Will third attempt work for ELW regulations?

By Kwaak Je-yup

However strong the regulations become, Korean "ants," or individual investors, always seem to find a way around them.

Even in the case of derivatives, themselves tools for volatility control, local investors have managed to play them like high-risk investment games, prompting government action to no avail ― until now.

Equity-linked warrants (ELW), which caught the headlines when 11 leaders of brokerage firms were brought to court by prosecutors for market manipulation last year and acquitted two weeks ago, will be restricted again in March, as announced last month, but doubts remain as to the effectiveness of this third-in-two-years measure.

The regulators tried twice before to reduce volatility for the sake of protecting at-home traders, yet they still make up 50 percent of trading volume in the world's second largest ELW market after Hong Kong ― and continue to hemorrhage money.

Korea already has some of the most stringent requirements for listing warrants, which has led several foreign securities firms to scrap that particular business here.

The number of listed warrants has come down from 9,206 last January to 6,981 this month but in July went up to 9,618.

The turnover has fallen from 35.5 trillion won ($31.6 billion) a year ago to 21.5 trillion last month, but signs are unclear as the amount recovered came to 30.8 trillion the month before.

Meanwhile, professional retail investors, dubbed "scalpers," are placing bigger trades and increasing turnover, outsmarting individual investors with speedy bets. The alleged collusion between the brokers, or liquidity providers (LP), and them led to the court proceedings.

The failure to contain this trend has even led a scholar to propose a complete closure of the ELW market.

"If the efforts to solve individual investors' losses do not eliminate speculative and unfair trades, fundamental measures like restructuring or closing may be necessary," said Kim Young-do, a research fellow of financial markets and systems at the Korea Institute of Finance, a private research body funded by domestic banks.

The measure expected in March will limit LPs' market-making power. The number of warrants for listing will be under review, and the bid-ask spread will increase further to discourage short-term investing.

The Financial Supervisory Service (FSS), the executive arm of the Financial Services Commission, has reiterated that the ELW market is too overheated and that the at-home traders suffer from the asymmetric information problem, but those subjected to the new regulation only reduces liquidity.

Investors wanting to buy warrants already face a margin deposit requirement of 15 million won ($13,365) and must undergo a one-hour training session.

Each warrant must have full daily disclosure of open position, turnover and volatility while LPs are also subjected to a quarterly grading system, the failure of which ultimately leads to a ban from business.

According to the documents the FSS submitted to the National Assembly audit in last September, the five-year span between 2006 and 2011 saw 1.8 trillion won in individual investor losses from ELW markets, while the Korea Exchange and LPs had net gains of 72.5 billion won and 106.7 billion won respectively.