By Bob Chen
Nov. 5 (Bloomberg) -- Asian regulators may limit currency derivatives after losses helped push the South Korean won to a decade low, led to lawsuits in India and caused shares of China's Citic Pacific Ltd. to collapse.
South Korea will announce measures by December to restrict company purchases of the contracts to a percentage of overseas earnings, Hyeon Jung Gun, head of Korea's Financial Supervisory Services' derivatives market team, said in a Nov. 3 interview. China plans to improve monitoring of performance and compliance. Hong Kong is investigating improper sales of financial products by banks.
``There were companies that went over-hedging and banks that failed to remind options buyers of the embedded risk,'' Hyeon said. ``Under new regulations, companies will have access to derivative products based only on real demand.''
Governments face demands for tougher rules after the collapse of Lehman Brothers Holdings Inc. in September caused credit markets to freeze and emerging-market currencies to plunge. Korean companies may lose as much as $2.3 billion on derivatives after the won dropped 28 percent this year, Standard & Poor's estimates. Citic Pacific, a unit of China's biggest state-owned investment company, predicted a $2 billion loss because of unauthorized bets on the Australian dollar, which plunged 24 percent in 2008.
Derivatives Market
Restrictions may slow growth in the market for foreign- exchange over-the-counter derivatives, which swelled 78 percent in the two years ended 2007 to $56 trillion, according to the Bank for International Settlements in Basel, Switzerland. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates. OTC products aren't exchange-traded and can be customized.
``Users of currency derivatives should face regulations regarding their qualifications and exposure,'' said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd., a Hong Kong-based brokerage focused on emerging markets. ``Automakers are allowed to produce fast cars, but drivers must be license holders and required to observe speed limits.''
Some 100 South Korean exporters filed a group lawsuit against 13 banks, seeking to nullify contracts bought from lenders including Citigroup Inc., Standard Chartered Plc, Shinhan Bank and Korea Exchange Bank. Spokespeople at the banks had no immediate comment.
`Unlimited Losses'
``We hope to prevent the recurrence of these incidents and urge regulators to address this issue and more thoroughly supervise on derivatives,'' said Kim Tae Hwan, a general manager at the Korea Federation of Small and Medium Business, which helped organize the action. ``They are extremely speculative products that exposed exporters to unlimited losses.''
The so-called knock-in knock-out options pay companies a fixed exchange rate as long as the dollar trades within a set range against the won. The firms are required to pay twice the amount of the contract if the U.S. currency appreciates beyond the range.
The won slumped to 1,495 per dollar on Oct. 28, the lowest in 10 years, from 902 last November. JPMorgan Chase & Co.'s Emerging Market Volatility Index soared to a record 32.96 on Oct. 23 before declining to 25.48 yesterday.
Citic Pacific dropped 73 percent in Hong Kong when its trading blunder was announced last month. The company has contracts that require it to buy as much as A$9.44 billion ($6.4 billion) of Australian dollars, according to an Oct. 20 statement. The trades were supposed to hedge an iron ore project in Australia that required A$1.6 billion.
Aussie Versus Dollar
The Australian dollar fell to 60.09 U.S. cents on Oct. 27, the weakest since April 2003, from a 25-year high of 98.49 on July 16.
``We want banks to sell appropriate products to clients,'' Li Fuan, head of the banking innovation department at the China Banking Regulatory Commission, said in an Oct. 30 interview. ``Monitoring measures may include reviewing products' legal documents and tracking their performance in real time.''
Citic Pacific identified HSBC Holdings Plc, BNP Paribas SA and Citigroup as among the sellers of the derivatives. Spokespeople at the banks declined to comment yesterday.
The Hong Kong Monetary Authority is reviewing ``whether the current `buyer beware' policy for the protection of investors remains appropriate,'' Chief Executive Joseph Yam wrote in an Oct. 9 note. An HKMA spokesman referred to that statement when asked about currency derivatives this week and said the review of rules will be completed this year.
``The mantra of `buyer beware' has been taken to extremes, and it's likely regulators will seek to redress the balance,'' said Simon Grose-Hodge, a strategist in Singapore at LGT Group, the bank owned by Liechtenstein's royal family. ``Any product that exposes a client to unlimited downside risk should never be described or sold as a hedge.''
To contact the reporter on this story: Bob Chen in Hong Kong at bchen45@bloomberg.net
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