1. The Korean Bond Market Post Asian Crisis and Beyond May 12, 2003
Korea Stock Exchange
Seoul, Korea
Ismail Dalla, CFA
Director, Financial Markets Consulting Group
RONCO Consulting Corporation

2. East Asian Bond Markets

3. World Economic Prospects

4. Growth of World Bond Markets

5. Key Econ. Indicators: East Asia and Pacific

6. Global Bond Market

7. East Asian Bond Markets

8. Government Bond Market in Asia

9. Government Domestic Debt Markets
Notes : Government domestic debt securities are the sum of bonds issued by Central Government,
Local Government and Central Bank.
Source: Bank for International Settlements. BIS Quarterly Review. March2003.

10. Emerging Market Debt Issuance (1991 – 2002)
Notes : Sovereign - all the sovereign governments and their agencies
Sub-sovereign - the municipal governments (cities, regions etc.)
Sov-supported - companies and banks owned by the government of a respective country or with a majority government share.
Corporate – all private companies
Bank – all private banks
Sourece: Jane Brauer. Corporate Debt in Emerging Markets. Merrill Lynch. April, 2002.

11. Securitized Corporate Bond Issuance in Asia

12. The Korean Bond Market

13. Key Econ. Indicators: Korea

14. Korean Bond Market

15. Korean Government Bonds

16. Corporate Bonds

17. Composition of Corporate Bonds

18. Exchange VS OTC Market

19. Asset-Backed Securities

20. Bond Investor Profile in the Korean Bond Market

21. Korea Financial and Legal Sector Reforms
Changed the rules and regulations of banks and other financial institutions in line with global financial regulatory standards.
Ensured financial institutions' autonomy and accountability.
Overhauled the financial supervisory framework.
Fully opened the door to foreign investors in order to lure FDI.
Received over US$ 40 billion from 1998 and 2000.
Increasing number of foreign CEOs in domestic firms.

22. Korea Financial and Legal Sector Reforms (cont.)
Raised efficiency and profitability of banks via exits and mergers of financial institutions.
Creation of Large Financial Holding Companies
e.g. Woori Financial Holding Company and Shinhan Finance Holdings Company
Banking Sector Restructuring (From Dec to Dec. 2001)

23. New Financial Supervisory Structure in Korea
Prior consultation
on formulation or
amendment of
statutes
Request for
reconsideration
Financial
Supervisory
Commission
Ministry of
Finance and
Economy
Offer of
Information and
documentation
Offer of
Information and
documentation
The Bank
of Korea
Request for
examination
Request for
examination
Financial
Supervisory
Service
Korea Deposit
Insurance
Corporation
Source: The Bank of Korea <

24. Lessons from the Korean Financial Reforms
Full recovery of Korean economy to pre-crisis level in a short period of time.
GDP: 1998: -6.7% => 2000: 9.3%, 2001: 3.0%
Inflation: 1998: 7.5% => 2000: 2.3%, 2001: 4.3%
Unemployment Rate: 1998: 6.8% => 2001: 3.7%
Current Account Balance: 1997: US$-8.2Bil. => 2001: US$8.6Bil.
Foreign Exchange Reserves: 1997: US$19.7Bil. =>2002: US$120.8Bil.
Aggressive financial sector reforms
Improved Market efficiency, Productivity, Transparency, Capital Structure of Banks and Corporations, etc.
Rapidly growing Asset Backed Security Market
Size of ABS issued: 6.7 Tril. Won (1999) => 50.9 Tril. Won (2001)
First ABS issued based on the newly enacted asset securitization act following the Korean financial crisis.
The Korea Asset Management Corporation has issued ABS backed by NPLs and contributed to increase the size of ABS market in Korea.

25. Lessons from Korean Financial Reforms (cont)
Robust Government Bond market
The size: 28.5 Tril.Won (1997) => 82.4 Tril.Won (2001)
A safe haven.
The role of a benchmark bond.
Increasing Non-Guaranteed Corporate Bond Issues
Pre-crisis: over 84% of corporate bonds were guaranteed.
The year 2001: over 98% of corporate bonds were non-guaranteed.
Reason: Korean financial institutions’ reluctance to guarantee new corporate bond issues after the crisis.
Excessive Household Debt
Attributable to Government domestic economy stimulus plan
Total credit to households: Tril.Won (1997) => Tril.Won (2001)
Ratio of total household credit over GDP: 46.6% (1997) => 62.7% (2001)

26. Lessons from Korean Financial Reforms (cont.)
Rising Foreigners’ Investment in the Korean Stock and Bond Market
Value of domestic bonds owned by foreigners
1997: Negligible amount => Oct.2002: 606 Bil.Won
Market value of stocks owned by foreign investors.
1997: 10.4 Tril.Won => Oct.2002: 94.8 Tril.Won
Korea aiming at a new financial center in Asia
Newly elected Korean president Noh vowed to continue to reform the Korean economy and financial system.
Many outside economic observer's view:
High probability of success in reforming the Korean economy and financial system
Korea as an international financial center such as Hong Kong and Singapore by 2010.

27. Primary Dealer System (PDS)

28. Primary Dealer System
Primary Dealers (PDs) are specialized financial intermediaries selected to perform a specialized role in the market for government securities.
The PDS is an agreement between the debt managers and a group of dealers.
PDS is widely used to promote the government bond market. However, some of the countries with developed government bond markets do not have PDS.
e.g., Australia, Germany, Japan, New Zealand, and Switzerland.

29. The Roles of Primary Dealers
A channel between debt manager (issuer) and investor
Bookmakers and distributors
Providers of immediate liquidity
Providers of asset transformation and market making services
Promoters of continuous market and efficient price discovery
Agents and relationship managers educating investors
Advisors to the government

30. Benefits of PDS Drawbacks of PDS
Improvement of efficiency of the government securities market
Reduction in operating costs
The increasing level of competition
Relief of occasional shortfalls of liquidity
Supply of distribution channels
Collection and report of market information
Easier implementation of monetary policy
Drawbacks of PDS
Less competition and possible
oligopolistic behavior
The public’s misconception of primary dealership

31. Necessary Conditions for PDS
The advanced public announcement of the government’s plan for issuing securities
Liberalized interest rates
An adequate number of end investors
A minimum set of attractively designed securities
The government’s commitment to secondary market development.
The government’s commitment to market-determined outcomes.
Careful arrangements between primary dealers and the debt managers in the auction system
Sufficient debt and a potential volume of secondary market trade

32. Obligation of Primary Dealers
Role of market makers in the effort to support the sale of government securities.
firm two-way price quote
Supply of market information and analysis to the authority
Privileges for Primary Dealers
Exclusive rights or advantages to bid at auctions.
Exclusive access to blind inter-dealer broker screens
Permission to perform wider range of activities

33. Criteria for PD Designation
A sound financial capacity, gauged in terms of capital adequacy
Adequate management skills
Technical capacity
Active market presence, measured by trading activity
Willingness to provide information to the authorities

34. Primary Dealer System in Selected Countries

35. Measures of size and liquidity

36. Secondary Bond Markets in the Korea

37. Primary Dealer Systems in the U.S. and Korea

38. The U.S. Primary Dealer System
Introduction
Establishment of the first U.S. PD system with only 18 PDs in 1960
Supervisory Role: The Federal Reserve Bank of NY, The SEC, and The Treasury
The opening of an automated Treasury auction system in 1993
The opening of the automated open market operations began in 1994
22 primary dealers as of March 2003.
The number declined from a peak of 46 in 1988 to 22 in 2002 mainly due to consolidation of many companies.
Primary dealers’ total daily trading volume: Around $375 billion per day as of March 2003.
The U.S. Primary Dealer System

39. 22 Primary Dealers in the U.S.
Domestic PDs
Banc of America Securities LLC
Banc One Capital Markets, Inc.
Bear, Stearns & Co., Inc.
CIBC World Markets Corp.
Citigroup Global Markets Inc. (Former Salomon Smith Barney Inc.)
Goldman, Sachs & Co.
Greenwich Capital Markets, Inc.
J.P.Morgan Securities, Inc.
Lehman Brothers Inc
Merrill Lynch Government Securities Inc.
Morgan Stanley & Co. Incorporated
UBS Warburg LLC.
Foreign PDs
ABN AMRO Bank, N.V., New York Branch
BNP Paribas Securities Corp.
Barclays Capital Inc.
Credit Suisse First Boston LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Dresdner Kleinwort Wasserstein Securities LLC.
HSBC Securities (USA) Inc.
Mizuho Securities USA Inc.
Nomura Securities International, Inc.
The U.S. Primary Dealer System

40. 1992 Amendment Problems: two major misconceptions in the U.S. PDS
The Fed regulates the primary dealer firms.
The designation of primary dealer gives the companies special status.
Major changes made in 1992 Amendment
It lifted a standard for trading volume with customers.
It removed the Bank’s dealer surveillance unit and focused on market surveillance.
The U.S. Primary Dealer System

41. Selection Criteria of Primary Dealers
Capital adequacy of primary dealers
Active role in the government securities market
Free from a felony crime
Financial expertise such as skilled staff
The U.S. Primary Dealer System

42. Obligation of Primary Dealers
Participation in the Fed’s open market operations, Treasury auctions, and other activities
Supply of market information that is valuable to the market surveillance effort to the Fed
Privileges of Primary Dealers
Privilege to be an exclusive counterparty for central bank’s open market operations.
Privilege to borrow securities from the central bank’s portfolio during its daily securities lending operation.
The U.S. Primary Dealer System

43. The Korean PDS Establishment in July 1999
20 primary dealers and 2 pre primary dealers as of April 1st, 2003
5 foreign dealers out of 22 primary and pre primary dealers.
Under supervision of the Ministry of Finance and Economy
Designation and revocation of a primary dealer by Minister of Finance and Economy
Thorough scrutiny of the Primary Dealer Designation Review Committee is required.
The Korean Primary Dealer System

44. Selection Criteria The level of capital adequacy
Bank related PDs: BIS ratio ≥ 8%
Securities co. related PDs: Operating Net Capital Ratio ≥ 150%
Operating Net Capital Ratio:(Total Capital - Fixed Capital (Land, Factory, Equipment, etc.)) / Weighted Risk of Debts.
The level of involvement in the government bond market
The level of expertise in handling government bond trading
Primary dealership applicants must hire the required number of government bond experts
The number of regulation breaches in trading government benchmark bonds in the KSE inter-dealer market
The Korean Primary Dealer System

45. Obligation of Primary Dealers
Minimum requirement to underwrite 5% of total issued government bonds
Minimum requirement to trade 5% of total traded government bonds
Requirement to trade one of each 3, 5, and 10 year government major benchmark bonds in the KSE inter-dealer market
The Korean Primary Dealer System

46. Obligation of Primary Dealers
Two-way quotes on government bonds on real time basis
Compulsory trading with customers at their request
Obligation to trade 40% of a PD’s total traded government bonds through the KSE inter-dealer market
Requirement to report information on trading activities and positions
The Korean Primary Dealer System

47. Privileges of Primary Dealers
Exclusive right to bid at the government bond auctions
Exclusive right to bid on behalf of non primary dealers
Exclusive access to dealer financing
Maturity of less than 30 days
Interest rate of average call rate minus 1% point
Consultation with the government over debt management policy
The Korean Primary Dealer System

48. OECD Best Practices for Public Debt Markets
Primary Public Debt Market
Korea
Issuing strategy based on regular auctions
The issuance of benchmarks
Abolition of privileged access by governments
A transparent debt management framework
Primary dealer framework with the capacity to develop markets √
50/50 Short-Term Benchmark ?
50:50
Source: OECD. Debt Management and Government Securities Markets in the 21st Century
The Korean Primary Dealer System

49. OECD Best Practices for Public Debt Markets (cont.)
Secondary Public Debt Market
Korea
50:50 √
Liquid markets with a large stock of outstanding benchmark issues and repo market financing
Safe and sound clearing and settlement systems
Transparent and equitable regulatory and supervisory framework
Source: OECD. Debt Management and Government Securities Markets in the 21st Century
The Korean Primary Dealer System

50. OECD Best Practices for Public Debt Markets (cont.)
Secondary Public Debt Market
Korea
A market-making structure based on primary dealers
Liquid futures markets
Good access by foreign investors to domestic domestic debt markets √
50:50
Source: OECD. Debt Management and Government Securities Markets in the 21st Century
The Korean Primary Dealer System

51. Suggestions to Further Enhance Korea Bond Market
Consolidate Primary Dealer System
Integration of current PDs and Bank of Korea trading partners
Create a more liquid market
Short-term benchmark
Short-term Treasury Bills (3, 6, 12 months)
Inter-Bank Rate
e.g. London Inter-Bank Offered Rate
Provide access to Repo markets
Further develop the derivative markets
Increase fixed income derivative products
Consider replacing MSBs with Treasury bills
The Korean Primary Dealer System