6 Trillion Won Loss Risk?…Precarious 'Hong Kong ELS' [Song Seungseop's Financial Light]

Make Money Just by Matching the Price Range?…The Magic of ELS
"Stock Market Stability Needed"…The Emergence of Ultra-High-Risk Derivatives
Despite Over 50% Plunge…First Half Maturity Amount Hits 10 Trillion

6,000,000,000,000 KRW.

Concerns are growing that a certain investment product sold by domestic banks will incur massive losses. There are even forecasts that the loss amount could approach 6 trillion KRW in the first half of the year. This is about Equity-Linked Securities (ELS). What kind of product is ELS that could cause such enormous losses? Why did banks start selling products like ELS? Is it still advisable to buy ELS in the future?

Make money as long as the price range fits? ... The magic of ELS

On the afternoon of the 19th, investors in Hong Kong H Index (Hang Seng China Enterprises Index) equity-linked securities (ELS) are urging for compensation for damages in front of the Financial Supervisory Service in Yeouido, Yeongdeungpo-gu, Seoul.
[Image source=Yonhap News]

On the afternoon of the 19th, investors in Hong Kong H Index (Hang Seng China Enterprises Index) equity-linked securities (ELS) are urging for compensation for damages in front of the Financial Supervisory Service in Yeouido, Yeongdeungpo-gu, Seoul.
[Image source=Yonhap News]

ELS is a financial product whose returns are linked to stock prices, as the name suggests. A specific stock or index range is preset, and if the actual price falls within that range at maturity, investors earn profits. If it falls outside the range, losses occur. The key is the ‘range.’ Even if the stock price drops, as long as it stays within the agreed range, you make money. Conversely, if the stock price slightly declines but falls outside the range, you could lose the entire principal according to the contract.

When used well, ELS can generate excellent investment returns. ELS is essentially a game of predicting roughly where stock prices or indices will be several years later. If ELS is created with stocks or indices that have very low volatility, it can be safe while offering higher returns than savings or time deposits. It allows some defense against market downturn risks while still investing in a rising market. If it’s difficult to predict whether the market will rise or fall, ELS becomes even more useful.

Of course, ELS is a legitimate investment product. It is not a miraculous fountain that always yields profits. Naturally, losses can occur in investments. There are many ELS products that have recorded losses of tens of percent, and many with loss rates as high as 99%.

"Let’s stabilize the stock market" ... The emergence of ultra-high-risk derivatives

2003 Stock-Linked Product Sales Status. ELS products sold a total of 1.7888 trillion KRW within six months of launch. Data=Financial Supervisory Service 'Stock-Linked Product Sales Status and Impact Analysis', Photo by Capital Market Institute

ELS first appeared in the late 1980s. It was created by the U.S. investment banking (IB) industry. At that time, there was a major crisis called ‘Black Monday,’ but IBs were also expanding their roles, such as M&A advisory. As the investment market grew, ELS began to attract serious attention. Around the 1990s, as commercial banks in the U.S. and Europe also entered the IB sector, the name ELS became known to general investors.

ELS was introduced in Korea in March 2003. In October 2022, banks began selling stock-linked products, and ELS started to be handled as well. ELS was wildly popular from the start. According to the Korea Capital Market Institute, 149.8 billion KRW worth of ELS was sold in the first month, jumping to 522.1 billion KRW in July. This was 51.1 billion KRW more than the 471 billion KRW sold in Equity-Linked Funds (ELF). In just half a year, the total ELS sales reached 1.7888 trillion KRW.

Ironically, the Korean government allowed the sale of ultra-high-risk products like ELS to ‘stabilize the market.’ The second half of 2002 was a year when bank interest rates fell and the stock market was sluggish. Excess funds in the market flowed into the more profitable real estate market, even showing signs of a bubble. In response, the Ministry of Finance and Economy (now the Ministry of Economy and Finance) held an economic policy coordination meeting and announced a ‘stock market stabilization measure.’ To attract money back into the stock market, they decided to allow profitable products like ELS.

The ELS currently under controversy is linked to the Hang Seng China Enterprises Index. The Hang Seng China Enterprises Index is commonly called the Hong Kong H Index (H Index). It is composed of 50 Chinese companies listed on the Hong Kong stock exchange. The product predicts where the H Index will be at maturity several years later. The usual maturity is three years. As long as the index does not fall below 70% compared to the subscription time, investors make money. If it falls more than that, losses occur proportional to the decline.

Fell over 50%... Maturities worth 10 trillion KRW in the first half

Since it is now 2024, most products maturing now were sold in 2021. At the beginning of 2021, the H Index hovered above 12,000. Recently, however, the H Index is around 5,300, only about 40% of the subscription time level. To receive money, the index needs to be around 70%, but now it has plummeted by more than half. For investors to at least protect their principal, the index would need to rebound by more than 30% from now, which is a very bleak situation.

Losses are snowballing. According to the financial sector, the maturity loss amount of Hong Kong H Index ELS sold by KB Kookmin, Shinhan, Hana, and NH Nonghyup banks reached 312.1 billion KRW as of the 26th. The confirmed maturity loss rate is 53%. The outstanding balance of Hong Kong ELS maturing in the first half is about 10.2 trillion KRW. If the current trend continues until the first half, losses could grow to 5 to 6 trillion KRW, according to some estimates.

Investors are strongly protesting. The reason is alleged incomplete sales by financial companies. On the 23rd, Yang Jeong-suk, a member of the Democratic Party of Korea, held a related forum at the National Assembly, where one investor claimed that an ELS product was sold to a 90-year-old father showing early symptoms of dementia. Another investor raised their voice, saying, “My mother asked for a fixed deposit product, but was encouraged to re-subscribe to the Hong Kong H Index-linked product, claiming it would not incur losses, without being informed of the risks.”

The financial authorities are investigating whether incomplete sales actually occurred. If incomplete sales are confirmed, financial companies will have to compensate customers for part of the losses. Similar incidents happened during the 2019 Derivative-Linked Fund (DLF) scandal and the 2021 Lime Fund scandal. The Financial Supervisory Service’s Dispute Mediation Committee recommended compensation of 40-80% of the losses at that time. The Financial Supervisory Service plans to complete the investigation and announce related measures by March.

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