Hard times for derivatives market

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Hard times for derivatives market


Korea’s derivatives market was bullish two years ago, but it has turned bearish due to a lack of investor sentiment amid lingering economic malaise and stricter regulations by financial authorities. According to the financial investment industry, in 2011 Korea had the world’s largest trading volume of financial derivatives. However, its volume fell to fifth-largest last year and out of the Top 10 so far this year, falling behind India, Brazil, Russia and others.

At the Seoul bourse, the total amount of Kospi 200 futures and options trading has been on a decline. The volume of Kospi 200 futures trading fell 29.5 percent last year compared to the previous year and 11.6 percent in the first half of this year. Trading volume of Kospi 200 options also fell 30 percent last year and more than 8 percent from January through June.

Korean financial institutions have introduced various types of financial derivatives products since the market was established in 1995 for investors looking to bet on the value of underlying assets.

Industry officials say the derivatives market has stagnated because of a decline in overall stock trading and tougher government regulations.

In 2010, German-based Deutsche Bank was found to have carried out illegal derivatives trading by conducting massive selling of stock index options, fueling concerns over improper trading activities in the market. For six months, the bank was suspended from trading in derivatives. And ever since, the government started coming up with measures to increase transparency in the market and avoid overheating.

In March 2012, the government implemented measures that included raising the contract multiplier from 100,000 won ($89.84) to 500,000 won to protect individual investors from seeing huge losses for Kospi 200 futures. And with a higher trading unit, individual investors started leaving the market.

The financial authority also implemented stricter rules on foreign exchange margin trading, causing financial institutions to limit their marketing activities, which pushed the market to contract.

Stricter regulations on financial derivatives products, however, aren’t the story of Korea. After the global financial crisis of 2008, the United States and European Union strengthened rules on over-the-counter derivatives considered to be highly risky. The Korean government has focused on imposing tougher regulations on exchange-traded derivatives such as futures options and equity-linked warrants, out of concern that there could be a high possibility of illegal transactions by foreign investors.

There has been criticism, though, that the government’s tough regulations on derivatives have sent investors to the exits.

The trading volume of ELWs, which are a type of derivatives in which the holder has the right to buy or sell underlying assets such as stocks at a set price on or before an expiration date, has also fallen. In October 2010, the average daily trading volume exceeded 2 trillion won, but now the volume is just over 100 billion won. ELWs have been in the spotlight lately, especially among retail investors wishing to invest a small amount of money in expensive blue chip stocks.

“I agree with the government’s tougher rules with an aim to protect investors, but imposing direct regulations like putting a quotation limit on liquidity providers is unprecedented,” said Park Eun-joo, an official from Korea Investment and Securities.

Lee Joong-ho, a researcher from Tongyang Securities, also said, “The government has splashed water on the bonfire rather than taking out some firewood or adjusting the air.”

Meanwhile, due to the government’s strict approval system, there have been no new financial derivatives products added to the 15 currently available. The Chicago Board of Trade has 1,258 products and the Eurex Exchange 254.

BY YOON CHANG-HEE, HONG SANG-JI [angie@joongang.co.kr]
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