Derivative securities worry the regulator

Derivatives linked to Treasuries are now front and center for the regulators, as the rally in bonds could hit investors holding the recently volatile securities.

As of Aug. 7, the balance on derivative-linked securities (DLS) in Korea totaled 822.4 billion won ($679 million), according to the Financial Supervisory Service (FSS) on Monday.

These products invest in underlying assets, such as Treasury bonds, currencies and oil prices. Investors can get in trouble if prices move suddenly, as they have done recently in the U.S. government bond market as investors rush to safe havens. The U.S. Treasury yield curve is now inverted, with the 10-year bond trading below the 2-year.

In Korea, 3,600 retail investors could suffer massive losses, with most if not all of their investments vanishing, when these products mature.

The FSS’s study has found that 99 percent of the DLS products were sold in the form of private equity funds by banks, and almost all of these were marketed by Woori, KEB Hana and KB Kookmin Bank.

Woori Bank has sold the most, at 401.2 billion won, or 48.8 percent, while KEB Hana Bank sold 387.6 billion won (47.1 percent) and KB Kookmin Bank 26.2 billion won (3.2 percent).

DLS products sold by brokerage firms totaled 7.3 billion won.

The majority are retail investors ? 3,654 investors have invested a total of 732.6 billion won in the derivative products, which accounts for 89.1 percent of the total investment in the asset class. One hundred and eighty-eight companies invested 89.8 billion won in the derivative products.

Most of the investments were made in U.S. and U.K. constant maturity swaps (CMS). The balance in the CMS market is currently 695.8 billion won, which accounts for 85 percent of the total investment made in DLS products.

The FSS estimates that 85.8 percent, or 597.3 billion won, are already underwater. If Treasuries remain where they are, investors will on average lose 56.2 percent of their investments for a total of 335.4 billion won.

The ones facing immediate crisis are those who invested in German 10-year government bonds. Currently, 126.6 billion won is invested in the products, which expire between September and November.

The FSS estimates that unless the yield on German government bonds goes up by November, on average, investors will lose about 95.1 percent of the investments made. If so, out of the 126.6 billion won invested, 120.4 billion won will vanish.

The FSS will look into whether the companies that have sold the products informed investors of the risks.

BY LEE HO-JEONG [lee.hojeong@joongang.co.kr]