Foreign Bank Derivatives Booming

The Korea Investment and Securities Co. recently introduced a new investment instrument called, ‘Rich Father’s Equity Linked Securities (ELS)’. The new vehicle has drawn popularity in the market with its principal-protected structure, even when accumulated profits are negative.

However, there is a catch. The product is not domestic securities. It was designed by a foreign bank and Korea Investment and Securities Co. just sells the product on behalf of the foreign bank.

There is more. Most derivatives, such as Equity Linked Deposit and Equity Linked funds, are designed by foreign financial institutions.

There are very few, if any, domestically designed derivatives, but still they are adjusted forms of foreign products.

Whey this is happening?

Foreign banks enter into the Korean derivatives market-

Derivatives are financial instruments whose prices and yields are determined by changes in foreign exchange, bonds, and stocks.

Equity Linked Securities whose return is connected to an underlying equity is a typically well-known derivative to general investors.

Its condition changes “magically” depending on economic variables so it is often used as a hedging device for risky or big investments.

For example, an exporting company, which suffers losses in today’s environment with the strengthening won, benefits from trading derivatives bringing profits in times of the strengthening won.

Derivatives, unlike deposits or loans, reflect both economic factors and math and statistics.

Therefore, Korean financial institutions with a short history compared to foreign counterparts have a hard time understanding the structure of each product let alone designing them.

The Financial Supervisory Service said on December 20 that derivatives account for a mere 3.6% share of the operating income of Korean financial institutions for the first two quarters this year. In contrast, the share amounted to 86.7% for foreign banks operating in Korea.

Foreign banks’ advances into the Korean derivatives market have accelerated recently.

Macquarie Securities applied to the Financial Supervisory Service for sanctions for over-the-counter derivatives, and 3 or 4 other foreign financial companies are reportedly preparing for similar applications.

Korea, still in its infancy, needs experts-

Of course, Korean financial companies are working to obtain competitiveness in this field. Seo Hyeok-jun, a researcher at Woori Investment and Securities, said, “Our company designed on our own about 40% of products we are selling. We are expanding human resources needed for derivatives designing.” The company’s ELS sales amount to 4 trillion won a year.

Kookmin Bank recently stuck a deal for derivatives with a French bank. Other financial companies are working to increase the share of products made on their own.

However, one of the major obstacles on the path is lack of experts and talent.

One official of a foreign investment bank said, “Attractive incentives such as exceptional compensation are needed to secure talents who are capable of designing derivatives, which is hard considering business conditions of Korean companies.”

Yoon Man-ho, head of the trading center at the Korea Development Bank, said, “Most of financial instruments traded in the future will be linked to derivatives. We need to be equipped with capable human resources and to develop needed system.”

jarrett@donga.com