[Hong Kong ELS Trauma]③ Margin Call Concerns Arise, but Experts Say It's Okay?

Editor's Note A total of 967 equity-linked securities (ELS) based on the Hong Kong H Index have entered the loss zone (principal loss). 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 recent plunge of the Hong Kong H Index is pushing investors to the brink once again. 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 investment status of domestic investors in the Hong Kong H Index and examined the variables that could impact the index.

[Asia Economy Reporter Minji Lee] As the Hong Kong H Index continues to decline, concerns about a margin call crisis similar to that of March 2020 have emerged. However, experts analyze that considering the government's regulatory policies that ensured securities firms secured dollar liquidity, there is unlikely to be a market-shaking risk.

According to financial authorities on the 9th, in response to the recent global stock market plunge, securities firms with large hedge positions are checking hedge operation losses and the risk of margin call expansion to manage risks. This is to guard against a repeat of the March 2020 situation during the COVID-19 pandemic when securities firms issuing ELS faced margin call demands from overseas financial institutions due to overseas index plunges, leading to liquidity shortages. At that time, securities firms lacking funds issued a large volume of commercial paper (CP), which caused CP rates to surge excessively, spreading the crisis to the short-term funding market.

Although the Hong Kong H Index recently fell below the 5,000 level, showing a steeper decline than two years ago, concerns about margin calls appear to be less significant than expected. After the margin call crisis, financial authorities implemented stringent regulations on derivative-linked securities, establishing mechanisms to withstand significant index drops. The Financial Supervisory Service regulated the total issuance volume of ELS to discourage indiscriminate issuance. Additionally, for ELS based on overseas indices, securities firms were required to hold 20% of their hedge positions in foreign currency liquid assets. Securities firms themselves also reduced the proportion of ‘self-hedging,’ which involves direct hedge operations to increase operational profits, and increased ‘back-to-back hedging,’ which manages losses and gains through contracts with overseas institutions.

Baek Doo-san, a researcher at Korea Investment & Securities, explained, "The recent Hong Kong H Index has been steadily declining, allowing for proactive preparation, so securities firms' hedge profits and losses likely have not deteriorated as much as in March 2020," adding, "As securities firms have strengthened their internal soundness as a measure to stabilize the derivative-linked securities market, there will likely be no significant impact on or from the foreign currency funding market and credit market."

However, experts are cautious about predicting the timing of a rise in the Hong Kong H Index. With President Xi Jinping’s third term and the onset of winter COVID-19 spread, COVID-19 controls have been tightened in major cities such as Beijing, Zhengzhou, and Shanghai, leading to expectations of increased short-term volatility. Especially since Hong Kong operates under a dollar peg system, it moves in tandem with U.S. interest rate hikes, raising concerns about worsening economic headwinds.

Jeon Jong-gyu, a researcher at Samsung Securities, said, "The Hong Kong stock market is currently approaching an oversold zone due to foreign capital outflows and the release of ELS principal loss volumes," adding, "At this point, the most important factor is that the Xi Jinping leadership's financial market stabilization measures to prevent a stock market collapse must ease distrust in the financial market and economy for an upward trend to emerge."

Park Su-jin, a researcher at Mirae Asset Securities, said, "Market anxiety may continue due to the expansion of uncertainty following Xi Jinping’s third-term administration," but added, "However, since China is attracting funds into strategies such as becoming a science powerhouse, securing national security systems, and new energy, it is advisable to maintain investment sentiment toward related companies."