Bond Market in Korea

Editor's Notes

• #2: Thanks, Chairman. It is my pleasure to have an opportunity to discuss the current stage of bond market development in Korea and I am looking forward to learning from your expertise in this workshop. Given the time limit, let me be very brief in my presentation.
• #11: In the fungible issue system, bonds issued during a certain period of time are made so that they have identical maturities and coupon rates to expand the size of bond issuances of the same series. In Korea, the fungible issue system was first introduced in May 2000. In the beginning, the reopening period was 3 months. (i.e., dditional issues during every three-month period were issued with identical maturity dates and coupon rates.) However, since March 2003, the reopening period and interest payment periods were extended from 3 to 6 months.
• #12: Primary Dealer system is also introduced. The obligation of and the privileges for PDs in Korea are summarized in the slide. Frankly speaking, the privileges for PDs are not strong enough relative to their obligations yet, and most PDs in Korea still prefer to be a broker instead of being a market maker. Therefore, the government is working hard to maintain the momentum of the primary dealer system at this stage. (As can be seen in <Table 2>, the privileges for PDs are not strong enough relative to obligations. The number of PDs in Korea (20) also seems to be too many by international standard and relative to the size of the market to establish the prestige of the PD status. Due to the lack of private incentives, most PDs in Korea still prefer to be a broker instead of being a market maker. Considering the important role of PDs in developing efficient government bond markets, the government is trying hard to provide “ carrots ” to PDs as well as strengthening her obligations: reducing the number of PDs and increasing securities financing opportunities for secondary market trading by PDs are policy options currently in debate.)
• #13: The introduction of ETS in Korea is a case that takes advantage of the benefits of a latecomer in developing the government bond markets. Instead of being satisfied with developing just an OTC markets, the Korean government tried to promote an electronic exchange trading platform along the lines of the MTS system in Italy. As government bonds are relatively easy to standardize and Korea has a very competitive IT industry, it decides to introduce an ETS (electronic trading system) for the government bond markets and later makes it mandatory to trade benchmark issues using electronic exchange trading system. Rather than following the path of other countries, the Korean government decided to adopt the most advanced trading system in the world from the very beginning. The following micro trading data at the Korea Stock Exchange (KSE) show that the decision was right. The electronic trading system has not only improved the transparency of the market but also increased the liquidity of off-the-run issues as well as on-the-run benchmark issues.
• #14: In October 2002, the government introduced new policies measures for activating the KSE market to enhance liquidity and transparency of government bond trading. It mandated that primary dealers (PDs) to trade benchmark issues of the government bonds only in the KSE market. PDs should also trade more than 20% of the their total government bond trading within the KSE market. In January 2003, the mandatory trading requirements for PDs ware strengthened, raising the minimum trading proportion within the exchange from 20% to 40%. As shown in the figure, after the mandatory trading requirement, the proportion of benchmark issue trading within the exchange has significantly increased since April 2002. (It was rising even before the initiation of the new requirements in October 2002, thanks to the government ’ s administrative efforts in advance of the introduction of the policies.) It is not surprising that the exchange trading proportion of benchmark issues increased from 20% to 51.5% during this period. But, it is noteworthy that, during the same period, the proportion of non-benchmark issues jumped from 5% to nearly 25%.
• #15: The rise in exchange trading did not draw away liquidity in the OTC market. If the increase in exchange trading came at the expense of a loss of liquidity in the OTC market, then we cannot say that the mandatory trading enforcement has increased overall market liquidity. However, there is little evidence that trading volume in the OTC declined during this period. Liquidity in the OTC market remained stable, suggesting that the policies have had an overall positive effect on the market.
• #16: The most clear evidence of the improved liquidity is the changes in bid-Ask spread of benchmark issues. Following the imposition of exchange trading requirements, the bid-ask spreads of benchmark issues fell sharply from 18bp to 6.7 bp.
• #17: Now 3-year KTB futures belongs to the world top 10 list of treasury bond futures market.
• #20: Now 3-year KTB futures belongs to the world top 10 list of treasury bond futures market.
• #23: The rise of the corporate bond market has a contribution.
• #24: However, there is no free lunch. As time went on, however, the large proportion of corporate bonds issued in 1998 was defaulted. About 22% of the total value of the corporate bonds that were issued from December 1997 to December 1999 has been defaulted during the same period and it contributed the recurrent credit crunch problems and increased ultimate costs of financial restructuring.
• #25: Now 3-year KTB futures belongs to the world top 10 list of treasury bond futures market.
• #26: This is an overview of Market Settlement. There are five settlement systems for KSE, KOSDAQ, ECN, INAS (Settlement system for Institutional investors) and OTC Bond market. Trade comparison for KSE, KOSDAQ and ECN are completed at the point of trade execution termed “ Locked-in Trade ” The trade comparison under INAS system, which takes place on T+1, is termed one sided confirmation because KSD send trade confirmation to Institutional investors who in turn, affirm the trades. Under OTC bond market, the buyer and seller of bonds report their trade details to KSD and KSD matches the trade. This process is done through SAFE21, the Participant communication terminal Multilateral netting and DVP settlement in KSE, KOSDAQ and ECN and bilateral netting and DVP settlement in INAS. And these markets are settled in commercial bank ’ s money, so-called next-day fund. Whereas RTGS system linking KSD ’ s settlement system and BOK wire is put in operation in OTC bond market. The settlement is done in central bank ’ s money, so-called same-day fund.
• #27: However, there is no free lunch. As time went on, however, the large proportion of corporate bonds issued in 1998 was defaulted. About 22% of the total value of the corporate bonds that were issued from December 1997 to December 1999 has been defaulted during the same period and it contributed the recurrent credit crunch problems and increased ultimate costs of financial restructuring.
• #28: This is an overview of Market Settlement. There are five settlement systems for KSE, KOSDAQ, ECN, INAS (Settlement system for Institutional investors) and OTC Bond market. Trade comparison for KSE, KOSDAQ and ECN are completed at the point of trade execution termed “ Locked-in Trade ” The trade comparison under INAS system, which takes place on T+1, is termed one sided confirmation because KSD send trade confirmation to Institutional investors who in turn, affirm the trades. Under OTC bond market, the buyer and seller of bonds report their trade details to KSD and KSD matches the trade. This process is done through SAFE21, the Participant communication terminal Multilateral netting and DVP settlement in KSE, KOSDAQ and ECN and bilateral netting and DVP settlement in INAS. And these markets are settled in commercial bank ’ s money, so-called next-day fund. Whereas RTGS system linking KSD ’ s settlement system and BOK wire is put in operation in OTC bond market. The settlement is done in central bank ’ s money, so-called same-day fund.
• #29: Now 3-year KTB futures belongs to the world top 10 list of treasury bond futures market.
• #31: Now let me move to the CBO scheme KCGF, which is public credit guarantee agency, provides P-CBO / CLO guarantee, which is categorized as special guarantee. P-CBO / CLO guarantees is provided for a pool of corporate bonds and loans. These types of guarantees were first introduced in 2000, in order to cope with the ailing capital market which had not recovered from the financial crisis in the late 1990s. Combining the mechanism of Asset-backed Securities and credit guarantees, P-CBO/CLO guarantee allowed KCGF to extend large amount of guarantees in a short period of time, which not only facilitated corporate financing but also stabilized the capital market. Its unique structure of pooling has drawn much attention at various fora on the Asian bond market development. After the credit crunch problems were solved, MOFE started SME securitization using the same structure. Our program has been motivated by another SME securitization program launched by the SBC. Regarding the SBC program, Dr. Oh, who will be taking the floor right after me, will explain in detail. So let me introduce SME securitization program ran by KCGF.
• #33: First, Securitization can be an effective policy tool for overcoming credit crunch problems or reducing the credit quality gap. In any country, companies are bound to experience temporary difficulties in financing due to unfavorable credit ratings according to business cycles. Therefore, Korea serves as a good model. Someone said financial crisis in Korea is disguised blessing. We also learned from experience that a crisis can be an opportunity. 2. Second, securitization evolves as market need arises. Korea has experienced quite different path from that of U.S. Korea introduced relatively difficult type from the beginning, due to the economic situation. However, it was successful because there was consolidate market demand. 3. Third, Korea has developed ABS market in such a short time. In this process, there was active government role and relevant policy measures and the required regulatory reforms for the ABS market were carried out in a compressed timetable. Korea and Korean government policy initiative serves as a good benchmark to whom wants to develop ABS market in a compressed time table. 4. Fourth, large institutional investor base are necessary to ABS market both quantitatively and qualitatively. Institutional investors play a vital role in bond market development, and are critical to advancing securitization as well. They can play the facilitation of efficient pooling of long-term funds, risk mitigation and diversification, reduced reliance on commercial banks, etc. Korea has developed rapidly, mainly due to the existence of a large institutional investor base. It is not surprising that Korea, with more than 44% of the region's institutional assets under management as of year 2002, has a domestic bond market with a similar share of regional bond market assets-and by far the largest market in ABS as well. 5. Last but not the lease, an important precondition for developing an ABS market is a deep domestic bond market with an efficient infrastructure. In addition, an ABS market requires other supporting structures, including credible credit rating agencies, a modern and well-functioning trading system, a modern clearing and settlement system, and efficient market intermediaries. A sound regulatory framework and effective enforcement procedures are equally essential for the development of an ABS market. Korea has the required regulatory framework and other supporting infrastructures in place for further development of the ABS market. Bond trading system, Clearing and settlement systems, Bond pricing and Credit rating agency facilitated ABS market in full blossoms.
• #34: Now 3-year KTB futures belongs to the world top 10 list of treasury bond futures market.
• #39: The ABS related business guideline took effect on May first this year based on the opinions of about 70 ABS related institutions such as securities companies, banks, credit rating agencies, and financial supervisory institutions. This is like the market's self regulatory guideline of what to observe when carrying out ABS business. The guideline standardizes works of each ABS related party such as asset management company, the trustee(/consignee?), trust company and securities companies. It clearly draws the line between the works and responsibilities of each related party.   This will minimize the instability of the ABS market. And we expect it to create an environment that is favorable to investment and enables sound growth.    Furthermore, it sets a concrete device that checks and keeps surveillance on ABS related parties. ABS related disclosure has also been strengthened.  
• #40: The ABS related business guideline took effect on May first this year based on the opinions of about 70 ABS related institutions such as securities companies, banks, credit rating agencies, and financial supervisory institutions. This is like the market's self regulatory guideline of what to observe when carrying out ABS business. The guideline standardizes works of each ABS related party such as asset management company, the trustee(/consignee?), trust company and securities companies. It clearly draws the line between the works and responsibilities of each related party.   This will minimize the instability of the ABS market. And we expect it to create an environment that is favorable to investment and enables sound growth.    Furthermore, it sets a concrete device that checks and keeps surveillance on ABS related parties. ABS related disclosure has also been strengthened.  
• #43: Now, I will turn to Korea ’ s MBS (Mortgage Backed Securities) in Korea The Korean government established the KHFC last year like Cagamas in Malaysia, in order to help low and mid-income families buy their own houses, induce a softlanding of household debts, and develop the long-term bond market. Mortgage loans were virtually introduced. In order the enhance the reliability of the KHFC, the government and the Bank of Korea financed all of the paid-in capital and grounds for loss compensation were laid out.