hana insight (hana institute of finance)_issue#2
DESCRIPTION
This English-language publication, produced by the Hana Institute of Finance, provides opinion and analysis or issues related to Korea's economy, financial markets and financial services.TRANSCRIPT
Contributors
Editor-in-Chief
Warren Park, Senior Researcher
Feature
Warren Park, Senior Researcher
Bohyeong Jang, Fellow
Issues
Warren Park, Senior Researcher
Jinho Noh, Fellow
Wanjoong Kim, Fellow
Wongeun Choi, Fellow
Yunshin Ju, Senior Researcher
Market Watcher
Seungryong Kim, Assistant Researcher
Yootag Jung, Associate Researcher
Kyungshik Yang, Chief Strategist (Hana Daetoo Securities)
Please direct inquiries and comments to Warren Park ([email protected]).
Table of Contents
Feature | 03 | 2012 Outlook: The Korean Economy in the Face of Global
Uncertainties
Warren Park & Bohyeong Jang
Issues | 10 | Assessing the Profitability of Korean Banks
Warren Park & Jinho Noh
| 15 | Unbalanced Foreign Investment in Korean Bonds Poses Potential
Threats
Wanjoong Kim
| 21 | Strengthening the Soundness of Korea's Derivatives Markets
Wongeun Choi
| 26 | Recent Changes in Korea's Retirement Pension System and
Implications
Yunshin Ju
Market
Watcher
| 32 | Interest Rates: Yields should fluctuate narrowly on global
monetary easing
Seungryong Kim
| 34 | Exchange Rate: The Korean won should appreciate, but there are
risk factors
Yootag Jung
| 36 | Equities: Volatility risk remains, but a major correction is unlikely
Kyungshik Yang, Hana Daetoo Securities
Dec 2011 Hana Insight ・ 3
Feature
Global uncertainties spread while the
domestic and global growth outlook
deteriorates
Global financial turmoil resurfaced this
summer, based on fears that the European debt sit-
uation was spinning out of control and that the US
could experience another recession. To those who
thought the recovery from the global financial cri-
sis was complete, or that the sovereign debt ratings
in Europe's periphery were being met with forceful
and effective coordination, the events may have
been an unforeseen blow.
The reality, however, is that the market turmoil
should not have been entirely surprising. After all,
2012 Outlook: The Korean Economy in the Face
of Global UncertaintiesWarren Park, Senior Researcher
Bohyeong Jang, Fellow
As we approach 2012, the global economy is fraught with uncertainty, and Korea is no exception.
In the period of just over three years since the collapse of Lehman Brothers, the global economy has
emerged from the abyss and recovered on the back of a massive and coordinated unleashing of policy
stimulus across the globe, but more recently finds itself increasingly subject to the whims of major
policy coordination. Since Korea is a small, open economy, it cannot be completely immune to turbulence
from overseas. But given its improved fundamentals and the small likelihood of a serious US dollar
liquidity crunch, any negative external shocks to Korea's economy are likely to have a limited impact.
Figure 1 | Global Financial Turmoil Reemerges Figure 2 | Economic Outlook Revised Downward
0
3 0
6 0
9 0
2 0 07 20 08 2 00 9 2 01 0 20 11
(VIX) G lobalF inancial
C risis
2 0 10
Europe anC risis
2 0 11European
C risis
1 .
0
2
4
6
8
10
World US
Euro
zone
China
Korea
JuneOutlook
SeptemberRevisedOutlook
(% (2011)
0
2
4
6
8
10
World US
Eurozo
neCh
ina
Kore
a
JuneOutlook
SeptemberRevisedOutlook
(% (2012)
Source : Bloomberg Source: IMF
4 · Hana Insight Dec 2011
Feature
the debt crisis in Europe has been a topic of atten-
tion since the end of 2009, albeit the subject of
varying degrees of optimism and pessimism, so it
is definitely not something that could not have
been predicted. As for the US, there has been on-
going concern about the threat posed by its bur-
geoning fiscal deficits in the midst of slow growth,
the longtime forecast of those who believed that
the extraordinary policy measures implemented in
the wake of the global financial crisis would even-
tually run out of steam.
While bouts of uncertainty, albeit not the tim-
ing, could have been predicted in advance, there is
the sense that the uncertainty is a greater threat this
time around, especially given that the un-
precedented measures enlisted to deal with the fi-
nancial crisis have not produced the sort of sustain-
able global recovery that had been hoped for.
The most recent turmoil was caused
largely by a crisis of confidence in pol-
icy
To make matters worse, the major economies
are experiencing crises of policy. For one thing,
they already used up much of their available am-
munition when they lowered policy rates to
near-zero level, implemented quantitative easing,
or used the government balance sheet to bail out
failing financial institutions, housing markets, or
even ailing corporations. As as result, there are far
fewer resources available for stimulative mone-
tary or fiscal policy. The more serious crisis of pol-
icy, however, is the significant weakening of poli-
cy credibility. This has been most evident in the
lack of policy coordination in both Europe and the
United States, and it has added a decidedly politi-
cal dimension to the direction of the global econo-
my and financial markets that has heightened
uncertainties.
Figure 3 | Leading & Coincident Indicators Figure 4 | Major Risk Factors in 2012
-6
-4
-2
0
2
4
6
8
10
12
14
2001 2003 2005 2007 2009 2011
88
90
92
94
96
98
100
102
104
106
108
Leading Indicator (L)
Coincident Indicator (R )
(YoY, % ) (C yclical Variable)
1.
European Crisis- Default in the periphery
- Failures of financial institutions
USD Liquidity Crunch- Contagion from Europe to US
- Crunch in money markets
US Sovereign Risk- Failure to agree on debt ceiling
- Additional sovereign downgrade
China Hard-Landing- Sharp drop in export demand
- Local government debt risks
Domestic Credit Crisis- Drop in housing prices
- Increased debt burdens
Source : Statistics Korea Source: Hana Institute of Finance
Dec 2011 Hana Insight ・ 5
Feature
Indeed, the current uncertainties stem from the
global crisis of confidence, particularly in govern-
ment policy, and this loss of confidence has fed
back into the financial system. An example of this
can be seen in the United States and the eurozone,
where a lack of trust in the efficacy of government
guarantees has led to downgrades across the bank-
ing sector. Although such lack of trust in govern-
ment finances is partially the result of government
efforts to socialize financial sector losses in the af-
termath of the financial crisis, such fiscal un-
certainty has the potential to reverse course and
spill back first into the financial system, and sub-
sequently the real economy.
It should thus come as no surprise that, with
heightened risks on the one hand, and a much
smaller range of policy options on the other, there
has been a flurry of downward revisions to the
global economic outlook. Before August, the gen-
eral consensus was that the global economic re-
covery was sustainable enough to commence seri-
ous discussions regarding exit strategies from
overly accommodative policy. But with such rosy
outlooks more the exception than the norm, the fo-
cus of debate now revolves around the likelihood
of a global depression. Perhaps more important,
however, is the growing concern that the global
chaos that took hold of financial markets in August
could rapidly spill over into the real economy, par-
ticularly given the increasing evidence that the de-
gree of interconnectedness between the financial
and real sectors has strengthened recently. Indeed,
there has been a pronounced slowdown in Korea's
growth momentum since 2Q, suggesting the real
possibility that its economy could be headed for an
economic slowdown.
Figure 5 | Growth Trends of Major Economies Figure 6 | Korea's Expt. Dependence & Fin. Openness
-6
-4
-2
0
2
4
6
8
10
2001 2003 2005 2007 2009 2011
W orld Korea
(YoY, %)
1 .
0
20
40
60
80
100
1994 1997 2000 2003 2006 2009
Export Dependence
Financial Openness
(%)
Source : BOK, IMFNote: Financial Openness = Foreign Investment/Nominal GDPSource: BOK
6 · Hana Insight Dec 2011
Feature
The current environment is a reminder
of Korea's vulnerability to external un-
certainties
Korea's economy is sensitive to external un-
certainties, especially through financial markets,
since its economic growth is highly correlated
with that of the global economy. Why is this the
case?
First, Korea is highly reliant on overseas mar-
kets, particularly through the channel of exports.
As recently as the early 2000s, exports accounted
for barely over 30% of Korea's nominal GDP.
Now, however, they account for around 50%,
which shows the large role that exports play in de-
termining Korea's growth path, as well as just how
sensitive Korea's economy has become to the
global economic cycle. Indeed, since 4Q 2009,
just after the global financial crisis, Korea's econo-
my has grown by an average of 5.3% YoY per
quarter, while exports' contribution to growth has
averaged 6.5%p YoY per quarter.
Second, Korea's financial markets have grown
very open to cross-border capital flows. Its degree
of financial openness, measured as foreign invest-
ments as a percentage of nominal GDP, stood at
40% in the early 2000s, but this figure has more re-
cently risen to above 80%. Such a high rate of for
eign investment in Korea is the result of its efforts
to develop its financial markets by focusing on fi-
nancial liberalization. The result, however, is that
foreign investment has become a channel through
which external risks are transmitted into the do-
mestic markets. Once clear example of this is the
FX liquidity crisis that occurred during the global
financial crisis. Despite the fact that Korea's direct
exposure to subprime-related investments was
very minimal, Korea's economy was drawn into
the crisis through foreign investment, specifically
the sudden and massive withdrawal of short-term
Figure 7 | Growth in Korea's Exports and Imports Figure 8 | Foreign and EU Investment in Korea
-40
-20
0
20
40
60
2 00 7 2 0 08 20 09 2 01 0 2 01 1 20 12
Ex ports
Imports
(YoY, %) (forecast)
1.
0
1
2
3
4
5
6
7
8
07 EU 08 EU 10 EU 11.6
Equities Bonds Other($100bn)
(33.6)
(29.1)
(27.0)
Source : BOK, Hana Institute of FinanceNote: Figures in parentheses represent foreign investment fromthe EU as share of total foreign investment.Source: BOK (Other includes short-term borrowings)
Dec 2011 Hana Insight ・ 7
Feature
funding.
Moreover, Korea's equity and financial mar-
kets possess exceptional liquidity, a factor that can
also serve as a vulnerability. When external tur-
moil intensifies, not only do foreign investors look
first to Korea to lock-in capital gains or secure liq-
uidity, but because the financial markets of China
and other neighboring Asian countries are not as
developed or open, Korea's markets are often used
as a sort of investment proxy for these other
emerging Asian economies.
Spillover effects into Korea's financial
sector should be limited
Even now, there is the possibility that foreign
capital, especially that from Europe, could be
withdrawn in massive amounts in the event of ex-
ternal shocks. However, the likelihood of such an
event remains fairly remote at this time. This is be-
cause, more than anything, the likelihood of a
global dollar liquidity crunch remains fairly low.
Indeed, the current situation is unlike that
which occurred in the aftermath of the Lehman
Brothers collapse. Specifically, it is highly un-
likely that there will be additional market shocks
on the scale of that debacle. Back then, complex
structured products such as CDOs, shadow bank-
ing, and other complex and opaque products and
institutions made it difficult to discern the location
of risk. In the current crisis, where sovereign debt
is the primary culprit, however, it is possible to
identify sovereign debt exposures beforehand,
making it easier to ascertain risks and avoid finan-
cial panic or relentless and indiscriminate
deleveraging.
In addition, the collapse of Lehman Brothers
was such a shock to global financial markets parti-
ally because of a major disruption in US money
markets, which are the main source of global US
dollar liquidity. Granted, there are serious con-
cerns about a potential liquidity crunch centered
around European financial institutions, but this is
Figure 9 | Leading & Coincident Indicators Figure 10 | Global Liquidity Indicators
-6
-4
-2
0
2
4
6
8
10
12
14
2001 2003 2005 2007 2009 2011
88
90
92
94
96
98
100
102
104
106
108
Le ading Indicator (L)
Coincident Indicator (R )
(YoY, % ) (C yclical Variable)
1 .
0
10 0
20 0
30 0
40 0
2 00 8 20 09 2 010 2 011
-40 0
-30 0
-20 0
-10 0
0
US O IS Spread
Euribor O IS Spread
Euro Basis Swap (R)
(bp) (Re verse
ax is, pt)
Source: Statistics Korea Source: Bloomberg
8 · Hana Insight Dec 2011
Feature
because USmoney market funds have already cut
their exposures to these institutions in order to
stem losses. As such, there is little sign of a poten-
tial liquidity crunch in either the US or globally, so
the potential for a global financial panic remains
fairly remote.
Korea's improved FX soundness is another
reason for optimism. There are some indications
that recent financial turmoil abroad may have
caused some European financial institutions to
withdraw money from Korea. But considering the
improvements in Korea's fundamentals -- its level
of FX reserves, its ratios of short term to external
debt, its current account surplus, as well as the pre-
emptive measures it has taken, such as entering in-
to multilateral swap agreement -- the likelihood of
an FX liquidity shortage, a chronic concern of the
authorities, remains fairly remote.
Of course, this does not mean that there is no
reason to be concerned about negative overseas
events. Given that foreigners' portfolios invest-
ments in Korea have surged, it is inevitable that
Korea's stock and bond markets will be volatile
during periods of overseas financial turmoil.
Korea will need to remain vigilant of
the potential for shocks in the real
sector
In the event of contagion, however, the recent
crisis is probably more likely to transmit through
the real sector than through the financial channel.
Indeed, the main reason for Korea's rapid recovery
from the crisis has been its robust growth in
exports. But overseas turmoil now appears to be
exerting severe stress on global demand, the direct
result of which could be a contraction in exports.
A less direct effect could be that problems in
household debt or other domestic weaknesses,
which have been veiled to some extent by Korea's
robust performance in exports, could develop into
serious risks.
Figure 11 | Contributions to GDP Figure 12 | Foreign and EU Investment
-10
-5
0
5
10
15
2006 2007 2008 2009 2010 2011
Exports
Construction Inve stment
Facilit ie s Inve stmentP rivate Consumption
G DP G rowth
(YoY, %, %p)
1.
0 5 10 15 2 0
010203 04 0
Shipbuilding
Passenge r Cars
Semiconductors
IT
Stee l P roducts
Oi l P roducts US
Japan
China
EU
SE Asia
ME
Source : BOK Source: Statistics Korea (Bottom axis is for product categories)
Dec 2011 Hana Insight ・ 9
Feature
Fortunately, external turmoil has begun to ease
somewhat recently, owing to coordinated policy
efforts in Europe and abroad, as well as rising ex-
pectations of a US recovery. Given the weak state
of global governance, however, there remain
doubts about whether the policy coordination will
be implemented, or the durability of the US
recovery. Given these factors, there is a significant
risk of additional market turmoil going forward,
along with the possibility that the underlying risks
stemming from Korea's household debt sector
could intensify.
But these risk variables are still latent and
could still be contained depending on the degree of
progress made on a variety of domestic and ex-
ternal issues. Thus, despite the existence of latent
risk factors, 2012 will likely experience a gradual
easing of external uncertainties. Moreover, given
that most domestic risk factors are already known,
and that there is still plenty of room for domestic
policy, the likelihood of significant shocks is not
high. Nevertheless, there is the possibility that
downward pressure on domestic and external de-
mand could be rather large.
As external turmoil subsides, growth
should be low in 1H 2012 but rise in
H2
In this context, as Korea's economy absorbs
domestic and external stress, it is likely to bottom
in 1H 2012 and then recover in 2H, driven by an
easing of high oil prices and inflationary pres-
sures, improvement in its terms-of-trade, and a re-
newed recovery in emerging economies. Since it is
likely that turmoil could reassert itself on a limited
basis, there is a good chance that the recovery will
be gradual and limited in degree. As a result,
growth in 2012 may be slightly higher than in
2011, but it will likely be based more on factors
such as pent-up demand or the base effect, rather
than a recovery based on a healthy economy.
Figure 13 | Real GDP & GDP Trend Figure 14 | Key Elements of 2012 Forecast
-6
-4
-2
0
2
4
6
8
2006 2008 2010 2012
90
120
150
180
210
240
270
300G DP G ap
Real G DP (R )
G DP Trend (R)
(%) (\ tn)
1 .
2010 2011 (P) 2012 (E)
World Growth Rate 5.1% 3.8% 3.9%
Advanced Economies 3.1% 1.5% 1.8%
Emerging Economies 7.3% 6.3% 6.1%
Oil Price (Dubai, avg.) 78.1$ 104.7$ 94.3$
Won/Dollar (avg) 1,156₩ 1,105₩ 1,070₩
TB Yield (3Y, avg) 3.72% 3.65% 3.70%
Korean GDP Growth 6.2% 3.7% 3.9%
CPI Growth 2.9% 4.5% 3.4%
Note: HP filtering was used for the trend and GDP gap.Source : BOK, Hana Institute of Finance
Source: Hana Institute of Finance
10 ・ Hana insight Dec 2011
Issue
Korea's banking sector posted record
profits in 1H 2011
In 1H 2011, the net income of Korea's banking
sector rose by 4.8tn to 10.4tn, an increase of₩ ₩
86% over the same period in 2010. The main fac-
tors contributing to this increase were an increase
in gross income ( 3.5tn) combined with a de₩ -
crease in loss provisions ( 3.3tn), which had a₩
combined impact of 6.8tn on the bottom line.₩
Interest income increased by 0.5tn YoY, based₩
on an expansion in net interest margins (NIMs),
whereas non-interest income rose by 3.0tn₩
YoY, thanks largely to the sale of equity stakes in
1) PPOP = Pre-Provision Operating Profit
Assessing the Profitability of Korean BanksWarren Park, Senior Researcher
Jinho Noh, Fellow
In 1H 2011, Korea's banking industry posted record profits, fueling something of a public backlash aimed
at the perceived greed of the financial industry. A closer look at the components of bank profits, how-
ever, revealed that they were largely the result of temporary factors, such as the sale of stakes in
Hyundai E&C by several banks, as well as a large decline in provisions for loan losses, which were atypically
high in 2010. In other words, the performance of banks in 2011 revealed that the profit structures
of Korea's banks remain very weak. Improving them will be essential in fostering the development
of Korea's financial industry and enhancing its resilience against financial crisis.
Figure 1 | Profit Trends of Korea's Banks (Unit: tn)₩
2005 2006 2007 2008 2009 2010 1H 2011
Impact on
Net Income
(YoY)1H 2010
1. Gross Income 32.1 33.9 42.0 39.6 37.5 45.3 22.9 26.4 +3.5
(Interest Income) (28.0) (29.5) (31.2) (34.5) (32.2) (37.5) (19.0) (19.5) (+0.5)
(Non-Interest Income) (4.1) (4.5) (10.8) (5.1) (5.3) (7.8) (3.9) (6.9) (+3.0)
2. SG&A (cost) 14.6 15.7 17.6 18.2 17.7 18.6 8.8 9.2 -0.4
3. PPOP1) (=1-2) 17.5 18.2 24.3 21.4 19.8 26.7 14.1 17.2 +3.1
4. Provisions (cost) 5.1 5.0 4.5 10.2 12.1 14.1 7.1 3.8 +3.3
5. Operating Income (=3-4) 12.4 13.3 19.8 11.2 7.7 12.5 7.0 13.4 +6.4
6. Non-Operating Income 3.4 4.2 1.3 -0.2 0.8 -0.2 0.1 0.1 -
7. Pre-Tax Income (5+6) 15.8 17.4 21.1 11.0 8.5 12.3 7.1 13.5 +6.4
8. Income Tax (cost) 2.2 3.9 6.1 3.3 1.6 2.9 1.5 3.1 -1.6
9. Net Income (=7-8) 13.6 13.5 15.0 7.7 6.9 9.4 5.6 10.4 +4.8
Source: Financial Supervisory Service (FSS)
Dec 2011 Hana Insight ・11
Issue
Hyundai E&C by a number of banks. Provisions
for losses decreased by 3.3tn YoY. This was due₩
partially to the fact that banks set aside greater
amounts of loss provisions in 2010 on a precau-
tionary basis, and partially due to a shift to IFRS
accounting standards. Meanwhile, increases in
SG&A and income tax contributed to a decline in
income ( 2.0 tn).₩
Koreans banks' profit-generating ca-
pacity remains below pre-crisis levels
Korean banks' gross income margin, a meas-
ure of asset efficiency, was 2.98% in 1H 2011,
while ROAwas 1.18%. Both of these figures were
below pre-crisis levels, in spite of an expansion in
gross income centered around non-interest
income. The structural profit rate, which indicates
a bank's fundamental ability to generate profits by
eliminating the impact of one-time gains, was at
1.48%, also below pre-crisis levels. Interest in-
come margins and net interest margins, the main
components in the profit structure of commercial
banks, were also far below pre-Lehman levels, at
2.20% and 2.36%, respectively. By comparison,
the interest margins and NIMs for US banks with
assets of $1bn or greater were 3.24% and 3.80%,
respectively, over the same period.
Korean banks continue to rely mostly
on interest margins for their profits
Korean banks' profit structures remain inferior
to their counterparts in advanced economies, even
though the performance of those banks has deter-
iorated since the financial crisis. That is, their prof-
it structures remain highly dependent on interest
margins, which tend to be rather low. As in the
United States, regulations separating the oper-
ations of Korean banks and securities firms are
very strict, restricting banks from trading or inves-
ting their own capital, a potential source of non-in-
terest income. Thus, Korean banks have depended
on NIM for the majority of their profits. In Europe
and the UK, by contrast, the separation between
banking, securities firms, and insurance compa-
nies is weak. So while interest income accounts for
a small proportion of profits and NIMs are small,
banks can generate a large proportion of their prof-
its from trading, derivatives, insurance, commis-
Figure 2 | Trends in Profit Indicators of Korea's Banks (Unit: %)
2005 2006 2007 2008 2009 2010 1H 20111H 2010
Gross Income/Total Assets1)
2.98 2.83 3.06 2.44 2.12 2.62 2.66 2.98
- Interest Income/Total Assets 2.60 2.46 2.28 2.12 1.82 2.17 2.21 2.20
- NIM2) 2.81 2.64 2.44 2.30 1.98 2.32 2.36 2.36
Structural Profit Rate3)
1.63 1.51 1.37 1.29 1.06 1.36 1.48 1.48
ROA (Net Income/Total Assets) 1.26 1.13 1.09 0.47 0.39 0.54 0.65 1.18Note: 1) Estimated were used for Total Assets (average balance) for 2011.
2) NIM = (Return on interest-earning assets - Interest paid on borrowed funds) / Interest-earning assets
3) Structural Profit Rate = (Interest Income + Commissions + Income from trust services - SG&A) / Total Assets
Source: FSS
12 ・ Hana insight Dec 2011
Issue
sions, etc. In Korea, not only are NIMs lower than
those of the United States, the UK or Europe, but
income from commissions is lower as well. Even
with such weak profit structures, however, Korean
banks have been posting relatively strong per-
formance because of the relatively solid quality of
their assets. In fact, during the 2009-2010 period,
the NPL ratio of the Top 4 banks stood at 1.67% in
Korea, versus 5.53% in the US, 5.29% in the UK,
and 4.51% in Europe.
Korea's banks are likely to be hurt by
slowing global growth and fewer op-
portunities for non-interest income
Going forward, it appears that Korean banks
will be faced with gradual downward pressure on
their profit margins as the demand for credit de-
clines and opportunities to generate non-interest
income become more scarce. In the past, net inter-
est spreads on existing loans have been fairly
strong on account of the gradual economic recov-
ery and strength in the area of residential lending.
On a YoY basis, lending increased by 15.1% in
2007, 14.3% in 2008, 4.5% in 2009, 3.4% in 2010
and 5.6% in 1H 2011, whereas net interest spreads
on such loans increased by 3.1% in 2006, 3.0% in
2007, 2.7% in 2008, 2.1% in 2009, 2.7% in 2010
and 3.0% in 1H 2011.
However, the net interest spread on new loans
has been on a downtrend. Given that these loans
will later become existing loans, it is uncertain
whether interest income will be able to continue to
increase.
In 1H 2011, non-interest income increased sig-
nificantly, but the bulk of it was from gains on the
sale of securities, rather than commissions or
trust-related income. This suggests that the up-
trend will be difficult to maintain. Such a rapid
surge in securities-related profits was due to banks'
sales of equity stakes that they had acquired in cor-
porations facing serious liquidity problems.
Figure 3 | Profit Structure of the Top 4 Banks in Major Countries (2009-2010 Avg.) (Unit: %)Korea USA UK Europe China Japan
Rate of
Gain/Loss
Gross Income/Total Assets 2.52 3.62 1.86 2.36 2.67 1.26
POPP Margin 1.25 2.18 0.75 1.02 1.86 0.56
Net Interest Margin (NIM) 2.42 3.11 1.03 1.51 2.44 0.97Adjusted NIM
(Post-NPL writedowns)1.50 1.61 0.36 1.03 2.13 0.68
NPL Ratio 1.67 5.53 5.29 4.51 1.61 1.32
Share of
Gross Income
Interest Income 80.4 75.6 51.1 57.5 79.5 73.5Subtotal 19.6 24.4 48.9 42.5 20.5 26.5
Non-
InterestTrading & Derivatives 2.1 7.5 30.6 11.4 0.6 8.0
Income Securities 6.3 4.5 2.1 1.9 1.0 0.1Insurance-related 0.0 0.6 -10.0 3.1 0.0 0.0Commissions 11.3 11.9 26.1 25.9 18.8 18.4
Source: Bankscope
Dec 2011 Hana Insight ・13
Issue
Profits were distorted in 1H 2011 by
changes in accounting standards and
lower loss provisions
Although loss provisioning burdens have
eased as a result of changes in accounting stand-
ards and unusually large provisions last year, they
are likely to increase going forward, especially
since losses on real estate PF and other loans are
expected to increase. In 2010, as a precautionary
measure against corporate restructuring and losses
related to real estate PF, the Financial Supervisory
Service issued a recommendation calling for in-
creased loss provisions by banks. The banks
agreed, greatly expanding their loss provisions.
As a result of banks' active asset sales, their
NPL ratios declined in 2011. And as a result of
changes in accounting standards, the burden to in-
crease loss provisions was significantly eased.
Prior to 2011, banks were conservative in setting
aside loss provisions, based on expected losses,
but IFRS accounting standards stipulated that loss
provisions were only required in cases where
"objective losses" had occurred. Because this was
a weakness from the perspective of risk manage-
ment, corporations and financial in the US were
actively in favor of IFRS, whereas the SEC and
other regulatory agencies opposed their adoption.
However, since downward cyclical pressures
are high both in Korea and overseas, and because
there is a high likelihood that losses on real estate
PF loans will increase, it appears likely that the
pressure to raise loss provisions will increase.
Improved bank profit structures will
help strengthen Korea's financial in-
dustry against crises
Thus, rather than focusing on the temporarily
high profit levels of Korean banks, it is more im-
portant that more active efforts be made to im-
prove the feeble profit structures of Korea's banks
so as to prevent the incidence of financial crises
Figure 4 | Trends in Korean Banking's NIMs Figure 5 | Delinquency Rates & NPL Ratios
-1
0
1
2
3
4
5
2001 2003 2005 2007 2009 2011
3YR KTB - 90D CD
NIM on New Loans
NIM on Existing Loans
(%)
Post-Lehman
1 .
-5
0
5
10
15
1999 2001 2003 2005 2007 2009 11.1H
FX Derivatives
Securities-related
Trust-Related
Fees/Commissions
Total
(\tn)
Source: BOK Source: FSS
14 ・ Hana insight Dec 2011
Issue
and aid in the development of Korea's financial
services industry. Although a decrease in loss pro-
visioning and the sales of stakes in Hyundai E&C
contributed to the growth of Korean banks' profits
in 1H 2011, the reality is that their profitability ra-
tios, and their overall profit structures, which re-
flect the sustainability of their profits, remain very
weak relative not only to peers in other financially
advanced countries but even in relation to China.
The risk in banks having weak profit structures is
that they may be tempted to engage in high-return,
high-risk business, or that it could remain difficult
to accumulate capital, thus hampering their ca-
pacity to expand overseas.
If Korean banks are to improve their profit
structures, which are currently based primarily on
low interest margins, there will be a need not only
for banks to put forth greater efforts, but also for
greater interest and deeper discussion among the
government, academia and the media. After all, he
reason why the non-interest income of Korean
banks is so low is that strengthened regulations
have forced them to reduce their exposure to trad-
ing activities and portfolio investment; there are
no account maintenance fees; and the principle of
separation between banking and industrial firms
has created an environment in which banks have
no choice but to engage in commision-cutting
competition.
Figure 6 | NPLs & Coverage Ratios of Banks Figure 7 | Delinquency Rates & NPL Ratios
0
10
20
30
40
02 03 04 05 06 07 08 09 10 11
0
1
2
3
NPLs (L) Coverage Ratio(R)
(?tn) (%)
1.
0
1
2
3
06 07 08 09 10 11
NPL Ratio
SME LoanDelinquency Rate
Corporate LoanDelinquency RateHousehold LoanDelinquency Rate
(%)
Source: FSS Source: FSS
Dec 2011 Hana Insight ・15
Issue
Foreign investment in Korean bonds
fell sharply after the financial crisis,
has been rising ever since
Since 2007, foreign investment in Korean
bonds, which includes not only investment in fu-
tures but also arbitrage-type investments in the
spot market, have exerted increasing influence on
the domestic bond market. The increase in invest-
ment in Korean bonds by foreigners was prompted
partially by expanded investment in overseas in-
vestment funds, spurred by improving conditions
in global equity markets and enhanced tax bene-
fits, as well as an increase in the sale of forward
contracts by Korea's exporters, both of which re-
Unbalanced Foreign Investment in Korean Bonds
Poses Potential ThreatsWanjoong Kim, Fellow
On the surface, foreign investment in the Korean bond market appears to be stable, as the amount
of capital being withdrawn by Europeans has been exceeded by capital inflows from Asia. However,
certain imbalances in the way foreigners invest in Korean bonds, such as their tendency to invest primar-
ily in Korean treasury bonds, at particular maturities, as well as the fact that investment volume by
certain institutional investors is very large, pose a latent risk to Korea's bond and currency markets.
Thus, it may be worthwhile to devise measures to induce foreigners to invest in a more diverse range
of Korean bonds and to foster the development retirement pensions and investment in overseas secur-
ities in order to guard against abrupt capital inflows during times of external distress.
Figure 1 | Swap Basis vs. AUM of Overseas Funds Figure 2 | Exch. Rate & For. Holdings of K-Bonds
0
100
200
300
400
500
0 6 .1 0 7 .1 0 8 .1 0 9 .1 1 0 .1 1 1 .1
(bp)
0
2 0
40
60
80
100(\ tn)
AU M ofOverseasInve stmentFunds(R )Swap Basis(L)
2 0
4 0
6 0
8 0
1 0 0
08 .1 0 8 .1 0 0 9 .7 10 .4 1 1 .1 1 1 .1 0
(\ tn) 9 0 0
1 ,1 0 0
1 ,3 0 0
1 ,5 0 0
Fore ign Bond Holdings(L)
KR W /U SD(R )
Note: Swap basis is the spread between the currency swaprate and the interest rate swap rate.Source: KOFIA, FnGuide
Source: FSS, BOK
16 ・ Hana insight Dec 2011
Issue
sulted in increased arbitrage opportunities as the
spread between currency swaps and interest rate
swaps widened.
During the global financial crisis, there was a
massive outflow of foreign capital from Korea as
global liquidity disappeared. Once the crisis was
overcome, however, attention turned again to the
relative merits of Korea's bond market as an in-
vestment destination, leading to a large inflow of
portfolio investment. Such factors that made
Korea appealing as an investment destination are
its solid fiscal position, the advanced structure of
its markets, and hopes for currency gains based on
an expected uptrend in the KRW.
The increased participation of foreigners in
Korea's bond markets is positive in the sense that
there are more potential buyers, but there is also
need for caution, considering such participation
could also serve as a major source of volatility. In
particular, foreigner investment in Korea bonds
tends to be overly concentrated in certain matur-
ities and bond categories, which could lead to in-
creased instability when market conditions shift.
Recent events in overseas markets
have raised concerns about a sudden
outflow of capital
In August, as the European debt crisis wors-
ened and fears of a US double-dip came to the fore,
global financial market turmoil spread, inciting
concerns about the potential for a massive outflow
of capital and a plunge in the KRW similar to what
occurred during the global financial crisis, when a
lack of global USD liquidity led to a massive out-
flow of capital from Korea and a plunge in the val-
ue of the KRW, as market turmoil spread and ex-
change-rate volatility soared.
During August and September, there was a
clear and significant outflow of European capital
from Korea's equity market, whereas in the bond
Figure 3 | Capital Flows from Foreign Portfolios Figure 4 | Foreign Holdings of Korean Bonds
-6
-4
-2
0
2
4
11.8 11.9 11.10 11.11
(\tn)
Ne t Equ ityPu rchas e
Ne t BondPu rchas e
■
11.8~9
■ 11.10
Non-
Euro
Net Bond Purchases
Euro
KTBs MSBs Other Total
200725.4
(66.1)
11.9
(31.0)
1.1
(2.9)
38.4
(100)
200820.1
(53.6)
16.2
(43.2)
1.2
(3.2)
37.5
(100)
200927.5
(48.8)
28.2
(49.9)
0.8
(1.3)
56.5
(100)
201047.7
(64.4)
25.4
(34.3)
1.0
(1.3)
74.2
(100)
2011.11.2161.1
(70.1)
21.2
(24.3)
4.9
(5.6)
87.2
(100)
Note: Above figures as of 2011.11.21. Figures for bonds arebased on rate of increase/decrease of holdings.
Source: FSS, Yonhap InfomaxSource: BOK, Hana Institute of Finance
Dec 2011 Hana Insight ・17
Issue
market, there was no such capital flight. On the
contrary, although net inflows into Korea's bond
market declined, foreigner holdings of Korean
bonds actually increased somewhat.
In November as well, as turmoil from the
Eurozone began to spread again, investor interest
turned again to the merits of Korea's bond market,
as central banks from emerging economies and
long-term-oriented institutional investors in
search of currency gains increased their alloca-
tions to Korean bonds, thereby limiting capital
outflows. Since August, foreign investment in
Korea's equity markets has seen a net outflow of
8.4 trillion, whereas foreign holdings in Korea's₩
bondmarket have increased by 2.3 trillion (as of₩
November 18).
Outflows of European capital have
been replaced by inflows from Asia,
but risks of further turmoil remain
With yields on Italian government debt rising
above 7%, indicating that the fiscal turmoil in cer-
tain European countries has been spreading, there
are now growing concerns about the possibility
that France, Italy's largest creditor, could be
downgraded. Indeed, while the PIIGS' external
debt is around $2.48 trillion, Italy's is $940 billion.
French banks' exposure to these countries was
27.4% and 44.3%, respectively, as of June 2011.
If troubled banks in the Eurozone end up re-
questing financial support, this could give rise not
only to turmoil in Europe's financial markets, but
also to credit downgrades in the financial sector as
well as sector deleveraging, throwing the markets
into chaos. Of foreign holdings of Korean bonds,
Europeans hold 25.2 trillion, or 29.1%, of the₩
outstanding amount. However, although the out-
flow of European capital has been replaced by cap-
ital from Asian countries, resulting in a rise in for-
eign holdings of Korean bonds, the risk of further
turmoil and capital outflows remains.
The structure of foreign investment in
Korean bonds also poses the potential
threat of market turmoil
Foreign investment in Korean bonds is tilted
toward mostly KTBs and monetary stabilization
bonds (MSBs). As a result, every half-year, a mas-
sive amount of bonds reach maturity and a high
proportion of bonds have to be rolled over, creat-
ing that threat of capital outflows and increased
volatility. The reason for the disproportionate con-
centration of foreign investment in KTBs and
MSBs is that, as fungible issues, they are highly
liquid, and that it is easy to hedge such investments
through the futures market, in effect making them
risk-free.
Because the increase in investment has been
centered around benchmark KTBs, there have
been market distortions resulting from market
squeezes resulting from excessive concentration
18 ・ Hana insight Dec 2011
Issue
in certain maturities and a reduction in outstanding
volume, as well as a reduction in the efficacy of
monetary policy. The sudden drop in the yield of
the 3-year KTBmaturing at end-2010 was caused
by the concentrated volume of rollover purchases
by foreigners as well as the decrease in outstanding
volume.
Though capital flows have become more sta-
ble thanks to greater diversification of investing
countries and institutional investors, increased in-
vestment by certain investment funds that consid-
er exchange positions important could become a
risk factor in the event of a sudden change in mar-
ket conditions. One example of such a potential
threat could be Franklin Templeton, which cur-
rently holds around 22 trillion worth of Korean₩
bonds through investment funds registered in the
United States and Europe.
Changes in bond issuance could dis-
tort the market
There are concerns that as the maturity date of
a particular issue that foreigners hold in con-
centrated amounts approaches, there could be a
large amount of rollover purchases centered
around certain issues, resulting in a distortion of
the yield curve along with a weakening in the effi-
cacy of monetary policy. In such a situation, even
if the policy rate is hiked, and increase in foreign
investment in Korean bonds and a drop in
long-term rates stemming from concerns about an
economic slowdown could result in an inverse
yield curve.
In addition, considering the investment be-
havior of foreigners, a slowdown in the growth of
new issuance of KTBs based on the principle of
fiscal balance is likely to give rise to market dis-
tortions and increased volatility. It is forecast that
the net increase in the amount of KTBs will fall
significantly beginning in 2013, but if this is not
Figure 5 | Franklin Templeton's Korean Bonds Figure 6 | Concentration at Certain Maturities
43
59 .963 .764.9
71.9
30.5
16.521 18.7
11.1
0
2
4
6
8
10
8-6 9-2 9-4 10-2 10-6 9-3 11-2 10-5 11-1 11-5
(\ tn )
0
20
40
60
80(%)Holdings(L)
P roport ion He ld(R )
M aturity 1M 7M 1Y
1 M
1Y
7M
2Y
1M
2Y
10M
3Y
10M3Y
7M
4Y
10
4Y
4M
8 .0
9 .5
8 .4
6 .67 .0
0
2
4
6
8
1 0
1 0 .1 1 0 .7 1 1 .1 1 1 .7 1 2 .1 1 2 .7
(\ tn ) R e de m pt ion s
Source: Bank of Korea (BOK) Source: Bank of Korea (BOK)
Dec 2011 Hana Insight ・19
Issue
accompanied by a change in the market structure,
it is likely that the reduction in the outstanding vol-
ume of KTBs will result in a market with greater
demand than supply.
On the other hand, an increase in the invest-
ment demand for Korean government bonds re-
sulting from regulatory changes in the banking and
insurance industry, combined with increased in-
vestment by foreigners, will be main factors con-
tributing to a prolongation of the low interest rate
environment as well as market distortions. Basel
III regulations on liquidity ratios in the banking
sector and the introduction of risk-based capital re-
quirements in the insurance sector are likely to in-
crease the demand for safe assets, thus resulting in
higher demand for bonds.
Considering the negative side-effects that
could potentially result from imbalances in
Korea's bond market, including increased invest-
ment centered around benchmark KTBs, a con-
centration around certain maturities as a result of
fungible bond issuance, and excessive holdings by
certain institutional investors, there is a need for
appropriate countermeasures. After all, an in-
crease in capital flows resulting from external
shocks will inevitably cause greater volatility in
the exchange rate and the bond market.
Various methods can be utilized to
guard against capital outflows
While it is clear that foreigners' imbalanced
preference for investing in KTBs and monetary
stabilization bonds is due to their high liquidity
and low risk, an indirect cause is the lack of trans-
parency and closed-off nature of Korea's corporate
bond markets. Given that long-term-oriented in-
stitutional investors are expanding their partic-
ipation in Korea's bond markets, there will be a
need to expand available bond investment options,
including in special bonds, such as those of public
corporations, or in covered bonds, through further
Figure 7 | Foreign Holdings of Korean Bonds Figure 8 | Forecast of KTB Issuance and Volume
43
59.963.764.9
71.9
30.5
16.521 18.7
11.1
0
2
4
6
8
10
8-6 9-2 9-4 10-2 10-6 9-3 11-2 10-5 11-1 11-5
(\tn )
0
20
40
60
80(%)Holdings (L)
P roportion He ld(R)
Maturi
ty
1M 7M 1Y
1M
1Y
7M
2Y
1M
2Y
10M
3Y
10M3Y
7M
4Y
10
4Y
4M
IssuanceAmount
Repaid
Amount
Outstanding
Net
Increase
2009 85.0 43.4 280.9 41.6
2010 77.7 48.5 310.1 29.2
2011 78.9 48.5 340.5 30.4
2012(E) 80.9 55.6 365.7 25.3
2013(E) 76.5 65.0 377.2 11.5
2014(E) 77.7 70.4 384.4 7.3
2015(E) 77.0 70.9 390.6 6.1
Source: Yonhap, Infomax Source: Bank of Korea (BOK)
20 ・ Hana insight Dec 2011
Issue
development of that market.
In order to deal with potential outflows of for-
eign capital, there may be a need to pursue meas-
ures to foster development of managed investment
products, for instance by raising limits on pension
contributions eligible for tax deductions, or by cre-
ating an environment conducive to institutional in-
vestors, so as to expand the base of potential do-
mestic investors in Korean bonds. Fostering the
retirement pension market through expanded tax
deductions on contributions can aid not only in re-
tirement planning for individuals, by inducing
changes in household balance sheets, but can also
contribute to the long-term development of the fi-
nancial industry.
Moreover, given the possibility of a sudden
outflow of capital caused by the large-scale with-
drawal of foreign capital, there is a need to mitigate
the cyclical volatility of FX liquidity by fostering
investment in overseas markets.With regard to the
capital gains of investment funds, in addition to a
mitigation of cyclicality through the introduction
of measures that completely or partially exempt
investors from taxes on investment gains or in-
come, it would be helpful to grant tax deductions
for investments in installment fund products.
Dec 2011 Hana Insight ・21
Issue
Korea's financial derivatives market
has grown at a blistering pace
Despite its short history, Korea's financial de-
rivatives market has grown rapidly. By 2009, the
trading volume of listed derivatives had grown to
be the largest in the world, an extreme level rela-
tive to Korea's cash markets. The notional value of
trades of listed and OTC derivatives in Korea to-
talled 28.537 quadrilion won in 2010, and is pro-
jected to exceed 30 quadrillion for the first time in
2011. Derivatives trading volume on the Korea
Exchange (KRX) reached 3,752,000,000 con-
tracts in 2010, over double the amount of the sec-
ond largest exchange, and accounting for 16.8% of
the global total.
Highly volatility products, which have be-
come cause for concern lately, have displayed par-
ticularly explosive growth in recent years, with
several such products already amongst the most
traded derivatives products in the world. For in-
stance, in terms of trading volume, the market for
KOSPI index options has easily been the largest in
the world for while now, accounting for as much as
69% of the global market for stock index options
in 2010. In the equity-linked warrant (ELW) mar-
kets, the daily average trading value rose to be sec-
ond-place in the world, behind Hong Kong, since
being established at the end of 2005. The market
for FXmargin trading, which was formed in 2006,
posted trading value of only US$76.5 billion in
2007, but then surged to 492.4 billion in the fol-
lowing year. In 2010, that figure had pulled back
only slightly, to US$463.8 billion. The equi-
ty-linked securities (ELS) market has also been
growing at a rapid pace, with issuance volume
through October of this year at 20 trillion, an in₩ -
crease of over 30% over the previous year.
Strengthening the Soundness of Korea's
Derivatives MarketsWongeun Choi, Fellow
Recently, there has been increasing concern that Korea's derivatives markets have become a playground
for speculation and improper trading practices, fueling heightened criticism. In response to rising criti-
cism, the regulatory authorities have recently released a reform plan designed to strengthen the sound-
ness of the derivatives market while providing greater protections for individual investors. Though it
appears that the objectives and basic direction of the reform plan are appropriate and timely, some
of the specific measures may be somewhat excessive, leading to a shrinkage in the markets over the
short term. Thus, the authorities should have measures in place to ensure their rapid normalization.
22 ・ Hana insight Dec 2011
Issue
The rapid growth of Korea's de-
rivatives market has been more of a
curse than boon to individual investors
Along with the rapid growth in the market,
there has been increasing criticism about the high
incidence of speculation and unfair trading practi-
ces in Korea's derivatives market, as well as the
high level of participation by non-professional, in-
dividual investors, many of whom end up suffer-
ing significant losses. Individual investors have
played a large role in the growth of Korea's de-
rivatives markets, largely by their participation in
speculative trading in the quest for higher returns.
Given that individuals do not possess the in-
formation or expertise of professional investors,
and that derivatives can be highly risky by nature,
however, individuals investors have consistently
suffered significant losses in this market, to the ex-
tent that it has now become a societal problem.
When it comes to FX margin trading, in-
dividual investors account for the majority of mar-
ket participants yet often do not have an adequate
understanding of the payoff structure or risks in-
volved in each trade, and tend to be lured into em-
ploying high levels of leverage. As a result, the
majority of these individuals (around 90%) suffer
losses on such trades that amount to tens of billions
of Korean won every year.
In the ELW market, which is comprised pri-
marily of individual investors and liquidity pro-
viders (LPs), not only is options trading inherently
high-risk but individual investors are at a sig-
nificant information disadvantage to liquidity pro-
viders, which dominate the market. In addition,
scalper, which comprise a small minority of the
market, tend to have an inordinate amount of con-
trol over the market.
In the ELSmarket, unfair trading based on price
Figure 1 | Traded Value of Korean Derivatives Figure 2 | Traded Volume of Derivatives
0
1
2
3
2006 2007 2008 2009 2010
(\10qdn)
1 .
2006 2008 2010Market
Share
KRX 2,475 2,867 3,752 16.8%
Eurex
(Germany)1,527 2,165 1,897 8.5%
CME
(US)1,403 1,893 1,656 7.4%
NSE
(India)194 602 1,616 7.2%
Euronext 730 1,050 1,223 5.5%
Total 11,882 17,668 22,298 3.9%
Source: Korea Exchange, FSSNote: Unit = million contractsSource: Korea Exchange
Dec 2011 Hana Insight ・23
Issue
manipulation, as well as the sale of such products
based on incomplete communication of the unique
risks of each product, have played a role in inflict-
ing significant losses on individual investors. A
representative example of such an unfair trading
practice is flooding the market with an underlying
assets immediately before the expiration of hedge
positions. In fact, such a practice occurred in
November 2010, when Deutsche Bank was ex-
posed by Korea's regulators for selling massive
amounts of equities on the expiry date of a short po-
sition in futures index options, enabling them to
reap amassive profit. As for ELS products, there are
many instances in which sales of such products are
made to customer despite inadequate explanation
of the risk, including the fact that such products
have limited liquidity and that there is the potential
for a loss of principal on non-guaranteed products.
The adverse effects of Korea's de-
rivatives market have spurred calls for
market reforms
Because of the high incidence of the problems
mentioned above, increased attention has turned to
the derivatives markets, along with increased calls
on the need to reform the regulatory environment
of Korea's derivatives market so as to enhance its
stability and sustainability. Indeed, such concerns
are reflective of the post-crisis global environment
in which societal demands for strengthened con-
sumer protections and more stable financial mar-
ekts have become a priority. Thus, on December 1,
Korea's financial authorities proposed a detailed
reform plan designed to address some of the prob-
lem arising from Korea's major derivatives mar-
kets through strengthened prudential measures.
The new measures aim to strengthen
regulation of the most problematic
derivatives markets
The regulatory authorities' new prudential
measures are aimed at improving the soundness of
Korea's derivatives markets by reining in ex-
cessive speculation and strengthening protections
for non-professional investors. In particular, they
focus on strengthening rules on themost problem-
atic markets, such as KOSPI options and futures,
the ELW market and the market for FX trading.
With respect to KOSPI 200 options, the meas-
ures raise the contract multiplier from the current
100,000 won to 500,000 won, which is the current
multiplier for KOSPI 200 futures contracts. Wtih
regard to futures trading by individuals, the meas-
ures raise the cash deposit ratio from 1/3 to 1/2.
For the ELW market, the measures limit the
submittal of bid-ask prices by liquidity providers
to the purpose of liquidity provision only. They al-
so limit the number of listings from the current
twice per month to once per month.
For the FX margin trading market, the meas-
ures raise margin requirements and lower leverage
limits to 10 times, while strengthening disclosure
24 ・ Hana insight Dec 2011
Issue
requirements of trading risks and restricting ex-
cessive marketing practices.
Excesses in the derivatives markets
stem from a variety of problems
The problems in Korea's derivatives market
stem from factors such as its excessive growth rel-
ative to cash markets, the increased variety and
complexity of product structures, the tendency of
investors to seek high returns, and a lack of under-
standing of and/or faith in investment fund
products. Despite the fact that investors need more
education and better risk management in order to
deal with the growth in the derivatives market and
the increased variety and complexity of products,
their lack of understanding has resulted in a grow-
ing gap between professionals and
non-professionals. Nevertheless, investors are
likely to continue to seek higher returns, especially
considering that the economy is likely to remain in
a low-growth environment and that interest rates
will likely remain low aswell. Moreover, there has
been a lack of progress in efforts to rebuild the con-
fidence in the investment fund market that has
been severely damaged by the moral hazard and
disappointing returns of the last few years.
Any reforms of the derivatives market
should take into account their linkages
with their underlying market
The reform plan for Korea's derivatives mar-
kets seeks to protect individual investors, who are
relatively information-disadvantaged, and also
make the markets more sounds, both of which are
worthwhile objectives. At the same time, how-
ever, it would be wise to consider the interlinkages
between the derivatives and cash markets while, if
possible, ensuring that market shocks resulting
from the implementation of such reforms do not
have negative repurcussions beyond the short
term.
Themeasures seek to suppress the incidence of
speculative behavior on the part of individuals in
derivatives markets. They seek to strengthen the
system of educating and marketing the risks of de-
rivatives in order to induce the spreading of sound
investment practices. Their longer-term objective
is to induce investors into the investment fund
markets through beneficial measures such as the
provision of tax benefits.
Themeasures also seek to strengthen monitor-
ing of improper trading behavior, which keeps be-
comingmore sophisticated because of advances in
information technologies and the design of com-
plex structured products. The monitoring and su-
pervision of such activities will have to become
more sophisticated and refined.
Nevertheless, although the derivatives mar-
kets should not become a playground for unbridled
speculation, given that the derivatives market is
tightly interwoven with the cash markets, it is im-
Dec 2011 Hana Insight ・25
Issue
portant to recognize that large amounts of spec-
ulative transactions are necessary of the hedging
process, a necessary and indispensible function of
derivatives markets. Thus, it is important that re-
formmeasures do not become overly restrictive of
all types of speculative activity, without regard for
their purpose. In this vein, it will be necessary to
continuously develop a variety of new products
that serve a beneficial economic function, such as
futures on stock index volatility, while meeting the
demands of individual investors so that they do not
speculate in a limited number of products.
The derivatives reforms measures are
generally appropriate but may dimin-
ish the markets over a short horizon
First, the measures aimed at suppressing the
indiscriminate participation of small-scale, in-
dividual investors in speculative activities are ap-
propriate in principle. But it should be recognized
that the simultaneous implementation of
broad-reaching or excessive measures could
shock the market and prevent its proper function-
ing beyond the short term. One way of preventing
a severe shock to the market might be to phase in
the measures instead of implementing them all at
once.
As for potentially negative effects of the re-
forms that need to be prevented, two possibilities
come to mind. For example, as a result of a sort of
balloon effect, investors could move en masse to
non-regulated markets or lightly regulated mar-
kets overseas. Or, a lack of market liquidity could
result in market inefficiencies, potentially leading
to greater price volatility or instances of price
manipulation.
Also, considering that the index futures and
options markets are used more often than other de-
rivatives markets for hedging purposes against
cash-market positions, it can be said they play an
important role in the national economy. Thus, it
will be important to minimize or shorten the dura-
tion of any market shocks, should they occur.
26 ・ Hana insight Dec 2011
Issue
Korea's retirement pension market
picks up growth momentum
Since its introduction in 2005, Korea's retire-
ment pension market has grown at a steady pace.
More recently, however, such growth has accel-
erated, as existing tax benefits on legacy severance
payments schemes were phased out. Corporate
pension assets, which were a modest 14.0 tril₩ -
lion at end-2009, surged by 172% to 38.1 trillion₩
by the end-September 2011. Moreover, with ma-
jor companies such as KEPCO, Kia Motors and
Korean Airlines expected to adopt corporate pen-
sion plans in 2H, and with plans to raise the ceiling
on tax deductions for contributions to corporate
pensions and personal pensions from the current
3 million to 4 million in the current tax year,₩ ₩
it is forecast that Korea's corporate pension market
could grow to around 50 trillion by end-2011.₩ 2)
Amid this recent surge in growth, recent re-
visions to the Employee Retirement Benefit
Security Act (ERBSA) and the Regulations on the
Supervision of Retirement Pensions have been
passed, paving the way for changes in the size,
quality and dynamics of the market.
The National Assembly ratifies the re-
vised ERBSA
The revised ERBSA was finally passed on
June 30, 2011, even though work on it had begun
in November 2007 and it had initially been sub-
mitted to the National Assembly for legislation in
November 2008. The purpose of the revisions are
to foster the growth of Korea's retirement pension
system by helping Korean citizens to secure their
retirement incomes while strengthening the stabil-
ity of the retirement pension system. Once the
2) Financial Supervisory Service Press Release (August 2011)
Recent Changes in Korea's Retirement Pension
System and ImplicationsYunshin Ju, Senior Researcher
Recent revisions to the Employee Retirement Benefit Security Act (ERBSA) and the Regulations on the
Supervision of Retirement Pensions are likely to have a significant impact on Korea's retirement pension
market. Anticipated changes include an expansion of the potential size of the market, primarily due
to growth in Individual Retirement Pensions (IRP), strengthened protections for plan participants, and
the expanded role of insurance companies. Combined with the active efforts of various market partic-
ipants, such changes are expected to help Korea's retirement pension market to grow not only in terms
of size, but also in terms of quality and sophistication.
Dec 2011 Hana Insight ・27
Issue
amendment receives presidential approval, it will
go into effect beginning in July 2012. Given that it
specifically seeks to address many of the short-
comings of the current pension system, it is ex-
pected to bring about many changes in Korea's
pension market going forward.
Broadly speaking, the amendment to ERBSA
outlines changes in the following areas: Pension
Adoption, Design & Administration; Pension
Continuity & Benefit Rights; Expansion of the
Pension System; and Administrative
Infrastructure.3)
First, in terms of the Pension Adoption, Design
& Administration category, the revised ERBSA
permits workers to participate in multiple pension
plans, thereby enhancing flexibility in pension de-
sign, while also permitting the use of multi-spon-
sor pensions in order to encourage adoption by
SMEs. Under current law, an employee can
choose either a DB plan or a DCplan, but not both.
In response, the revised ERBSA enhances options
for employees by permitting them to participate in
DB and DC plans simultaneously. In addition, be-
cause administering a single-sponsor pension plan
can be a large burden to small businesses, resulting
in a low rate of adoption, the amendment lays the
framework whereby a representative sponsor may
establish a pension plan (DC only) that can be
adopted by multiple companies.
Second, with regard to Pension Continuity &
Benefit Rights, the amendment limits the circum-
stances under which employees may request early
withdrawals of pension benefits, and permits em-
ployees who are leaving a particular company to
transfer their benefits into an IRP. It also seeks to
3) Ministry of Employment and Labor
Figure 1 | Main Points of the Revisions to the ERBSA
Category Description
Pension Adoption, Design
and Administration
- Permits participation in multiple plans (DB, DC or DB + DC) (Article. 6)
- Introduces multi-sponsor pension system (Article 23)
Pension Continuity &
Benefit Rights
- Imposes new restrictions on interim withdrawals of benefits (Article 8, Clause 2)
- Strengthens continuity of the pension system (Article 17, Clause 4; Article 19, Clause 2;
Article 20, Clauses 5&6)
- Ensures sponsor ability to make benefit payments on DB plans (Article 16, Clauses 2&3)
Expansion of the
Pension System
- Forces newly established business to adopt pension plans (Article 5)
- Expands the Individual Retirement Pension (IRP) System (Article 24, Clauses 2&3)
Business
Practices
- Specifies those entities permitted to engage in pension plan sales activities (Article 31)
- Creates legal basis for the termination of licenses for inactive pension services providers
(Article 27)
- Provides guidelines for the appropriate disclosure of financial transactions involving pension
service providers (Article 37)
Source: Revised version of the ERBSA
28 ・ Hana insight Dec 2011
Issue
ensure that minimum pension assets are main-
tained at appropriate levels. Under the current sys-
tem, employers are permitted to honor requests for
interimwithdrawals, leading to a high incidence of
employees depleting their pension benefits even
before reaching retirement. By limiting the cir-
cumstances under which employees may be grant-
ed interim withdrawals to, for example, cases
where a non-homeowner requires the funds to pur-
chase a home, the revision seeks to improve the
odds that the employee will be able to accumulate
sufficient savings for retirement.
Moreover, given that the average tenure of
Korean workers is only 5.7 years, the amendment
strengthens the continuity of the pension system
by enabling plan participants to transfer their ac-
crued benefits to an IRP, thereby enabling them to
preserve their benefits until they are 55 years old,
the age at which they become eligible to receive
pension payouts.
Third, in terms of Expansion of the Pension
System, the revised ERBSA makes it obligatory
for new businesses to automatically establish pen-
sion plans, and includes provisions aimed at fos-
tering the utilization of individual retirement plans
(IRP). Under the current system, severance pay-
ment plans are mandatory, but the choice of
whether to adopt a corporate pension plan is left up
to individual companies, based on agreement be-
tween management and labor. Given this option,
the number of companies adopting pension plans
has remained fairly low. As of May 2011, only
29.7% (2.71 million) of 9.13 million regular work-
ers are enrolled in a pension plan. Thus, the
amendment seeks to expand participation in retire-
ment pensions by requiring that any company es-
tablished after the revised ERBSA becomes effec-
tive to establish a retirement pension system with-
in one year of its date of establishment.
Moreover, under the current system, only em-
ployed workers are permitted to enroll in in-
dividual retirement accounts (IRAs). As a remedy,
the revisions introduce an individual retirement
pension (IRP) system. Through this system, em-
ployees currently enrolled in a DB or DC plan, as
well as self-employed individuals, can establish an
Figure 2 | Adoption of Retirement Pensions by Number of Employees in Company
Category10 or fewer
employees
10-29
employees
30-99
employees
100-299
employees
300-499
employees
500
employeesTotal
(A) Pension Plan
Sponsors58,048 30,573 13,769 3,615 572 706 107,283
(B) Total Companies 1,277,326 167,033 50,007 10,309 1,363 1,120 1,507,158
Adoption Rate
(A/B, %)4.5 18.3 27.5 35.1 42.0 63.0 7.1
Source: Ministry of Employment and Labor (Korea)
Dec 2011 Hana Insight ・29
Issue
IRP and make contributions into it, thereby pro-
viding increased retirement planning options for
employed workers who want to accumulate addi-
tional retirement funds or for self-employed in-
dividuals who do not receive a regular income
stream.
Fourth, in terms of Business Practices, the re-
vised ERBSA specifies the channels through
which pension products can be distributed and cre-
ates the legal basis for the termination of licenses
for inactive pension services providers. It also per-
mits the Ministry of Employment & Labor to re-
quest relevant information in supervising the
sound management of the retirement pension
system. Although the current ERBSA does not in-
clude specific regulations on the sales of pension
products, regulators have issued legal inter-
pretations that only permit pension service pro-
viders to engage in pension-related sales activities.
Insurance agents have continuously requested
permission to engage pension sales, claiming that
it is unfair and without legal basis to limit such ac-
tivities to pension service providers. Thus, the re-
vised ERBSA not only reaffirms the legal basis for
pension service providers to engage in sales activ-
ities, but also outlines the requirements, scope of
activity and areas of compliance that must be sat-
isfied by persons who want to be delegated with
the authority to engage in such activities.
The Regulations on the Supervision of
Retirement Pensions were also revised
Revisions to the Regulations on the
Supervision of Retirement Pensions were ap-
proved by the Financial Services Commission this
October. Their main impact will be to limit pen-
sion allocation to certain types of assets, strength-
en the public disclosure requirements of pension
service providers, and regulate inappropriate pen-
sion sales practices.
First, in order to stem excessive competition
via abnormally high fixed interest rates, the re-
visions stipulate that a service provider can allo-
cate nomore than 70% of pension plan assets to its
own guaranteed investment products. In the case
of insurance contracts, however, a company does
not invest in its own products during the asset man-
agement process, so insurance is exempt from this
regulation. In addition, in order to ensure the pro-
vision of accurate and transparent information, the
revisions seek to improve the public disclosure
process for pension service providers, by requir-
ing the disclosure of investment returns and regis-
tration documentation, shorter interval between
disclosures, as well as corrections or revision by
service providers and industry groups. Finally, the
amendment seeks to stem the incidence of in app-
propriate business practices by offering guidance
on actions that can be construed as improper or co-
ercive, such as the provision of gifts or tangible/in-
tangible economies benefits, excessive under-
30 ・ Hana insight Dec 2011
Issue
writing of costs for plan participants, or other such
unfair sales practices.
The various changes in the retirement
pension system should foster quanti-
tative and qualitative growth in the
retirement pension market
To summarize, the various recent changes to
Korea's retirement pension system are expected to
impact Korea's retirement pension market in a va-
riety of ways. First, new provisions that require
newly established businesses to adopt retirement
pension plans and that limit interim severance pay-
ment withdrawals should serve to expand the po-
tential asset base of the pension market. In partic-
ular, given that the revisions permit employees to
transfer their pension benefits to an IRP when
changing workplaces, and that the IRP system has
been expanded to included self-employed in-
dividuals, growth in IRPs is expected to be a major
driver in the overall growth of the market.
As of end-June 2011, domestic IRA assets
stood at 3.6 trillion, only 9.8% of the total retire₩ -
ment pension assets. According to a simulation
run by the Korea Insurance Research Institute
(KIRI), the IRP market is forecast to grow very
rapidly as a result of the ERBSA amendment, with
the number of participants forecast to climb from
around 80,000 currently to around 150,000 in
2015, 290,000 in 2020, and 810,000 in 2030.
In the US, where the retirement pension mar-
ket is highly developed, the range of entities that
can join IRA plans is diverse, including not only
employees participating in their corporate pension
plans, but also individuals who are not eligible to
participate in a corporate pension plan. Its IRA
market was able to develop so rapidly in part be-
cause it developed a diverse range of products to
suit the needs of a diverse customer base. As of
end-September 2010, IRA assets in the US ac-
counted for an already high 27% of total pension
assets, and have been on an uptrend. As such, it ap-
Figure 3 | Private Pension Plan Assets in Korea Figure 4 | Pension Assets by Plan Type
0
5
10
15
20
25
30
35
40
45
07.1 08.1 09.1 10.1 11.1
(\tn won) 10.0%
18.0%
72.0%
DB
DC
IRA
Source: Financial Supervisory Service Note: As of end-June 2011Source: Financial Supervisory Service
Dec 2011 Hana Insight ・31
Issue
pears that the ability for employees leaving a par-
ticular company to transfer their retirement bene-
fits to an IRP, as well as the expansion in the range
of eligible individuals, will serve as a significant
boost to Korea's IRP market.
The revisions to the ERBSA and the
Regulations on the Supervision of Retirement
Pensions should also strengthen protections for
participants by strengthening pension benefit
rights, and by regulating excessive competition
and in appropriate pension sales practices. For ex-
ample, to ensure that DB plans are adequately
funded, the revised ERBSA stipulates that plan
sponsors must inform employees whether or not
pension funds exceed the required minimum. If
the pension assets fall below 90% of that mini-
mum, the sponsor must make a contribution in an
amount equal to the shortfall. Ensuring that pen-
sion assets are maintained at or above a certain lev-
el should help to ensure the pension rights of plan
participants. It is also expected that restrictions on
the amount of a service provider's own products
that can be invested in, as well as guidelines on
what constitutes improper gifts or coercion in sales
activities, will also help to improve the quality of
Korea's pension market by mitigating excesses
caused by overheated competition.
Finally, it is expected that insurance compa-
nies will play a growing role in the retirement pen-
sion market through the utilization of their net-
works of agents. The revised ERBSA provides a
legal basis for the delegation of pension plan sales
activities, thereby enabling insurance companies
to register their agents as authorized sellers of pen-
sion products. This will pave the way for insurance
companies to place their networks of agents on the
front line in selling pension products, and will
thereby cause amajor shift in the channels through
which pension products are sold. In addition, the
clause that limits the proportion of pension assets
that can be invested in principal-and-inter-
est-guaranteed products of the service provider or
its affiliates will likely have a negative impact on
banks and securities firms, while benefitting in-
surance companies.
As mentioned above, the various recent regu-
latory changes are likely to help Korea's retirement
pension system to grown in both size and in
quality. The revisions should resolve many of the
problems inherent in the existing retirement pen-
sion system, thus setting the stage for its further
development. The market is in agreement that the
regulations should be favorable. What is now
needed, however, is the efforts of each participant
in the pension market, including plan participants,
sponsors and service providers, as well as the regu-
latory authorities. Once the relevant parties con-
tribute in the efficient operation of the reformed re-
tirement pension system, the true potential of
Korea's retirement pension system just may be
realized.
32 ・ Hana insight Dec 2011
Market Watcher
Amid the ongoing low interest rate environ-
ment, Korean bond yields faced continued pres-
sure in 4Q, based on global market turmoil stem-
ming from the European debt crisis, further slow-
down in the real economy, and the fleeing of in-
vestors to safe assets. As the debt crisis in Europe
flared up, and as the USD/KRW exchange rate
rose, there was increasing concern that European
financial institutions could flee Korea's bond mar-
kets, creating some upward pressure on bond
yields. This concern was extinguished, however,
as Asian countries increased their investments in
Korea's bond markets. Meanwhile, reflecting
global financial turbulence as well as a slowdown
in the real economy, the policy rate was held un-
changed since July, helping yields to stabilize at
slightly lower levels. Moreover, the monetary pol-
icy decision-making burden was eased as consum-
er prices, which had been the main factor in pre-
vious rate hikes, fell sharply as increased fears of
a global slowdown caused a severe correction in
commodity prices, particularly agricultural prices.
Inflation fears will ease and the policy rate
stance will likely remain on hold for a significant
period, but continued uncertainty regarding mone-
tary policy will likely persist. While financial tur-
moil from the crisis in Europe will likely continue,
and global slowdown will likely mitigate infla-
tionary pressures and expectations, the current
monetary policy stance of keeping the policy rate
unchanged will likely continue for a while, as do-
mestic growth momentum weakens, problems
with household debt continue to fester, and the
global trend toward monetary policy easing
continues. But considering that globally coordi-
nated easing of monetary policy remains a possi-
bility, we cannot rule out the chances of a change
Figure 1 | Key Interest Rates Figure 2 | Changes in Yield Curves of KTB Issues
1
2
3
4
5
6
7
8
09 .1 09.7 10.1 10 .7 11 .1 11 .7
(%) Corporate Bond (AA-)
3YR KTB
10YR KTB
Policy Rate (Overnight Call)
2 .5
3 .0
3 .5
4 .0
4 .5
5 .0
3M 1YR 3YR 5YR 10YR 20YR
(%)
201 1-03-30
201 1-06-30
201 1-09-30
201 1-12-08
Source: Fnguide Source : KOFIA
n Interest Rates: Yield should fluctuate narrowly on global monetary easing
Seungryong Kim, Researcher
Dec 2011 Hana Insight ・33
Market Watcher
in the Bank of Korea's monetary policy stance.
Meanwhile, it is also likely that external un-
certainties and an environment where demand out-
weighs supply could keep yields at low levels.
Given the expectation that the Bank of Korea
Monetary Policy Committee's stance of keeping
the policy rate on hold is likely to bemaintained for
a significant period of time, support for bond
yields has become strengthened. As such, yields
will likely continue to move within a range, influ-
enced more by whether foreigners holding Korean
bonds substitute their maturing holdings with new
holdings, rather than events out of Europe.
In 1Q 2012, domestic bond yields are pro-
jected to stay with the 3.2~3.5% range (based on
3-yr KTBs), owing to weaker growth, easing infla-
tionary pressures, buybacks of KTBs and an in-
flow of foreign investment into Korea's bond
market. Demand will likely continue to outweigh
supply, given the traditional base of institutional
demand, expanded demand for KTBs from banks
in preparation for Basel III, continued net pur-
chases by foreigners, and buybacks of KTBs, re-
sulting in limited upward pressure on yields. But
given that external risk factors could change, vola-
tility in the bond market could increase, since fur-
ther downgrades of sovereigns or financial in-
stitutions could impact global capital flows, there-
by impacting Korea's bond market. Vigilance will
be required, however, since major market shocks,
such as major downgrades in the US or France,
could cause Korean bond yields to rise.
As for corporate bonds, they were issued in
large volume right after the financial crisis, so
many of these issues will need to be rolled over as
maturity dates approach, resulting in greater
supply. It is forecast that the credit risk premiums
on such bonds will become more differentiated,
with demand outweighing supply.
Figure 3 | Capital Flows into Korea Figure 4 | Monetary Easing at the Global Level
-2 .0
-1 .5
-1 .0
-0 .5
0 .0
0 .5
1 .0
1 .5
Europe US Asia
(\ tn)
11 .8 1 1 .9
11 .1 0 1 1 .1 1 -15 0
-10 0
-5 0
0
(bp)
-50 bp
8 .4
-2 5bp
8 .2-50 bp
9 ,12
-15 0bp
10~1 2
-50bp
1 1 .4
-7 5bp
10~12
-2 5bp
12 .1-5 0bp
11~12
CH TR IL ID BRAU EU TH
0 .0 0 5 .75 4 .25 6 .00 11 .04 .25 1 .00
Target
rate 3 .25
Source : FSSNote: Target rate is as of 2011.12.08.Source : Thomson Reuters Datastream
34 ・ Hana insight Dec 2011
Market Watcher
In 4Q, the USD/KRW exchange rate has been
fluctuating in line with developments in the
European debt crisis. In early October, as Greece
failed to reach its fiscal austerity commitments,
there was increasing talk of its impending default.
This spurred an increase in the volatility of the
USD/KRWexchange rate, pushing it above 1,200
won. But the ECB's move to expand its supply of
liquidity and the decision to expand the EFSF
helped to soothemarket anxieties, causing the ris-
ing exchange rate to reverse course. Various other
measures aimed at resolving the European crisis,
such as raising the haircut on Greek debt, leverag-
ing the EFSF, and recapitalizing the banking sys-
tem, exerted further downward pressure on the ex-
change rate. But growing skepticism about the ef-
fectiveness of proposed measures, increased wari-
ness about the solvency of Greece and Italy, and
concerns about the potential for contagion from
the periphery of Europe to its core caused the ex-
change rate to rise again.
Based on concerns about Italy's massive out-
standing sovereign debt and related exposures
within Europe, yields on French sovereign debt
surged, fomenting worries about a sovereign
downgrade and instilling the view that core coun-
tries were not immune from the crisis. Given the
ongoing dialogue regarding support from the IMF,
the US, or from other global policy coordination,
however, it is likely that much of the uncertainty
will subside. Although the liquidity crunch in
Europe has shut down a large part of the funding
markets for European financial institutions, the re-
cent agreement by themajor central banks to lower
the interest rate on currency swaps is likely to ease
some of the tightness in US dollar funding markets.
Although the focus of attention has been on
n Exchange Rate: The Korean won should appreciate, but there are risk factors
Yootag Jung, Researcher
Figure 1 | USD/KRW and EUR/USD Figure 2 | Yields on 10-Year Govt. Bonds in Europe
1000
1050
1100
1150
1200
1250
11.1 11.3 11.5 11.7 11.9 11.11
1.25
1.30
1.35
1.40
1.45
1.50
Won/Dollar(L)
Dollar/Euro(R)
(KRW) (USD)
2
3
4
5
6
7
8
11.1 11.3 11.5 11.7 11.9 11.11
France Spain
Itay Belgium
(%)
Source: Infomax Source: Bloomberg
Dec 2011 Hana Insight ・35
Market Watcher
Europe as of late, there is a need to pay heed to some
of the latent global risk factors stemming from the
US or China. For example, the United States' recent
failure to agree on a fiscal austerity plan and the
subsequent action by Fitch to lower it outlook on
the United States had a limited impact on the mar-
kets, but there remain a number of risks related to
sovereign debt, including uncertainty over the fea-
sibility of economic stimulus plans and concerns
about deterioration in fiscal soundness. In the case
of China, the slowdown in its exports and its on-
going decline in manufacturing activity are caus-
ing increased worries about the possibility of eco-
nomic contraction in China, a major risk that could
trigger turmoil across the global economy. Also, if
the United States' weak fiscal position causes it to
resort to weakening the US dollar to stimulate its
economy, such an action could collide with China's
attempts to keep the yuan from appreciating in re-
sponse to a slowdown in China, thus raising the
stakes in the competitive battle for devaluation.
Thus, the USD/KRW exchange rate is likely to
experience a period of volatility as a result of ex-
ternal uncertainties, but based on strengthened
hopes surrounding policy measures to fight the
European crisis, it may be able to fall below the
1,000 won level in early 2012. Several other fac-
tors could exert downward pressure on the ex-
change rate, including the trend depreciation of the
US dollar resulting from US sovereign risk and its
policy stimulus measures, Korea's currency swap
with China and Japan, favorable domestic FX liq-
uidity conditions and fiscal soundness, and im-
provements in Korea's external credibility. Of
course, one cannot ignore the potential for in-
creased volatility based on the ebb and flow of
events out of Europe, the potential for deterio-
ration in domestic fundamentals stemming from
weakened global demand, or other latent risk
factors. As a result, the general trend in the ex-
change rate is likely to be down, but stabilizing be-
low 1,100 won will not be easy in the near term.
Figure 3 | China's Export Growth & Mfg. PMI Figure 4 | Government Debt Levels (2011)
-30
-15
0
15
30
45
2007 2008 2009 2010 2011
35
41
47
53
59
65
ExportGrowth (L)
Mfg. PMI (R)
(YoY, 3MA, %) (Index)
87 166 121 32 67 1000
30
60
90
120
150
180
France Greece Itay Korea Spain US
(% of GDP)
(G20 Avg.: 79%)
Source: Bloomberg Source: IMF Estimates (Fiscal Monitor, 2011.09)
36 ・ Hana insight Dec 2011
Market Watcher
Global equity markets suffered amajor correc-
tion in August, owing to the European debt crisis
and the US downgrade, but then entered a up-and
down pattern as volatility subsided somewhat. In
October, equities staged a solid rally, as the
European summit produced favorable announce-
ments and economic indicators out of the United
States suggested that a recession was not in the im-
mediate horizon.
By November, however, as resolution of the
crisis in Greece was delayed, the crisis spread to
Italy and Spain, fueling rumors of a potential
downgrade of France, and funding problems
spread through the European banking sector. As a
result, global equity markets were thrown back in-
to disorder, with the KOSPI sliding down as far as
the 1760 level at one point.
In the United States, economic indicators
showed that employment, consumer spending and
the housing market were improving in general,
helping to ease pessimism about the economy.
Combined with positive expectations for a strong
holiday shopping season, global equity markets
began to rebound again in early December, with
the KOSPI recovering to the 1,900 level.
With expectations that European summit in
December will produce further plans to resolve the
debt crisis, along with high hopes for solid holiday
shopping in the United States and the positive eco-
nomic effects of the Lunar New Year season in
China in early 2012, the equity markets appears to
have some additional upward momentum, al-
though there is a chance that the debt crisis could
still cause Europe's economy to slow. Also, given
that the maturity dates on the sovereign debt of
Europe's peripheral countries are concentrated in
n Equities: Volatility risk remains, but a major correction is unlikely
Kyungshik Yang, Chief Strategist (Hana Daetoo Securities)
Figure 1 | KOSPI Volatility Figure 2 | Maturity Schedule of PIGS Debt
0
5
10
15
20
25
30
1997 1999 2001 2003 2005 2007 2009 2011
(%)
Asian
Crisis
IT Bubble
Collapse
9/11
Tripl
e Bear Stearns
Lehman
Brothers
Collapse
European
Crisis
0
20
40
60
80
100
120
11. 11 12. 1 12. 3 12. 5 12. 7 12. 9 12. 11 13. 1
Portugal Italy Greece Spain(€bn)
41% in 2012
Source : Bloomberg, Hana Daetoo Securities Source : Bloomberg, Hana Daetoo Securities
Dec 2011 Hana Insight ・37
Market Watcher
February-April 2012, additional upward moves in
equity markets should be limited, leaving open the
possibility of a return of volatility.
Ironically, as we have experienced before, the
more dangerous global financial markets become,
the stronger and faster the policy responses, and
this is likely to continue into the future as well. To
take a recent example, as funding conditions for
European banks deteriorated, central banks from
the United States and other advanced economies
agreed to set up a commodity swap in response to
a deterioration in funding conditions at European
banks.
As global inflationary pressures wane, the ma-
jor economies are likely to ease their tightening
stances. Brazil, Australia and other emerging
economies have already lowered their policy rates,
China has lowered its reserve requirement ratio,
and it appears that the United States may resume
discussions on additional quantitative easing
measures. Such policy measures are likely to pro-
vide support for global equity markets.
Though Korea's stock market cannot be im-
mune from volatility, there are two reasons why it
is likely to outperform other global equity
markets. First, Korean companies' earnings
growth (based onMSCI 12-month forward EPS) is
higher than the global average or that of emerging
economies. Second, despite the ongoing turmoil in
global financial markets, the Financial Condition
Index is more stable that in the past, reflecting
Korea's improved fundamentals.
Figure 3 | Policy Rates of Major Economies Figure 4 | KOSPI & Financial Conditions Index (FCI)
0
1
2
3
4
5
6
7
8
2000 2002 2004 2006 2008 2010
US UK
Eurozone Australia
China Korea
(%)
1400
1500
1600
1700
1800
1900
2000
2100
2200
2300
11.1 11.3 11.5 11.7 11.9 11.11
550
570
590
610
630
650
670
690
710
730
KOSPI (L)
Financial Conditions Index (R)
(p) (index)
Source : Thomson Reuters, Hana Daetoo Securities Source: Bloomberg, Hana Daetoo SecuritiesNote: The Financial Conditions Index is an equal-weightedindex of daily movements in equities, bonds and FX.
Hana Insight
Vol. 1, No. 2
Published December 14, 2011
Editor-in-Chief: Warren Park
Publisher: Choe, Heungsik, President
Hana Institute of Finance
27-3, Yoido-dong, Youngdungpo-gu
Seoul, Korea 150-705
Tel: 82-2-2002-2200
Homepage: www.hanaif.re.kr
Printed by KwangMoonDang Co., Ltd.
The views and opinions contained herein are those
of individual authors and do not necessarily reflect
the stance of the Hana Institute of Finance.