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S. Korean Investment Banking Industry Embroiled in DLS Controversy
Investors in DLFs at Risk of Losing 80% of Principal
S. Korean Investment Banking Industry Embroiled in DLS Controversy
  • By Yoon Young-sil
  • August 16, 2019, 11:51
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Domestic investment banking companies that designed derivatives-linked fund (DLF) products based on the interest rate of Germany’s 10-year government bonds are likely to face a compensation suit from investors at risk of losing up to 80 percent of their principal. 

A storm is brewing in the Korean financial industry as investors in derivatives-linked fund (DLF) products are set to suffer huge losses amounting to hundreds of billions of won. The problem stems from the DLFs based on the interest rate of Germany’s 10-year government bonds.

Investors who purchased the fund products are at risk of losing up to 80 percent of the principal, so they have filed a suit against the banks that sold the products, alleging that the banks failed to fully alert them to the risks of the products. While filing a complaint with the financial authorities, they are also planning to take legal action against securities companies and asset management firms that have designed the fund products.

Contrary to expectations, the interest rate of Germany’s 10-year government bonds has recently dropped steeply, raising the risk of loss for investors. The interest rate of Germany’s 10-year government bonds decreased from 0.168 percent a year earlier this year to -0.582 percent as of Aug. 7. This is largely a result of the rise in the price of bonds as an increasing number of investors prefer risk-free assets due to increasing uncertainties, fueled by the trade dispute between the United States and China.

A DLF is a fund based on derivative linked securities (DLS). Hana Financial Investment Co., IBK Investment & Securities Co., NH Investment & Securities Co. issued DLS, while KyoboAxa Investment Managers Co., Ryukyung PSG Asset Management Inc., KB Asset Management Co. and HDC Asset Management Co. have created DLF products based on the securities.

These fund products were mostly sold by commercial banks. For instance, Woori Bank sold a total of 125 billion won (US$102.92 million) worth of DLF products between March and May. The products have short maturity from four to six months. They will all mature by the end of this year starting from Sept. 19.

The DLS products can make a profit rate of 4 to 5 percent if the interest rate of Germany’s 10-year government bonds does not fall below -0.2 percent. However, investors can lose 20 percent of the principal if the interest rate drops below -0.3 percent, 40 percent if the rate falls below -0.4 percent, 60 percent on -0.5 percent, 80 percent on -0.6 percent and 100 percent on -0.7 percent.

The interest rate of Britain’s 7-year CMS moves in a similar direction with the 7-year government bonds. As of Aug. 14, the interest rate of the government bonds was 0.349 percent, down 68 percent from 1.102 percent a year ago. The DLF products sold after the end of September last year will come due starting from next month, with investors at risk of loss. The balance of investments comes to 390 billion won (US$321.15 million). A large-scale loss appears inevitable.

A South Korean law firm announced its plans to file a compensation suit against not only commercial banks which sold the products but also related IB institutions.

However, IB companies say that the main cause of the problem is the incomplete sales practice of commercial banks, not the IB industry that designed the products.