Korean regulator seeks further crackdown on ELW market

Financial Services Commission considers restrictions on liquidity providers to cool down Korean warrant market

South Korea's Financial Services Commission (FSC) is planning to announce new regulations in the equity-linked warrant (ELW) market, including possibly raising the amount of capital required to be held by liquidity providers (LPs) against ELW issuance, and forcing LPs to stop providing liquidity once a stipulated number of warrants has been issued.

According to one dealer, LP representatives met with Zhin Woong Seob, the head of capital markets at the FSC in Seoul, in early November to try and persuade the FSC not to introduce further barriers in the ELW market in South Korea.

The market has already been hit by the introduction of a minimum deposit by investors of 15 million won ($15,000), which came into effect in August following concerns that retail buyers were sustaining heavy losses trading warrants. "Korean regulations are already more stringent compared with other countries and we don't know the outcome of these regulations, so why don't we wait longer?" asks the dealer.

The new rules will effectively prevent LPs from providing liquidity once a certain proportion of issued warrants has been sold and market prices – not including those quotes provided by LPs – are within a certain range.

The dealer provides an example of the possible thresholds: "So, for example, if we have issued 100 warrants in the underlying shares of a company, once 50 are sold and the spread of quotes is within a 20% range, without LP quotes, we would have to stop market-making."

Turnover has increased because professional retail investors are still active, increasing in number and placing bigger trades. This may be a cause of the concerns by regulators

If the spread of market prices on those 50 warrants exceeds 20%, LPs would be allowed to start making markets again. However, they would not be able to sell the remaining warrants that have been issued above the threshold. Dealers tend to issue warrants across a range of prices to appeal to investors – but typically only 5% of warrants issued are sold.

Dealers are concerned about the possible rule change given the heavy investment in electronic platforms and trading systems that would be needed.

Another option being considered by the FSC is to target buyers of warrants directly by raising the ELW trading fee, currently averaging around 0.015%, in order to cool the market.

Dealers say the FSC has looked at the market volumes and assumed that the 15 million won deposit has not worked as the turnover has increased significantly from 10.5 trillion won in August to 12.5 trillion won in November.

 

 

 

 

 

 

 

 

 

 

Source: Bloomberg

"Turnover has increased because professional retail investors are still active, increasing in number and placing bigger trades. This may be a cause of the concerns by regulators," says the dealer.

Earlier this year, an investigation by Korean authorities found these professional retail investors – known as scalpers – were bypassing firewalls at securities firms to gain speed advantages in the ELW market.

While turnover has increased, the issuance of warrants has declined since June, when a new regulation came into force prohibiting the issuance of deep out-of-the-money warrants. All ELW strike prices now must be within a 15% range of the current strike level.

A number of firms have pulled out of the warrants market since the regulations came into force, including UBS, Meritz, HMC Investment and Hanwha.

Despite this, BNP Paribas has pressed ahead with its licence application and received approval from the FSC on November 4, a bank spokesperson confirmed.