Derivative Investment Takes Direct Hit... Principal Loss and Long-term Investment Fund Freeze Become Reality

Equity-Linked Securities and ETFs
Widening Damage from Global Stock Market Shock
Oil Price Crash Causes Snowballing Losses in Crude Oil DLS

[Asia Economy Reporters Jihwan Park, Minji Lee] The fear of a global stock market downturn triggered by the spread of the novel coronavirus infection (COVID-19) is engulfing investors in derivative products such as equity-linked securities (ELS), derivative-linked securities (DLS), and exchange-traded funds (ETF). Following the World Health Organization's (WHO) declaration of COVID-19 as a 'pandemic,' domestic and international stock markets have plunged, making concerns about principal losses or long-term capital lock-up a reality. Currently, some DLS based on crude oil assets and leveraged ETFs have incurred principal losses, and other derivative products like ELS are also facing uncertain situations.

According to the Korea Exchange on the 13th, individual investors betting on the KODEX Leverage ETF, expecting a rise in the domestic stock market from the 9th to the previous day, invested approximately 630 billion KRW. During this period, the ETF index fell by about 13%. Compared to the year's highest price (15,570 KRW), it dropped by 39%. Individual investors holding leveraged ETFs and ETNs, hoping for an index rebound, have already lost about 20% of their principal.

Red flags have also appeared for ELS products, which mainly use global indices as underlying assets. According to the Korea Securities Depository, the issuance scale of domestic ELS from the beginning of the year to the 12th of this month was 15.8182 trillion KRW, a 36% increase compared to the same period last year (11.6058 trillion KRW). The stock indices most frequently used as underlying assets for ELS are KOSPI 200, Hong Kong H Index, Euro Stoxx 50, and S&P 500. The structure yields profits if asset prices do not fall below a certain level until maturity (2-3 years).

The problem is that the major indices underlying these products have shown significant declines compared to their highest points this year. The U.S. S&P 500 index reached a record high of 3,386.15 on the 19th of last month but plunged about 26% within a month.

The Euro Stoxx 50 index also crashed 34%, from 3,865.18 on the 21st of last month to 2,546.84. The Hong Kong H Index (14%) and KOSPI 200 (20%) also fell sharply. Considering that the loss threshold for ELS is around 60-65% of the reference price, the possibility of losses for products based on the Euro Stoxx 50 has increased.

Seol Taehyun, a researcher at DB Financial Investment, explained, "The Euro Stoxx 50, which is showing a pronounced decline centered on Italy, has about 4% left until the loss threshold (65% of the reference price) based on the average stock index in January this year, indicating low shock absorption capacity. ELS issued within the last six months based on indices such as S&P, Nikkei 225, Hong Kong H Index, and KOSPI 200 are judged to have about 20% shock absorption capacity remaining."

Oil prices, poised to fall to the $20 per barrel level, are also a major concern. On the previous day (local time), April delivery West Texas Intermediate (WTI) crude oil on the New York Mercantile Exchange (NYMEX) closed at $31.50 per barrel, down 4.5% ($1.48) from the previous trading day. Brent crude also recorded $33.33 per barrel, down 7.18% ($2.57).

DLS are based on underlying assets such as stocks, commodities, interest rates, credit, and equities, with international oil prices widely used domestically. The 'knock-in barrier' (principal loss threshold) for oil DLS is usually 50-60% of the oil price at subscription. Considering that many securities firms' DLS knock-in prices are in the low $30 range, and some are at $36-37, some DLS products are believed to have entered the knock-in barrier.

A securities firm derivative product official expressed concern, saying, "If international oil prices fall below the $30 level, principal losses on oil DLS products could snowball."

As of the 11th, the outstanding balance of DLS issuance was 2.6291 trillion KRW based on public offerings. Among these, the outstanding balance of public DLS issued based on WTI is 921.7 billion KRW, and Brent crude is 537.6 billion KRW. Considering that some DLS are based on both indices and thus double-counted, it is estimated that more than 600 billion KRW worth of DLS are exposed to loss risks due to the sharp drop in oil prices.

The problem is that the downward trend in global stock markets and oil prices may not end easily. The COVID-19 situation is turning into a prolonged battle, and it is difficult to predict when the oil war between Saudi Arabia and Russia will be resolved. A financial investment industry official said, "If the stock market continues to decline for a long time due to the COVID-19 situation, depending on the product structure and subscription timing, investors' principal losses or capital lock-up situations will become a reality."

This content was produced with the assistance of AI translation services.