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Koreans Who Didn't Read Fine Print Risk Losing It All on Derivatives

Kyungji Cho
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Koreans Who Didn't Read Fine Print Risk Losing It All on Derivatives

(Bloomberg) -- S.H. Wi, a 59-year-old self-employed South Korean, had more than $350,000 stashed away in a time deposit to fund a future house purchase. When the deposit matured, little did he know that the next investment his bank recommended might cause him to lose almost all that money.

At a local bank in Gyeonggi, near Seoul, he was offered a product linked to dollar and pound-based market rates with a targeted annual return of 3.7%. Wi didn’t read the small print carefully though: investors buying it faced the risk of losing almost all of their principal if the market went the wrong way. As things stand, Wi is likely to suffer big losses when the contract matures in December, he said.

“What kind of madman would buy such a product if he knew he could lose 100% of his money?” said Wi, who asked to be identified only by initials for his first name to protect his privacy.

Wi is one of many South Korean individual investors who, faced with falling interest rates and a sluggish share market, have jumped into derivative-linked products that carry massive risks. While it’s the investor’s responsibility to read up on the risks of an investment, Korea’s financial regulators are in the midst of a probe into whether those products were sold without enough information provided to buyers or whether they had design flaws.

Read more: Korea to Probe Sales of Product That Risks Wiping Out Investors

“Because market rates are down globally, more people are desperate for extra returns, but it’s getting more difficult to design attractive products,” said Jun Gyun, a derivatives analyst at Samsung Securities Co. in Seoul.

Wi put 427 million won ($357,800) in a fund that holds securities tied to a U.S. dollar five-year swap rate and the equivalent U.K. pound seven-year gauge. Investors can lose as much as 96.3% of the money they put in depending on moves in the rates.

Such risks are unusual. Most derivative-linked products have caps on how much losses an investor can suffer, according to Jun at Samsung Securities.

There’s a big market for products like those in Korea. The outstanding amount of securities linked to overseas interest rates was about 822 billion won, and individual investors accounted for 89.1% of the total, the Financial Supervisory Service said in a statement last month.

The overall market for derivatives tied to stocks or non-equity assets such as commodities, interest rates and real estate has boomed in Korea, more than doubling since 2012 to 112 trillion won outstanding, according to Korea Securities Depository data.

The soaring popularity of the products has hurt the financial health of some brokerages selling them, as the firms need short-term funds to manage those products. Samsung Securities’ credit rating was cut this week by Moody’s Investors Service, which cited its weakening funding and liquidity profiles.

The FSS said this week it’s continuing an investigation into the product design, manufacture and sales of derivative-linked securities or funds tied to overseas rates.

Korean individuals have become more familiar with structured products as the market grows, according to Lee Jung-ho, a derivatives analyst at KB Securities Co. in Seoul. The bankers that designed products like the one that Wi bought may not have been expecting market rates to move so rapidly, he said.

South Korea’s recent history might be a factor in individuals’ rush into high-risk products.

“Koreans haven’t really experienced low interest rates as we went through rapid economic growth and people remember they got decent returns in the past,” Lee said. “Their expectations for returns are high.”

(Updates currency conversion.)

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