South Korean equity-linked securities (ELSs) featuring the Hang Seng China Enterprise Index (HSCEI) have breached their knock-in barriers for the first time since the global financial crisis in 2008 following the fall of the Chinese equities market. Last week, Hanwha Securities informed investors in its Hanwha Smart ELS 3073, which was issued back in April, that the underlying had breached its knock-in barrier and that, unless the index level recovers by 80% of its initial level at maturity, the product will be subject to capital loss.

The product was issued when the HSCEI was at 14,536.67 points on April 17 with a downside barrier set at 65% of its initial level, which is 9,448.83 points, according to Hanwha. However, the HSCEI dropped to 9,427.93 points on August 26, which meant the product touched its knock-in barrier.

Although this does not mean that the product will be exposed to capital loss immediately, unless it recovers to 85% of its initial level (ie. 12,356.16 points) by maturity, or knocks out by reaching 80% of its initial level on the remaining observation dates, the product will be exposed to potential capital loss, said the provider in a statement.

According to SRP data, there are 4,276 outstanding products worth KRW17tr in retail and private banking featuring the HSCEI and CSI 300, which were launched between April and June, at which point the indices were at 14,000 points and 4,500 points, respectively. As of September 2, these indices have fallen by 33% and 35%, respectively, affecting products with downside barriers set at 65% to 67%. There are 15 products worth KRW26bn, mainly from Hanwha Securities, that include downside barriers of 62% to 65% issued between April and June, while 3,213 products worth KRW12tr feature downside barriers ranging from 35% to 60% of their initial levels, according to SRP data.

“While it is true that the plunge of HSCEI raises concerns around knock-in barriers of some ELSs, it is still too early to be worried, as the lowest point of the index over the last five years was around 9,000 points,” said Changkyu Choi, analyst at NH Investment & Securities.

Kyun Chun, analyst at Samsung Securities said that, while the volume of products subject to knock-in will not be high, the fall in the index level will delay knockouts, with a decrease in rollover opportunities if the market stagnation continues.

There are 19,473 live products that feature the CSI 300 and Hang Seng China Enterprises indices, of which 96% of products are non-principal protected, according to SRP data. Furthermore, 6,478 outstanding products worth KRW33tr that include the CSI 300 and Hang Seng China Enterprises indices feature knockout payoffs.

In a recent regulator update, South Korea’s Financial Services Commission stated that “if the dominance of certain underlyings increases market risk” it may consider a temporary ban on structured notes issuance linked to specific underlyings.

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