H-share free fall brings back margin call spook for Korean brokerages amid liquidity woes

[Captured from Hang Seng Indexes]

The Chinese risk from extension of the power grip of Chinese strongman Xi Jinping may worsen the currency and liquidity woes for Korean brokerages as they may be forced to sell assets to cover for widening losses in financial products connected to equities listed in Hong Kong with underlying Chinese assets due to their free fall in stock prices.

According to the Korea Securities Depository, the outstanding balance Koreans hold in instruments dubbed equity-linked securities (ELS) tied to Hang Seng China Enterprise Index (HSCEI) and H-shares of mainland Chinese enterprises amounted to 21.2 trillion won ($14.9 billion) as of September 30, up 34 percent on year.

Due to a plunge in H-shares accelerated by the lengthening of the one-man rule in Beijing, related ELS products managed by Korean brokerages have mostly entered the knock-in option area, which could cause a loss of principal for holders - mostly retail investors - in Korea.

The knock-in line for most HSCEI ELS products sold in Korea is set at between 5,000 and 6,000, meaning that investors would lose even their principal investment when the HSCEI dips below 6,000. Many of the products were sold when the index hovered above 10,000.

The HSCEI has tumbled 26.3 percent against its peak over four months. It fell 7.4 percent on Monday, the biggest fall since the 2008 global financial crisis after Xi¡¯s third term was pronounced over the weekend. It is trading above 53,000 on Thursday.

The plunge in H-shares may have broad repercussions for the Korean market due to fragility in the country's currency and debt market on top of the worsening liquidity woes of brokerages.

Similar havoc was experienced in March 2020.

Overseas institutions issued margin calls on 20 trillion won worth of Hong Kong index-tied ELS products operated by Korean brokerage firms after Hong Kong shares plummeted. To meet the margin call, Korean securities firms had to urgently dispose of dollar assets and Korean bonds to raise quick cash. The market short in US dollars amid outbreaks of Covid-19 sent the Korean won crashing due to flight in the greenback.

Since then, brokerages were required to stock dollar reserves of up to 20 percent for hedging in ELS instruments.

For now, brokerage houses expect to avoid a margin call and are safer in dollar reserves. But contingency measures are needed against unexpected buildup, given the fragility of liquidity conditions, the finanicial industry argues.

[¨Ï Maeil Business Newspaper & mk.co.kr, All rights reserved]