The Risks of Structured Products (ELS/DLS) — The Trap of Conditional Payoffs

Structured products are financial products whose payoff is set 'conditionally' according to the movement of an underlying asset (a stock index, individual stock, commodity, and so on).

The representative ones are ELS (equity-linked securities) and DLS (derivative-linked securities). ELS are based on stock indexes or stocks, DLS on interest rates, exchange rates, commodities, and the like.

The typical structure goes: 'If the underlying doesn't fall below a certain level, it pays the promised return; if it falls below a specific line (the knock-in), a principal loss occurs.'

In other words, in normal times it looks like a higher return than a deposit, but if the conditions are broken, an asymmetric structure produces a large loss.

The core of a structured product is the knock-in condition. When the underlying falls below a certain proportion of the initial reference price (often around 50%), the 'knock-in' triggers and it enters the principal-loss zone.

The problem is that this structure is designed for 'small gains, rare but large losses.' In most cases you receive the promised return, but on the rare occasion a large decline comes, the loss is large.

In other words, even if the probability looks low, it carries a 'tail risk' where, once it goes off, the loss can reach more than half of your principal. If you trust only the explanation that 'the chance of principal loss is low,' it's easy to miss this tail.

The representative case where this risk became reality is the 2024 Hong Kong H-Index (HSCEI) ELS episode in Korea.

The H-Index rose to about 12,230 in February 2021 and then plunged to about 5,481 in January 2024. Three-year-maturity ELS products bought near the peak three years earlier hit knock-ins and maturities en masse, locking in losses.

Of the roughly 435.3 billion won that matured in the first three weeks of January 2024, banks repaid only about 257.5 billion won, so the average loss rate reached about 52.7%. The total H-Index ELS sold by banks was about 18.8 trillion won, and the 2024 loss was estimated at up to about 6 trillion won.

Financial authorities, citing incomplete sales, signaled about 2 trillion won in penalties and the like against five banks.

The lesson of the ELS/DLS episodes is clear. Behind the surface of 'a higher return than a deposit' there is always 'under what conditions you lose your principal.'

If you enroll for the reason that 'the rate is high,' without understanding the knock-in level, the underlying's volatility, and the scenarios to maturity, you take on the tail of a rare but large loss.

As this service emphasizes, for any product you must weigh not just the 'expected return' but also how much you could lose in the worst case (the maximum loss). Especially with complex structures, you must be able to understand the conditions inside them yourself.