HSCEI-linked ELS losses near $750m, more surges expected

[Graphics by Song Ji-yoon and Chang Iou-chung ]

Losses from equity-linked securities (ELS) that are tied to Hong Kong’s Hang Seng China Enterprises Index (HSCEI) and sold by South Korean commercial banks are approaching the 1 trillion won ($750 million) mark. There are expectations of further surges in March 2024, but forecasts suggest a potential decrease in losses by 30 to 40 percent if the index rebounds to 6500 from its current level of 5700.

On Monday, Maeil Business Newspaper compiled the losses from HSCEI-linked ELS products at six major banks—KB Kookmin Bank, Shinhan Bank, Hana Bank, Woori Bank, NH Nonghyup Bank, and Standard Chartered Bank Korea—and the damage amounted to 934.3 billion won as of Thursday, significantly surpassing the cumulative losses of around 270 billion won at five of the major banks in late January 2024.

The outlook remains bleak as ELS losses are expected to escalate rapidly from March onwards and the Financial Supervisory Service indicates that ELS products worth 9 trillion won, out of a total sale worth 15.9 trillion won, are set to mature in the first half of 2024. With an average ELS loss rate of 53.6 percent and the HSCEI at its current level, estimated losses could reach around 4 trillion won in the first half of the year, including the losses nearing 1 trillion won that are already confirmed.

ELS losses are determined by following the movement of the underlying index, with the principal guaranteed only if the index at maturity exceeds either 65 percent or 70 percent of the index at the time of subscription. According to the FSS, ELS products guaranteeing the principal under the 70 percent condition amount to 7.8 trillion won, while those under the 65 percent condition stand at 8 trillion won.

The HSCEI’s rebound in February 2024 is a positive sign, with a rise of 10.2 percent from the beginning of the month until Monday. Financial authorities suggest that an index recovery could alleviate the damage, and according to a simulated scenario commissioned by Maeil Business Newspaper and conducted by a bank, potential losses could be reduced by 20 percent if the HSCEI reaches 6000, by 38 percent at 6500, and by 66 percent at 7000.

Authorities are expected to outline compensation measures shortly, following the completion of on-site inspections of 11 ELS sellers by the FSS within the week. Differential compensation ratios are under consideration, based on factors such as customer age and previous experience in ELS investment.

In response to the 2019 scandal involving foreign interest rate-linked derivative-linked funds (DLFs), which incurred losses of up to 90 percent of their principal, the FSS applied different compensation percentages, including 30 percent for mis-selling, 20 percent for internal control deficiencies at bank headquarters, and 5 percent for the sale of ultra-high-risk products.