Korea reveals derivatives safety measures

By Song Jung-a in Seoul. This article originally appeared on the Financial Times website, FT.com on August 29th, 2014

Korea Exchange said on Friday it would introduce safety measures to protect investors and counterparties from the fallout of erroneous derivatives transactions.

The exchange, one of the world’s largest derivatives exchanges for trading index options, will introduce a real-time price limit system and increase the number of underlying equities for stock futures.

The move to fix or reject mistaken orders comes after HanMag Securities, a local futures broker, collapsed late last year when a trading algorithm malfunctioned. HanMag, which had just Won20bn of equity capital, suffered a loss of Won46.2bn in just 143 seconds in December after entering thousands of erroneous trades in Kospi options.

Many large foreign banks and brokers were unexpectedly forced to take on the losses after the KRX-owned clearing house bypassed using its own funds to help repay counterparties.

Under the new system that takes effect on September 15, KRX can fix or reject orders for futures and options that go beyond the price limit, which ranges from 1 per cent to 5 per cent of the last trade.

This will apply to Kospi 200 futures and options, single stock futures, treasury bond futures, and currency futures. South Korea has an active equity-linked options and futures market, although it suffered a sharp drop in liquidity in recent years due to stricter regulations. Nevertheless, more than 580m single stock options were traded on KRX last year, second only to the National Stock Exchange of India, according to statistics from the World Federation of Exchanges.

Stocks and derivatives are traded on a common platform of KRX. The Kospi 200 stock index is composed of 200 biggest companies listed on the main bourse.

KRX said the new system was designed to improve the settlement system and prevent recurrences of cases such as Hanmag. “It is to protect investors from massive losses stemming from erroneous orders and enhance the settlement stability of the market,” the exchange said in a statement.

In order to reactivate the derivatives market, KRX will increase the number of underlying equities for single stock futures from 25 to 60. Among the newly added underlying equities are Hyundai Mobis, Samsung Life Insurance, Lotte Shopping, and LG Chemical. It will also extend the maximum period of maturity for the futures from one year to three years to facilitate investors’ long-term hedging.

Separately, KRX has introduced a “kill switch” system to minimise the fallout from erroneous transactions, amid growing calls from investors that the market should enhance risk management systems. The exchange is now able to cancel all erroneous orders from pre-registered algorithmic trading accounts, if its members request this.

About New York Institute of Finance

With a history dating back more than 90 years, the New York Institute of Finance is a global leader in training for the financial services and related industries with course topics covering investment banking, securities, retirement income planning, insurance, mutual funds, financial planning, finance and accounting, and lending.  The New York Institute of Finance has a faculty of industry leaders and offers a range of program delivery options including self-study, online and in classroom.

For more information on the New York Institute of Finance, visit the homepage or view in-person and online finance courses below: