[Edaily Marketin Hur Jieun Reporter] With volatility in the domestic stock market intensifying this year and the exchange rate soaring, concerns are growing over the risks faced by companies that raised funds through share price return swaps (PRS). While this was a useful financing channel that did not increase debt ratios at the time of funding, critics point out that the clause requiring companies to cover losses when stock prices fall is turning into a “boomerang” that creates a burden of cash outflows.

Keeping a Close Eye on Share Prices of Listed Affiliates

According to the financial investment industry on the 12th, major conglomerates such as POSCO, Hanwha, and SK have successively pursued PRS transactions this year using stakes in their affiliates as underlying assets. The total value of these transactions alone amounts to 6.3505 trillion won.

Equity-linked financing by corporations began to be utilized in the mid-2010s, primarily through total return swaps (TRS). TRS garnered attention as a means for large conglomerates to raise funds and restructure their corporate governance, as it allows companies to retain direct ownership of their shares while exchanging economic gains and losses resulting from stock price fluctuations with a counterparty (a financial institution).

However, since TRS has a structure essentially similar to a stock-backed loan and has been embroiled in controversy surrounding the substance of transactions—such as “parking deals”—and their accounting treatment, PRS, which is closer to a genuine sale of equity, began to be used as an alternative.

PRS is an over-the-counter derivative in which a company transfers its shares or other securities to a financial institution and uses them as the underlying asset to settle price fluctuations at the end of the contract. If the price of the underlying asset falls below the strike price, the company pays the difference to the counterparty; conversely, if it rises, the company receives the profit.

From a corporate perspective, the advantage is that it is not recognized as a liability on the balance sheet, thereby reducing the burden on financial statements while allowing for the rapid securing of liquidity; however, losses may occur depending on fluctuations in the price of the underlying asset.

Consequently, large conglomerates that have entered into PRS contracts using shares of their listed affiliates as the underlying asset are closely monitoring stock price movements. SK, HANWHA SYSTEMS, and POSCO Holdings are prime examples. Typically, PRS contracts have a three-year term, and the fair value of the underlying asset is assessed quarterly or semi-annually, with any changes reflected in derivative gains or losses. Although these are merely paper losses on the books for now and do not result in actual cash outflows, they represent a significant outflow burden at maturity or settlement.

SK(034730) HANWHA SYSTEMS(272210)and each executed PRS deals on February 26 and March 25, respectively, using their existing stakes in SK BIOPHARMACEUTICALS and . However, the KOSPI index was in the 5,600–6,300 range at that time, so the decline relative to the current index level is limited. Since POSCO Holdings also signed a new contract on the 7th, after the KOSPI had already undergone a significant correction, there is speculation that its settlement burden may be relatively low should the stock market rebound in the future. Hanwha Ocean(042660)

Stakes in Unlisted Companies and Overseas Subsidiaries Pose Fair Value and Exchange Rate Risks

Companies that raised PRS funds based on stakes in unlisted companies or overseas subsidiaries are exposed to a different dimension of risk. While they are somewhat insulated from fluctuations in the KOSPI index, they are exposed to exchange rate volatility when converting the value of their foreign-currency-denominated stakes into Korean won. When the exchange rate falls, as it has recently, the won value of those stakes inevitably decreases.

Furthermore, if the business performance or market conditions of the target entity deteriorate, there is a possibility of settlement losses due to a decline in fair value. Examples include KoreaZinc(010130), which utilized new shares of an Australian subsidiary, and HANWHA SOLUTIONS(009830), which utilized shares in Hanwha Q CELLS’ U.S. subsidiary.

These concerns are already being reflected in book losses. SK Innovation disclosed a valuation loss of 1.2169 trillion won on PRS derivatives for the second quarter of this year. Over the course of 2024 and last year, SK Innovation entered into PRS contracts totaling 3.8 trillion won using stakes in its subsidiaries SK On (unlisted) and SK ie technology (listed). While this does not result in an immediate cash outflow, it could lead to a massive cash outflow burden if the value does not recover by the maturity date or at the time of early settlement.

As market conditions deteriorate and market sensitivity to derivative risks increases, there have been a series of instances where PRS financing has fallen through. Hanwha Energy had sought to raise up to 900 billion won through a PRS using HANWHA SYSTEMS shares as the underlying asset, but temporarily suspended the plan due to controversy surrounding HANWHA SOLUTIONS’ previous rights offering and market backlash against derivative contracts.

An investment banking (IB) industry official stated, “PRS involves a structural imbalance where companies pay fees without receiving additional profits when stock prices rise, but must bear losses when prices fall,” adding, “Given the growing uncertainty in the stock market and corporate earnings, excessive reliance on PRS could weaken a company’s liquidity resilience.”