The offshore arm of China's CITIC Securities has won the Best House, South Korea award for its growth in the retail equity-linked securities (ELS) market.

In 2022, CITIC CLSA traded approximately US$3 billion of notional in derivatives with local securities houses in South Korea, one-third of which were exotic options with the remainder going to delta one products (mostly futures and index swaps).

For the exotic options, which are wrapped as equity-linked securities (ELS), the notional represented seven percent of the market share. Nearly 90% of it came from public offerings driven by ELS linked to the Hang Seng China Enterprises Index (HSCEI).  

Equity-linked securities grew over 200% in 2022 compared to 2021, two years after it set foot in Korea’s derivatives segment as a manufacturer by booking trades from Hong Kong SAR, according to Sejun Park (pictured), director, equity derivatives sales at CITIC CLSA.

In South Korea, ELS are typically autocallable products with a stepdown or worst-of option offering a pre-determined coupon. Currently, only 10% to 20% of the ELS are autocallable with a lizard payoff, according to Park. Lizard structures used to be more popular as they can feature an extra layer of downside protection.

Park noted that no autocall event has occurred for a number of HSCEI-linked ELS after as the underlying index struggled to recover from a record low seen in October 2022. As such, investor money is stuck in the market.  

“The equity market has been rallying this year, except for the HSCEI. As a result, investors have shifted to cash equities from structured products,” he told SRP. “The performance of the HSCEI is very important to the ELS market this year.”

The underlying assets of retail ELS that come with less than 80% capital protection have been limited to five major market indices – the Kospi200, S&P 500, Eurostoxx 50, HSCEI and Nikkei 225 – since February 2021 in the wake of the 2019 mis-selling incident.

“I’ve seen little innovation in ELS in the past two years. There are few new underliers for private offerings,” said Park. “US stocks are gaining some traction, but headline indices remain dominant.”

From January to May, the ELS market size dropped by 15% year-on-year, which is in line with CITIC CLSA’s volume at around US$400m.

“The ELS traded early this year are very likely to be autocalled in Q3 2023 as most ELS are observed on a semi-annual basis,” said Park. “I expect an influx of rollover amounts by then.”

At CITIC CLSA, which was acquired by CITIC Securities in 2013, the EQD team covering Korea comprises two exotic traders, one delta-one trader, two structurers and two salespeople, who all sit together and can react well to clients in Korea, said Park.

In the first two years, the Chinese house started with the CSI 300 as the only hedge provider capable of doing so in the ELS market. In 2022, the team shifted to the HSCEI due to less demand for the Chinese equity benchmark, which brings better business.

The CSI 500, a household equity index name for Chinese investors, remains unfamiliar for many Korean investors and it is considered more volatile than the CSI 300.

“Korean investors generally think the CSI 300 is equivalent to the HSCEI in terms of volatility. But the CSI 300 Agricole is not among the five indices that are eligible for ELS public offerings unfortunately,” he said. “We're looking to offer the CSI 500 and the CSI 300 through private placements, but it’s not easy.”

In view of the loss taken from some HSCEI-linked ELS, a potential conversation with regulators about the expansion of underlying assets for public offerings has been difficult, according to Park.

He noted that CITIC CLSA is also seeking to bring new underliers to the ELS market through private placements, such as GMAT 2, which is a multi-asset quantitative investment strategy (QIS) index developed by Citic Securities. It has been widely used in the Chinese structured product space.   

In Q1 23, the sales volume of ELS stood at KRW6.7 trillion (US$5.1 billion), down 27.9% year-on-year while that of equity-linked bonds (ELBs), which differs from ELS in terms of capital protection, saw its volume increase 10.3% to KRW3 trillion, as SRP reported.

Despite the slowdown, the ELS market has attracted new players over the last two years, including some local securities houses and foreign investment banks.

“We see other Chinese securities houses coming into the space. The pie is very small,” said Park. “They may help Korean investors know better about Chinese underlying names, which will benefit us all.”