Korea’s ‘worst-of’ times are here to stay

Chinese houses’ success in Korean autocalls could stymie hopes of diversifying the product mix

South Korea’s structured products market has new players in town. Chinese Securities houses have burst onto the scene with abundant ambition and risk appetite to match. 

This might present a challenge for incumbent players, which have been desperate to break investors’ addiction to some of the trickiest products: ‘worst-of’ autocallable bonds. 

This particular breed of autocall has been linked to sizable losses for its issuers. In 2018, Natixis took a $290 million hit on its Korea autocall book when US-China trade tensions caused the Hang Seng China Enterprises Index (HSCEI) to tank. In March 2020, it was Societe Generale and BNP Paribas’ turn to lose hundreds of millions of dollars when stocks plunged at the onset of the Covid-19 pandemic. 

For investors, it’s easy to see the appeal. The short-term products use correlation to offer outsize coupons linked to the worst performer of three equity underlyings – typically indexes such as the S&P 500, Eurostoxx 50, Nikkei 225 or HSCEI. If the worst performer hits a pre-agreed level, the products knock out and investors receive a juicy pickup.  

Yet this correlation exposure can be dicey for issuers to hedge when markets move violently in unison – exactly what happened in the first quarter of 2020.

Ever since, a steady stream of new or tweaked payoffs have hit the market, with the aim of shunting investors off the traditional worst-of structure. 

Some banks have tried to market single-stock equity autocallables, albeit with little success. Another product to have emerged in recent years is linked to the average basket performance instead of the worst performer. A shape-shifting alternative starts off as a worst-of autocallable, but switches to a single underlying if it is not called after one year. 

These variations are all aimed at leaving dealers with more manageable exposures; if alternative products prove a hit with distributors and end-investors, dealer structured books would be more diversified and less vulnerable to the type of scenario that played out in 2020. 

Or so the theory goes. 

Chinese securities houses have since eyed an opportunity in the Korean market, and – as-yet unscathed by worst-of havoc – appear eager to satisfy demand for the risky instruments in a bid to win market share.  

Huatai Securities began manufacturing autocall products for Korean retail investors at the start of the year and has quickly carved out a 7% share. Huatai follows closely behind Citic Securities, which stepped in two years ago. The efforts of the two houses contributed to wins across three Asia Risk Awards this year.

Clearly, if some banks are less inclined to sell the worst-of products that Korea’s risk-loving retail investors crave, Chinese houses are only too happy to fill the gap. 

The evident success of Huatai and Citic in meeting investor demand can only undermine rival efforts to divert clients away from worst-of structures, and they may be forced to choose between profitability and risk reduction. 

For now, incumbent banks may be thwarted in their dreams of redesigning the Korean structured products market into something a bit more palatable for issuers. At least, until the next stock market meltdown triggers yet another rethink. 

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