South Korea’s structured products market saw an increase of 50% in capital inflows to derivative-linked bonds (DLBs) and derivative-linked securities (DLSs) featuring funds as underlyings in 2014, despite regulations prohibiting private placement products targeted at retail investors. “As the low interest rate environment continued through last year, South Korean investors specifically favoured DLBs linked to the performance of mutual funds, which provided between 5% and 7% annualised returns at maturity,” said Chan Ho Kim, managing director at Commerzbank. “Mutual funds are viewed as rather stable and transparent, as they are quoted on a daily basis.”

Sales of DLSs and DLBs linked to funds stood at KRW1.4tr ($1.3bn) in 2013, but increased by 50% to reach KRW2.2tr ($2bn) in 2014, according to SRP data, which also reveals that sales were driven by increased use of overseas funds as well as exchange-traded funds (ETFs).

Some of the most popular funds used as underlyings in structured products last year included mutual funds issued by Franklin Templeton Investments, M&G Investments and Deutsche Asset & Wealth Management (DAWM), according to SRP data. Most of the funds featuring in South Korean derivatives-linked products are offered in the form of "at the money calls" or "annualised calls" which observe only the final level of the fund and provide 80% to 100% participation in the performance of the fund, according to Kim. “While they can also be structured in a complicated way with certain volatility targets, local investors prefer simpler structures.”

South Korean regulators have banned the sale of fund-linked DLBs to retail investors, unless they are operated by retirement pension licensees to manage retirement pension fund pools.

Despite the ban, the use of funds as underlyings for DLBs will help the market to establish these products among the investing community, according to Kim. “[The use of funds] will definitely be beneficial to the market in terms of bringing transparency and establishing funds as underlying for the local structured product market as it diversifies the product range with attractive yields,” he said.

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