[Derivative Products ABC] Puzzling 'ELS·DLS'... What Are Their Similarities and Differences?

[Asia Economy Reporter Park Jihwan] Derivative financial products such as Equity-Linked Securities (ELS) and Derivative-Linked Securities (DLS) sound unfamiliar just by their names. What exactly are these products?

ELS are equity-linked securities based on stocks as the underlying assets. They are linked to the price of specific stocks or stock indices. On the other hand, DLS are derivative-linked securities based on bonds, commodities (gold, silver, crude oil), exchange rates, and so forth.

Although the underlying assets differ, the profit structures of the two products are almost the same. ELS are managed by investing assets in high-quality bonds to preserve the principal, while investing a portion in derivatives such as stock index options to earn high returns. The maturity is usually three years, and there is an early redemption opportunity every six months before maturity if certain conditions are met, allowing investors to receive interest and principal. If, after six months, the underlying asset, the U.S. S&P 500 index, does not fall below 90% of the initial price, the principal and promised interest are paid.

DLS refer to derivative products linked to major overseas interest rates. As long as the interest rate stays within a certain range until maturity, an annual yield of 3.5 to 4.0% is guaranteed.

The risks of the two products are also similar. The underlying assets, such as stock prices or real asset indices, fluctuate in real time. Above all, they are difficult to predict. Both ELS and DLS are unsecured and unguaranteed products issued on the securities company's own credit and are not covered by depositor protection. Banks only receive sales commissions and do not guarantee the principal.

These products have a structure where losses can occur if the underlying assets enter a loss zone. Even principal-protected ELS are not covered by depositor protection, so if the issuer goes bankrupt, the principal can be lost. Also, if early redemption is not received, a large sum of money may be tied up until maturity, and if early redemption is requested, fees may cause principal loss.

DLS can also incur principal losses if interest rates fall below the benchmark. The more interest rates drop, the larger the loss grows like a snowball. For example, last year, as German government bond yields continuously declined and remained in negative territory, domestic DLS products based on German government bond yields faced the risk of incurring significant losses.