DLS Outstanding Balance Down 31% in One Year... Financial Supervisory Service to Strengthen Supervision of Fund-Based DLS

[Asia Economy Reporter Ji Yeon-jin] The market for other derivative-linked securities (DLS) has significantly contracted following large-scale losses in overseas interest rate-linked derivative-linked funds (DLF).

According to the Financial Supervisory Service on the 10th, the DLS market size stood at 12.7 trillion KRW at the end of June last year, marking a 31% decrease over one year. This contraction is much sharper compared to the overall derivative-linked securities market, which shrank by 7.6% from 116.5 trillion KRW to 107.6 trillion KRW during the same period.

DLS are principal non-guaranteed derivative-linked securities issued based on various underlying assets such as credit, funds, and interest rates, in addition to stocks and stock indices, which are the underlying assets of equity-linked securities (ELS). Introduced in 2005, the DLS market once grew to around 17 trillion KRW but has been shrinking due to heightened risk factors highlighted by incidents such as the 2019 DLF crisis.

By underlying asset, the market was composed mainly of credit (4.4 trillion KRW, 34.3%), exchange-traded funds (ETF) (2.5 trillion KRW, 19.6%), funds (2.4 trillion KRW, 19.0%), interest rates (2.2 trillion KRW, 17.2%), and commodities (1.3 trillion KRW, 9.9%).

DLS based on credit have continued to be steadily issued and sold, unlike those based on other underlying assets. Although principal losses can occur if the companies underlying the credit deteriorate, demand is supported by the fact that these are mainly issued based on entities with high credit ratings such as governments, public institutions (e.g., LH Corporation), and large corporations, making large-scale principal loss unlikely.

DLS based on funds have effectively ceased new issuances recently due to expanded loss risks following redemption suspensions of some funds such as Germany’s Heritage and Hong Kong-based Gentuo. As of the end of June last year, about 62% (1.5 trillion KRW) of the 2.4 trillion KRW balance was affected by redemption suspension reasons.

Interest rate-based DLS have mostly been newly issued and sold to institutional investors since the DLF crisis, so the risk of losses for individual investors is relatively low. Commodity-based DLS appeared to face principal loss concerns due to the sharp drop in oil prices but have stabilized recently as oil prices recovered. However, with strengthened public offering requirements following the DLF incident, new issuances are expected to decline sharply.

The Financial Supervisory Service assessed that while quantitative growth in the DLS market is limited and qualitative improvements are underway, some DLS still carry risk factors. The FSS stated, "We will strengthen monitoring of the overall DLS market and enhance detailed supervision of fund-based DLS with high potential for problems such as large-scale redemption suspensions."

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