ELS, 4.5938 Trillion Won Principal Loss Fear

Issued 6 trillion last month... Balance 48 trillion
About 890 ELS in loss zone within a month
Loss realization if Euro Stoxx crashes

[Asia Economy Reporter Minji Lee] As the global stock markets have been brutally crushed by the novel coronavirus disease (COVID-19), investors who invested in equity-linked securities (ELS) are also deeply distressed. ELS are products that generate returns based on price fluctuations using major indices and individual stocks as underlying assets, with an outstanding issuance amount reaching approximately 48 trillion won.

◆ Issuance of 6 trillion won in ELS last month... Loss zones reached within a month = According to the securities industry on the 23rd, major global indices fell more than 30% compared to the previous month, causing ELS products issued based on these indices to enter loss zones one after another. In February, a total of 1,435 ELS worth 6.5278 trillion won were issued in the domestic stock market, with about 90% investing in indices of major countries such as the U.S., Europe, Japan, and Hong Kong. Among these, about 890 ELS, amounting to approximately 4.5938 trillion won, entered the principal loss zone within a month. Most of these indices are based on the Euro Stoxx 50.

The Euro Stoxx 50 index closed at 2,548.50 on the 20th (local time), up 3.85% from the previous day. This rebound occurred as major countries aggressively announced liquidity supply measures to recover the stock market. However, compared to the all-time intraday high recorded last month (February 20), it has plunged nearly 35%.

The period with a high risk of principal loss for ELS issued based on the Euro Stoxx 50 last month is from February 2 to 24. During this period, the index moved within the 3,700 to 3,800 range, but the current price is about 34% lower on average compared to that period. Typically, the loss zone for ELS is 50-65%, meaning that if the underlying asset price falls 35-50% below the issue price, principal loss occurs.

Go-eun Kim, a researcher at Meritz Securities, explained, "Among the underlying assets of ELS, the Euro Stoxx 50 index has the highest issuance proportion," adding, "If the index breaks below 2,000 points, the principal loss for ELS investors approaching maturity is highly likely to materialize."

Losses in stock-type ELS are also a concern. Stock-type ELS are issued based on blue-chip stocks with relatively stable price movements, but recently, most stocks in the market have fallen sharply, and some have entered the loss zone. The 'KBableELS No. 873 (ELS)', which uses SK Innovation and LG Electronics as underlying assets and matures on the 28th of next month, will incur a 10% principal loss if the price on the maturity evaluation date is below 90% of the initial reference price. Considering that the stock prices of SK Innovation and LG Electronics have fallen by 64% and 40%, respectively, since the issue date, it is unlikely that prices will recover by maturity.

◆ Issuing securities firms also face profitability deterioration = The securities industry expects that if the global stock market continues to decline, the scale of ELS losses will increase further. This is because other major indices besides the Euro Stoxx 50 are also experiencing larger declines. The U.S. Standard & Poor's (S&P) 500 has fallen 31% from its peak (February 19 this year), and the Hong Kong H-Index (January 2018) and Nikkei 225 index (January 20 this year) have plunged 33% and 31%, respectively. Songcheol Kang, a researcher at Shinhan Financial Investment, diagnosed, "If the Hong Kong H-Index falls below 7,000 points, principal loss becomes possible," and "For the Nikkei index, principal loss is likely below 13,000 points."

[Image source=Reuters Yonhap News]

Major securities firms have already informed investors about the possibility of losses in ELS products through their websites. A total of 503 ELS products, with an outstanding balance of 623.7 billion won, have been announced by 16 major domestic securities firms, including Korea Investment & Securities, as having a risk of principal loss due to declines in domestic and foreign stock indices, individual stock prices, or oil prices. When combined with losses in derivative-linked securities (DLS) caused by the recent oil price war among major oil-producing countries (574 products, 884.7 billion won), it is estimated that about 1.5094 trillion won of investment funds are at risk of principal loss.

The securities firm with the most loss-risk products is Korea Investment & Securities, with 38 ELS and 185 DLS products, totaling 223 products at risk of principal loss. This is followed by Shinhan Financial Investment (217 products), NH Investment & Securities (127 products), Samsung Securities (115 products), and Mirae Asset Daewoo (88 products).

Accordingly, profitability is expected to be significantly impaired mainly for securities firms with large outstanding issuance amounts. Securities firms hedge ELS by posting margin deposits and trading derivatives on overseas exchanges, but due to the sharp decline in major indices, margin calls demanding additional margin deposits are flooding in. It is reported that overseas exchanges have requested margin calls amounting to about 3 to 4 trillion won from major domestic securities firms.

Baeseung Jeon, a researcher at eBest Investment & Securities, said, "Securities firms maintain a self-hedge ratio of 40-80% for ELS operations, but if the current stock price level is maintained, early redemption will be difficult, and hedge costs will inevitably increase," adding, "It is inevitable that securities firms will incur operational losses related to ELS in the second and third quarters."

However, for products issued at the peak last month, there is nearly a year left until maturity, so losses are not immediately reflected. If the index does not fall to 50-65% of the underlying asset value at maturity, investors can receive their principal and the agreed returns. A securities industry official said, "Many investors have recently inquired about whether to redeem early, but if maturity is not within a year, it is better to wait until the end rather than redeem early," adding, "For investors with maturities in the first or second half of the year, demand for early redemption may increase."

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