’Speculation markes market’
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By Kim Da-ye
The spot market wouldn’t exist without derivatives, the head of Korea’s major securities firm said.
“What does it mean to get rid of derivatives? If investors can no longer hedge risks or prepare for the future, they wouldn’t buy stocks,” Hwang Sung-ho, CEO and president of Woori Investment & Securities, said in an interview with The Korea Times.
The comment comes at a sensitive time when 12 former and current chiefs of securities firms including Hwang have been charged by prosecutors for having made the investment environment more favorable toward certain clients.
The Seoul Central District Prosecutors’ Office claimed that the securities companies helped some retail investors specialized in high frequency trading called “scalpers” buy and sell securities quicker than ordinary individuals by providing a separate online trading route.
Some industry insiders fear that the government intends to get rid of the market for equity-linked warrants (ELW), a sort of an option contract sliced, listed and made easily accessible to retail investors.
Hwang couldn’t discuss the lawsuit because it is an ongoing case, but shared his candid thoughts on the functions of derivatives and investor protection.
The veteran banker, who had headed CJ Investment Trust & Securities, now Hi Investment & Securities, and PCA Investment Trust Management, divides investors into two types: financial consumers and users.
“Those people who consume non-risky financial products including savings accounts at banks, insurances and credit card must be protected,” Hwang said.
“Once they buy stocks they are no longer financial consumers. They become financial users _ the investors. What are the principles in protecting them? That’s very important.”
Hwang then broke up the users into three groups: speculators, investors who aim to hedge risks and arbitrageurs who trade identical or similar assets in different markets simultaneously to make profits from the price difference.
He said that the second and third groups make little impact on the market prices, while the first group actively suggests market prices with the belief they would rise and fall and with the purpose to profit from the fluctuation.
“Would the market exist if speculators were banned from it? No, it wouldn’t.”
Hwang finds derivatives everywhere in our daily life. He takes an example of “jeonse,” a rental system in which tenants pay a lump-sum down payment to their landlord at the beginning of their tenancy and get the full amount back when they move out.
The down payment for jeonse has skyrocketed in the last two years as the housing market slumped and people stopped buying houses for investment purposes.
Hwang sees buying and selling houses as spot sales and jeonse as a derivative. The “spot market” slowed down, but “derivatives” prospered, helping the whole housing market exist.
He elaborated further by asking if this reporter would buy a house that can be sold only when its price goes up. If the price falls or remains unmoved, the house cannot be sold even if this reporter needs to move to a bigger house. This reporter shook her head.
In this analogy, Hwang tried to explain that investors wouldn’t buy stocks if they could not hedge against possible losses with derivatives.
But unlike in that ideal world where investors would buy derivatives to hedge against the rise and fall of the securities they are holding, many individuals in Korea are making unreasonable bets, aiming for a highly unlikely jackpot.
In an extreme case, two individuals detonated homemade bombs at Seoul Station and Gangnam Express Bus Terminal in May to cause a massive drop in the stock market. They had invested heavily into put options, derivatives designed to yield significant profits when the stock prices drop below certain levels.
Hwang believes individuals or retail investors should invest indirectly _ for instance, by putting into mutual funds or hedge funds.
And if they want to directly trade derivatives, they should do so within a reasonable range, he recommended.
The two bombing suspects allegedly bought 30 million won of put options that give the right to sell securities when the KOSPI 200 index drops to or below 277 and 20 million won of options that could be exercised when the index falls to or below 275.
The KOSPI 200, an index consisting of 200 large KOSPI-listed companies, fell 2.19 percent, a considerably large margin, to 280.02. In order to gain from their 30 million won investment, the index had to fall at least by 3.25 percent, which is improbable.
“Some bet on unreasonable prices, for example, on a Samsung Electronics share falling from 1 million won to 100,000 won. That’s like buying a lottery ticket, but you don’t blame or sue the issuer of the lottery when you don’t win,” Hwang said.
He also distinguished big-scale retail investors, who are aware of the volatility and risks in the capital market, from other individuals, who take stock investment merely as a side job or a hobby.
“We have individual clients with wealth of 50 to 100 billion asking for a loan of 20 to 30 billion won. We ask what they are doing. They aren’t chaebol, but are just the stock-rich,” Hwang said.
“They have a considerable commitment to investment in stocks and derivatives. They bet their life on it.”
So what would be the best regulatory solution for the Korean market where individuals have a significant stake? Individuals accounted for nearly 54 percent of ELW trading by volume between January and March.
Hwang said that the authorities needs to come up with a good regulatory framework, which people must obey, but, at the end of the day, things should be left to the market. He didn’t discuss details for ideal regulations, but mentioned limiting too much leveraging and creating a central clearing house.
“Some make 10 billion won out of a billion, and that’s up to the investors’ efforts. Those who make money aren’t bad. What matters is the legality in how they make money,” Hwang said.
“You can tell those who made a lot of money to share, but you cannot criticize them for having made gains.”