Nobel laureate defends victims of controversial currency derivative

By Kim Eun-jung
SEOUL, Dec. 17 (Yonhap) -- A visiting Nobel economics laureate from the U.S. said
Thursday that a controversial foreign currency derivative, named "knock-in,
knock-out" (KIKO), sold by Korean banks primarily to small and medium-sized
companies is a flawed and unfair product.
In a rare appearance at a Korean court hearing, Robert Engle, a New York
University professor, said that the KIKO currency option deals -- sold to help
customers avoid foreign exchange losses -- did not actually work as hedges and
rather increased risks for the Korean banks' corporate customers.
South Korean firms, mostly exporters, used KIKO contracts as a way to hedge
against foreign exchange risks under expectations that the won's value would not
fall sharply. But following the onset of the global credit crunch last year, the
Korean currency tumbled 25.7 percent to the U.S. dollar last year alone, leading
to heavy losses for KIKO buyers.
Engle was visiting South Korea to speak about KIKOs as a witness at the request
of 17 local firms that filed a collective suit against local banks.
While the banks argued KIKO was a fair agreement and the margin charged on the
contract was reasonable, Engle said it was rather designed in favor of lenders,
not for exporters.
He made the assertion at the Seoul Central District Court while speaking in
defense of a South Korean firm, which lost a huge sum of money in a KIKO deal, in
its damages suit against Woori Bank.
"It is flawed as a currency option. Implied volatility calculated at the time of
signing the contract did not reflect the on-coming crisis," Engle said at the
hearing.
"The margin charged by the banks was excessive. Moreover, the companies had more
risks with KIKO than if they didn't have [them] at all," said Engle, who is an
expert in financial products.
"I think it is interesting to see that although it is widely used as an
instrument across Asia, the performance is unilaterally disastrous," he added.
Industry watchers expect his remarks on the controversial contract could affect
other similar cases pending in the court. Last year, nearly 100 small-sized
companies filed petitions against the banks that sold them the options after
suffering heavy losses.
ejkim@yna.co.kr
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