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Korea to Probe Sales of Product That Risks Big Losses

Korea to Probe Sales of Product That Risks Wiping Out Investors

(Bloomberg) -- South Korean financial regulators will start a probe into sales of derivative products that carry the risk of individual investors losing almost all their money depending on moves in overseas market rates.

Those products include 127 billion won ($105 million) of securities tied to the German 10-year government bond yield, according to a statement from the Financial Supervisory Service. While they offer high returns if the German yield stays above a certain level, the securities expose investors to losses that increase as the yield falls more and more below that level.

After the recent plunge in global bond yields, investors in the German rate product stand to lose 95.1% of their principal on average if it matures with interest rates around current levels, according to the FSS. The outstanding amount of such securities linked to overseas interest rates was about 822 billion won as of Aug. 7, and individual investors accounted for 89.1% of that total, according to the regulator.

The sale of such a high-risk product mainly to individuals highlights how low interest rates in Korea are making investors desperate for extra return, to such an extent that they are willing to buy a product that will cause them to lose almost everything they put in if the market moves the wrong way. The regulator said that after the probe it will seek to reconcile a dispute about whether the products were sold without providing enough information.

Korea to Probe Sales of Product That Risks Big Losses

A law firm called Hannuri Law, which is talking to investors, said on its website that most of the investors are known to be elderly people, retirees and housewives, who typically are risk averse.

FSS said it will investigate relevant parties -- banks, brokerages, and asset management firms.

Among the products tied to overseas rates, 401 billion won of the securities were sold by Woori Bank, while 388 billion won was sold by Hana Bank, according to the FSS. Spokespeople for both lenders said they will faithfully take part in the probe.

One of the German rate-linked products offers a return of 2% on the six-month securities if the 10-year yield is minus 0.25% or higher, according to the FSS. But if it falls below that level, investors lose 2.5% of their principal every time the yield drops one basis point. They stand to lose as much as 98% of their investment if the rate falls 40 basis points or more from the target level, under the product’s terms. The German sovereign yield was minus 0.69% last week.

Another 696 billion won of securities are linked to the U.S. dollar five-year constant maturity swap rate and U.K. pound seven-year constant maturity swap rate. Investors may lose 56.2% of their principal on average if the rates stay at levels as of Aug. 7, according to the FSS.

The market for such products in South Korea is big.

The outstanding amount of so-called derivatives-linked securities and funds tied to non-equity assets such as interest rates and exchange rates was about 40.8 trillion won, while those linked to equity-related products came to 74.9 trillion won, according to data from Korea Securities Depository.

“Retail investors will now consider those products risky and they will likely take a conservative approach,” said Jun Gyun, a derivatives analyst at Samsung Securities Co. in Seoul. “Issuance of such products may dwindle due to soured investor sentiment.”

To contact the reporter on this story: Kyungji Cho in Seoul at kcho54@bloomberg.net

To contact the editors responsible for this story: Andrew Monahan at amonahan@bloomberg.net, Ken McCallum

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