South Korean individual investors are leaving the domestic derivatives market including futures and options and going abroad. This is because there are now higher entry barriers to the domestic derivatives market and securities companies urge to make an investment in overseas derivatives to boost their fee earnings. Voices demanding the system improvement to prevent liquidity shrinkage in the domestic market and protect investors are growing.
According to the Korea Exchange (KRX) on November 5, the number of contracts in the domestic derivatives market dropped by a whopping 79 percent from 3.93 billion in 2011 to 827.87 million as November 3 this year. As individual and institutional investors showed the decline in participation, the percentage of foreign investors has been increased to as much as 49 percent. The percentage of individual investors decreased from 31.89 percent to 29.71 percent in terms of numbers of contracts over the same period, while that of institutional investors declined from 30.89 percent to 21.21 percent. Individual investors showed the steep drop in terms of trading values. The figure decreased by half from 25.62 percent in 2011 and 13.07 percent this year. In particular, the share of foreign investors in KOSPI 200 futures doubled from 31.4 percent in 2011 to 62.19 percent last year, while that of institutional investors declined by half from 35.4 percent to 14.05 percent.
In contrast, the investment in the global derivatives market soared. The KRX said the overseas derivatives investment by domestic investors reached some 7 trillion won (US$6.28 billion) on a daily basis, up by two times compared to 2011.
This is largely due to the fact that entry barriers to domestic derivatives investment has been raised in 2011. Currently, the deposits required for domestic investors invest in the derivatives market are 30 million won (US$26,894) for futures and 50 million won (US$44,823) for options. They also need to spend 30 hours for orientation and 50 hours for mock trading, respectively. This year, regulations for options that have a relatively low risk of loss have been relaxed, lowering their basic deposit from 500 million won (US$44,823) to 300 million won (US$26,894). However, the market still has been shrunken compared to a few years ago.
Securities firms also urge investors to make investment in derivatives abroad since a considerable amount of deposit and orientation are not required and they can have higher earnings. Lim Jae-joon, director of the derivatives market product division at the KRX, said, “Securities companies often recommend overseas derivatives investment that can have higher fee-related earnings.”
The problem is investment risks. Lim said, “There are concerns that domestic investors will not be able to be protected when they make an investment in overseas derivatives products that have high risks. In short, regulations which were designed to raise the market transparency now lead to the balloon effect and investors in derivatives that went abroad are left alone in the end.
Reduced liquidity in the domestic derivatives market is another source of concerns. Hwang Se-woon, head of research at the Korea Capital Market Institute, said, “There is no absolute standard that what percentage of foreign investors are desirable but it can be hit hard by their capital flows. Moreover, the market efficiency, including price discovery function, can be adversely affected when the size of the domestic derivatives market decrease that will lead to liquidity shrinkage.