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[Market Close-up] Battered brokerages to get breather after risky assets tank

Office buildings of South Korean brokerage houses in Yeouido, Seoul (Yonhap)
Office buildings of South Korean brokerage houses in Yeouido, Seoul (Yonhap)

South Korea’s brokerage houses suffering from recent losses on risky structured products that placed bets on foreign stock indexes are expected to get some relief after the government allocated a larger-than-expected slice of its stimulus package to the sector. 

Reporting on the results of a meeting presided by Moon Jae-in on Tuesday, the Financial Services Commission said authorities would 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 will use 2.5 trillion won to issue short-term bonds like repurchase agreements, while another 2.5 trillion won will be used for loans.

Analysts said the “beyond-expectations” measure will relieve 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.

Five brokerages -- Mirae Asset Daewoo, Samsung Securities, Korea Investment & Securities, KB Securities and NH Investment & Securities -- issued over 60 percent of the total in 2019, according to the Korea Securities Depository.

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.

Euro Stoxx 50 -- one of the most favored assets tied to the structured products -- 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 nosedives dragged down the value of the assets 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 can 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 possibility that investors in the structured products will not 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 Euro Stoxx 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 a different knock-in barrier, but we assume that investors will start losing their original investment if Euro Stoxx 50 falls below 2,000 points,” Kim wrote in a recent note.

By Son Ji-hyoung (consnow@heraldcorp.com)

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