South Korea to probe sales of product that risks big losses

Bloomberg

South Korean financial regulators will start a probe into sales of derivative products that carry the risk of individual investors losing almost all their money depending on moves in overseas market rates.
Those products include 127 billion won ($105 million) of securities tied to the German 10-year government bond yield, according to a statement from the Financial Supervisory Service. While they offer high returns if the German yield stays above a certain level, the securities expose investors to losses that increase as the yield falls more and more below that level.
After recent plunge in global bond yields, investors in German rate product stand to lose 95.1% of their principal on average if it matures with interest rates around current levels, according to the FSS. The outstanding amount of such securities linked to overseas interest rates was about 822 billion won as of August 7, and individual investors accounted for 89.1% of that total, according to the regulator.
The sale of such a high-risk product mainly to individuals highlights how low interest rates in Korea are making investors desperate for extra return, to such an extent that they are willing to buy a product that will cause them to lose almost everything they put in if the market moves the wrong way. The regulator said that after the probe it will seek to reconcile a dispute about whether the products were sold without providing enough information.
FSS said it will investigate relevant parties — banks, brokerages, and asset management companies.
Among the products tied to overseas rates, 401 billion won of securities were sold by Woori Bank, while 388 billion won was sold by Hana Bank, according to the FSS. Spokespeople for both lenders said they will faithfully take part in the probe.
One of the German rate-linked products offers a return of 2% on the six-month securities if the 10-year yield is minus 0.25% or higher, according to the FSS. But if it falls below that level, investors lose 2.5% of their principal every time the yield drops one basis point. They stand to lose as much as 98% of their investment if the rate falls 40 basis points or more from the target level, under the product’s terms.
Another 696 billion won of securities are linked to the US dollar five-year constant maturity swap rate and UK pound seven-year constant maturity swap rate. Investors may lose 56.2% of their principal on average if the rates stay at levels as of August 7, according to the FSS. The market for such products in South Korea is big.
The outstanding amount of so-called derivatives-linked securities and funds tied to non-equity assets such as interest rates and exchange rates was about 40.8 trillion won, while those linked to equity-related products came to 74.9 trillion won, reports said.