H Index-linked ELS losses likely to be reduced by half

[Photo by Yonhap]

As Hong Kong‘s benchmark H Index has climbed back upwards since April 2024 after a sharp drop at the beginning of the year, expectations are growing that South Korea’s potential losses from the index-linked equity-linked securities (ELS) will decrease significantly.

According to sources from the country’s financial sector on Monday, recent simulation results of expected H Index-linked ELS losses at six major banks - KB Kookmin Bank, Shinhan Bank, Hana Bank, Woori Bank, NH Nonghyup Bank, and Standard Chartered Bank Korea - indicated that if the index remains at the current level of 6,500, a key break-even point for ELS, the expected losses are estimated to be 1.11 trillion won ($819.24 million) after May 2024.

There were no losses for all ELS at maturity after July 2024 and the expected loss size is nearly half of the 2.19 trillion won estimated in a simulation from the end of February 2024, which was calculated based on the assumption that the H Index would remain at 5,700.

ELS products have losses capped by the direction of the stock index, meaning that depending on the type of product, investors need the index at maturity to be at least 65 percent to 70 percent of the index at the time of subscription to preserve the principal. The recent rise of the Hong Kong H index has reduced the expected losses, but if the index continues to rise, the losses could decrease even faster.

There is also hope for ELS investors who have longer maturities, as the Hong Kong H index has rallied in earnest since April 2024. The index hit a low of 4,900 in January 2024, but recovered to the 6,500-level last Friday amid recent upward trends.

If the index continues its upward trend to hit 7,000, the loss size after May 2024 would be further reduced to 640.7 billion won and this would be 42 percent less than if the index remained at its current level. But if the index falls back to 6,000, the losses will increase to 1.46 trillion won, 31 percent higher than when the index is at 6,500, and there could be possible losses on ELS maturing in October 2024.

On the other hand, the losses for customers whose ELS have already matured are almost at the 3 trillion won mark. The confirmed customer losses from the six banks totaled 2.92 trillion last Thursday, increasing more than 2.5 times in two months from the 930 billion won range in February 2024.

Regarding these customer losses, the country’s Financial Supervisory Service (FSS) is expected to release guidelines on the compensation ratio between banks and customers soon. It also plans to hold a dispute mediation committee on May 13th, 2024, to set specific investor compensation ratios for one representative case from each bank. It is expected that the customer compensation ratio will be set at 20 percent to 30 percent for each bank, plus an additive or subtractive factor depending on the investor and that the representative case compensation ratio will be determined within the range of 30 percent to 60 percent.

While the Hong Kong H Index’s upward trend could mean a decrease in customer losses and bank compensation amounts for future maturity, banks are still unable to relax. The FSS recently sent inspection opinions to major sales institutions, including banks, outlining the deficiencies in their sales systems and lack of customer protection management systems discovered during inspections.

These institutions are currently preparing their responses, which the FSS will review before forming a sanctions committee to develop sanction measures.