Some local securities firms in South Korea – the world’s largest market for autocallable products – are rapidly building up risk in their positions from equity-linked products, raising uncertainties among issuers about their ability to manage market volatility.
Mirae Asset Daewoo and Korea Investment & Securities are among a number of firms leading a trend of managing their own trading books from selling equity-linked products. The two South Korean houses have recently increased risk warehousing, reportedly hedging over KRW4 trillion (US$3.3 billion) and KRW5 trillion, respectively. The two securities firms hedged around KRW2 trillion to KRW3 trillion notional on autocalls last year.
The move from Korean dealers to warehouse higher levels of exotic risk comes on the back of a sharp rise in the volume of early redemptions in April as well as a senior management changes at the firms. Mirae Asset Daewoo poached veteran traders from Korea Investment & Securities early this year.
Differing models and approach to risk means there is less certainty as to how well issuers in aggregate manage market volatility and shifts in correlation
The rapid increase in the amount of risk warehoused by local issuers has prompted concerns over under-priced or unhedged risks.
“Differing models and approach to risk means there is less certainty as to how well issuers in aggregate manage market volatility and shifts in correlation,” said Bharat Sachanandani (pictured), head of flow strategy and solutions for Asia Pacific at Societe Generale.
Kyungho Kim, head of retail derivatives solution and distribution at Mirae Asset Daewoo, said the stock brokerage and investment banking firm is now turning more “conservative” due to a drop in redemption volumes in May.
“Nowadays, there aren’t many local securities firms, including us, that are warehousing more risk,” said Kim. “We are also keeping close tabs on the outstanding notional.”
Mirae Asset Daewoo and Korea Investment & Securities are both tier one issuers in the country. Mirae’s sales volume so far this year stands at over KRW4.7 trillion– the biggest among all local securities firms – while that of Korea Investment & Securities stands at KRW4.1 trillion, according to Korea Securities Depository data.
Despite the increased risk warehousing, not all local securities firms in South Korea are in the race to win business, according to Gyun Jun, derivatives analyst at Samsung Securities.
“NH Investment & Securities is downsizing the amount of risk that it warehouses,” said Jun, pointing to the fact that “local houses disagree on having a large book will always result in more revenue.”
Out of the KRW73 trillion notional on equity-linked products in South Korea as of the end of last year, domestic securities houses hedged 56% or KRW41 trillion of it, according to Financial Supervisory Service. This marks an over 30% rise from the KRW31 trillion notional reached at the end of 2017, but the ratio stood at almost the same level at 55.4%.
The rest of the trades are done through the so-called ‘back-to-back’ transactions in which a local securities firm enters a swap contract with a foreign investment bank to secure the coupon for investors but transfer the hedging risks when dealing with the products.