Low rates to favour equity-linked securities in South Korea this year

Low interest and deposit rates are set to boost the equity-linked securities (ELS) market further this year, with the bulk of the demand coming from yield-hungry retail investors.

"[Over the past year] the main demand came from retail investors," says Harold Moon, managing director, head of structured equity derivatives at Nomura, Korea, in Seoul.

"We saw a pick-up in ELS activity in November and retail investors started investing again, especially because the product in Korea has a step-down/knockout feature, which investors could feel relatively safe with in the uncertain environment.

"Our forecast is that the ELS market will grow by 10% minimum in 2012 because we expect an additional deposit rates cut, which makes the product more attractive. Previously, we observed that ELS demand increased dramatically when the Bank of Korea rate dropped below 3%," says Moon.

Other products the bank expects to do well include credit-linked notes (CLNs) and first-to-default baskets.

Our forecast is that the ELS market will grow by 10% minimum in 2012 because we expect an additional deposit rates cut, which makes the product more attractive

"Since the second half [of 2011], CLNs and first-to-default baskets have been growing in popularity due to low interest rates and few investment opportunities. Momentum is likely to continue this year because of deleveraging in Europe and the US," says Moon.

Although hybrid notes proved popular last year among institutional investors as a means of dealing with low interest rates, their popularity may be dented by increased issuer risk and a stronger focus on local issuers, according to one Seoul-based banker at a foreign investment bank.

"Last year, we saw rates come down a lot and clients needed to find other sources of investment to boost yield enhancement, [which] they easily captured in the past through buying simple domestic corporate bonds," says the banker. "But from the middle of last year they needed to find other sources considering the criss-crossed market, [such as] US dollar-denominated hybrid notes in a callable format."

Derivatives-linked securities are also expected to remain a popular yield-enhancement vehicle, adds the banker, though smaller in size compared to the ELS market. "The ELS market is enormous, approximately $20 to $24 billion in size," he says.

Meanwhile, the equity-linked warrant space has been hit by several regulatory changes, the latest one due to come into force in March, which has led market participants to expect a drop in turnover by as much as 90%, according to Jennifer Lee, executive director in Nomura's equity derivatives team in Hong Kong. "If the market shrinks to 10% this means liquidity will go away and retail investors might find it difficult to buy and sell."

Other changes significantly affecting equity-linked warrants have included mandatory education for retail investors, the introduction of a minimum deposit requirement of USD$15,000 and a change in tenor.

"It is not possible to issue a different term than the listed options, and as the longest tenor for listed options is one year, terms must be shorter than one year and longer than three months," says Lee. "This change is actually against the nature of warrants products because the latter are a retail product for leverage. However the reason for having to issue the same term as listed options is also to make it easier for investors to compare prices and ease concerns over the high premia in the products."