22.

In Q3 22, the ELS repayment amount came to KRW 6.1 trillion, similar to the level seen in the prior quarter. Early redemption made up KRW5 trillion, translating to a 44.6% increase driven by ELS that were not linked to the HSCEI.

The ELS balance rose to KRW68.1 trillion from KRW60.6 trillion a quarter ago as at 30 September 2022. The HSCEI contributed to KRW20.9 trillion, a similar amount recorded a quarter ago, followed by the S&P 500 (KRW3.9 trillion), Eurostoxx 50 (KRW trillion) and Kospi 200 (KRW3.5 trillion).