Securities Lending in Taiwan

Pony B.L.Huang

Trading Department

Taiwan Stock Exchange

SBL Market Conditions

• Taiwan Stock Exchange launched SBL system on June 30, 2003.  

2003/06/30-12/31 2004/01/01-12/31 2005/01/01-12/31

Total transactions

105 orders 1311 orders 1120 orders

Total volume traded

344,634,000 shares

3,048,953,000 shares

2,275,341,000 shares

Total value traded

10,806,478,000 NTD

(around 337 million USD)

81,255,152,400 NTD

(around 2.5 billion USD)

68,461,675,090 NTD

(around 2.1 billion USD)

Trading Value by Month

0.000

2,000.000

4,000.000

6,000.000

8,000.000

10,000.000

12,000.000

Jul2003

Oct Jan2004

Apr Jul Oct Jan2005

Apr July Oct Jan2006

As of Jan. 31 , 2006(NTD. millions)

Transaction Types Analysis by Year

0

10

20

30

40

50

60

70

80

90

2003 2004 2005

Fixed-Rate

Competitive

Negotiated

Borrower Analysis by Year

0

20

40

60

80

100

2003 2004 2005

FINI

Local Securities Dealer

Local Futures Dealer

Lender Analysis by Year

0

10

20

30

40

50

60

70

80

90

100

2003 2004 2005

FINI

Insurance Co.

Securities InvestmentFund

Bank

Government Fund

Trust Co.

Some Important Principles of SBL

• Targeted at qualified institutional investors.• Most short sales have to follow the up-tick rules, o

nly some exemptions.• Provides three kinds of transactions:

fixed-rate transaction

competitive auction transaction

negotiated transaction• Set ceiling for total short selling volume

Roles of the TSE in the SBL Market

• Acts as an intermediary in the SBL system.• For fixed-rate transactions and competitive

auction transactions, TSE acts as a guarantor to assume the risk from lenders. TSE requires collateral and handles collateral management.

• Sets SBL regulations and maintains the SBL system.

Roles of SBL Brokers

• Act as agents for borrowers and lenders.

• Sign a contract with the TSE and take the TSE’s training course before conducting business.

• Relay the TSE’s information,e.g. margin call or manufactured dividends, and inform their clients. Handle settlements with TSE.

Fixed Rate Transactions and Competitive Auction

Transactions

Lender

Borrower

Brokerr

Broker

TSE

Matching

TSCD

Sending the

lending

application

Sending the

borrowing

application

Forwarding

the

application

Forwarding

the

application

Informing the securities and collateral have been frozen Informing the securities have been transferred

Reporting the

execution

Reporting the

execution

Reporting the

execution Reporting the

execution

Informing the lending security and collateral to be frozen.

Informing the securities to be transferred

Transferring the

lending securities

after matching.

Negotiated Transactions

TSCD

TSE

Lender

Borrower

Transferring

the collateral

Transferring the

lending securities

Sending the

application

Sending the

application

Reporting the borrowing

Informing the securities to be transferred

Broker

Broker

Reporting the lending

Acceptable Collateral from FINIsTransaction

TypesFee Rates Collateral

RatesAcceptable Collateral

Pledgee Guarantor

Fixed rate 3.5% 140% of the loan

NTD or eligible

Securities for margin trading

TSEC TSEC

Competitive Bids and Offers

140% of the loan

NTD or eligible

Securities for margin trading

TSEC TSEC

Negotiated Negotiable Negotiable Onshore Cash or Securities or offshore collateral

Lender N/A

Qualified Borrowers:

• FINIs

• Securities dealers

• Futures dealers

• Securities investment trust enterprises

(only ETF issuers)

Qualified Lenders:• Insurance companies• Banks, trust investment companies• Securities investment trust enterprises • FINIs • Futures dealers• Securities firms• Other: Labor Insurance Fund Post Office Insurance Fund Labor Pension Fund Public Service Pension Fund

Restrictions on Covered Short Sales • When short selling borrowed stock, all transactions

have to follow the up-tick rules. • Exemptions: Short selling ETF for conducting arbitrage or hedging of

ETF. Short selling underlying stock of put warrants for hedging of

put warrants.( for warrants issuers ) Short selling underlying stock of stock options for hedging

purpose.( for stock options market makers ) Short selling underlying stock of structured notes for hedging

purpose. ( for structured products issuers )

• Borrowing and selling of stocks have to go through the same SBL brokerage firm.

Tax Responsibility for Borrowing Fee and Manufactured Dividend

Lender Borrower Business tax responsibility

Income tax responsibility

Domestic FINIs Domestic lender Domestic lender

FINIs Domestic Domestic borrower Domestic borrower should withhold 20% of income on behalf of the FINI lender

FINIs FINIs FINI lender FINI lender

Domestic Domestic Domestic lender Domestic lender

Tax Responsibility for Interest Revenue from Cash Collateral

Lender Borrower Income tax responsibility for fixed rate or competitive auction transactions

Income tax responsibility

for negotiated transactions

Domestic Domestic TSEC withholds the tax on behalf of the borrower

Domestic lender withhold the tax on behalf of domestic borrower

FINIs Domestic TSEC withholds the tax Domestic borrower

FINIs FINIs TSEC withholds the tax FINIs borrower (No tax liability for offshore collateral)

Domestic FINIs TSEC withholds the tax Domestic lender has to withhold the tax on behalf of the FINIs borrower

Regulatory Update

Regulations Implemented in 2005

• One rollover permitted• Partial return• Taiwan scripless government bonds accepte

d as collateral.• Cash collateral directly credited into the bor

rower’s account. • Borrower can withdraw the excess collatera

l ( over 140% of the loan) at any time.

Regulations Implemented in 2005 ( Cont. )• Remove purpose test requirement and on shore coll

ateral restrictions.• Set ceilings for short selling. 1. Daily maximum short selling shares of borrowed stock cannot exceed

3% of outstanding shares per lending stocks. 2. Maximum short selling of borrowed stock cannot exceed 10% of outs

tanding shares per lending stock. 3. The total volume of short selling of borrowed stock and short selling b

y margin transactions cannot exceed 25% of outstanding shares per stock.

• Investors can get the real time available short selling shares through the TSEC Market Information System on http://mis.tse.com.tw/

Regulations Implemented in 2005 ( Cont. )

• In addition to the underlying stocks of financial derivatives, those securities eligible for margin trading were included in the loanable securities for Securities Lending.

• Allow participants to open multiple SBL accounts and transfer the lending securities among them freely.

Regulations Implemented on January 23, 2006

• In addition to 10-day prior notice, TSEC allows 3-day prior notice for recall by a lender in a fixed-rate or a competitive auction transaction.

Feedback from the Market

Suggestions from PASLA Taiwan Roundtable Meeting Held on Dec. 15, 2005

• Establish a short-term SBL market to facilitate settlement issues.

• Abolish current up-tick rule or establish a more flexible up-tick rule.

• Create an exemption from manufactured dividend tax and when the collateral is held overseas an exemption from lending income tax.

• Allow borrowed securities to be further lent out.

Suggestions from PASLA Taiwan Roundtable Meeting Held on Dec. 15, 2005 (Cont.)

• Allow account-level collateralization and margin call.

• Allow lending fee settlement on a monthly basis.

• Allow return of manufactured dividends and return of a SBL trade to be handled separately.

Prospects for the Future

• Securities Exchange Act, Article 60 already was passed on Dec. 20th, 2005, implementation pending.

• Based on the revised Article 60, a securities firm can conduct SBL business as a principal, an agent or an intermediary.

• Securities Financing Company can be a lender in TSEC’s lending system.

Thank you.

Pony Bo-Li HuangVice President

Trading DepartmentTaiwan Stock ExchangeTel: 886-2-8101-3573Fax: 886-2-8101-3685

E-mail: pony@tse.com.tw