- South Korea is the third largest market in Asia Pacific
- South Korea also performed well in 2016 as revenues jumped by 45% to $242m
- Average fees, already the highest in Asia, climbed a further 30% for the year to 4.3%
- Balance also climbed, jumping 8% on average for the year to $5.5bn
- Celltrion earned a massive $84m for beneficial owners, over $60m more than any other Korean stock
- Inventories were flat at $82bn
Last year was another stand-out year for South Korea in terms of gross securities lending revenues produced, with 43% year-on-year growth from $165m to $236m. It established South Korea as the third largest market in Asia Pacific, just behind Hong Kong at $238m (down 34% in 2016 from $358m) and the number one market Japan at $294m (following its 50% increase from $196m). It is the sixth largest market globally.
South Korea remains an attractive trading destination, which has enjoyed increased demand over the last two years. “This has largely been driven by various regulatory changes aimed at facilitating increased market liquidity, as well as its exposure to a slowing China. Regulatory changes in other jurisdictions have also helped make South Korea a more attractive destination,” says Dane Fannin head of capital markets, Asia Pacific, Northern Trust.
Under Korea’s system, the borrower and the lender choose the type of transaction and enter application details into the web-based Korean Securities Depository (KSD) securities borrowing and lending (SBL) system. A trade is matched when the application details of the lender and the borrower are met on issues, quantity and fee rates among other metrics. Securities are directly transferred by book-entry from the lender’s account to the borrower’s account. More than 4.9 billion shares were traded this way in 2016, according to the KSD, up from around 4.5 billion in 2015.
South Korea operates on a pseudo-CCP model in respect of the requirement for SBL to be intermediated by the KSD, Korea Securities Finance Corporation (KSFC) or an authorised local broker.
Darren Measures, executive director, product manager for agent lending, Asia Pacific, J.P.Morgan, says: “This hybrid model has proven to be a popular reference point for success in the market as developing markets in India, Philippines, Indonesia and Vietnam look to emulate an SBL process that gives control and transparency to the local exchange, while being open enough to attract international borrowers, agents and lenders into the market.”
South Korea continues to be dominated by specials, with wide variability month-on-month. During 2016 trading values ranged KRW12.9trn to KRW23.8trn (average KRW15.82trn) and in terms of shares traded between 341 million shares to 579 million shares (average 413 million).
“Korea was the bright star of the middle of last year. Fees were going really high and there were lots of specials. The outstanding notional values were not biggest, but they were decent. It is still an interesting market with very attractive average fees – but the demand seems to have reduced,” says Ariel Winiger, head of secured financing Asia Pacific, Societe Generale.
A leading example of this is renewable energy equipment firm Celltrion, which was the top special in Asia and the fourth biggest globally, contributing almost 3% of revenue (Tesla, the biggest, contributed 8%). During 2016 the fees were between 15% and 20% but this has since reduced to 6%.
Other top revenue earning stocks included: Oci Co Ltd, Kakao Corp, Hotel Shilla, Hanmi Pharm and Samsung Heavy Industries.
South Korea represented 59% of emerging markets’ total revenue, with Taiwan at 20% and Malaysia at 6%. It also takes the number one spot in available inventory with 36% (versus 22% from South Africa and 16% from Taiwan) and loans with 40% (versus 24% from Taiwan and 19% from South Africa).
“Interestingly, from an emerging market perspective, South Korea is now the global number one emerging market in terms of revenues, loans and inventory, claiming the top spot by a very long margin from local markets such as Taiwan and Malaysia,” says Measures. “Given the exposure of South Korea to China, and lack of international SBL opportunities in China domestically, this emerging market predominance is expected to continue until workable international models are implemented in India and China,” adds Measures.
The SBL model at KSD continues to evolve, and good progress was made in 2016 in working through nuanced issues in the market. Standing proxies can now send in details of each month’s transactions, while duration limits in between have been loosened and ETF collateral valuation ratios have been improved to give borrowers more headroom. “KSD organised an international securities financing forum in Hong Kong in October, which was well received by the market and continues to show the partnership that exists to try and evolve in the process and system to fully meet its long-term potential,” says Measures.
However, challenges remain for market participants. For example, “various corporate action events routinely require lenders to action immediate recalls of securities, in order to protect beneficial owner entitlements,” says Fannin. “This is an unusual requirement that dampens broader market liquidity, particularly for those securities trading special. South Korea also requires borrowers to pre-borrow prior to any intended execution. This increases borrower transaction costs in cases where trades are ultimately not executed.”
Chamil Ioussoupov, head of equity finance Hong Kong, Natixis, says: “Korea, in comparison to other markets, is already very restrictive and controlled in terms of reporting trades and registration. The framework is already in place. The main barrier in the market today is the foreign ownership limit, but that has existed for a long time.”
The most recent development was a note released by Korea Exchange (KRX) in early February announcing its intention to change its rules regarding the designation of “overheated” short-sold stocks. Detail has not yet been provided but it will include strengthened penalties against the short selling rule violators and will take effect from 27 March 2017.
“Any new limitations or finger-pointing is of course important, especially if it brings the license into question or heftier fines,” says Ioussoupov “But what is more important is the framework, rather than just one mechanism.”
At the moment it is not clear how it is going to work, or its scope. “Suspensions and limits exist in every market, on particular stocks or even more widely,” says Ioussoupov. “If it aligns the market mechanism controlling liquidity to prevent abrupt moves, it’s absolutely fine. But if it’s supertight, very hard to manage or understand, then I’m more sceptical.”
Another source, who asked not to be named, says: “The Chinese regulator tried it last year and it was basically a massive failure. It’s not exactly the same thing, but there is a parallel. You have to be very careful about the effects of any new implementation because you also will influence how the market liquidity will react.”
“The Korean hedge fund industry is expanding sharply,” says Rakesh Patel, head of equities, Asia- Pacific, HSBC. “There are now around 250 hedge funds based in Korea, which has come up from nothing five years ago, mainly backed by domestic life and asset management companies. The AuM is not particularly large but the Korean government bodies are trying to promote a larger industry.”
“Today, the reality is that the main driver of the market is the offshore community,” says Natixis’ Ioussoupov. “Onshore hedge funds have not had a meaningful impact yet but it is a growing space.”
“Korean onshore hedge funds are much more likely to take positions in single stocks, especially the smaller names, rather than sector or country exposure. Korean hedge funds will be very focused only on Korea whereas international demand will see Korea as a sector – the approach is completely different.”
Korean collateral can be managed and allocated by either a transfer of title or by the Kun-jilkwon pledge solution. Both collateral solutions and the choice of which largely depend on our clients’ need including preferences, which need to be agreed between the collateral provider and receiver. “The use of Korean collateral has been a very popular discussion topic for the Asian trading community and we expect this to continue into 2017,” says Natalie Wallder, head of collateral management & segregation, Asia Pacific, BNY Mellon.
“We are starting to see some domestic Korean counterparts emerging into the marketplace whose need is to source collateral for OTC derivative margining requirements. This trend will likely continue and has the potential to develop into demand for support related to other types of collateralised trading instruments, domestically in Korea.”
“Korean collateral continues to be an interesting proposition for any tri-party collateral agent whereby the market infrastructure continues to evolve, particularly in the collateral transaction space where the market is hopeful that certain changes will be adopted in 2017. Financing in Korea tends to be against US dollar lending and the Korean collateral financing market is expected to expand further over the course of 2017.”
Ioussoupov predicts that 2017 will see a “huge” increase in liquidity. “The next layer is to develop the financing side of Korean assets, so you can see the development of tri-party on a more liquid basis. Tri-Party agents will have to focus on Korea to make it as smooth as they can.”