Korea Exchange unveils ETN plan

The Korea Exchange (KRX) has unveiled a detailed execution plan to introduce exchange-traded notes (ETN) in the country.

The introduction of ETNs in South Korea’s retail space was revealed in the plan to develop the local derivatives market announced by the Financial Services Commission (FSC) in June.

The South Korean regulator said it was aiming to launch an ETN platform in the Korea Exchange by 17 November, and will add a new piece of regulation setting up the basis for ETNs under its guidelines on marketable securities listing and securities business by September 15.

Background
YongKuk Lee, head of marketable securities division at KRX told SRP that local investors, securities firms and the overall domestic derivatives market will benefit from the introduction of ETNs.

“In the past, local investors were not granted with enough investment choices and were limited by strict entry requirements compared with institutional or professional investors,” said Lee. “From now on, local investors will have full exposure to the ETN market, where they can freely purchase and sell under the supervision of exchange.”

According to Lee, while there will be restrictions for local investors from investing in complex ETNs, the Korea Exchange will set up screens during the listing stage to allow all local investors into the market.

“Securities firms will be able to fully perform their capability while managing ETNs, [and] they can also use ETNs as hedging tool and seek for additional profits through arbitrage activity,” added Lee. “While securities firms’ profit model was traditionally dominated by the brokerage business, the introduction of ETNs will provide a new source for earning profits.”

Overall, said Lee, the South Korean capital market will see increased liquidity and efficiency.

Underlyings
Lee also said that while synthetic exchange-traded funds (ETFs) seem to vary in their liquidity and trading volume depending on the choice of underlyings, the exchange will work to provide different underlyings that are applicable to ETNs.

“The underlying assets to be used in ETNs can be introduced in various combination,” said Lee. “Index strategies matter the most for differentiation and there will not be much restriction on how securities firms choose to manage or adopt different investment strategy.”

According to Lee, some of the underlyings being considered include baskets of oversea indices such as the Russel2000, DAX and CAC40; the Alerian MLP Infrastructure Index; combinations of the Kospi200 futures and six-month corporate bonds with AA credit rating; bond indices including corporate bond indices with A credit rating; high yield bond indices and strategic indices including Kospi futures and dollar futures with long short positions.

Listing requirement
In order to enter the ETN space securities firms will be required to have more than KRW1tr ($985m) of owned capital with credit ratings of more than AA- with the net capital ratio at or above 200%.

Furthermore, firms will have to provide evidence of having an over-the-counter (OTC) derivatives business license for more than three years. Securities firms that have fulfilled the entry level requirements include Daewoo Securities, Woori Investment & Securities, Samsung Securities and Korea Investment & Securities and other five local securities firms.

While the Korea Exchange has largely reduced ETN screening examination days to 15 days as opposed to the two months for listing ETFs, the examination will remain to protect individual investors.

“As ETNs are purely credit based products targeted at individual investors, the indices will need to be calculated by renowned and trustworthy calculating agents while the price will need to be calculated in real time basis,” concluded Lee. “The Korea Exchange will strictly screen whether the ETNs carry high commercial value and that the underlyings fulfill public posting regulation.”

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Korea Exchange unveils ETN plan