Kim Hyun-Sook is bracing for massive losses on her 100 million won ($74,000) investments in structured products tied to Chinese stocks.
When the former language teacher bought them in 2021, Chinese equities had mounted a swift recovery from the pandemic trough, and there seemed little risk of a crash in the Hang Seng China Enterprises Index over the next three years.
The once-unthinkable scenario has now become all too possible. The gauge has more than halved from a Feb. 2021 peak, placing as much as 14 trillion won of securities tied to the HSCEI at risk when they mature next year. The potential losses showcase how South Korean investors were caught out by China’s sudden economic decline and the risks posed by complex financial products that have become a staple with the country’s moms and pops.
“I wasn’t worried because among the products that I invested in the past, an underlying index has never gone below the knock-in barrier,” said Kim, who has bought structured securities for two decades, referring to a level below which investors can lose their money.
Kim would face losses equivalent to the index performance if the HSCEI — which tracks Chinese stocks listed in Hong Kong — continues to languish through May 2024, when her investments mature. Lured by the promise of bond-like coupons, the 57-year old and her fellow investors are another example of how low rates had spurred investments in complicated products.
The losses will be the latest in a series of shocks for Korea’s 96 trillion won market for structured notes, one of Asia’s biggest. Confidence had already been shaken by the 2015 China stocks crash, the 2016 Brexit surprise, and the 2020 oil market slump. Regulators intervened back in 2019 when retail investors stood to lose all their money in derivatives tied to German bond yields.
The financial watchdog warned that this time 7 trillion won of equity-linked securities — a majority of which are called autocallables — are at risk. The total contracts facing losses may be twice that, according to Samsung Securities Co., as official data excluded products designed without knock-in barriers.
Most of the HSCEI-linked contracts come due in the first six months of next year, compressing the pain. April is the peak with 2.4 trillion won due, according to Samsung Securities’ analysis.
Brokers — which include some of the nation’s biggest such as KB Securities Co., Samsung Securities and Mirae Asset Securities Co. — will have to rush to unwind their ELS-related hedges, which may trigger volatility in other assets including Hong Kong equity futures.
“It’s pretty rare to see products in such large scale to be maturing around the same time,” Samsung Securities derivative analyst Jun Gyun said. “It looks like investors were expecting continued growth in China in 2021.”
Back then, China’s zero Covid-policy protected the economy and pandemic-related exports boomed, leading to almost 19% growth in the first quarter. The HSCEI —- which was used as an underlying asset in 40% of newly-issued equity-linked securities in Korea in the first half of 2021 — had advanced about 43% from the pandemic low to its peak that year.
Margin Calls
That was as good as it got.
Staying too long in a Covid-bubble, a property market crisis and low consumer confidence became mill-stones on the Chinese economy, spurring a wave of relentless selling in its equity markets.
The HSCEI has declined about 13% this year, adding to the 19% slump in 2022.
“If the HSCEI gauge plunges again in a short period, brokers will face margin calls and rush to get funds, which may be difficult if combined with other issues in the financial market,” said Lee Hyo Seob, senior researcher at Korea Capital Market Institute. Losses near maturity dates will cause huge swings in options positions, he said.
Upon expiry, the liquidation of the products will add as much as $2.2 billion worth of contracts each month in 2024 to the HSCEI futures markets, according to Samsung Securities’ Jun. While there’s normally ample liquidity, there may be a squeeze if sentiment is jittery due to issues including global risks, he added.
The looming turmoil is a reminder of the risk of betting big on esoteric financial products, which have been popular among middle-aged and elderly Koreans. An insufficient pension system, high living costs and rapid aging have all provided fertile ground for the market to boom during the low interest rates era.
The nation’s retail investors are known for their embrace of risky bets, with big stakes in digital coins, growth stocks like Tesla Inc., and overseas properties.
Massive Losses
Kim, who has bought 18 ELS products tied to the HSCEI, said she is “bracing for massive losses.” Two of the notes were issued in May 2021 when the gauge was above 10,000. It currently trades below 5,900.
According to the prospectus from KB Securities, Kim would receive a 4.5% annual coupon if none of the three underlying assets — the HSCEI, S&P 500 and Samsung Electronics Co., fall more than 50% from their closing prices on May 7, 2021.
Kim needs the HSCEI to close above 8,024.25 by its maturity in May 2024 to get all her money back. That would require a 37% gain from current levels at a time when pessimism over Chinese stocks remains prevalent due to its slowing economy and geopolitical tensions.
“Traditionally, South Korean autocalls have provided a steady 7% annual return over the past 15 years. However, as market dynamics change, investors may think twice before reinvesting in these products,” said Tiago Fernandes, head of data and platform at WSD, a structured products software provider.
--With assistance from Jaehyun Eom.