FSS alarm bells ring as brokerages take big risks for yield

The rush for yield has driven securities firms into dangerous waters, with trillion of their won and the won of their clients invested in risky assets overseas. Some of what they bought could be in trouble due to the pandemic, raising concerns that Korea could see a repeat of past scandals and losses for those who can least afford it.

The Financial Supervisory Service (FSS) said Monday alternative investments by 22 local securities firms totaled 48 trillion won ($44.2 billion) as of April 2020. The firms invested 23.1 trillion won in foreign real estate, and 24.9 trillion won in special assets, such as ports and railroads. In the age of low-interest rates worldwide, securities firms are shifting their strategies from the conventional investments into equity and bonds to competitively investing in offices, hotels and ports abroad.

According to the FSS, 15.7 percent of the entire amount, or 7.5 trillion won, is at risk on their watch list. Of that, 4.8 trillion won is individual or institutional money while 2.7 trillion is money from the balance sheets of the securities companies.

Principal loss is a real possibility. Half of the financial products sold to customers, around 2.3 trillion won, were derivative-linked securities (DLS). DLS, which are often sold at brokerages, are high-risk financial products structured to track the performance of underlying assets, such as bonds, stocks, commodities and interest rates. Their value is dependent on the underlying product, and the principal is not protected.

A repeat of the German DLS product disaster is feared. Shinhan Investment sold large amounts of German Heritage DLS products starting in 2017. The products involved buying convertible bonds of development projects in Germany. However, the developers went bankrupt in 2020, and the investors have been having difficulties in getting their money back.

“Most securities firms do not undergo thorough legal reviews or conduct due diligence when making DLS products with offshore funds,” said Park Chang-gyun, a senior research fellow at the Korea Capital Market Institute.

When offshore alternative investments become risky, they can have a negative impact on the asset quality of the local securities firms. Major securities firms have invested mainly in foreign hotel chains and condos, but as the coronavirus pandemic hit tourism, the profit from rent or even return of principal is now in doubt.

“If the coronavirus pandemic continues, the recovery of the global commercial real estate market will be delayed, and the dangers facing the alternative investments of securities firms may become bigger,” said Kim Hyun-tae, a senior research fellow at the Korea Institute of Finance.

BY YEOM JI-HYUN [lee.jeeyoung1@joongang.co.kr]