1 Taiwan Bond & Private Repo Market

2 Date: 2006 Source: CBC * * Only 4 insurance companies are licensed government bond auction dealers since Taiwanese Government Bond Market Holders of Government Bonds

3 Period: 2006 Source: GreTai Securities Market, KGI Securities Over-the-Counter Phone Quotation Electronic Bond Trading System (EBTS) Break Down of Trading Volume

4 Total Trading Volume* *means the sum of transactions through Over-the-Counter Phone quotation and EBTS Period: 2006 Source: GreTai Securities Market, KGI Securities

5 * Government bonds only ** Repo volume (of government, corporate and supranational NT$ bonds) Source: Statistics from OTC Unit:NT$ Billion Taiwanese Government Bond Market Monthly Turnover of Government Bonds

6 Phase I (1988~2000) : Repo Development Period (Stimulate liquidity and encourage market participation) Government Bond Outright / Repo Market Government Bond Market Average daily outright trading volume: NT$ 6 Billion Average daily repo trading volume: NT$ 72 Billion Period: to Source: GreTai Securities Market In Billion NTD Average daily outright trading volume: NT$ 32 Billion Average daily repo trading volume: NT$ 182 Billion

7 Phase II (2001~Present) : New Product Development Period (Rely on ample liquidity of repo and outright transactions) Government Bond Market Average daily outright trading volume: NT$ 182 Billion Average daily repo trading volume: NT$ 177 Billion Period: to Source: GreTai Securities Market In Billion NTD Government Bond Outright / Repo Market

8 Taiwanese Bond Repo Market Composition Booming Period of Bond Fund Brewing period of Bond Fund Private Repo Market Birth of Bond Fund Before Birth of Bond Fund Stage 1 According to 3 major bill houses’ experience~ RP Counterparties Composition Individual50~60% Corporation 10~20% Financial Institution20~30% According to asset management companies and securities houses estimations~  Bond Fund Investors Composition RP End Investor Simulation Individual35~50% Corporation 25~40% Financial Institution15~25% Individual 0~5% Repo Corporation 10~15% Financial Institution 10~15% Bond Fund 70~80% Individual 50~55%  Repo Counterparties Composition Corporation 20~30% Financial Institution 10~15% Stage 2

9 Taiwanese Bond Repo Market Composition Post-Bond Fund Period Private Repo Market 2004 current Stage 3 According to asset management companies and securities houses estimations~  Bond Fund Investors Composition Individual 10~15% Repo Corporation 15~20% Financial Institution 15~20% Bond Fund 50~55% Individual 40~45%  Repo Counterparties Composition Corporation 30~40% Financial Institution 15~20%  RP End Investor Simulation Individual 30~40% Corporation 30~45% Financial Institution 20~30% Bond fund size dropped to NT$ 1.10 trillion on the end of 2006 from NT$2.47trillion in 2004

10 Background of Taiwanese Repo Market Private Repo Market  RP transactions are de facto tax-free for individuals if the maturity of RP doesn’t cross the interest-paying date. With the high credit protection and tax advantage, repo was the preferred money market instrument for high new worth individuals before the birth of bond funds.  The investment strategy of Taiwanese bond funds is more similar to that of money market funds. Currently, Taiwanese bond funds allocate more than half of their assets in repo transactions.  Accordingly, bond funds had replaced repo as the main tax shelter instrument for high net worth individuals and corporations, because of their high liquidity and attractive returns. However, after the bond fund crisis happened in 2004, some institutional investors withdrew from bond funds to prevent from eventful and capricious risk of bond funds.  Directly and indirectly, individuals and corporations provide 60% to 85% liquidity for Taiwanese bond repo market. The ample liquidity from the repo market encourages securities and bill houses to participate in outright trading.

11 Regulation for Securities Dealers’ Repo Counterparties Private Repo Regulation Article 3Before entering into a RP/RS transaction with a securities dealer, a client shall provide his/her personal ID card or a copy of his/her business license [whichever is relevant], then sign the RP/RS Master Agreement. Opening a securities account is not required. Rules Governing Over-the-Counter RP/RS Transactions by Taiwan GreTai Securities Market  A securities dealer can be a bank, bill house, or securities house; however, banks and bill houses are normally licensed to do fixed income related securities business rather than equity business.  A securities dealer is permitted to engage in repo transactions with individuals, corporations, financial institutions, and any other juristic person according to the above regulation.  In other words, individuals and corporations are free to engage in repo transactions with securities dealers.

12  Total repo or total reverse repo position shall not exceed 6 times net worth  Repo on non-government bonds + other outstanding liabilities shall not exceed 4 times net worth Securities Houses:  No limit  Required to maintain 7% liquidity reserve requirement on outstanding repo agreements Banks:  Total reverse repo positions should be no more than 4 times net worth  Total liability should be no more than 14 times net worth Bill Finance Companies: Taiwanese Bond Repo Market Limitation on Amount of Outstanding Repo for Financial Institutions

13 *The authority is GreTai Securities Market (OTC), which is governed by the Securities and Futures Bureau (SFB). Taiwanese Bond Repo Market Practices  Government Bonds  Corporate Bonds (including Convertible Bonds)  Bank Debentures  Supranational Bonds  Securitization Products Acceptable Repo Collateral (not stipulated by authority*)  Securities houses can design their own credit policies, as long as the total market value of underlying securities is kept at a minimum of 90% of total repo liabilities. Value of Repo/Reverse Repo Collateral Private Repo Regulation

14 * Note that individuals’ first NT$270,000 interest income are exempt from tax. ** Bond fund itself is subject to 10% withholding tax on coupon received. Business Tax Securities Transaction Tax Securities Transaction Tax Capital Gains Tax Interest Income Tax Interest Income Tax None Repo Bond Fund Supranational Bond 1.Offshore interest income for individual investors is exempt from income tax. 2.Accrued basis for institutional investors. 1.Offshore interest income for individual investors is exempt from income tax. 2.Accrued basis for institutional investors. 1.If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals 2.Accrued basis for institutional investors 1.If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals 2.Accrued basis for institutional investors None as long as no dividend/interest paid** None 1.Accrued basis for institutional investors 2.Cash basis for individual investors* Government & Corporate Bond None Taxation

15 Taiwanese Government Bond Market Volatility of 10Yr Government Bonds Period: 2002 to 2006 Source: KGI Securities Max = 30.7 bps Min = 0.05 bps Average = bps

16 Repo Market in U.S. U.S. Government Securities Dealers’ RP & RS Average Daily Outstanding as a % of U.S. Treasury Securities Outstanding * Corporate securities are included from July Figures cover financing involving government, federal agency, and federal agency MBS securities. Source: Federal Reserve Bank of New York and U.S. Treasury $ Billion

17 Repo Market in U.S. Merrill Lynch Lehman Brothers In Billion as Dec As % of Total Assets As % of Total Equity In Billion as Dec As % of Total Assets As % of Total Equity RP (Liability) %764.89% %691.84% RS (Asset) %658.15% %632.52% Total Assets %1,913% %2,442.3% Total Equity %100% %100% Classification Position of Investment Banks Source: Annual reports of Merrill Lynch and Lehman Brothers

18 Vitalizing REPO

19 Long Position 1.Spread Trade Matching Long Term Bond with Private REPO. 2.Use REPO as a channel of future funding. Expect bond yield to drop in near future but don’t have enough funding. Hold a certain of bond in portfolio. Use Bond in portfolio to fund current buying until obtaining new fund. 2.1Use REPO to leverage our portfolio holding. Vitalizing REPO

20 Short Position 1.Use REPO as a channel to borrow bond. Use borrowed bond to sell short in secondary market Vitalizing REPO Enhance bond holding return By lending out the holding of bond in portfolio, bond holder can enhance return by collecting fee.

21 Appendix: Bond Fund Crisis (UIT Event)

22 “Crisis of confidence” in the domestic bond funds market and thereafter In the week of 12 July 2004, United Securities Investment Trust (UIT) adjusted its bond portfolio by reducing exposure in certain areas such as illiquid CBs and structured notes, and as a result, posted a drop in NAV for its three bond funds. UIT was worse hit, and the effects were felt throughout the industry with estimates putting total redemptions at over NT$200bn, or around 10% of total market fund size, in the week following the incident UIT event deadline for bond funds to dispose of structured bonds deadline of bond funds transformation

23 “Crisis of confidence” in the domestic bond funds market and thereafter In order to deal with the fallout from the overinvestment in structured products over previous years and to rehabilitate confidence in the Taiwanese asset management industry, the following policy measures and initiatives had been announced: Bond funds are prohibited from purchasing any structured bonds anymore. Bond funds are required to dispose of all their structured bonds by the end of Bond funds are required to migrate themselves into one of the following three types of funds:  Quasi money market funds ： Bonds make up less than 30% of the assets. The tenor of each bond in the assets should not be more than five-years. Mark-to-market requirement is waived. Weighted average duration of the bonds in the assets should be less than three years.  Pure bond funds ： Bonds weigh at least 50% of total assets. They are required to mark-to-market on daily basis.  Status-Quo bond funds ： (Not favored by FSC) Bonds weigh 30% to 50% of the assets. Bonds that are purchased by such funds after the beginning of 2006 will have to mark to market.

24 The total size of bond funds is shrinking continuously Until the end of 2006, quasi money market funds account for 94.82% of the total bond fund size while pure bond funds and status-quo bond funds account for 0.99% and 4.19% respectively. The returns of quasi money market funds in general are less attractive than the rising repo rates. Besides less attractive returns, some institutional investors also withdrew from bond funds to prevent from eventful and capricious risk of bond funds. Bond fund size dropped to NT$ 1.16 trillion on the end of September 2006 from the top in 2004 Source ： KGI Securities Unit: Unit: % Repo rate Bond fund size Unit: Unit: NT$ trillion