[Hong Kong ELS Trauma]② Nightmare of 2015 Loss Repeating... ELS Unpaid Balance 'Surges'

Editor's Note A total of 967 equity-linked securities (ELS) based on the Hong Kong H Index have entered the principal loss (knock-in) zone. Individual investors, believing they could earn stable returns even in a bear market, hastily invested over 10 trillion won, but now find themselves unable to recover even their principal. Following the sharp declines in 2015 and 2020, the Hong Kong H Index is once again pushing investors to the brink. Will the nightmare of the past repeat itself? With high-intensity tightening by major countries, economic recession, and China's policy risks all converging, Hong Kong is being regarded as a riskier investment destination than the Chinese market. We have urgently reviewed the current status of domestic investors' investments in the Hong Kong H Index and examined the variables that could impact the index.

[Asia Economy Reporter Minji Lee] ‘2015, 2020, 2022’

ELS (equity-linked securities) investors have been hit again by the high volatility of the Hong Kong H Index. Before the 2020 COVID-19 crash had even fully subsided, investors faced the fear of principal loss within just two years. Although the index recovered by maturity, and only a small number of investors suffered principal losses for a short period, investors endured daily anxiety over the possibility that their principal might never be returned.

ELS are generally considered "medium risk, medium return." Most ELS issued domestically are "step-down ELS" based on domestic and foreign stock indices as underlying assets. If the underlying stock index does not fall significantly, early redemption conditions are met, allowing investors to earn stable profits in a short period. However, if the underlying asset index suddenly declines, the situation changes. If early redemption fails and the index remains in the knock-in (principal loss) zone, investors will not be able to recover their principal in full.

According to the financial investment industry on the 8th, the Hong Kong H Index recorded 4,919.03 on the 31st of last month, hitting a historic low. The index, which fluctuated between 8,000 and 9,000 at the beginning of the year, fell below 5,000 in less than a year, dropping by about half. Prolonged economic recession in China, regulations on real estate and big tech companies, and news of President Xi Jinping’s third term dampened investor sentiment. As of this date, the Hong Kong H Index has shown a slight recovery from its low, moving around the 5,500 level.

Looking back at previous times when sharp declines in the Hong Kong H Index triggered crises in the ELS market, 2015 and 2020 stand out. Seven years ago, the Hong Kong H Index reached 14,801.94 on May 29, 2015, but within six months, it fell to the 7,500 level (February 2016), marking a decline of over 50%. The index halved in a short period, plunging global financial markets into chaos and forcing ELS investors to endure a prolonged nightmare. Although individual investors began actively entering the stock market from 2014, the Chinese government banned leveraged investments by individual investors, and growing concerns about economic recession led to significant capital outflows, causing the index decline.

During the 2020 COVID-19 pandemic, ELS investors also had to be anxious. The Hong Kong H Index dropped from the 12,000 level on January 1, 2020, to the 9,000 level within about two months, a decline of approximately 30%. Although the decline was not as prolonged as in 2015, it was enough to raise investor concerns about the Hong Kong H Index’s fall.

A key indicator of ELS investment risk is the outstanding balance. As the index continues to decline and fewer ELS meet early redemption conditions, the number of unredeemed ELS increases. In fact, in January 2016, the outstanding balance of publicly offered ELS based on the Hong Kong H Index was 24.5124 trillion won, 25% higher than in January 2015. In February 2020, the outstanding balance was around 22 trillion won but increased by 2 trillion won to 24 trillion won within three months.

Jang Geun-hyuk, a researcher at the Korea Capital Market Institute, said, "The increase in outstanding balances due to a sharp drop in early redemptions, combined with growing uncertainty in the global financial market, is a source of instability in the ELS market. Investors need to approach the risk structurally, even if the coupon yield is relatively low, by focusing on the lower knock-in zones to reduce the possibility of investment losses." As of the end of last month, the outstanding balance of ELS based on the Hong Kong H Index was 19 trillion won, 21% higher than 15.58 trillion won in October last year.