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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
East Asian Bond Markets
2
World Economic Prospects
World GDP Growth
(Unit: %)
Current Estimate Current Forecast
2000 2001 2002 2003 2004
World 3.8 1.1 1.7 2.5 3.1
High-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 1.3
Euro 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 4.7
East Asia and Pacific 7.0 5.5 6.3 6.1 6.4
Europe and Central Asia 6.6 2.3 3.6 3.4 3.6
Transition Countries 6.4 4.6 3.5 3.3 3.5
Latin America and the Caribbean 3.7 0.4 -1.1 1.8 3.7
Excluding Argentina 4.5 1.2 0.7 1.9 3.6
Middle East and North Africa 4.2 3.2 2.5 3.5 3.7
Oil Exporters 3.6 2.4 2.4 3.7 3.6
Diversified Economies 3.7 4.3 2.2 2.7 3.6
South Asia 4.8 4.4 4.6 5.4 5.8
Sub-Saharan Africa 3.2 2.9 2.5 3.2 3.8
Source: The World Bank, Global Economic Prospects 2003 . 3
Growth of World Bond Markets
History of Size and Structure of the World Bond Markets (1990 - 2001)
(In Billions of U.S. Dollars)
1994 1995 1996 1997 1998 1999 2000 2001
Government Bonds 12,552.9 13,617.4 14,034.9 13,926.2 15,405.3 16,237.7 16,314.6 16,571.7
Corporate Bonds 5,431.9 6,002.4 6,286.9 6,362.7 7,400.5 8,267.9 8,645.5 9,312.8
Foreign Bonds 474.0 565.4 641.5 688.7 767.2 712.3 815.1 817.5
Eurobonds 1,679.0 1,942.8 2,352.6 2,708.8 3,131.2 3,479.4 4,155.3 4,550.3
Total 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 Mark et: 2002 , April 2002.
4
Key Econ. Indicators: East Asia and Pacific
(Unit: %)
1991-2000 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
1
Gross domestic investment/GDP 28.7 29.2 30.1 32.8 33.9 34.9
2
Inflation 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
3
Export market growth 9.7 14.1 -2.5 3.6 9.2 8.7
4
Export volume 11.4 22.5 2.5 15.9 15.7 11.3
Terms of trade/GDP 5 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.
5
Global Bond Market
Size and Structure of the Global Bond Market in 2001
(Unit: US$ Bil.)
Total Bonds Domestic
International1
Outstanding Government Financial Institutions Corporate
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 12.6
Euro Area2 7,861.5 21.1 3,210.4 40.8 1,751.7 22.3 355.4 4.5 2,544.0 32.4
Japan 6,104.0 16.4 4,439.8 72.7 713.8 11.7 693.2 11.4 257.2 4.2
Other Mature Markets 3,537.2 9.5 123.0 31.7 775.6 21.9 403.5 11.4 1,235.4 34.9
Subtotal 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 Mark ets
Asia 1,098.7 3.0 541.7 49.3 223.9 20.4 186.5 17.0 146.6 13.3
Latin America 694.3 1.9 384.4 55.4 67.4 9.7 23.4 3.4 219.1 31.6
Eastern Europe,
Middle East and 284.4 0.8 207.7 73.0 4.2 1.5 6.4 2.3 66.2 23.3
Africa
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
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.
Source: Bank for International Settlements.
6
East Asian Bond Markets
East Asian Domestic Bonds Outstanding
(Unit: Bil. US$)
1997 1998 1999 2000 2001
% of % of % of % of % of
Bil. US$ Bil. US$ Bil. US$ Bil. US$ Bil. US$
East Asia East Asia East Asia East Asia 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.
7
Government Bond Market in Asia
Sovereign Bonds % of 2001 Nominal GDP
India
China
Philippines
Singapore
Korea
Japan
Malaysia
Thailand
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
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.
8
Merrill Lynch, Size & Structure of the World Bond Market: 2002.
Government Domestic Debt Markets
Government Domestic Debt Securities VS Nominal GDP
(Unit: % of GDP, 2001)
100.0% 94.3%
90.0% 86.1%
80.0%
70.0%
58.1%
60.0%
50.0%
42.4%
38.8% 36.4%
40.0% 33.7%
30.0% 26.9%
18.3% 17.4% 16.0%
20.0%
10.0%
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Notes : Government domestic debt securities are the sum of bonds issued by Central Government,
Local Government and Central Bank. 9
Source: Bank for International Settlements. BIS Quarterly Review. March2003.
Emerging Market Debt Issuance
(1991 – 2002)
Issuer
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
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.
10
Securitized Corporate Bond Issuance
in Asia
(Unit: US$ Mil.) 1995 1996 1997 1998 1999 2000
Hong Kong
Securitized bonds 235 134 2,056 711 1,615 450
Non-securitized bonds 2,280 3,096 6,977 2,444 7,617 5,492
Indonesia
Securitized bonds 21 589 489 400 n.a. n.a.
Non-securitized bonds 1,674 5,007 8,271 254 80 999
Korea
Securitized bonds n.a. n.a. 1,150 600 940 10,114
Non-securitized bonds 2,815 3,349 6,668 1,656 2,689 8,746
Malaysia
Securitized bonds n.a. 32 n.a. 400 592 53
Non-securitized bonds 2,783 3,121 9,337 2,722 5,600 7,363
Singapore
Securitized bonds n.a. 225 n.a. 550 2,543 1,711
Non-securitized bonds 1,844 2,490 2,593 2,093 2,078 7,989
Thailand
Securitized bonds 250 n.a. 333 100 108 100
Non-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 46,178
Total 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 21,184
Non-securitized bonds 50,233 81,700 56,646 118,656 80,104 82,999
Source: Ismail Dalla, The World Bank, Asset-Backed Securities M arket in Selected East 11
Asian Countries.
The Korean Bond Market
12
Key Econ. Indicators: Korea
Key Macroeconomic Indicators (1995-2002)
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 grow th (% 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%
Unem ploym ent 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
Governm ent 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.
13
Korean Bond Market
Grow th of Korean Bond Market 426,550
450,000
(Unit: Bil. Won) 393,859
400,000
348,640
307,875
350,000
300,000
250,000
200,000
147,901
150,000
Total: 58,163
100,000
50,000
0
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.
14
Korean Government Bonds
Korean Government Bonds Outstanding (1995-2002)
(Unit: Bil.Won)
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 Bonds 1 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
15
Corporate Bonds
Corporate Bond Issuance
Issues Outstanding
Am ount Am ount Am ount Am ount
Cases Cases
(Bil.Won) (Bil.US$) (Bil.Won) (Bil.US$)
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.
16
Composition of Corporate Bonds
(Unit: Bil. Won)
90,000
Guaranteed Non-Guaranteed 82,747
80,000
70,000
60,000
57,398
50,000 38,391
40,000 27,379 29,188
30,000
17,514 29,339
20,000
10,000 2,526 1,279 1,462 1,402
5,134
0
1996 1997 1998 1999 2000 2001*
Source: Financial Supervisory Service, Monthly Statistics Bulletin, Feb. 2002.
17
Exchange VS OTC Market
Traded Value of Bonds (Unit: Bil. Won)
OTC Market Traded Bonds
500,000 3,000,000
Exchange Traded Bonds
Exchange Traded Bonds 399,561 2,424,682
400,000 OTC Market Traded Bonds 2,500,000
1,833,533
2,126,449 2,000,000
300,000
1,500,000
887,998
200,000
1,000,000
279,280
100,000 26,155 15,873
500,000
23,733
0 6,875 0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Source: Financial Supervisory Service, Monthly Financial Statistics Bulletin , Feb. 2002.
18
Asset-Backed Securities
Issued Amount of Asset Backed Securities
(Unit: Bil. Won)
The 1st half The 1st half
1999 2000 2001
of 2001 of 2002
Issued Amount
6,771 49,383 50,934 22,078 14,530
(Bil.Won)
Issued Amount
4.8 39.2 38.4 17.0 12.1
(Bil.US$)
% of Total
14.5% 69.9% 45.4% 53.8% 46.9%
Corporate Bonds
Number of Issues 32 154 194 87 76
Source: Financial Supervisory Service, Analysis of ABS Issues. <www.fss.or.kr>
19
Bond Investor Profile in the Korean Bond Market
Investor Profile: Bond Holding
(Unit: % of Total)
Banks
Others
26.0%
29.7%
Non Residents
1.1% Insurance companies &
Pension Funds
Securities 13.7%
Companies
2.1%
Post Office Investment Trust Bank Trust
5.0% Companies Accounts
10.7% 11.6%
Source: Hyeon-Jin Cha, ANALYSIS OF THE SLUGGISH DEVELOPMENT OF THE SECONDARY
MARKET FOR KOREAN GOVERNMENT BONDS, AND SOME PROPOSALS , May, 2002.
20
Korea Financial and Legal Sector Reforms
• Changed the rules and regulations of banks and
other financial institutions in line with global
financial regulatory standards.
• Ensured financial institutions' autonomy and
accountability.
• Overhauled the financial supervisory framework.
• Fully opened the door to foreign investors in order
to lure FDI.
– Received over US$ 40 billion from 1998 and 2000.
– Increasing number of foreign CEOs in domestic firms.
21
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)
Number as of New Number as of
(Unit: # of Banks) Dec. 1997 Exits Mergers Total Entries 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 Companies
Source: Hyeon-Jin Cha, Analysis of The Sluggish Development of The Secondary Market for Korean 22
Government Bonds , and Some Proposals , May. 2002.
New Financial Supervisory Structure in Korea
Prior consultation
on formulation or
Request for amendment of
reconsideration statutes
Financial Ministry of
Supervisory Finance and
Offer of Commission Offer of Economy
Information and Information and
documentation documentation
Request for Request for
examination Financial examination Korea Deposit
Supervisory Insurance
Service Corporation
Source: The Bank of Korea <http://www.bok.or.kr>
23
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.
24
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)
25
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. 26
Primary Dealer System
(PDS)
27
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.
28
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
29
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 30
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
31
trade
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
32
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
33
Primary Dealer System
in Selected Countries
Availability of
Primary Number Number of Open
Starting Liquidity or Stock
Dealers of Primary Market Supervision
Date Facilities with the
System Dealers Dealers Operations
Central Bank
Australia N
Austria Y 1989 N.A. 26 Federal Financing Agency
Belgium Y 1991 22 17 Ministry of Finance
Central Bank, Ministry of Finance,
Canada Y 1998 44 12 Y Y
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
Central Bank, Finance Supervisory
Sweden Y 1989 7 7 Y
Inst.
United Kingdom Y 1986 N.A. 17 Ministry of Finance/DMO, FSA
The Fed., The SEC,
United States Y 1960 N.A. 22 Y Y
The Treasury
Notes ; The number in ( ) indicates the number of pre primary dealers.
34
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.
Measures of size and liquidity
(In billions of US dollars)
Outstanding central Yearly cash and
Bid-ask spreads for
government debt futures turnover Turnover ratio2
on-the-run issues 3
(end-1997)1 (1997)
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
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 Mark ets in the 21st Century .2002.
35
Secondary Bond Markets in the Korea
(Unit: Bil. Won)
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
a
[turnover ratio]
b
Government bonds 0.6 1.6 11.3 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
Outstanding volume
28543 41573 61118 71226 82390
of government bonds
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 1999 36
Source: Hyeon Jin Cha, Financial Market Department, The Bank of Korea
Primary Dealer Systems
in the U.S. and Korea
37
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.
38
The U.S. Primary Dealer System
22 Primary Dealers in the U.S.
Domestic PDs Foreign PDs
• Banc of America Securities LLC • ABN AMRO Bank, N.V., New York
Branch
• Banc One Capital Markets, Inc.
• BNP Paribas Securities Corp.
• Bear, Stearns & Co., Inc.
• Barclays Capital Inc.
• CIBC World Markets Corp.
• Credit Suisse First Boston LLC
• Citigroup Global Markets Inc. (Former
Salomon Smith Barney Inc.) • Daiwa Securities America Inc.
• Goldman, Sachs & Co. • Deutsche Bank Securities Inc.
• Greenwich Capital Markets, Inc. • Dresdner Kleinwort Wasserstein
Securities LLC.
• J.P.Morgan Securities, Inc.
• HSBC Securities (USA) Inc.
• Lehman Brothers Inc
• Mizuho Securities USA Inc.
• Merrill Lynch Government Securities Inc.
• Nomura Securities International, Inc.
• Morgan Stanley & Co. Incorporated
• UBS Warburg LLC. 39
The U.S. Primary Dealer System
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.
40
The U.S. Primary Dealer System
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
41
The U.S. Primary Dealer System
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.
42
The U.S. Primary Dealer System
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.
43
The Korean Primary Dealer System
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 44
The Korean Primary Dealer System
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
45
The Korean Primary Dealer System
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
46
The Korean Primary Dealer System
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
47
The Korean Primary Dealer System
OECD Best Practices for Public Debt Markets
Primary Public Debt Market Korea
• Issuing strategy based on regular auctions √
• The issuance of benchmarks 50/50
Short-Term Benchmark
• Abolition of privileged access by governments ?
• A transparent debt management framework √
• Primary dealer framework with the capacity to 50:50
develop markets
Source: OECD. Debt Management and Government Securities Markets in the 21 st Century. 2002.
48
The Korean Primary Dealer System
OECD Best Practices for Public Debt Markets (cont.)
Secondary Public Debt Market Korea
• Liquid markets with a large stock of
50:50
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 21 st Century. 2002.
49
The Korean Primary Dealer System
OECD Best Practices for Public Debt Markets (cont.)
Secondary Public Debt Market Korea
• A market-making structure based on √
primary dealers
• Liquid futures markets 50:50
• Good access by foreign investors to √
domestic domestic debt markets
Source: OECD. Debt Management and Government Securities Markets in the 21 st Century. 2002.
50
The Korean Primary Dealer System
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
51
The Korean Primary Dealer System
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