The Korean Bond MarketPost Asian Crisis and Beyond

May 12, 2003

Korea Stock ExchangeSeoul, Korea

Ismail Dalla, CFA

Director, Financial Markets Consulting GroupRONCO Consulting Corporation

2

East Asian Bond Markets

3

World Economic Prospects

2000 2001 2002 2003 2004

World 3.8 1.1 1.7 2.5 3.1High-Income Countries 3.5 0.7 1.5 2.1 2.7

OECD Countries 3.4 0.8 1.4 2.1 2.6 United States 3.8 0.3 2.3 2.6 3.1

Japan 2.1 -0.3 0.0 0.8 1.3Euro Area 3.7 1.5 0.8 1.8 2.6

Non-OECD Countries 6.8 -0.7 2.3 3.7 5.3

Developing Countries 5.2 2.9 2.8 3.9 4.7East Asia and Pacific 7.0 5.5 6.3 6.1 6.4Europe and Central Asia 6.6 2.3 3.6 3.4 3.6

Transition Countries 6.4 4.6 3.5 3.3 3.5Latin America and the Caribbean 3.7 0.4 -1.1 1.8 3.7

Excluding Argentina 4.5 1.2 0.7 1.9 3.6Middle East and North Africa 4.2 3.2 2.5 3.5 3.7

Oil Exporters 3.6 2.4 2.4 3.7 3.6Diversified Economies 3.7 4.3 2.2 2.7 3.6

South Asia 4.8 4.4 4.6 5.4 5.8Sub-Saharan Africa 3.2 2.9 2.5 3.2 3.8

Source: The World Bank, Global Economic Prospects 2003 .

Current ForecastCurrent Estimate

World GDP Growth(Unit: %)

4

Growth of World Bond Markets

1994 1995 1996 1997 1998 1999 2000 2001Government Bonds 12,552.9 13,617.4 14,034.9 13,926.2 15,405.3 16,237.7 16,314.6 16,571.7Corporate Bonds 5,431.9 6,002.4 6,286.9 6,362.7 7,400.5 8,267.9 8,645.5 9,312.8Foreign Bonds 474.0 565.4 641.5 688.7 767.2 712.3 815.1 817.5Eurobonds 1,679.0 1,942.8 2,352.6 2,708.8 3,131.2 3,479.4 4,155.3 4,550.3Total 20,148.0 22,150.7 23,351.8 23,688.9 26,858.2 28,574.2 29,804.1 31,348.5

Source: Merrill Lynch, Size & Structure of the World Bond Market: 2002 , April 2002.

History of Size and Structure of the World Bond Markets (1990 - 2001)(In Billions of U.S. Dollars)

5

Key Econ. Indicators: East Asia and Pacific

2000 2001 2002(E) 2003(E) 2004(E)

Real GDP growth 7.7 7.0 5.5 6.3 6.1 6.4

Private consumption per capita 5.8 6.0 6.2 5.7 5.2 5.6

GDP per capita 6.4 5.9 4.5 5.4 5.2 5.6

Gross domestic investment/GDP1 28.7 29.2 30.1 32.8 33.9 34.9

Inflation2 5.6 5.0 6.6 2.5 3.6 3.6

Central gvt. Budget balance/GDP -1.2 -3.3 -3.3 -3.6 -3.4 -3.3

Export market growth3 9.7 14.1 -2.5 3.6 9.2 8.7

Export volume4 11.4 22.5 2.5 15.9 15.7 11.3

Terms of trade/GDP5 0.0 0.0 -0.4 -0.5 -0.1 -0.3

Current account/GDP 0.5 3.6 2.7 2.7 2.7 2.5

GDP growth: East Asia excluding China 4.5 5.0 2.3 3.6 3.8 4.3

Note: 1. Fixed investment, measured in real terms. 2. Local currency GDP deflator, median. 3. Weighted average growth of import demand in export markets 4. Goods and nonfactor services. 5. Change in terms of trade, measured as a proportion to GDP (percentage).Source: The World Bank, Global Economic Prospects 2003.

(Unit: %)

1991-2000

6

Global Bond Market

US$ Bil. % of Total US$ Bil. % of Total US$ Bil. % of Total US$ Bil. % of Total US$ Bil. % of Total

United States 17,598.2 47.3 8,557.1 48.6 4,367.4 24.8 2,452.5 13.9 2,221.2 12.6Euro Area2 7,861.5 21.1 3,210.4 40.8 1,751.7 22.3 355.4 4.5 2,544.0 32.4Japan 6,104.0 16.4 4,439.8 72.7 713.8 11.7 693.2 11.4 257.2 4.2Other Mature Markets 3,537.2 9.5 123.0 31.7 775.6 21.9 403.5 11.4 1,235.4 34.9Subtotal 35,100.9 94.4 17,330.3 49.4 7,608.5 21.7 3,904.6 11.1 6,257.8 17.8

Emerging MarketsAsia 1,098.7 3.0 541.7 49.3 223.9 20.4 186.5 17.0 146.6 13.3Latin America 694.3 1.9 384.4 55.4 67.4 9.7 23.4 3.4 219.1 31.6Eastern Europe, Middle East and Africa

284.4 0.8 207.7 73.0 4.2 1.5 6.4 2.3 66.2 23.3

Subtotal 2,077.4 5.6 1,133.8 54.6 295.5 14.2 216.3 10.4 431.9 20.8

Total 37,178.3 100.0 18,464.1 49.7 7,904.0 21.3 4,120.9 11.1 6,689.7 18.0

Size and Structure of the Global Bond Market in 2001(Unit: US$ Bil.)

Total Bonds Outstanding International1

Government Financial Institutions Corporate

Domestic

Source: Bank for International Settlements.

Note: 1.Includes bonds issued by governments, financial institutions, and corporates in international markets. 2.Euro area includes a total of 11 members of the euro zone, excluding Luxembourg.

7

East Asian Bond Markets

Bil. US$% of

East AsiaBil. US$

% of East Asia

Bil. US$% of

East AsiaBil. US$

% of East Asia

Bil. US$% of

East Asia

China 102.7 21.1% 143.9 26.6% 195.3 27.5% 253.4 29.0% 208.3 24.3%

Hong Kong 35.2 7.2% 50.3 9.3% 57.1 8.1% 60.9 7.0% 63.3 7.4%

Indonesia 7.8 1.6% 5.7 1.1% 10.1 1.4% 9.8 1.1% 7.5 0.9%

Korea 235.5 48.4% 238.3 44.0% 306.4 43.2% 375.4 43.0% 381.4 44.5%

Malaysia 40.4 8.3% 36.0 6.6% 41.5 5.9% 63.9 7.3% 72.5 8.5%

Philippines 20.4 4.2% 15.8 2.9% 25.0 3.5% 24.2 2.8% 24.5 2.9%

Singapore 26.9 5.5% 29.0 5.4% 36.8 5.2% 44.8 5.1% 56.8 6.6%

Thailand 17.4 3.6% 22.8 4.2% 36.8 5.2% 40.8 4.7% 42.7 5.0%

East Asia 486.2 100.0% 541.7 100.0% 709.0 100.0% 873.1 100.0% 856.9 100.0%

Source: The World Bank, Asset-Backed Securities Market in Selected East Asian Countries , July 2002.

2000 2001

East Asian Domestic Bonds Outstanding(Unit: Bil. US$)

1997 1998 1999

8

Government Bond Market in AsiaSovereign Bonds % of 2001 Nominal GDP

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Thailand

Malaysia

Japan

Korea

Singapore

Philippines

China

India

Source: Nazir Razak, Intermediating The Economy: A Sustainable Ringgit Fixed Income Market . Reserve Bank of India <http://w w w .rbi.org.in> Mohammad Tahir, Development of Bond market in India. Merrill Lynch, Size & Structure of the World Bond Market: 2002.

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.

Government Domestic Debt Securities VS Nominal GDP (Unit: % of GDP, 2001)

94.3%

86.1%

58.1%

42.4%38.8% 36.4% 33.7%

26.9%

18.3% 17.4% 16.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

10

Emerging Market Debt Issuance(1991 – 2002)

Bank Corporation Sovereign Sovereign-Sup Sub-Sovereign

1991 120 1,964 1,968 2,796 61

1992 3,015 4,916 3,111 3,363 450

1993 6,102 10,517 8,000 7,473 0

1994 5,168 6,923 5,168 5,153 100

1995 5,197 7,439 16,566 6,613 268

1996 8,060 22,050 34,820 6,642 1,349

1997 12,531 28,870 32,941 5,959 2,160

1998 7,142 12,778 39,865 11,559 1,002

1999 5,327 10,117 45,676 10,301 949

2000 4,932 8,716 45,347 2,748 95

2001 3,042 7,795 38,666 9,158 1,270

2002 3,293 6,439 31,426 12,925 81

Issuer

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 banksSourece: Jane Brauer. Corporate Debt in Emerging Markets. Merrill Lynch. April, 2002.

11

Securitized Corporate Bond Issuance in Asia

(Unit: US$ Mil.) 1995 1996 1997 1998 1999 2000

Hong KongSecuritized bonds 235 134 2,056 711 1,615 450Non-securitized bonds 2,280 3,096 6,977 2,444 7,617 5,492

IndonesiaSecuritized bonds 21 589 489 400 n.a. n.a.Non-securitized bonds 1,674 5,007 8,271 254 80 999

KoreaSecuritized bonds n.a. n.a. 1,150 600 940 10,114Non-securitized bonds 2,815 3,349 6,668 1,656 2,689 8,746

MalaysiaSecuritized bonds n.a. 32 n.a. 400 592 53Non-securitized bonds 2,783 3,121 9,337 2,722 5,600 7,363

SingaporeSecuritized bonds n.a. 225 n.a. 550 2,543 1,711Non-securitized bonds 1,844 2,490 2,593 2,093 2,078 7,989

ThailandSecuritized bonds 250 n.a. 333 100 108 100Non-securitized bonds 538 952 1,268 1,645 3,004 3,161

Total corporate issuance 12,440 18,995 39,142 13,575 26,866 46,178Total securitized bonds 506 980 4,028 2,761 5,798 12,428

4.1% 5.2% 10.3% 20.3% 21.6% 26.9%Total non-securitized bonds 11,934 18,015 35,114 10,814 21,068 33,750

95.9% 94.8% 89.7% 79.7% 78.4% 73.1%Japan

Securitized bonds 417 1,083 2,331 14,083 20,781 21,184Non-securitized bonds 50,233 81,700 56,646 118,656 80,104 82,999

Source: Ismail Dalla, The World Bank, Asset-Backed Securities Market in Selected East Asian Countries.

12

The Korean Bond Market

13

Key Econ. Indicators: Korea

1995 1996 1997 1998 1999 2000 2001 2002

GDP (US$ Bil.) 489.4 520.0 476.6 317.7 405.8 461.7 427.3 476.6

Real GDP growth (% change) 8.9% 6.8% 5.0% -6.7% 10.9% 9.3% 3.1% 6.4%

GNI Per Capita 10,823 11,385 10,315 6,744 8,595 9,770 9,000 10,013

Inflation (% change) 4.5% 4.9% 4.4% 7.5% 0.8% 2.2% 4.1% 2.7%

Unemployment Rate (%) 2.0% 2.0% 2.6% 7.0% 6.3% 4.1% 3.8% 3.1%

Average Stock Price Index 935 833 655 406 807 734 573 757

Current Account Balance (US$ Mil.) -8,508 -23,005 -8,167 40,365 24,477 12,241 8,239 6,092

Government Budget Balance (Won Bil.) 1,241 1,099 -6,959 -18,757 -13,065 6,527 7,268 22,666

Total external debt (US$ Mil.) 127,491 163,489 159,237 148,705 137,069 131,668 118,818 131,003

Short term external debt (US$ Mil.) 71,894 93,319 63,559 30,697 39,222 47,921 41,008 49,780

Short term external debt to total ext. debt (%)

56.4% 57.1% 39.9% 20.6% 28.6% 36.4% 34.5% 38.0%

Foreign Exchange Holdings (US$ Mil.)1 31,928 32,402 19,710 51,963 73,700 95,855 102,488 120,811

Note: 1. Excludes gold, special draw ing rights, and IMF reserve position.

Source: The Bank of Korea <http://w w w .bok.or.kr/>

Korean Statistical Information System <http://w w w .nso.go.kr/kosisdb/>

Financial Supervisory Service, Monthly Financial Statistics Bulletin , Feb. 2002.

Key Macroeconomic Indicators (1995-2002)

14

Korean Bond MarketGrowth of Korean Bond Market (Unit: Bil. Won)

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

1990 1995 1998 1999 2000 Jun. 2001

Government Bonds Special Public Bonds Financial Debentures

Monetary Stabilization Bonds Corporate Bonds

Source: The Bank of Korea, Financial Markets in Korea, Dec. 2001.

Total: 58,163

147,901

307,875348,640

393,859

426,550

15

Korean Government Bonds

1995 1996 1997 1998 1999 2000 2001 2002

-Treasury Bonds 2,959 4,869 6,320 18,783 34,233 42,555 50,919 55,615

-National Housing Bonds 10,046 11,377 12,974 14,005 15,864 17,788 20,645 25,707

-For.Exch.Sta.Fund Bonds1 4,200 4,200 4,200 3,900 6,200 8,400 8,700 15,850

-Grain Securities 4,871 4,871 4,871 4,871 4,871 2,483 2,126 1,100

Total in Bil.Won 22,518 25,645 28,543 41,573 61,168 71,226 82,390 98,272

Total in Bil.US$ (End of Year) 29.2 31.9 30.0 29.7 51.4 63.0 63.8 78.5

Total as % to GDP 6.0% 6.1% 6.3% 9.4% 12.7% 13.6% 14.9% 16.5%

Notes: 1. Foreign Exchange Stabilization Fund Bonds.Source: The Bank of Korea

Korean Government Bonds Outstanding (1995-2002)(Unit: Bil.Won)

16

Corporate Bonds

CasesAmount (Bil.Won)

Amount (Bil.US$)

CasesAmount (Bil.Won)

Amount (Bil.US$)

1994 2,714 20,050 25.4 7926 47,761 60.6

1995 2,823 23,598 30.5 8541 61,024 78.8

1996 3,206 29,905 35.4 9079 76,007 90.0

1997 2,246 34,322 24.3 8438 90,107 63.7

1998 1,097 56,000 46.4 6624 122,682 101.6

1999 803 30,671 26.8 4121 119,662 104.5

2000 886 58,663 46.6 2406 133,649 106.1

2001 1,183 84,174 63.5 2498 154,400 116.4

Feb. 2002 117 5,958 4.5 2530 153,367 115.5

Source: Financial Supervisory Service,

Monthly Financial Statistics Bulletin, Feb. 2002.

Corporate Bond Issuance

Issues Outstanding

17

Composition of Corporate Bonds

(Unit: Bil. Won)

82,747

27,379 29,188

17,514

1,4021,4621,2795,134

2,526

57,398

29,339

38,391

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1996 1997 1998 1999 2000 2001*

Guaranteed Non-Guaranteed

Source: Financial Supervisory Service, Monthly Statistics Bulletin, Feb. 2002.

18

Exchange VS OTC Market

Traded Value of Bonds (Unit: Bil. Won)

6,87523,733

15,87326,155

399,561

2,126,449

2,424,682

1,833,533

887,998

279,280

0

100,000

200,000

300,000

400,000

500,000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000Exchange Traded Bonds

OTC Market Traded Bonds

Source: Financial Supervisory Service, Monthly Financial Statistics Bulletin , Feb. 2002.

Exch

ange

Tra

ded

Bond

sOTC Market Traded Bonds

19

Asset-Backed Securities

1999 2000 2001The 1st half

of 2001The 1st half

of 2002

Issued Amount (Bil.Won)

6,771 49,383 50,934 22,078 14,530

Issued Amount (Bil.US$)

4.8 39.2 38.4 17.0 12.1

% of Total Corporate Bonds

14.5% 69.9% 45.4% 53.8% 46.9%

Number of Issues 32 154 194 87 76

Source: Financial Supervisory Service, Analysis of ABS Issues. <www.fss.or.kr>

Issued Amount of Asset Backed Securities(Unit: Bil. Won)

20

Bond Investor Profile in the Korean Bond Market

Investor Profile: Bond Holding(Unit: % of Total)

Investment Trust Companies

10.7%

Bank Trust Accounts

11.6%

Insurance companies & Pension Funds

13.7%

Banks26.0%

Others29.7%

Securities Companies

2.1%Post Office

5.0%

Non Residents1.1%

Source: Hyeon-Jin Cha, ANALYSIS OF THE SLUGGISH DEVELOPMENT OF THE SECONDARY MARKET FOR KOREAN GOVERNMENT BONDS, AND SOME PROPOSALS , May, 2002.

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. 1997 to Dec. 2001)

(Unit: # of Banks)Number as of

Dec. 1997 Exits Mergers TotalNew

EntriesNumber as of

Dec. 2001(A) (B) (C) (A-B+C)

Banks 33 5 8 13 0 20

(Commercial Banks) 26 5 6 11 0 15

(Specialized Banks) 7 0 2 2 0 5

Merchant Banks 30 22 6 28 1 3

Securities Companies 36 6 2 8 17 45

ITCs1 31 7 1 8 7 30

Insurance Companies 45 7 7 14 2 33

Notes : 1.Investment Trust CompaniesSource: Hyeon-Jin Cha, Analysis of The Sluggish Development of The Secondary Market for Korean

Government Bonds , and Some Proposals , May. 2002.

23

New Financial Supervisory Structure in Korea

The Bank of Korea

Request forreconsideration

Offer of Information anddocumentation

Request for examination

Prior consultationon formulation or

amendment ofstatutes

Offer ofInformation anddocumentation

Request forexamination

FinancialSupervisoryCommission

FinancialSupervisory

Service

Korea Deposit

InsuranceCorporation

Ministry ofFinance and

Economy

Source: The Bank of Korea <http://www.bok.or.kr>

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: 211.2 Tril.Won (1997) => 341.7 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• 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 PDS1. The advanced public announcement of the government’s plan

for issuing securities

2. Liberalized interest rates

3. An adequate number of end investors

4. A minimum set of attractively designed securities

5. The government’s commitment to secondary market development.

6. The government’s commitment to market-determined outcomes.

7. Careful arrangements between primary dealers and the debt managers in the auction system

8. 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

Primary Dealers System

Starting Date

Number of

Dealers

Number of Primary Dealers

Open Market

Operations

Availability of Liquidity or Stock Facilities with the

Central Bank

Supervision

Australia N

Austria Y 1989 N.A. 26 Federal Financing Agency

Belgium Y 1991 22 17 Ministry of Finance

Canada Y 1998 44 12 Y YCentral Bank, Ministry of Finance, Investment Dealer Assoc.

France Y 1987 over 40 18 Ministry of Finance

Germany N

Korea Y 1999 57 22 (2)* Ministry of Finance

Netherlands Y 1999 dozens 13 Ministry of Finance

Norway Y 1995 15 6 Y Central Bank

Singapore Y 1987 31 11 Y Y Central Bank

Spain Y 1988 146 21 Ministry of Finance

Sweden Y 1989 7 7 YCentral Bank, Finance Supervisory Inst.

United Kingdom Y 1986 N.A. 17 Ministry of Finance/DMO, FSA

United States Y 1960 N.A. 22 Y YThe Fed., The SEC, The Treasury

Notes ; The number in ( ) indicates the number of pre primary dealers.

Source: Marco Arnone and George Iden, Primary Dealers in Government Securities: Policy Issues and Selected Countries' Experience, IMF Working Paper WP/03/45, March 2003.

35

Measures of size and liquidity

Outstanding central government debt

(end-1997)1

Yearly cash and futures turnover

(1997)Turnover ratio2

Bid-ask spreads for

on-the-run issues3

United States 2741 103829 37.9 3

Japan 1855 31735 17.1 7

Italy 971 10455 10.8 6

Germany 653 6600 10.1 4

France 484 18634 38.5 10

United Kingdom 459 6516 14.2 4

Canada 210 6428 30.6 5

Belgium 191 975 5.1 5

Netherlands 168 450 2.7 .

Sweden 102 4763 46.8 15

Switzerland 27 215 8.1 10

(In billions of US dollars)

Notes: 1. Nominal value outstanding 2. Defined as yearly trading volume divided by outstanding volume 3. On-the-run issues of 10-year bonds. The spreads are in basis points and apply to inter- dealer transactions Source: OECD. Debt Management and Government Securities Markets in the 21st Century .2002.

36

Secondary Bond Markets in the Korea

1997 1998 1999 2000 2001

[average daily trading volume]

Government bonds 44 223 2310 2031 3266

MSBs 13 391 967 2098 2842

Corporate bonds 444 1272 1456 929 882

Total 798 2288 4678 6317 9366

[turnover ratio]a

Government bonds 0.6 1.6 11.3 b 8.6 11.7

MSBs 0.2 2.5 2.9 9.3 10.7

Corporate bonds 1.48 3.7 3.6 2.1 1.7

28543 41573 61118 71226 82390Outstanding volume of government bonds

(Unit: Bil. Won)

Notes: a. Annual trading volume/ outstanding at end of period b. Transactions in the KSE inter-dealer market temporarily surged in relation to the introduction of the primary dealer system in July 1999Source: Hyeon Jin Cha, Financial Market Department, The Bank of 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.The U.S. Primary Dealer System

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.

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

The U.S. Primary Dealer System

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.

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

• 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 50/50 Short-Term BenchmarkShort-Term Benchmark

??

√√

50:5050:50

Primary Public Debt Market

Source: OECD. Debt Management and Government Securities Markets in the 21st Century. 2002.

Korea

The Korean Primary Dealer System

49

OECD Best Practices for Public Debt Markets (cont.)

• 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

50:5050:50

√√

√√

Secondary Public Debt Market

Source: OECD. Debt Management and Government Securities Markets in the 21st Century. 2002.

Korea

The Korean Primary Dealer System

50

OECD Best Practices for Public Debt Markets (cont.)

• A market-making structure based on primary dealers

• Liquid futures markets

• Good access by foreign investors to domestic domestic debt markets

√√

50:5050:50

√√

Secondary Public Debt Market

Source: OECD. Debt Management and Government Securities Markets in the 21st Century. 2002.

Korea

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 billsThe Korean Primary Dealer System