Korea Structured Notes Soar as Lehman Minibonds Bite Hong Kong

Structured-note sales in South Korea are soaring as individuals pile in, bucking the trend in Asia’s financial hubs, where losses from Lehman Brothers Holdings Inc.’s collapse led to rules that paralyzed the industry.

Issuance in South Korea surged 54 percent to a record 70 trillion won ($64 billion) last year in about 20,000 offerings, including private placements, according to data from Korea Financial Investment Association. That dwarfs 26 comparable products approved for public sales in Hong Kong and two registered in Singapore in 2012, based on listings posted by the two markets’ regulators.

Issuers have balked at public sales in the regional financial centers since the introduction of stricter rules to avoid a repeat of losses from Lehman-linked securities known as minibonds. In South Korea, changes have been less dramatic, thanks to limited exposure to the notes, giving issuers more freedom to introduce new products and lure individuals seeking high-return investments amid falling interest rates.

“For those who didn’t lose money during the Lehman crisis, they developed trust in these products,” Lee Jeong Hwan, general manager for derivatives sales at Daewoo Securities Co., said by phone. In South Korea, “regulations haven’t really been an obstacle. They actually helped strengthen investors’ trust.”

Korean Market

The securities are issued by licensed local brokerages that work with foreign banks for hedging and product development. Over the past decade, the industry has evolved to use assets from overseas equities to currencies to commodities.

South Korea probably now has the largest structured-note market for individuals in Asia, as sales in other markets including Hong Kong have been led by private bankers, according to Harold Moon, head of equities derivatives at Nomura Holdings Inc. in Seoul. About 30 percent of the issuance last year went to individual investors, according to the Korea Financial Investment Association figures.

When the securities were introduced in South Korea in 2003, structured-product sales to individuals amounted to an estimated $12 billion in Hong Kong and $5 billion in Singapore, according to 2005 research by Global Fund Services, based on surveys of issuers.

By the end of last year, the Hong Kong market shrank to HK$4.5 billion ($580 million) in outstanding investments, according to the Securities and Futures Commission. In dollar terms, that’s less than 1 percent of the 225 trillion won held in publicly sold securities in South Korea, according to the Korea Financial Investment Association data.

New Regulations

In Hong Kong, where more than 43,000 investors bought an estimated HK$20 billion of minibonds from banks, the Securities and Futures Commission has begun requiring reviews and regulatory approvals for all structured products sold to individuals.

Singapore’s Monetary Authority of Singapore last year started to ask distributors to assess clients’ investment knowledge before sales, after S$508 million ($410 million) of structured products tied to Lehman lost most or all of their value. The city-state in 2009 also banned banks including DBS Bank Ltd. and Royal Bank of Scotland Group Plc from selling structured notes for six months to two years.

Streamlining Issuance

South Korean regulators also have taken steps to better protect investors, such as requirements to disclose risks and restrictions on sales to individuals older than 65. The authorities are also watching the growth of securities linked to non-equity assets and plan to set up a system to monitor how brokerages manage the products, Financial Services Commission said in an e-mailed response to queries.

The new rules haven’t slowed down issuance in the country. South Korea’s brokerages can issue securities after submitting documents for the new notes, including prospectuses, to regulators through an electronic filing system that processes them as quickly as within a few hours, said Ha Chul Kyoo, who heads the structured-securities team at Woori Investment & Securities in Seoul.

For investors, the appeal of the products, which typically pay monthly coupons, are their returns averaging about 9 percent annually over the past five years, Nomura’s Moon said. Bank deposits currently yield about 3 percent in South Korea, according to the Bank of Korea.

Brokerages are making it easier to buy the securities to further capture surging demand. Companies led by Samsung Securities Co., the country’s largest brokerage by market value, are letting investors sign up for the products via the Internet, while some, including Mirae Asset Securities Co., have introduced similar applications for smartphones.

South Korea “offers economies of scale,” Moon said. “Given the market volume, it’s a good place for foreign banks to get in, as long as they trade and hedge properly.”

Before it's here, it's on the Bloomberg Terminal.