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보고서 1
Analysis on the Characteristics of Korea’s Strip Bond Market and Plans for Facilitating the Market [21-01]
Senior Research Fellow Kim, Pil-Kyu / Jan. 08, 2021
This study aims to analyze the characteristics and economic effects of Korea’s strip bond market in terms of the secondary market and the market’s issuers, investors, and yields, based on which to propose ideas for facilitating the market. A strip bond is a debt obligation which is broken into coupon and principal components and issued as several zero-coupon bonds. Investor can benefit from investing in those bonds as they offer a broader opportunity for long-term, arbitrage investment and eliminate the reinvestment risk a coupon bond usually has. In addition, more information on zero-coupon bonds with diverse maturities in the strip bond market could help complete the yield curve, making the market more comprehensive.
 
Korea’s strip bond market has been introduced in March 2006 for the purpose of improving the liquidity of benchmark Korea Treasury Bonds, revitalizing the long-term bond market, and effectively responding to market demand for long-term zero-interest bonds. It was 2010 that the issuance of strip bonds began picking up. A more significant increase has been observed around the on-exchange secondary market since 2016.

This paper analyzed the primary and secondary market data to grasp the main characteristics of Korea’s strip bond market. The results confirm the market’s wide-ranging benefits to investors. First, strip bonds have the effect of expanding the supply of long-term duration bonds in response to investors’ demand for long-term assets. With the average maturity of domestic strip bonds continuously on the rise, the proportion of stripped long-term government bonds has been also increasing. The prolonged maturity of those bonds results from two factors. First, the insurance sector increased investment in long-term bonds in response to regulatory changes. Second, institutions holding long-term debt are increasingly using strip bonds for the purpose of duration matching.

The main institutions that invest in strip bonds include insurers, pension funds, asset managers and banks. As a result of analyzing the behavior of major strip bond investors using the trading data of the over-the-counter market, insurers and pension funds tend to invest in long-term strip bonds in order to eliminate maturity mismatches between assets and liabilities. By contrast, asset managers are found to prefer high investment returns, investing in short-term principal strips and coupon strips that have relatively high spreads. Banks act as strip bond providers while investing in various types of strip bonds for higher profitability.

The most notable feature in Korea’s secondary market for strip bonds is the divergence of bond types and market participants between the on-exchange and the over-the exchange markets. The KRX—Korea’s on-exchange market—is a marketplace where principal strips that mature less than one year take up a large proportion of trading, while the OTC market sees a diversity of stripped principal and coupon components changing hands. Recently, liquidity of strip bonds in the KRX has improved significantly, mainly because of the government’s regulatory actions such as introducing a primary dealer system for strip bonds that mandates the dealers to engage in market making for strip bonds with less than one-year maturity. Such a boost in the on-exchange secondary market is certainly viewed positively as it has improved the liquidity of short-term strip bonds, and has helped complete the yield curve of short-term, risk-free bonds. However, its crowding-out effect of contracting trades of longer-term strip bonds is posing a negative aspect.

The introduction of strip bonds provides the effect of improving long-term government bonds and off-the-run bond liquidity. A comparative look at strip bonds with other risk-free bonds, strip bonds’ liquidity is lower than that of short-term KTBs and two-year Monetary Stabilization Bonds, but is higher than long-term KTBs. Stripping long-term KTBs helps boost the liquidity of those otherwise illiquid bonds. 

According to the analysis in this paper, Korea’s strip bonds showed higher excess spreads than government bonds do. The average yield on Korea’s strip bonds was found to be consistently higher than the mark-to-market yield on KTBs with the same maturity. Such a result could have been affected by strip bonds’ higher price sensitivity to interest rate changes, compared to coupon bonds with the same maturity. This paper also compared the yields on principal and coupon strips, and found coupon strips’ spread to be higher than principal strips, which is consistent with previous studies on strip bond prices in other countries. Because stripped interest payments are issued as various small-amount bonds, they are illiquid and serve for investors whose investment purpose and strategy are often different from those investing in stripped principal components. Also noteworthy was strip bonds’ spread varying widely across strip types, maturities, interest rate hikes, and trading venues, all of which suggest diverse factors behind how strip bonds are priced.

For steering Korea’s strip bond market towards sustainable development, several improvements are needed in the areas of issuers, investors, secondary market and market infrastructure. Plans are needed to help the issuers to accurately grasp the demand of strip bonds and to elastically supply them. Investors should refine their strategy, fully reflecting the market’s characteristics. Also necessary is a plan to introduce diverse packaged products based on strip bonds. The secondary market needs improvements in price efficiency, which could be achieved by improved liquidity of strip bonds. Last but not least, it is necessary to promote more information on the strip bond market and the underlying bonds to be analyzed and provided.
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보고서 1
Guidelines for Managing Outsourcing Risk of Financial Services Firms: Overseas Cases [20-01]
Senior Research Fellow Cho, Sung Hoon / Dec. 07, 2020
Outsourcing, which means allowing a third party outside the company to perform activities or functions that the company has performed internally, is a strategic decision-making aimed at reducing costs, enhancing management efficiency, and strengthening core competencies, and this importance is the same in the financial services industry. In particular, outsourcing is becoming more important as the value chain of the financial services industry changes according to the recent rapid technological development called the ‘4th industrial revolution.’ However, in Korea, there have been opinions that the statutory regulations on outsourcing are rigidly operated, limiting financial services firms’ use of outsourcing, and thus failing to respond to rapidly changing environments, and outsourcing regulations are on the trend of easing.

Major foreign countries, such as the United States, European Union, United Kingdom, and Singapore do not regulate outsourcing of financial services firms by law. Instead, regulatory or supervisory agencies have created and provided guidelines or guidances for outsourcing management of financial services firms. The guidelines of these agencies commonly emphasize the roles and responsibilities of the board of directors and top management in making and managing outsourcing decisions. In addition, the management process leading to outsourcing risk management, due diligence and selection of outsourcing suppliers, design and conclusion of outsourcing contracts, and supplier monitoring is presented in a similar manner.

All global financial services firms have developed a ‘Code of Conduct’ to manage their outsourcing and apply them to their suppliers. The Code of Conduct commonly contains matters concerning business ethics and integrity, labor and human rights, environment and sustainability, diversity and inclusion. This report also introduces the contents of JP Morgan’s ‘Minimum Control Requirements’ as a specific internal guideline for outsourcing management, which are very specific and detailed as defining minimum control requirements to effectively control IT outsourcing and manage related risks.

If Korea’s outsourcing regulations are continuously eased and ultimately shifted to principle-based, guidelines as soft norms will be needed, and these guidelines should be specific and specialized to provide practical assistance to financial services firms. Financial services firms’ internal outsourcing management guidelines should also be specialized, detailed and technical, and efforts should be made to secure the technical capabilities of their own personnel to create and implement these internal guidelines. With the increase of IT outsourcing, the importance of risk management related to data and information of customers and firms is growing, and firms need to raise awareness of the responsibilities of the board and top management for outsourcing management.
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보고서 1
Changes to US and EU Securitisation Regulation and Their Implications [19-03]
Senior Research Fellow Kim, Pil-Kyu and others / Feb. 08, 2019
This study aims to examine changes to securitisation regulations in the United States(US) and the European Union (EU) since the global financial crisis and draw implications of the findings for better securitisation regulatory framework in Korea.

Inadequate regulation of securitisation has been cited as one of the factors amplifying the global financing crisis. More specifically, the relevant disclosure regimes were not enough to capture ABS risks, and no regulatory tools were available to address conflicts of interest in ABS transactions, and no regulation was in place to curb excessive securitisation. On top of that, investors relied overly on credit rating agencies as a source of information regarding ABS because ABS information was often limitedly available.

Following the global financial crisis, the US and the EU have revamped their regulatory frameworks for ABS transactions. When looking at regulatory developments relating to ABS disclosure, the US revised Regulation AB in 2014, thereby tightening asset-level disclosure and introducing new requirements for certain asset classes to disclose standardized asset-level information in order to help investors better understand the characteristics of underlying assets. In addition, the revisions include expanded disclosures about underlying assets and transaction parties, and several changes to the content of disclosures so as to enable investors to conduct their own analysis of underlying assets and securitisation structures without reliance on credit ratings. Meantime, the EU strengthened the disclosure of information on ABS transaction parties to ensure that investors have a sufficient understanding of transaction structures and characteristics, and adopted specific reporting requirements for underlying assets. Notably, the EU introduced disclosure templates per asset class to provide investors with more detailed information about the assets underlying ABS by asset type, and imposed requirements on issuers, originators and sponsors to publish jointly information on the underlying assets and the structure of the securitisation transaction sufficient to conduct stress tests, if needed, to assess the creditworthiness of the underlying assets.

The major difference in the changes to ABS disclosure between the US and the EU is that the US adopted more detailed disclosure requirements only for the retail finance sector whereas the EU adopted disclosure templates for diverse asset classes, especially applying disclosure requirements to ABCP. Another difference can be found in shelf-registration. The US put shelf-offering process for ABS and shelf-registration forms for ABS issuers in place but the EU has no relevant requirements. This is attributable primarily to differences between the US and European ABS markets in terms of market size and structure, and different regulatory frameworks in the two regions.

The US and the EU introduced new regulation that requires originators to retain at least 5% of the credit risk of the underlying assets in order to address conflicts of interest in ABS transactions. The US and EU risk retention rules are slightly different. The US allows originators to use various risk retention methods, and impose more lax risk retention requirements on or provide exemptions from the requirements for any ABS backed by qualified assets, such as residential mortgages, commercial real estate loans, commercial loans, and auto loans that meet certain criteria, and mortgages acquired by government agencies issuing MBS. The EU has more stringent regulation that allows investments in ABS only if originators have explicitly disclosed that it will retain at least 5% of the securitised exposure.

The existing Basel II risk-weighted assets computation for securitisation exposures shows mechanistic reliance on credit ratings given by external credit rating agencies, and assigns relatively low risk weights to high-rated securitisation exposures and relatively high risk weights to low-rated securitisation exposures. Furthermore, the existing calculation may lead to so-called cliff-effects that refers to substantial increases in capital requirements resulting from deterioration in the credit quality of the underlying assets. To solve this problem, Basel III requires banks to conduct their own internal assessments if the securitisation exposures have an external credit ratings, eliminating certain cliff-effects associated with credit risk mitigation activities, and introducing higher capital requirements for complex securitisation transactions.
The tightening of ABS regulation had large impacts on the ABS markets. The stronger regulation and weaker investor confidence in ABS resulted in a significant market contraction. ABS issuance volumes in the US and the EU dropped by about half immediately after the global financial crisis. Since 2015, however, the US ABS market has recovered gradually whereas the European ABS market has remained sluggish.

One reason for the stuttering EU ABS market is an increase in issuance costs resulting from more stringent regulation. Discussions have been underway in Europe on how to revive the ABS market. Part of the efforts are the adoption of a single, uniform regulatory framework for all securitisations in the EU, and the introduction of a differentiated regulatory regime for simple, transparent and standardized(STS) securitisations. The EU defined the basic concept of STS securitisation, and introduced implementation mechanism based on the definition of STS securitisation. In the meantime, the Basel Committee on Banking Supervision made revisions to its securitisation framework to reduce risk weights for STS securitisations in the belief that because STS securitisation is a low-risk transaction in a relatively simple structure, a lower risk weight can be applied to a STS securitisation transaction than a complex securitisation transaction. STS securitisation has been introduced only recently and its concrete implementation plan has yet to be finalized, which make it somewhat difficult to assess its effects. Nevertheless, in the long term, STS securitisations is expected to help reduce regulatory costs and enhance incentives for investors to make investments in securitisation products.

Korea’s ABS market is different from the US or EU market in terms of the way the market was created. The US or EU ABS market sprang up and developed on the back of existing securities-related laws. Conversely, the Korean ABS market was created by the government. The enactment of the Asset-Backed Securitization Act(ABS Act) laid a legal and institutional foundation for the ABS market along with relatively stringent regulatory framework in place. The Korean market is also a far cry from the US or EU market in terms of market structure. Various securitisation structures and relatively complex structures can be seen in the US and European ABS markets. Moreover, a high proportion of securitisation transactions in these markets seek to obtain risk transfer. On the other hand, fund-raising is the primary purpose of securitisation in Korea.

Such differences should be reflected in drawing out implications of the changes to securitisation regulations in the major countries. Most importantly, revisions to the ABS Act are required to promote sound development of the ABS market in Korea. The ABS Act should be amended not only to enhance the soundness of the market but also to increase regulatory flexibility, thereby enabling the adoption of various securitisation structures. In addition, Korea needs to push for better ABS disclosure regime after looking into the improved ABS disclosure regimes in other countries. Among other things, stronger ABCP disclosure is needed. From a short-term perspective, it is worth considering the introduction of an integrated data system that provides ABCP issuance information along with rating summaries from credit rating agencies. From a long-term perspective, it should consider the adoption of a comprehensive disclosure regime for securitized products including both ABS and ABCP.

Furthermore, it is necessary to improve the domestic ABS disclosure regime in response to global regulatory changes and to consider the adoption of a regulatory framework to tackle conflicts of interests of originators. It should be noted, however, that the adoption of regulation on conflicts of interest has to be preceded by assessment of ABS characteristics and review of potential conflicts of interest. If the analysis results support the adoption of a requirement to have originators hold the subordinated tranches of a securitisation, a phased introduction of the risk retention requirement is worth considering together with measures to minimize its negative effects.
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