South Korea
18 March 2014
Local and international players give their thoughts on South Korea, including tips for hedge funds, thoughts on corporate actions, and frustration with CSDs
Image: Shutterstock
The securities lending and borrowing market in South Korea launched in 1996, with the Korean securities depository (KSD) introducing the unique concept of an 鈥渋ntermediary鈥�, which dealt with collateral management, corporate actions and other functions, on behalf of lenders.
Jinwan Yang, deputy general manager of the securities lending and borrowing intermediary team at Korea 麻豆传媒 Finance Corporation (KFSC), says that his firm is now playing the role of a lender and a borrower, as well as a securities lending and borrowing intermediary like KSD.
He adds that KSFC is particularly attractive as a lender due to an inventory that includes mid and small-cap domestic equities. He says that it is this inventory that enticed global prime brokerages to borrow equities from KSFC, starting in 2008 and with a large daily transaction volume since then.
Yang adds that the firm has dominated the bond borrowing and lending market since 2006, with a current market share of more than 80 percent.
鈥淢ost of the domestic broker-dealers borrow Korean treasury bonds through KSFC due to our broad collateral acceptance, favorable policies for borrowers, one-stop service of bond borrowing and repo, etc. Therefore, the South Korean repo market has been growing its volume.鈥�
Bradley Blackwell, client relations in Asia Pacific for Northern Trust, and Dane Fannin, head of securities lending trading in Asia for Northern Trust, both say that their bank remains an important strategic partner for its clients and borrowers in Asia, having established itself as a prominent provider of securities lending in the region for decades.
鈥淥ur experience and product knowledge help clients navigate Asia鈥檚 complex structural and regulatory landscape to ensure they capitalise on the significant growth opportunities the region presents.鈥�
They add that the bank recognises that there is not a one-size-fits-all approach with lending, so programmes are tailored for each client, including fees.
鈥淕eneral principles include our 24-hour global coverage and single platform allows our traders to share market information globally to negotiate fees with borrowers and obtain maximum value for securities. We access current market loan details through securities lending data providers. On-going review of lending fees throughout the life of a loan to assess current market supply and demand, and re-rate loans as appropriate.鈥�
Last year, the bank made a number of changes to its lending programme, including the expansion of new collateral types and borrowers, enhancements in reporting and technology, and program updates due to regulatory and tax changes.
Northern Trust, say Blackwell and Fannin, is actively monitoring the potential impact of global regulatory developments. 鈥淭he breadth of regulatory proposals has created uncertainty that has weighed upon the market. As more of these regulations are finalised, we will have greater clarity and be able to assess the direct and indirect effects of the new rules, such as counterparty limits and capital requirements.鈥�
Stuck in the middle
After some uncertainty about corporate action events in the beginnings of lending and borrowing in the country, now pretty much cleaned up, there seems to still a slight divergence of the South Korea from other global markets.
鈥淲ith regard to corporate action events, personally I think that the infrastructure is fully mature and standardised,鈥� says Yang. He adds that the caveat that, unlike the global lending and borrowing market, in South Korea there is not a fully automated infrastructure between lenders and borrowers.
鈥淭he reason for this is that a so-called intermediary still exists in the country, and both domestic lenders and borrowers don鈥檛 need to invest in electronic infrastructure for themselves. They are only dependent on securities lending and borrowing intermediaries, KSFC and KSD.鈥�
He says that if South Korean hedge funds want to act substantially in global markets, they should consider borrowing overseas equities in order to diversify trading strategies and returns.
Fannin and Blackwell agree, stating that while the majority of offshore market participants operate comfortably within the current framework, on a comparative basis South Korea remains somewhat non-standard.
This, they say, is largely a function of the unique segregated account structure lenders are required to navigate for clients, coupled with a punitive settlement regime demanding robust risk management processes.
Furthermore, the ability to process various corporate events via offshore securities lending and borrowing remains a challenge in certain cases.
Although these factors do not necessarily present barriers to entry, the impact is potentially a drag on the liquidity securities lending and borrowing facilitates for the broader market.
鈥淲hilst there is ubiquitous appreciation of the need for a robust regulatory framework pertaining to settlement rules, the extent to which this is explicitly clear for securities lending and borrowing in South Korea remains opaque, driving lenders to adopt conservative buffer policies which ultimately hampers supply,鈥� the pair say.
鈥淚ncreased regulatory transparency and greater consistency with other jurisdictions, such as Hong Kong, would potentially allow lenders to operate less conservatively, ultimately improving liquidity.鈥�
From a corporate actions perspective, Fannin and Blackwell disagree to an extent with Yang.
鈥淲hilst there have been notable lending and borrowing developments in allowing for improved processing efficiency for various events, there are certain instances in which the rules remain challenging for both lenders and borrowers, eg, mergers and acquisitions with associated dissenting votes.鈥�
鈥淲hilst it is not expected that the regulators amend broader market rules, it would certainly be beneficial for the industry to be granted exemptions pertaining to securities lending and borrowing.鈥�
Central securities depositories (CSDs) should focus on fundamental functions as securities settlement and safekeeping, says Yang.
鈥淐SDs should not compete with commercial financial institutions, which are their clients. Due to conflict of interest, CSDs鈥� active participation in securities lending and borrowing should be reconsidered and banned. When it comes to settlement failure events, CSDs can lend securities to prevent systematic disaster after clients鈥� acknowledgement.鈥�
Direction unknown
Blackwell and Fannin assert that they are not seeing any specific sector emerge as a main focus of directional demand, compared to other regional jurisdictions such as Hong Kong, Japan and Taiwan.
In South Korea, they say, demand has been more stock specific relative to underlying company fundamentals, concentrated largely in a handful of securities only.
Generally, they add, there has been more conviction to invest in other Asian markets that have presented more compelling revenue opportunities across an array of sectors, particularly with a perception that with South Korea鈥檚 heavy retail investor component, the market tends to be susceptible to volatility associated with macroeconomic events, deterring funds from deploying risk to any large degree.
Perception, reality and patience
In November 2013, South Korea lifted a short selling ban that had been in place for five years.
Yang says that the appeasement of the ban has had a favourable impact on the market environment, stating that as of 27 February trading balance was KRW 43.1 trillion ($40.3 billion).
However, Blackwell and Fannin say that in the short term, they didn鈥檛 really see any immediate impact from the ban removal.
鈥淒espite there being initial views of potential demand for brokerage stocks, given perceptions of increased competition within the sector which has eroded market share and future earnings capacity for many domestic firms.鈥�
鈥淗owever, with a risk of this news already being priced in and reluctance to trade new positions into year-end, hedge funds preferred to maintain a conservative stance.鈥�
But in the long term, it seems that both local and international players are positive. Fannin and Blackwell state that they expect that the news will have a positive impact for the industry, since an ability to short securities across an entire index without constraint will allow funds to position their strategies more effectively, which should encourage more trading volume and improve overall liquidity.
鈥淭his in turn should help attract more hedge fund interest to South Korea, which ought to spur greater securities lending and borrowing flow.鈥�
Jinwan Yang, deputy general manager of the securities lending and borrowing intermediary team at Korea 麻豆传媒 Finance Corporation (KFSC), says that his firm is now playing the role of a lender and a borrower, as well as a securities lending and borrowing intermediary like KSD.
He adds that KSFC is particularly attractive as a lender due to an inventory that includes mid and small-cap domestic equities. He says that it is this inventory that enticed global prime brokerages to borrow equities from KSFC, starting in 2008 and with a large daily transaction volume since then.
Yang adds that the firm has dominated the bond borrowing and lending market since 2006, with a current market share of more than 80 percent.
鈥淢ost of the domestic broker-dealers borrow Korean treasury bonds through KSFC due to our broad collateral acceptance, favorable policies for borrowers, one-stop service of bond borrowing and repo, etc. Therefore, the South Korean repo market has been growing its volume.鈥�
Bradley Blackwell, client relations in Asia Pacific for Northern Trust, and Dane Fannin, head of securities lending trading in Asia for Northern Trust, both say that their bank remains an important strategic partner for its clients and borrowers in Asia, having established itself as a prominent provider of securities lending in the region for decades.
鈥淥ur experience and product knowledge help clients navigate Asia鈥檚 complex structural and regulatory landscape to ensure they capitalise on the significant growth opportunities the region presents.鈥�
They add that the bank recognises that there is not a one-size-fits-all approach with lending, so programmes are tailored for each client, including fees.
鈥淕eneral principles include our 24-hour global coverage and single platform allows our traders to share market information globally to negotiate fees with borrowers and obtain maximum value for securities. We access current market loan details through securities lending data providers. On-going review of lending fees throughout the life of a loan to assess current market supply and demand, and re-rate loans as appropriate.鈥�
Last year, the bank made a number of changes to its lending programme, including the expansion of new collateral types and borrowers, enhancements in reporting and technology, and program updates due to regulatory and tax changes.
Northern Trust, say Blackwell and Fannin, is actively monitoring the potential impact of global regulatory developments. 鈥淭he breadth of regulatory proposals has created uncertainty that has weighed upon the market. As more of these regulations are finalised, we will have greater clarity and be able to assess the direct and indirect effects of the new rules, such as counterparty limits and capital requirements.鈥�
Stuck in the middle
After some uncertainty about corporate action events in the beginnings of lending and borrowing in the country, now pretty much cleaned up, there seems to still a slight divergence of the South Korea from other global markets.
鈥淲ith regard to corporate action events, personally I think that the infrastructure is fully mature and standardised,鈥� says Yang. He adds that the caveat that, unlike the global lending and borrowing market, in South Korea there is not a fully automated infrastructure between lenders and borrowers.
鈥淭he reason for this is that a so-called intermediary still exists in the country, and both domestic lenders and borrowers don鈥檛 need to invest in electronic infrastructure for themselves. They are only dependent on securities lending and borrowing intermediaries, KSFC and KSD.鈥�
He says that if South Korean hedge funds want to act substantially in global markets, they should consider borrowing overseas equities in order to diversify trading strategies and returns.
Fannin and Blackwell agree, stating that while the majority of offshore market participants operate comfortably within the current framework, on a comparative basis South Korea remains somewhat non-standard.
This, they say, is largely a function of the unique segregated account structure lenders are required to navigate for clients, coupled with a punitive settlement regime demanding robust risk management processes.
Furthermore, the ability to process various corporate events via offshore securities lending and borrowing remains a challenge in certain cases.
Although these factors do not necessarily present barriers to entry, the impact is potentially a drag on the liquidity securities lending and borrowing facilitates for the broader market.
鈥淲hilst there is ubiquitous appreciation of the need for a robust regulatory framework pertaining to settlement rules, the extent to which this is explicitly clear for securities lending and borrowing in South Korea remains opaque, driving lenders to adopt conservative buffer policies which ultimately hampers supply,鈥� the pair say.
鈥淚ncreased regulatory transparency and greater consistency with other jurisdictions, such as Hong Kong, would potentially allow lenders to operate less conservatively, ultimately improving liquidity.鈥�
From a corporate actions perspective, Fannin and Blackwell disagree to an extent with Yang.
鈥淲hilst there have been notable lending and borrowing developments in allowing for improved processing efficiency for various events, there are certain instances in which the rules remain challenging for both lenders and borrowers, eg, mergers and acquisitions with associated dissenting votes.鈥�
鈥淲hilst it is not expected that the regulators amend broader market rules, it would certainly be beneficial for the industry to be granted exemptions pertaining to securities lending and borrowing.鈥�
Central securities depositories (CSDs) should focus on fundamental functions as securities settlement and safekeeping, says Yang.
鈥淐SDs should not compete with commercial financial institutions, which are their clients. Due to conflict of interest, CSDs鈥� active participation in securities lending and borrowing should be reconsidered and banned. When it comes to settlement failure events, CSDs can lend securities to prevent systematic disaster after clients鈥� acknowledgement.鈥�
Direction unknown
Blackwell and Fannin assert that they are not seeing any specific sector emerge as a main focus of directional demand, compared to other regional jurisdictions such as Hong Kong, Japan and Taiwan.
In South Korea, they say, demand has been more stock specific relative to underlying company fundamentals, concentrated largely in a handful of securities only.
Generally, they add, there has been more conviction to invest in other Asian markets that have presented more compelling revenue opportunities across an array of sectors, particularly with a perception that with South Korea鈥檚 heavy retail investor component, the market tends to be susceptible to volatility associated with macroeconomic events, deterring funds from deploying risk to any large degree.
Perception, reality and patience
In November 2013, South Korea lifted a short selling ban that had been in place for five years.
Yang says that the appeasement of the ban has had a favourable impact on the market environment, stating that as of 27 February trading balance was KRW 43.1 trillion ($40.3 billion).
However, Blackwell and Fannin say that in the short term, they didn鈥檛 really see any immediate impact from the ban removal.
鈥淒espite there being initial views of potential demand for brokerage stocks, given perceptions of increased competition within the sector which has eroded market share and future earnings capacity for many domestic firms.鈥�
鈥淗owever, with a risk of this news already being priced in and reluctance to trade new positions into year-end, hedge funds preferred to maintain a conservative stance.鈥�
But in the long term, it seems that both local and international players are positive. Fannin and Blackwell state that they expect that the news will have a positive impact for the industry, since an ability to short securities across an entire index without constraint will allow funds to position their strategies more effectively, which should encourage more trading volume and improve overall liquidity.
鈥淭his in turn should help attract more hedge fund interest to South Korea, which ought to spur greater securities lending and borrowing flow.鈥�
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