Equity-linked securities weigh on top Korean brokerage firms

About 48 trillion won ($39 billion) of outstanding equity-linked securities (ELS) issued by South Korean brokerage companies has put their sector leaders under great strain, adding even more volatility to short-term funding and foreign exchange markets.

The recent sharp declines of the underlying assets, such as the S&P 500, the Euro Stoxx 50 and KOSPI indexes, led to increased margin calls on the futures and options contracts they have signed to hedge the ELS positions.

Facing margin calls exceeding 1 trillion won for a single day early this month, some securities companies were forced to offload or issue commercial paper for cash. On March 19, the volume of their one-day commercial paper issuance was a combined 2.5 trillion won.

Top players, such as Samsung Securities Co. Ltd., Korea Investment & Securities Co. Ltd. and Mirae Asset Daewoo Co. Ltd., have increasingly opted to hedge their ELS positions on their own using options, rather that entering into back-to-back transactions with foreign counterparts.

For Samsung, the outstanding hedging position for equity- and debt-linked securities is worth 7.2 trillion won, equivalent to 80% of the ELS and DLS notes it has sold, Yonhap News said on March 24, citing HI Investment & Securities Co. Ltd.

The volume of those contracts is 5.6 trillion won for Korea Investment, or 55% of its total; 3.5 trillion won for Mirae Asset; and 1.5 trillion won for NH Investment & Securities.

Some of the ELS products have entered the loss-making barrier for their buyers.

As liquidity conditions tighten amid the coronavirus fears, Mirae Asset Daewoo has increased the balance of commercial paper issuance to 4.3 trillion won this month form 3 trillion won early this year. Samsung Securities has raised over 1.3 trillion won in commercial paper so far this month.

Their rush to short-term funding markets was blamed for a surge in short-term borrowing costs and the dollar/won exchange rate. They had to exchange the money into dollars to top up the margins.

Some companies offered to sell overseas assets including commercial buildings and hotels, but failed to drum up interest.

They were also hit by refinancing failures in the 127-trillion-won asset-backed commercial paper market that accounts for half of the country’s 256-trillion-won commercial paper market.

RELIEF MEASURES

To ease their liquidity crunch, the South Korean government on March 24 unveiled a bond market stabilization fund worth 20 trillion won to buy corporate bonds, highly-rated commercial paper and financial notes issued by designated financial institutions.

The Bank of Korea will also expand the scope of repurchase agreement operations for securities companies. Additionally, securities companies will be provided with 5 trillion won collateralized loans, with the limit of short-term borrowings between brokerage companies doubling to 30% of equity capital.

But the announcement failed to reverse the mood in the commercial paper market.

The yield on the 91-day commercial paper with a single-A rating was 0.1% point higher to 1.65% on March 24, adding 0.29% points in the past week.

In contrast, the yield on the three-year, AA minus-rated corporate bond dipped to 2.006% from 2.01% on March 23.

Industry sources say that it is unclear how the government will define highly-rated commercial paper and if the commercial paper buyback plans will include both primary and secondary markets.

“The government measures may be limited to healthy companies, so companies and investors cannot respond immediately to the announcement,” said a financial industry source.

“Stability in the short-term funding markets will depend on how specifically the measures will be taken next month,” he added.

A total of 79 trillion won in commercial paper, including electronically-issued notes, are maturing by the end of this year, more than double the 37 trillion won of corporate bonds due within this year.

About half of the commercial paper due within this year, or 43 trillion won, are rated A2 or below, of which 28 trillion won are maturing within the first half of this year, according to SK Securities.

“In the worst-case scenario, short-term liquidity problems could send a profit-making securities company into bankruptcy in black,” said a source of the regulatory Financial Supervisory Service.

Write to Jin-sung Kim and Hyung Joo Oh at jskim1028@hankyung.com


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