1. ELW market in Korea
An ELW(equity-linked warrants) is an option that gives the holder the right but not the obligation to buy or sell an asset at a set price on or before an expiry date. Investors will buy a warrant at cheaper prices than the share price in the stock market and take profit by exercising the option when the stock price goes up on expiry date.
ELW market in korea has grown rapidly to the second largest ELW market in the world after introduced in 2005. This fast growing made numerous problems such as excessive investment or massive investors’ losses and FSC did put ELW regulations into practice to make sound ELW market on November, 2010. Existing regulations are the following; compulsory educations to investors, intensifying evaluation for LP(Liquidity Provider) and the control of unfair trade.
After those regulations, the volume of deals in ELW market fell slightly from 1.6 trillion on November, 2010 to 1.4 trillion on December, 2010. Nevertheless, new problems such as illegal privilege for scalper arise and additional regulations are desired.
2. Prosecution for collusion between securities companies and scalpers
South Korean prosecutors have launched a criminal inquiry over allegations that securities companies have colluded with professional day traders to raise profits from unfair practices, causing losses to private investors.
The Seoul Central District Prosecutors’ Office investigated suspicion over providing personal circuit to “scalpers”, who buy and sell stocks within seconds or minutes, seeking profits from quick moves in stock prices, with bribery. Among those under investigation are Samsung Securities Co., Woori Investment & Securities, Hyundai Securities Co.,Dai-shin Securities Co., HMC Securities Co., KTB Investement&Securities Co., Etrade Securities Co., LIG Securities Co., Eugene Investment&Securities Co., and Shinhan Securities Co. etc.
In response to concerns about soundness of ELW market, FSC made additional system reformation in 3 sections.
3. System Reformation
1) Enhance protection for investors
Imposing initial deposit
In most of derivatives products, investors are required to make basic deposits whereas there has been no requirement for entry in ELW and buying options deposits. From June 2011, however, initial deposit of KRW 15,000,000 will also be imposed to those two above while special accounts only for buying options will be abolished.
Restriction on issuing deep-OTM ELW
So far, retail investors have suffered losses after investing deep-OTM ELW. But KRX guidelines on listing will be revised to restrict new issuance of deep-OTM ELW on July, 2011. Banning new issuance of ELW with price parity** of less than 85% is one example.
*OTM ELW : Out-of-the-money ELW is a price level which doesn’t have intrinsic value although an investor exercises his warrant
⇨ Put ELW(underlying asset price>exercise price),
Call ELW(underlying asset price>exercise price)
** Price parity : the ratio between underlying asset price and exercise price). it was 11.2% in March, 2011
2) Plans to form a fair market price
Announcing premium ratio of index ELW publically by LP
Compared with index options of same structure, index ELWs are now being traded at excessively high price. In order to narrow the difference between index options and index ELW, FSC will encourage LPs to release index ELW premium ratio compared with options regularly.
< Comparison of ELW premium ratio per key LP >
* Average of premium ratio of ELWs for which the concerned LP has provided the liquidity
[(Closing price of ELW/ Closing price of option –1) X 100]
Tighten up the condition of Index LW Issuance.
It is difficult to compare prices between index ELWs and index options since conversion ratios* and last trading days are different depending on issuing houses. In order to make comparison of prices between index ELWs and index options easy, the authorities will induce issuers to adjust differing trading days and conversion ratios after July, 2011.
* conversion ratio : the number of common shares received at the time of conversion for each convertible security.
Stricter assessment of LP performance against Implied Volatility
In assessing LP performance, the weight given to the category of ‘implied volatility’* is low (10%). Therefore, there is a possibility for LPs to arbitrarily change prices. To make consistent prices of ELW, FSC plans to raise the weight for ‘implied volatility’ when assessing performance of LPs on October, 2011. At the same time, the weight for category of ‘fulfillment of obligation’ will be reduced from 40 points to 30 points since a majority of LPs has received a high score in that.
* Implied volatility : the volatility of the underlying price that is implied by the option’s market price based on an option pricing model. It measures quantitative expectation of market participants about fluctuation of underlying assets till maturity. If others are equal, implied volatility increases when the market is bearish and decreases when the market is bullish.
3) Order Routing Speed
Prior to order receipt
Securities companies are allowed to provide investors with a reasonable range of services such as provision of designated lines or installation of order system). To make sure that systems are operated in a stable and equitable manner, However, the authorities plan to introduce regulatory reforms following.
① Securities firms will be prohibited to install an order processing system for scalpers in the front-end-processing-system without passing through the firewall of companies.
② Retail investors will be permitted to use a dedicated line or choose places of their orders by an individual contract with a brokerage firm such as installation of processing system or trading room.
After order receipt
In principle, regulations will be revised to make quotations be submitted to KRX in the order according to the sequence which investors’ orders are received and processed by securities firms.
① Given that methods of order receipt have been diversified due to advanced communication technology nowadays, FSC will make a clear definition of order receipt. Even though there is difference depending on the method used to place the order, the ‘order receipt time’ is defined as the time when the investor’s order passes through the firewall of securities companies.
② When processing an order, securities companies are required to check effective items. The retail investors are also given an option of selecting separate ledger.
③ FSC will allow the assignment of individual process line per investor group, but it is restricted not to have difference in the processing speed. The authorities contemplate the case which an influx of order at a specific time may slow down the order processor when no dedicated line is provided to scalpers.
④ For the case that the computer centers of securities company is dispersed by region per investor type, the authorities push ahead with the measures to prevent such discrimination by location. As a general rule, all investors who are investing in the same product are supposed to go through the same computer center. In case where there is a difficulty in transferring the customers, an exception is made with the minimum speed differences between the computer centers.
Provision of information about options offered by securities companies
Securities companies are required to provide customers sufficient information to choose proper ways of orders and whether to use a special ledger.
4. Expected Effects and Critics
The coming regulations are designed to consider fairness between VIP consumers (i.e Scalpers) and retail investors and contain indiscriminate investors. By raising entry barriers, the thoughtless investment by retail investors will be reduced. Moreover, the environment for fair competition will be created through standardizing ELW products and widen information about ELW price. Clear standards will be set in regard with speed difference between securities order systems. The authorities anticipate positive outcome on both firms and customers. Brokerage firms will be able to use this marked standards when they design their ordering process and marketing strategies. Retail investors may have access to a high speed system by paying fees, if they need.
However, there have been criticisms on adopting new regulations. Opponents argue that trade volume for scalpers has ranged from many billions of KRWs to multi-billions. That means it is no use to stop scalpers’ transaction which was number one reason for ELW crisis the beginning of the year. In addition, securities business circles worried that high entry barriers scare investors and result in depression of overall ELW market.
Reference : Structure of Order System
Resources : http://www.fsc.go.kr
Hyejin Na : email@example.com