House of the Year, Korea: Hana Financial Investment
While equity-linked derivatives dominate South Korean structured products, Hana Financial Investment (HFI) has diversified into broader derivative-related securities (DLS) space. That move is paying off now amid choppy markets.
The company is the market leader in derivatives-related securities, with a market share of 16% at the end of 2017, up from 11.3% three years earlier. In the crowd of stock-linked securities (ELS), its market share increased by one percentage point to 8.5% over the same period. HFI ended the first half of 2018 with further gains, taking its share of the pie to 9% in ELS and almost a quarter in DLS.
“HFIthe main objective of ELS/DLS is to provide innovative and price-competitive structured payments with attractive risk/reward profiles, while being able to effectively recycle our own risk positions,” said Ken Woo, Head of Equity Division at HFI.
The two most popular investment formats in the Korean structured product markets are ELS and DLSwhich may be issued by licensed securities firms over-the-counter.
“The products have very different characteristics; ELS gains must be tied to single stocks and/or market indices. Nowadays the most popular ELS underlying is a basket of global stock indices such as the S&P 500, Euro Stoxx 50, Kospi 200, HSCEI and Nikkei 225. On the other hand, DLS earnings can be tied to many different types of asset classes, such as rates, credit, hybrids with equities, etc.
The returns that these derivatives have provided in a context of historically low interest rates have attracted retail investors to these structured products. Korean ELS sales volume reached $59 billion in 2017 from $46 billion in 2014, and DLS sales volume nearly doubled over the same period, reaching $16.7 billion in 2017. ELS volumes jumped to around $50 billion in the first six months of the year, but have since fallen as the emerging market crisis rocks Asian stock markets. But volumes of DLS with a steady gain remained intact.
“I believe both ELS and DLS have successfully established themselves as alternative asset classes for various types of investors seeking personalized return enhancement within a pre-defined/appropriate risk setting [paramaters]. In many cases, the volatility of the underlying assets, futures prices and correlation are the main sources of performance enhancement,” says Woo.
HFIthe main objective of ELS/DLS is to provide innovative and price-competitive structured payments with attractive risk/reward profiles, while being able to effectively recycle our own risk positions
Ken Woo, Hana Financial Investment
The complexity of the winnings differs; more ELS payments have features such as automatic calling mechanisms, correlation effects, and quanto components, which can be difficult to fully hedge in listed or interbank markets where only vanilla payments are traded. However, DLS payouts vary from simple examples such as those for credit-linked products to very complex examples.
In 2015, for example, HFI has decided to offer reverse convertibles with a duration between 6 and 12 months, with payoffs linked to 5 years or 10 years WE dollar constant maturity swaps (CMS). The offer was driven by signals of gradual rate increases in the WE Federal Reserve and the fact that customers who thought WE interest rates were unlikely to fall significantly in the short term wanted to benefit from this view.
After the rate hikes, WE dollar CMS rates have increased and DLS investors could achieve their goal of improving returns. However, due to the nature of the gains from the reverse conversion, the source of this yield improvement diminished significantly after WE dollar CMS prices have almost doubled. So since March 2017, HFI started using the British pound CMS – sometimes in addition to WE dollar CMSwith features of automatic call or call by transmitter.
HFIit is DLS products linked to various global rates introduce new investment opportunities for retail and private banking clients in the DLS market. Global rates, previously considered an exclusive asset class for institutional clients, has established itself as one of the main asset classes for retail and private banking clients thanks to HFIwide range of offers of underlying global interest rates.
The complexity of the cover is also varied. Like ELS are generally linked to a basket of global equity indices, the corresponding listed futures and options are traded on major exchanges with a very tight bid/ask spread and good liquidity. However, DLS can be tied to a range of asset classes, some of which are only traded in OTC or interbank markets, which can create higher slippage costs due to wider spreads between supply and price offers given by market makers.
“In the ELS market, HFI has in place various cross-hedging programs through which we can recycle a majority of exotic risks, which could be very difficult to hedge in distressed market conditions, with major global investment banks, while we manage positions vanilla-like residuals that are less risky,” says Woo. “Also, these idea-based cross-hedging schemes could be a great springboard for HFI further develop our internal hedging and risk management capabilities. In the DLS market, HFI tends to provide internal pricing for simple payments, such as simple credit-linked loans DLS. For complex payments with global underlyings that HFI does not actively trade, we use back-to-back business models where we can hedge most market risk through global investment banks.
The company also had to think carefully about how to recycle market risks embedded in ELS and DLS depending on the hedging tools available and their liquidity.
It has worked closely with large local banks on the distribution side and global investment banks on the product manufacturing side, while developing its risk management technology and operations for greater efficiency.
“HFI has continuously provided innovative and diversified structured products, supporting a successful business partnership with our society,” says a wealth manager at a Korean lender.
“HFI always places mutual success with our customers and business partners as a top priority,” says Woo. “In addition to being well connected with different types of market players, HFI invests significantly in developing our trading and risk management capabilities.