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Bond Market in Korea and KOFIA’s Role

December 2009

Han-Gu Lee

Fixed Income Dept.

Korea Financial Investment Association

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I. Current Status of the Korean Bond Market

II. Bond Market Surveillance & SRO

III. Information Dissemination

IV. Bond Trading System (ATS)

V. Regional Cooperation among Bond Dealers

Associations

Appendix 1. KOFIA’s Initiatives for Bond Market

Contents

Bond Markets in Korea &

KOFIA’s Role

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Size of Local Currency Bond Markets

I. Current Status of the Korean Bond Market

(Unit: US$ Billion)

Source: Asian Bonds Online

1997 2004 2008연간성장률

(97-08)

China 116 528 2,213 30.70%

Hong Kong 46 78 88 6.12%

Indonesia 5 58 68 27.74%

Korea 130 568 817 18.16%

Malaysia 57 111 163 10.02%

Philippines 17 35 59 12.02%

Singapore 24 79 129 16.62%

Thailand 10 68 143 26.83%

Viet Nam - 4 13 -

East-Asia

excl. 405 1,529 3,693 22.25%

JapanOthers(12.2%)

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1. Primary Market : Bond Issuance in Korea

The proportion of government bond issuance increased greatly

While the proportion of special bonds and corporate bonds decreased

Source : KOFIA, KOSCOM

0

100

200

300

400

500

600

700

800

900

1000

1100

1200

Corporate

Financial

MSB

Special

Municipal

Government

(Unit : Trillion Won)

Korean Outstanding Bond Market

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2. Secondary Market : Trends in Bond Trading

Most bonds used to be traded on the OTC markets. With the increase in primary

dealer trading (KRX), trading on regular exchanges has grown from 2.8% to 20.3%

Source : KOFIA, KRX

1,856

2,803

2,160

2,468

2,879

3,083

2,683

2,366

2,817

3,392

54 28 96

425

755 731 591

712 753 863

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

OTC KRX

(Unit : Trillion Won) Market centered on the OTC Market

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Secondary Market : Exchanges vs. OTC

Bond markets of the Korea Exchange (KRX) consist of the KTS and the Ordinary Bond Market

o Korea Treasury Bond Trading System (KTS)

- The Electronic Trading System (ETS) was established by KRX in March 1999,

with the aim of supporting competitive bidding between primary dealers

o Ordinary Bond Market

- Market for listed bonds other than government bonds; most bonds traded on

this market are issued for specific purposes

Exchanges (KRX)

OTC Market

Markets other than regular exchanges

Trading on the OTC market is either one-to-one or Inter-Dealer Broker (IDB)

o One-to-one

- Brokers exchange bid/ask quotations simultaneously over online messengers -> Bid/Ask

spread for benchmark issues has been reduced to 0.5bp, enhancing efficiency

o Inter-Dealer Broker (IDB)

- IDBs are brokerage firms specializing in bond trading; they do not hold bonds and

only intermediate trading between dealers. Currently, KIDB and KMB carry out this function

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3. Foreign Investment in Bond Markets

<Foreign Investment in Korean Equity and Bond>

With the complete opening of the bond market in July 1998 and regulatory reforms

since the Asian financial crisis, the investment environment for foreigners has

improved greatly, but foreigners’ participation in bond markets is not yet very active.

Recently, we are seeing an increasing percentage of foreign investors investing in

Korea’s bond market (5.46%), with major investments coming from the U.S., Thailand,

and Germany. Investments are mostly concentrated in treasury bonds or monetary

stabilization bonds that are risk-free.

Note : Foreigners’ ownership is in parenthesesSource : Financial Supervisory Service (FSS)

2006 2007 2008 2009.10

Equity 262.5 308.0 166.9 267.8

(37.3) (32.4) (28.9) (32.3)

Bond 4.6 38.4 37.5 55.3

(0.6) (4.63) (4.33) (5.46)

Total 267.1 344.9 204.8 323.1

(Unit: KRW Trillion, %)

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II. Bond markets surveillance & SRO

1. B-TRiS(Bond-Trade Report & Information Service)

2. Centralization & Disclosure of OTC Quotation

3. Calculation and Disclosure of Benchmark Bond Yields

4. Disclosure of Primary Dealer Quotations

5. Provision of CP/CD Issue info, Yields, and Indices

6. Benchmark Yields for Final Settlement Price of

Interest Rate Futures

7. Monitoring of Bond Valuation Agencies

8. Investor Protection



KOFIA’s Role

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1. B-TRiS (Bond-Trade Report & Information Service)

Starting from December 2002, securities firms have been required to report trading

details to the KOFIA within 15 minutes after trading execution (within 30 min. from

July 2000, and 5 min. from July 2001). KOFIA discloses this information through its

website (www.KOFIAbond.or.kr) and Information vendor (CHECK, Bloomberg etc).

Disclosed Information : Name of firm, branch number, buy or sell, counter-party in

trading, issue number, trading unit price, and trading type (self-account, cross

trading, or brokerage)

More than 3,000 daily disclosures on average, worth 10T - 20T won in trading value

Regulation : Regulation on Business and Operation of Financial Investment Companies,

and its Enforcement Bylaws

Function : Enhancement of transparency in OTC bond trading

Similar to the system for corporate bond price transparency, the Trade Reporting and

Compliance Engine (TRACE)


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B-TRiS(Bond-Trade Report & Information Service)


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ㅇ Real-time collection of quotes from 60 brokers

Systematic DB optimization

Online Messenger

(Yahoo, MSN, etc.)Confirm

Broker/Dealer

Search Quote/Order

Institution

Search Quote/Order

Confirm

BIS Information VendorIntegration and Disclosure

Powerful Real time Quotes

(Quote/Transaction Info on All Bonds)

Institutional,

Foreign & Retail Investor

▶ Regulations to be finalized by the 1st half of 2007; required systems in place by Oct. 2007

▶ Pilot operation of quote centralization system in Oct. & across the board implementation in

Dec. 2007

2. Centralization & Disclosure of OTC Quotation

Broker/Dealer, Institution, etc.


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Centralization & Disclosure of OTC Quotation


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3. Calculation and Disclosure of Benchmark Bond Yields

Discloses yields for 60 issues, including final quotation yields for 1-, 3-, 5,

10-, and 20-year treasury bonds

Final quotation yields for a specific time to maturity: 8 types 14 issues

Final quotation yields by time to maturity: 4 types 46 issues

Regulation: Regulation on Business and Operation of Financial Investment

Companies, and its Enforcement Bylaws


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Final Quotation Yields


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4. Disclosure of Primary Dealer Quotations

Primary Dealers were introduced in July 2000 to increase liquidity in the OTC

market through market-making by each bond type

A total of 19 Primary Dealers (13 securities firms & 6 banks) disclose their

buy/sell quotations on the KOFIA website

KOFIA receives daily quotations from PDs and discloses them on the website,

CHECK, and other online terminals

Regulation: Regulation on Business and Operation of Financial Investment



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Bid/Ask of Primary Dealer Quotations


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5. Provision of CP/CD Issue Info, Yields, and Indices

Publishes disclosures of CP yields & trading information in order for the FSS, MSF, the

Bank of Korea, and the Fair Trade Commission to reflect short-term corporate financing

activities in their policies

Disclosures have been provided daily and by time to maturity since August 1, 1997, the

date brokerage houses began dealing in CPs

Since July 1, 2002, in collaboration with KIS & Hankyung, provision of a CP index by

credit rating & time to maturity on BIS & CHECK terminals

Calculate yields daily based on CD (91d) yields from brokers according to issuance of 7

major commercial banks (KB, Woori, SC Cheil, Citi, Shinhan, Hana, Foreign

Exchange)

CD rate is used as the benchmark rate for bank loans & flexible rate private loans and

the calculated CD yield is disclosed on BIS & CHECK terminals


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CP Indices


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6. Benchmark Yields for Final Settlement Price of

Interest Rate Futures

Calculates and discloses benchmark yields that are to be used for final

settlement prices of 3 interest rate futures listed on KRX.

3- & 5-year treasury bonds (18 co.), 364-day MSBs (15 co.)

Regulation : Regulation on Business and Operation of Financial Investment



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7. Monitoring of Bond Pricing Agencies

After the introduction of initial bond valuation by KOFIA (Nov. 15, 1998), bond

valuation by 3 agencies(KIS, KBP, & NICE) was permitted in July 2000

Requests explanatory information and corrections on abnormal issues, after

monitoring the appropriateness of agencies’ assessed prices for a daily average

of 15,000 issues

Reports monthly monitoring results to the FSS

Monitors assessed prices monthly, upon request from the FSS

Function : Enhances the reliability of bond valuation agencies’ assessed prices

Regulation : Agreements with bond valuation agencies, from February 2004


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8. Investor Protection

Management of Agreements

Manages and reviews standard non-guaranteed corporate bonds trust agreement

: reviews proposed changes to trust agreement when a company is issuing

bonds in the domestic market

Manages the agreement on marketable securities lending & borrowing

Manages the agreement of inter-institutional REPO and retail REPO

Disclosure

Disclosure of bond trading details within 15 minutes after trading execution and monitors

any abnormal transactions

Disclosure of OTC Quotations

Disclosure of yields and releases bond market indices

Disclosure of Primary Dealer’s quotes and reports market making performance

Monthly Report : RP trading, OTC trading performance, CD, CP (calculation of benchmark

yields)

Market Monitoring

Monitors Bond Pricing Agencies’ prices


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1. Korea Bond Index

2. Bond Market Indices

3. Disclosure of Default Rate & Recovery Rate

4. Market Analysis Report

5. Bond Information Service (BIS)

6. KSTI training various bond course (on/off line)



KOFIA’s Role

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1. Korea Bond Index : KOFIA-Bloomberg Index

KBI quantifies the yield fluctuations and price changes in the bond markets for a

certain period of time

First released on Dec. 31, 1999, in collaboration with Bloomberg

Representative Indices : Treasury Bond Index, Corporate Bond Index,

Treasury Bond +Corporate Bond Index

Supplementary Indices : Indices by bond type, credit rating, time to maturity, etc.

Basis Time : September 5, 1998 =100.00


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MKF TB Index KEBI Index

Purpose Index for bond ETFs Sector index for KTB

Basis TimeJune 16, 2004 (Maturity date of KTB

futures, basket of 3 issues)June 30, 2009

Base index 100 point 100 point

Release

Frequency

Every 30 seconds each business

day(09:00-15:30)

Every 5 minutes each business day

(09:00-15:15)

IssuesKTB, 3 issues (two 3-year bonds and one

5-year bond)All government bond issues (35 issues)

Change of Issue10th day of March, June, September,

December

Time of issuance, excluding issues with

maturity less than 3 months

Information

Source

OTC market quotation and deal conclusion

information collected and disclosed on the

BQS run by KOFIA

OTC market quotation and deal conclusion

information collected and disclosed on the

BQS run by KOFIA

Date of Release June 1, 2009 July 1, 2009

Index released on real-time basis to provide information on bond market status and

bond ETFs< Comparison of Government Bond Indices>

1. Korea Bond Index : Real-time Bond Index (Treasury Bond)


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2. Bond Market Indices

Developed new indices to identify market risks systematically, which help

strengthen the bond markets’ self-correcting and risk-managing capabilities

Releases Bond Market Survey Index (BMSI), Bond Market Concentration Index

(HHI , Herfindahl-Hirschman Index), and Market Credit Risk Index (MCRI) on the

5th of every month.

Index Relevant Risks Expected Effects

BMSI Interest rate

risks

Predicts market

direction Strengthens bond

market’s self-

correcting and

risk-managing

capabilities

HHI Credit risks Distributes fund

according to

credit premium

changesMCRI


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Bond Market Indices : BMSI


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Aimed to enhance price discovery function of high-yield bond market and to

be used as base data for developing new products and managing risks

Provided through KOFIA’s Bond Information Service (www.kofiabond.or.kr)

once a year and consists of information on bond default rate, corporate default

rate, recovery rate, and analysis report

Category Contents

Bond Default Rate Yearly default rate and average cumulative default rate

Corporate

Default Rate

By year, industry, company size, asset size, type of corporate

disclosure and region

Recovery Rate By year, industry, company size and period

Analysis Report In-depth analysis on default rate, recovery rate

3. Disclosure of Default Rate & Recovery Rate

<Disclosed Information>


..\..\..\..\..\..\..\..\..\Documents and Settings\pc\Local Settings\Temp\www.kofiabond.or.kr

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4. Market Analysis Report

Publishes on-going and regular market analysis reports

Daily bond market trends (on a daily basis)

Weekly release of corporate bond issuance plans

KOFIA Bond Review (Monthly, in the beginning of the month)

Bond market indices analysis report (in the beginning of the month)

Publishes on-going data/information including short-term rate, index

likelihood analysis

Publishes Korean Bond Market Overview leaflet/information

Fixed Income Forum, Seminar


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5. Bond Information Service (BIS)

Maintains a wide range of bond market information; enabling access

for market participants, making trading more efficient, and thus facilitating

efficient pricing. (http://www.kofiabond.or.kr)

Promotes efficient pricing in the bond market

Helps monitor abnormal OTC bond trading, quotations

Establishes emergency disclosure system for real-time trading details

Strengthens links with the interest rate futures market

Increases convenience for members’ reporting


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IV. Bond Trading System(ATS)

The new system aims to enable more efficient and stable bond trading compared to

the previous trading practice carried out through online messengers

The new system is expected to take the place of online messenger trading,

by integrating KOFIA's Bond Quotation System (BQS), online messenger function

and bond trading platform

Bond

Trading

System

Online Messenger

Exclusive Messenger

Program for Bond

Trading

Bond Quotation System(BQS)

Expertise

Stability

Integration Convenience

Transparency

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IV. Bond Trading System(ATS)

Through the establishment of a standardized trading system for the bond market,

KOFIA expects to contribute to the enhancement of efficiency and stability of trading.

- The centralization will help investors to further optimize bid/ask quotes

- The establishment of an effective environment that promptly meets and reflects the

user's requests

Upon reflecting the feedback from the industry, KOFIA plans to finalize the

system within the first quarter of 2010.

- System development by Jan. 2010, System Testing by Feb.-Mar. 2010

- System launch by Mar. 2010

Messenger Functions(Market-friendly)

- Messenger functions for bond trading

Contact registration, group messaging,

file transfer, "buzz" function,

chat logs, time log by conversation,

fonts, saving conversations

- Chat room

Bond Trading System Functions

-Search bond transaction information (Quote search, analysis)

- Order/confirm quotes- Back-office- Strengthened system security- User preliminary registration- 1:N chatting

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Associations

Need to establish independent role of SRO

Assuming diverse roles in the development of each nation’s bond market

Bridging role between the government and market to facilitate the Asian bond market

Sharing information among bond dealer associations on a regular basis

Communication is essential in understanding the differences among nations’

bond market systems

Establishment of a consultative body of SROs for the Asian bond market

Discussing the integration of the region’s bond markets and the building of a uniform

standard

Need for education to expand investor base in the bond market

KOFIA has held a two-week seminar on the Korean capital market every year starting

year 2006 (11countries)

Holding various education programs on bonds to nurture experts and to expand

investor base

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Asian Bond Market Forum

Asian Bond Market Forum (ABMF)

Discussion on benchmarking Brouhns Group to form a uniform standard for

government bonds (secondary market)

Sequential Approach

Stage 1 (research): Research by bond dealing experts from private entities or

associations

Stage 2 (execution):High-level government officials of government bond divisions

Tasks

Survey on the differences of nations’ bond systems

Identify obstacles in bond trading among member countries

Discuss fields that need integration and ways to achieve it

Review the integration of regional bond markets and forming uniform standard

Recommend roadmap for each task

Discuss standards for corporate bonds


Associations

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Foster government

bond markets

Create benchmark

yield curves

Foster corporate bond

markets

Circulate domestic savings

Cross-border Bond Markets Private Placement Market

with common standard

format

Self-regulated market by

professional market players

Intra-regional circulation of

Asian savings

Heterogeneity

Homogeneity

Offshore Private Placement

Market

Local Bond Markets

Regional Market Infrastructure

Regional Settlement Intermediary

(RSI)

Regional Guarantee System

Asian Self Regulatory Organization

Self-governing rule-making

guidelines for Asian off-shore market

Outward issuance by residents,

inward issuance by non-residents

and cross-border investments

Subject to home country or host

country rules and regulations

Different stages of economic

development and heterogeneity

in legal and institutional systems

and infrastructure

Proposed Sequence of Bond Markets Development in Asia


Associations

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Private Placement Market for Professional Investors

Recommendation for Asian Private Placement Market

Measures to integrate corporate bond market

Form private placement market limited to professional investors

Similar to TF1’s Asian Currency MTN but enabling the issue of multi-currency

bonds

Contribute to setting a uniform standard by using a common form and standard

Gradual implementation

Begin with the participation of 4-5 countries at first, and limit the issuers to public

corporations

Gradually expand the scope of participants and issues

Setting a uniform standard

Asia Bond Market Forum vs. consultative body (SROs)


Associations

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Appendix 1: KOFIA’s Initiatives for the Bond Market

Dec. 1989 ⋅Operation of the Council for Bond Issuance

Coordinates issuance volume of corporate bonds (abolished in Oct. 1997) &

special bonds (in Apr. 1998) in advance to stabilize market rates.

Jul. 1, 1993 ⋅Collection and release of final quotation yields (8 types, 14 issues)

1-,3-,5-,10-,20-y treasury bonds, 3-y corporate bonds (non-guaranteed AA-

&BBB-), 3-y KEPCO bonds, 364-d & 2-y MSBs, 1-y industrial finance bonds,

and 91-d CDs

⋅Calculation and disclosure of final quotation yields for 91-d CP, 5-y national

housing bonds type I

Nov. 15, 1998 ⋅Introduction of mark-to-market system, exclusively by KOFIA

Sep. 1999 ⋅Disclosure of benchmark yields for settlement prices of government bond rate

futures

Apr. 1994 ⋅Disclosure of benchmark yields for settlement prices of 91-d CD rate futures

Dec. 13, 1999 ⋅Release of the KOFIA-Bloomberg Bond Index (basis 100 as of Sept. 5,1998)

Composite, Government bond, MSB, Special bond, Financial debentures,

Corporate bond indices, etc.

Feb. 2000 ⋅ Introduction of Inter Dealer Broker (start doing business from June)

The KOFIA considered participating, but KIDB & KMB filled this role instead.

Jul. 1, 2000 ⋅Use of mark-to-market system across the board (assigned to 3 private

companies)

Continues disclosure yields by bond type and time to maturity.

⋅Monitoring of bond valuation agencies: examination of prices and disclosure of

valuation information on KOFIA website


KOFIA’s Role

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I

Appendix 1: KOFIA’s Initiatives for the Bond Market

Jul. 2000 ⋅Introduction of Primary Dealers (Total of 24—15 securities firms & 9 banks)

Disclosure of buy/sell quotations through the KOFIA

⋅Improvement of Bond Information Disclosure System(B-TRiS)

Real-time disclosure [within 30 min.->5 min. (July 2001) ->15 min. (Dec.

2002)] of trading details

Jul. 1, 2002 ⋅Calculation and release of CP Index

Dec. 2002 ⋅Disclosure of benchmark yields for settlement prices of 364-d MSB rate futures

Jan. 2006 ⋅Calculation and release of Bond Market Survey Index (BMSI) :

BMSI (composite, call, economic season, interest rate outlook, inflation, &

won value BMSI’s) Herfindahl-Hirschman Index (by bond type & industry),

and Market Credit Risk Index (by bond type, credit rating & industry)

Oct. 2006 ⋅ BIS reopened after renovation (English website opened in January 2007)

Dec. 2007 ⋅ Centralization & Disclosure of OTC Quotations

Feb. 2009 ⋅ Disclosure of Default Rate & Recovery Rate

Jun. 2009 ⋅ Disclosure of Real-Time Bond Index(Treasury Bond)

Others ⋅Disclosure of Repo yields to customers , ⋅Disclosure of representative yields

⋅Release of valuation information , ⋅Other bond-related disclosures


KOFIA’s Role

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I

Thank You !


KOFIA’s Role