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Korean SLB Market & KSD SLB Service

Jong-Hyung Lee
Securities Lending & Borrowing Team
Korea Securities Depository

E-Mail : sbl@ksd.or.kr
SLB Transaction - Overview

 Definition
 The lending of securities by an institution to another for a certain fee
 Legal Characteristics
 Ownership of the loaned securities is transferred from the lender to
borrower
 Lender is entitled to all economic benefits from the loan securities
excluding voting rights
 Function
 Settlement coverage
 Means of arbitrage
 Means to enhance capital market stability and efficiency

2
Transaction Flow - Settlement Coverage

Instruction
Foreigner Custodian mismatch or
time lag

Sell
Non Member Member
Non Stock Stock
Member Sell order Brokerage Brokerage
Stock Buy
Brokerage
Settle
Institutional settlement

Borrow stock Intermediary


Lender
KSD
Transaction Flow - DR Arbitrage

Assumption
Assumption
Cost Neutral
Investment maturity: 10 days
Currency exchange risk: Hedged
Current Stock Price: 103,000 Won ADR
ADR Price: 99,000 Won

Long

Borrow underlying stock


Lender Borrower DR conversion to stock

Short borrowed stock

Spot Market
Return borrowed stock
Transaction Flow - CB/BW Arbitrage

Assumption
Assumption
Cost Neutral
Investment maturity: 10 days
Current Stock Price: 103,000 Won CB
Conversion Price: 99,000 Won

Long

Borrow underlying stock


Lender Borrower CB conversion to stock

Short borrowed stock

Spot Market
Return borrowed stock
Transaction Flow - Futures Arbitrage

Assumption
Assumption
Cost Neutral
Investment maturity: 20 days
Current KOSPI 200 Index: 110 Futures
KOSPI 200 Futures Index: 108

Backwardation (Basis -2) Long

Borrow underlying stock


Lender Borrower Settlement by Index

Short borrowed stock

Spot Market
Return borrowed stock
SLB Market - Development

 SLB market opened (Aug. 1996)


 KSD is firstly authorized as SLB intermediary
 KSFC (July 2000) and securities companies are allowed to act as
SLB intermediary. (Sep. 2000)
 SBL by Foreign investors was allowed (July 1998)
 Non-residents first began SLB transaction in Nov. 2001
 Approval system changed into Prior reporting system from Jan.
2006
 Borrowing limit without BOK Prior reporting increased to KRW 50
billion from KRW 10 billion from Jan. 2008
 Securities borrowing by indirect investment vehicles and
banks was allowed (May 2006)
 Foreign currency & Foreign securities added as eligible
SLB collateral from April. 2008

7
SLB Market - Growth

<SLB Balance(Stock)>
million shares
700

600

500

400

300

200

100

0
S- F- J- D- M- O- M- A- J- J- N- A- S- F- J- D- M- O- M- A- J- J- N- A- S- F- J- D-
96 97 97 97 98 98 99 99 00 00 00 01 01 02 02 02 03 03 04 04 05 05 05 06 06 07 07 07

Total KSD Securities Companies

8
SLB Market - Growth (Cont’d)
100

150

200

250
50

million shares
96/09 0

97/02
97/07
97/12
98/05
98/10

<SLB Transaction Volume(Stock)>


99/03
99/08
00/01
00/06
Total

00/11
01/04
KSD

01/09
02/02
02/07
Securities Companies

02/12
03/05
03/10
04/03
04/08
05/01
05/06
05/11
06/04
06/09
07/02
07/07
07/12
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SLB Market – SLB & KOSPI
KOSPI
1000

1500

2000

2500
500
0
2005 1
2005 2
2005 3
2005 4
2005 5
2005 6
2005 7
2005 8
2005 9
2005 10
2005 11
2005 12
2005. 01 ~ 2007. 12

2006 1
2006 2
2006 3
2006 4
2006 5
2006 6
2006 7
2006 8
2006 9
2006 10
2006 11
2006 12
2007 1
2007 2
(Unit : 100 million KRW)

2007 3
2007 4
2007 5
2007 6
2007 7
2007 8
2007 9
2007 10
2007 11
2007 12
0

50,000

100,000

150,000

200,000

250,000
10
20
08

255,000
260,000
265,000
270,000
275,000
280,000
285,000
/02
60 290,000
/0 08
/022
60
/0 08
2/030
6
/0 08
/024
60
/0 08
2/050
6
/0 08
/02 9
60
(Unit : 100 million KRW)

/1 08
2/000
6
/1 08
/02 1
60
/1 08
/022
60
/1 08
2/030
6
/1 08
/026
60
/1 08
2/070
6
/1 08
/028
60
/1 08
/029
60
/2 08
2008. 06. 02 ~ 2008. 06. 30 2/000
6
/2 08
2/00 3
6
/2 08
2/040
6
/2 08
5
SLB Market - SLB & KOSPI (Cont’d)

2/00
6
/2 08
2/060
6
/2 08
/07
6
/3
0
KOSPI

1550
1600
1650
1700
1750
1800
1850
1900

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SLB Market – SLB & Market volume

(Unit: 100 million KRW)

Ratio
Year SLB Volume Market Volume
(Value)
2005 170,831 12,326,358 1.4%

2006 348,818 12,759,944 2.7%

2007 760,964 18,622,701 4.1%

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SLB Market - Regulations (Intermediaries)
 Securities Companies, Korea Securities Finance Corporation
(KSFC) and KSD are allowed to act as SLB intermediaries
 SLB Regulations for Securities Companies
 Regulation on the Supervision of Securities Business
– Method of Brokerage: Direct & Indirect intermediation
– Collection of Collateral: Securities & cash
– Administration of Collateral: Directly or entrust to KSD, trust company, etc
– Delivery of Securities : DVP by KSD book-entry transfer
– Disclosure of Transaction Details: KSDA disclosure & FSC reporting
 KSDA Standard Agreement on Loan Transactions for Securities
 KSFC and KSD SLB operations are conducted according to
internal regulations
 KSD Regulation on Intermediation of Securities Lending & Borrowing
Transactions
 The SLB business of KSD and KSFC will be directly regulated by
FSS with the enactment of Capital Market Consolidated Act from Feb.
2009

13
SLB Market – Regulations (Participants)

 Participants Regulations & SLB Scope

Participant Regulation Scope


Securities Securities & Exchange Act Lending / Borrowing
Companies
Banks MoFE Ordinance Lending
Borrowing for hedging, fail-
cover & arbitrage
Fund Indirect Asset Management Lending (within 50% of total
Act Enforcement Decree asset value)
Borrowing (within 20% of
total asset value)
Insurance Regulation on the Lending
Company Supervision of Insurance
Business
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SLB Market - Regulations (Short Sale)

 Stock Short Sale Restrictions


 Only “covered” short sale is allowed
– Sale which delivery is possible by T+2
– Sale of borrowed securities
– Sale of securities which return is confirmed by settlement date
 Up Tick Rule
 Short sale allowed when the trade price is not lower than the
previously traded price
 Up tick rule exemptions
– Index arbitrage transaction
– ETFs sale & arbitrage transaction
 Bond Short Sale Restrictions
 Only securities companies can sell short

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KSD SLB Service - Timeline
KSD opened SLB market for the first time in Korea
 eligible securities : KOSPI stocks only
Aug. 1996
 fee rate : fixed fee rate in accordance with loan term
 transaction type : settlement coverage transaction only

Nov. 1997 Eligible securities expanded to KOSDAQ stocks


Sep. 1998 Eligible securities expanded to listed bonds

Bid-offer and customized transactions introduced


Mar. 2000
Rollover service introduced

Loan term of settlement coverage transaction shortened


July 2001 (T+5 →T+2)
Mark-to-market applied to bond collateral
Nov. 2001 Intermediary fee is reduced (5%→2%)
Dec. 2002 0% of collateral level allowed for customized transactions

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KSD SLB Service - Timeline (Cont’d)
Feb.2003 Arranged transaction introduced

July 2003 Partial return service introduced

Feb. 2004 Adjusted hair-cuts ratio for security collateral

Lowered collateral level for securities companies


Jun. 2005
 102% →100% ( only in case of bond SBL transaction)

Provided SLB consulting service for Thai Securities


Jun. 2005
Market

SLB service revised


 Rollover for settlement coverage transaction introduced
July 2006
 Eligible securities expanded to ELW
 Securities borrowings by funds and banks allowed

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KSD SLB Service - Timeline (Cont’d)

SLB fee calculation method revised


Transaction based monthly calculation replaced with mark-to-
Jan.2008 market method
New bond SLB transaction type launched
 T+1 settlement transaction added
Foreign currency collateral system launched
 USD & Treasury bonds added as eligible collateral for SLB
April 2008 transaction

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KSD SLB Service - Overview

 Market Participants
 Lenders : Foreign investors, Institutional investors including
investment-trust companies, banks, insurance companies,
mutual funds and pension funds
 Borrowers : Foreign investors, Securities companies, etc.
 Intermediary : KSD
 Advantages of KSD’s SLB Service
 Access to wide range of lenders and borrowers
 Collateral management and corporate actions know-how
 Guarantee of settlement by KSD ensures stable SLB
transactions (customized transactions excluded)

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KSD SLB Service - Eligible Securities

 Stocks
 KRX listed stock

 Bonds
 Listed bonds (Government bonds, municipal bonds, special
bonds, corporate bonds etc)

 Exchange Traded Funds (ETF)

 Equity Linked Warrants (ELW)

20
KSD SLB Service -Transaction Type
 Settlement-Coverage transaction
 Used to cover market settlement fails.
 Bid-Offer transaction
 Anonymous transactions with KSD as counterparty.
 Customized Transaction
 The lender and borrower decides the conditions and transacts
via KSD.
 The lender is the pledgee for the collateral.
 Arranged Transaction
 The lender and borrower decides the conditions and transacts
via KSD.
 KSD is the pledgee for the collateral and guarantees settlement.
21
KSD SLB Service - Transaction Type (Cont’d)

Settlement
Division Bid-Offer Arranged Customized
Coverage
Objective Fail coverage Investment strategy
Period 3 business days 1 year
Fee rate Bid-offer(25% max) Bid-offer Decided between trade parties
Collateral Mutual
100~110% according to participants credit rate
rate agreement
Pledgee KSD Lender
- Both borrower and lender
Early - In case of recall, the borrower must return the
Only for borrower
Termination shares within 3 business days (4 business days for
recalls after 12:00p.m.)
― Application and consent 3 business day prior to the maturity date
Rollover ― In settlement coverage transactions, application and consent is possible
until the maturity date
Partial
Possible
Return
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KSD SLB Service - Transaction Flow

1)Application
1)Application
Borrower 2)Collateral KSD Lender
3)Matching 3)Matching
Report Report

Borrower Lender
4)Credit (+) A/C Book A/C Book 4)Debit (-)

1) Application and Matching: Trades are matched when the conditions of the
lender and borrower are met
2) Collateral: The borrower provides the required collateral in cash or
securities to the pledgee
3) Matching Report: The lender and borrower are notified of the trade details
as soon as the trade is matched
4) Delivery: Once the collateral is pledged, the SLB securities are transferred
by book-entry from the lender’s account to the borrowers account
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KSD SLB Service - Collateral Management

 Collateral Requirement
 Borrowed securities
 Rights from borrowed securities (Rights issue, bonus shares,
dividends, etc)
 Fees (SLB fee+ intermediary fee)
 Collateral Ratio
 The collateral ratio is 100~110% depending on the participants
credit status rated by KSD (excepting customized transactions)
 Pledgee
 Customized Transactions: Lender
 Bid-offer, settlement coverage, arranged transactions: KSD

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KSD SLB – Collateral Management (Cont’d)

 Eligible Collateral and Evaluation Rate


 KRX-listed stocks : 70% ~ 80% of previous day’s closing price
 Bonds (BBB or higher) : 80% ~ 100% of market price
 ETFs : 80% of previous day’s closing price
 Cash : 100%(Rebate is paid to borrower)
 Marking-to-market
 Collateral is marked-to-market daily to account for the changes in
the price of the loan securities and collateral securities
 Exchange of Collateral
 When the collateral securities loses value or liquidity due to
bankruptcy, composition, liquidation of the issuer.
 When submission of the securities is required due to maturity, stock
split & merger, etc.

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KSD SLB Service - Termination

 Return at Maturity
 Borrower must return the same amount of the same securities at
the end of the SLB period
 Cash return is possible in case of bond SLB transactions when it
is difficult to return the securities, but an additional charge (1% of
previous day’s market price) must be paid
 Early return
 Lenders or borrowers can terminate SLB transactions at any
time during the SLB period by recalling or returning the securities
 Rollover
 Rollover is possible with the consent of the lender

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KSD SLB Service - Corporate Actions
 Principle
 The lender is entitled to all economic benefits from the loan
securities excluding voting rights. (Lenders cannot exercise
voting rights since ownership is transferred to the borrower, so
the securities must be recalled in order to exercise voting rights.)
 Cash Dividends, Bond Interest, Payment for Fractional
Shares
 The borrower pays the economics benefits of the loan securities
to KSD, who then relays it to the lender
 Stock dividends, Bonus Shares
 The borrower must deliver the shares to the lender within 3
business days of the listing date

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KSD SLB Service - Default

 Default Events
 The borrower is unable to return the loan securities or deliver the
entitlements derived from the loaned securities
 The borrower is unable to supplement insufficient collateral
 Default Rules
 Customized Transactions : The lender liquidates the collateral to
cover the loss
 Bid-offer, Arranged of Settlement Coverage Transactions : KSD
liquidates the collateral to settle the transaction, and afterwards
claims indemnification from the borrower

28
KSD SLB Service - Fees

 SLB Fee
 Fee paid by the borrower to the lender via KSD
– Closing price of the previous day x quantity x fee rate x SLB period /
365
 In case of settlement coverage transactions, a fee of KRW 30,000
is collected in case the SLB fee is KRW30,000 or less
 Intermediary fee
 Fee paid by the borrower and the lender to KSD, the intermediary
– SLB fee x 2%
– The intermediary fee is 2bp per annum in case the SLB fee rate is less
than 1%
 If the SLB fee is KRW 30,000, the borrowers pays KRW 3,000 as
the intermediary fee

29
KSD SLB Service - Taxation

 KSD withholds taxes on SLB income and delivers them to


the National Tax Service (NTS)
 Non-residents are taxed according to rates set by tax treaties
between their country of residence and Korea.

 Taxes are imposed on


 Bond interest (interest income)
 Stock dividends (dividend interest income)
– Manufactured dividend payments of SLB transaction between non-
residents are exempt from withholding tax.
 Interest on cash collateral (interest income)
 SBL fees (other income)

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Statistics - Transaction Amount

(Million Shares)
<SLB Volume>

1,800 91%

1,600
1,400
90%
1,200
1,000
800 82%

600 57%

400 56%

200
0
2003 2004 2005 2006 2007

Local Foreign 31
Statistics - Transaction Amount (Cont’d)

<SLB Value>
KRW 1000 Billion
90%
80
70
60
50 89%
40
30 83%
64%
20 65%
10
0
2003 2004 2005 2006 2007

Local Foreign
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Statistics - Transaction by SLB Type

Year 2007
<Local Investors>

23.7% 3.1%
27.1%

46.1%

Customized Arranged Bid-


Bid-Offer Fail Cover

33
Statistics - Transaction by SLB Type (Cont’d)

Year 2007
<Foreign Investors>
1.7%
3.9% 0.1%

94.3%

Customized Arranged Bid-


Bid-Offer Fail Cover

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Statistics - Top 5 SLB Stocks

Year 2007 (Unit: Thousand Shares)

Foreigner Local
Rank
Stock Volume Stock Volume
Korea Exchange
84,805 (5.2%) 1 KT Corp. 11,847 (0.7%)
Bank
Hynix Hynix
82,562 (5.1%) 2 10,766 (0.7%)
Semiconductor Semiconductor

KIA Motor 63,413 (3.9%) 3 KEPCO 5,693 (0.4%)

Woori Financial Shinhan Financial


60,875 (3.7%) 4 4,469 (0.3%)
Group Group
Woori Financial
LG.Phillips LCD 52,772 (3.2%) 5 3,958 (0.2%)
Group

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Statistics - Lending Ratio

Year 2007
Volume Value (100 Ratio
Division
(Shares) million won) (Value)
Pension Funds 144,013,458 48,750 6.4%
Asset
97,220,721 42,453 5.6%
Management
Securities
Local 75,054,457 9,746 1.3%
Company
Bank 1,561,979 905 0.1%
Other 5,079,000 1,628 0.2%
Sub-Total 322,929,615 103,482 13.6%
Foreign 1,370,169,383 657,482 86.4%
Total 1,693,098,998 760,964 100%

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Statistics - Borrowing Ratio

Year 2007
Volume Value (100 Ratio
Division
(Shares) million won) (Value)
Pension Funds - - -
Asset
3,193,196 1,352 0.2%
Management
Securities
Local 134,724,865 65,129 8.6%
Company
Bank 3,288,059 3,947 0.5%
Other 1,780,350 260 0.0%
Sub-Total 142,986,470 70,688 9.3%
Foreign 1,550,112,528 690,276 90.7%
Total 1,693,098,998 760,964 100%

37
SLB market – Issues

 Foreign Ownership Limit


 Foreigners are not allowed to borrow securities that are subject to
ownership limits for foreigners from local investors.
 FSS regulation on foreigners’ securities trading

 Prior Reporting System


 Foreigners who want to borrow securities exceeding KRW 50
billion from local lenders should declare the details to BOK before
actual borrowing

 Institutional investors needed to actively participate in SLB


market
 Borrowing by indirect investment vehicles is limited to 20% of total
asset value of each fund
 Unclear regulatory treatment for SLB transactions by banks

38
SLB market – Issues (Cont’d)

 SLB Market Segmentation


 Korean SLB market is divided by several SLB intermediaries.
 Rules or regulations can be different for each intermediary.

 Recall request for shareholders’ meeting


 Long-term borrows may be difficult
 High concentration of end-of-year recalls by major lenders limits
stock availability

39
SLB Market - Future prospect

 Improvement of SLB Environment for Foreign Investors


 Limit for borrowing from residents is expected to increase
 Prior-reporting is expected to be replaced by post-trade reporting
or abolished
 F/X market is scheduled to further liberalize by 2009

 Achievement of More Balanced Market


 Not only foreigners but local institutional investors will proactively
respond to the growing Korean SLB market

 Further growth of SLB market


 Growth of hedge fund with the enactment of Capital Market
Consolidated Act (from Feb. 2009~)
 Establishment of SLB system for individual investors

40
Thank you.

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