Korean financial institutions established repo funds worth hundreds of billions of won late last month and early this month, despite the Bank of Korea preparing interest rate hikes. The funds target 1.5-2 year corporate bonds, with 1.5-year AA- capital bond yields reaching 4.375% compared to 3.063% in mid-January, a rise of approximately 130 basis points. Market participants believe multiple rate hikes have already been priced into market rates, creating profit opportunities through leveraged purchases of corporate bonds even as further tightening approaches.
According to bond market sources on the 15th, the repo funds established late last month and early this month total hundreds of billions of won. Some funds list the National Health Insurance Service as beneficiaries, with other financial institutions also participating as beneficiaries.
Repo Funds Target Corporate Bonds with Leverage Strategy
The funds primarily purchase bonds in the 1.5-2 year corporate bond segment. The average rate for 1.5-year AA- capital bonds reached 4.375% compared to 3.063% in mid-January, representing an increase of approximately 130 basis points.
Repo funds typically purchase low-risk bonds such as AAA-rated public corporation bonds and use them as collateral to buy additional corporate bonds. Some funds use corporate bonds as collateral to purchase other bonds in a second round. Aggressive repo funds reportedly start by purchasing corporate bonds directly, then use them as collateral to raise repo funds for buying additional corporate bonds.
Investment Funds Hold 119.1 Trillion Won in RP Sales
According to the Bank of Korea's Financial Stability Report released late last year, investment funds' RP sales totaled 119.1 trillion won, accounting for 66.5% of total RP sales. Given that overnight positions represent 81.6% of asset management companies' RP sales, substantial fund amounts undergo daily rollover. This structure creates significant sensitivity to liquidity shocks.
Last month, redemptions surged in repo funds with mutual financial institutions and banks as beneficiaries, driven by concerns about accelerating interest rate increases. Some profit-differentiated repo funds established in the second half of last year reportedly experienced total principal losses for Type 2 beneficiaries, with valuation losses extending to Type 1 beneficiaries.
BOK Governor Warns of Refinancing Risks in RP Market
Monetary authorities have issued warning messages regarding these developments. Shin Hyun-song, Bank of Korea Governor, stated during his confirmation hearing in response to lawmaker Park Soo-young's question that leverage investment through RP sales fundamentally relies on short-term funding, which could increase refinancing risks due to liquidity difficulties when market instability intensifies. He added that this could lead to instability in the RP market and make it difficult to rule out the possibility of related risks spreading throughout the financial system.
A bond market participant said that if the base rate increases the next day, a significant number of repo funds established in the second half of last year would enter negative margin territory, noting the need for caution about anticipating monetary policy and increasing risks.
FAQ
What are repo funds targeting in the Korean bond market?
Repo funds established late last month and early this month primarily target 1.5-2 year corporate bonds. The 1.5-year AA- capital bond yield reached 4.375% compared to 3.063% in mid-January, an increase of approximately 130 basis points.
How much do investment funds hold in RP sales in Korea?
According to the Bank of Korea's Financial Stability Report released late last year, investment funds' RP sales totaled 119.1 trillion won, representing 66.5% of total RP sales. Overnight positions account for 81.6% of asset management companies' RP sales.
What risks did the BOK Governor identify in the RP market?
BOK Governor Shin Hyun-song stated that leverage investment through RP sales relies on short-term funding, which could increase refinancing risks during market instability. He warned that related risks could spread throughout the financial system and lead to RP market instability.
