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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.
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.
보고서 1
Effects of FX Hedging on Korea’s Outward Portfolio Investment [19-01]
Senior Research Fellow LEE, Seungho and others / Jan. 25, 2019
Korea has seen a rapid increase in foreign financial assets owned by local residents on the back of persistent current account surpluses. In particular, Korea’s outward portfolio investment has shown a pronounced upward trend since the global financial crisis. In the context of portfolio investment, effective management of exchange rate risk is very important to maximize the benefits of global diversification because exchange rate fluctuations could give rise to gains or losses. In this regard, the challenge facing major institutional investors in Korea is to have a foreign exchange (FX) risk management policy tailored to institution-specific characteristics.  

FX risk management by domestic institutional investors in relation to outward portfolio investment is still in its infancy. Many institutions do not have a well-established FX hedging policy or they usually take a conservative approach to managing FX risk arising from exchange rate changes. More specifically, most institutions or funds tend to emulate their larger peers (e.g., public funds) in designing an FX hedging policy rather than taking into account their unique features. As a result, domestic institutional investors maintain FX hedging policies under which their outward portfolio investments are hedged at the asset-class level with global stocks unhedged and global bonds fully hedged. However, the effects of FX hedging at the asset-class level are hardly consistent across countries and across periods. Furthermore, given the intended purpose of an FX hedging policy is to manage FX exposures within an international portfolio, hedging FX risks at the individual asset class level is a local optimum so that this approach does not guarantee a global optimum for a global multi-asset and multi-currency portfolio, which makes asset-level FX hedging become a limited tool.
In this study, we aim to highlight key considerations, decision-making criteria and analytical frameworks that major domestic institutional investors engaging in outward portfolio investment should take into account when formulating their FX risk management policies. We conduct a multi-faceted analysis on changes in the risk return profiles of global portfolios (based on final investment returns converted into Korean won) when FX hedging policy is established either at the asset-class or portfolio level. In addition, we examine the effects of FX hedging on the foreign exchange market in that the foreign exchange market is affected by the FX hedging policies of institutional investors engaging in outward portfolio investment, and accordingly the foreign exchange authorities directly or indirectly regulate FX hedging policy formulation and implementation by institutional investors, which in turn affects FX hedging practices in the market.   
More specifically, we investigate the effects of asset-level FX hedging on stocks and bonds issued in four developed economies (the US, Japan, Eurozone, and the UK) and two emerging market economies (China and Brazil) since 2004 in order to explore the efficiency and persistence of the asset-level FX hedging policy adopted by the majority of Korean institutional investors. Our empirical analysis yielded different results for developed and emerging market economies when it comes to foreign stocks. As for developed countries including the US, a strong negative correlation was found between stock and currency returns, which means leaving foreign stocks unhedged would be an effective risk minimizing strategy. On the other hand, the full hedge strategy performed better in Brazil, one of the emerging markets. But no significant difference between fully hedged and unhedged foreign stocks was found in the case of China. Also, we analyze the impacts of asset-level FX hedging on the foreign stocks and bonds in different periods, taking the 2008 global financial crisis into consideration, to measure the persistence of static FX hedging policy. We find that there can be no assurance that FX hedging effects will be persistent. However, the findings provide strong support for fully hedging foreign stocks, which is the FX hedging policy widely used by domestic institutional investors engaging in outward portfolio investment. 

We also analyze the effects of portfolio-level FX hedging on the foreign stocks and bonds to confirm the importance of portfolio hedging, which is the focus of our study.  The analysis of the portfolio-level hedging showed different results in several respects from the analysis of the asset-level hedging described above. With the asset-level FX hedging over the entire sample period, it seems desirable for foreign stocks to be unhedged and for foreign bonds to be fully hedged. With the portfolio-level FX hedging, however, full hedging looks effective for all asset classes to minimize the overall portfolio volatility. In addition, the analysis of global multi-asset class and multi-currency portfolios reveals that as the number of currencies and asset classes included in the portfolio increases, the use of a full hedge should be reduced, if possible, in order to maximize global diversification effects and mitigate the volatility of the overall portfolio. Not only that, we find FX hedging at the total portfolio level would be more stable in terms of persistence of the hedging effects. 
Turning to the foreign exchange market, we discover that the FX hedging of outward portfolio investments has a negative impact on the swap rate in the FX swap market rather than the spot rate, but this finding is not statistically significant. Nevertheless, it is difficult to exclude the possibility that when Korean residents invest in foreign bonds, if over- hedging of exchange rate risk as seen today continues and the investment volume rises steadily, then such hedging activities would create demand for FX swaps, which would eventually result in greater imbalance in the FX swap market. 
The following implications can be drawn from the results: First, further review is required for asset-level FX hedging policies, which domestic institutions have in place as a result of imitating their larger peers, in terms of consistency or persistence of the effects. A shift in FX hedging should be made by institutional investors with global multi-asset and multi-currency portfolios to make FX hedging decisions at the portfolio level rather than the asset-class level. 

Second, a single bottom line instead of a double bottom line, which seeks higher returns and less risks at the same time, should be adopted as criteria for determining an optimal FX hedge strategy. Recognizing that FX hedging is an intrinsic part of risk management, institutions need to develop a FX hedging policy that reflect risks lurking in their portfolios. Further, the FX hedging policy should factor in institution-specific characteristics, such as the size of investment, debt or maturity structure, and risk tolerance, as well as portfolio-specific features.   

Third, it is worth noting that FX hedging could have greater influence on the FX market because of continuously growing outward portfolio investments. The foreign exchange authorities need to keep in mind that the practice of over-hedging for foreign bonds in the absence of clear FX hedging policies among Korean institutional investors would reduce the positive effects of a virtuous cycle in which idle foreign currency-denominated funds arising as a result of current account surpluses are channeled into portfolio investment, and that such over-hedging practice would add more imbalance and volatility to the FX market. In the meantime, institutional investors investing in overseas markets should formulate their FX hedging policies considering that the effects of FX hedging in global portfolio investments on the FX market, may differ between the spot market and the swap market depending on whether or not to hedge.   
보고서 1
Comparative analysis of the margin trading system between the Korean and Japanese stock markets [19-01]
Senior Research Fellow Hwang, Seiwoon / Jan. 10, 2019
Stock trading in the domestic stock market has developed mainly focusing on cash trading, but margin trading has been also steadily increasing. The most important role of stock margin trading will be to increase the market liquidity. This is because frequent trading is likely to ensure the credibility of the prices observed in the market. Market liquidity can give the confidence in the prices by repeatedly providing opportunities for the information on companies to be reflected in the price.

For a long time, margin trading has developed mainly for margin trading long. On the other hand, despite the same economic functioning, margin trading short was very sluggish. Margin trading is a system that can work symmetrically with respect to rises and falls in the stock price, but there exists a high level of asymmetry in the usage of long and short.
It is also noteworthy that the margin trading short has a close relationship with short selling by individual investors. For institutional investors, there are no significant constraints on stock borrowing. However, since individual investors are relatively lower in the credit grade, it is almost impossible to borrow stocks. The margin trading shos virtually a unique borrowing vehicle available to retail investors. This means that if the margin trading short is active, individual investors' accessibility to short sale can be greatly improved. Thus the margin trading short may have a significant impact on individual investors' short selling activities.
Margin trading is divided into the in-house financing in which securities companies use their own funds or securities as lending resources and the KSFC financing in which funds or securities are borrowed from KSFC. KSFC financing is divided into the long and the short again. The operating structure of the long is more complicated than the short. This is because the funds for the long are homogeneous for all cases, whereas stocks for the short can be different case by case. Due to the characteristics of the short, the provision of loan resources is much more difficult for the short than for the long. If these structural differences are not sufficiently reflected in the design of the margin trading system, the symmetry of the long and the short will not be realized properly.

Japanese stock market has a system that can reliably supply the short services to individual investors. The credit problems on individual investors are solved through a centralized supply mechanism. A securities finance company acquires resources for the short by its own credit and provides them to securities companies for the retail services. The centralized supply mechanism is believed to systematically support the short selling activities of individual investors. It is also reported in the academia that this centralized approach significantly mitigated the short selling restrictions on individual investors.
Short selling in the domestic stock markets has been steadily increasing. Active investor groups in the short selling include institutional investors and foreign investors. The share of foreign investors in the short selling in Korea is overwhelmingly high and that of individual investors is extremely low. As of June 2018, the short interests amounted to 16.7 trillion won, a 60% increase over the two-year time period. The KOSPI and the KOSDAQ had short interests of KRW 12.7 trillion and KRW 4.0 trillion, respectively.

In the KOSPI and the KOSDAQ, 0.5% and 1.0% of total short selling are done by individual investors respectively. The sluggish short selling by individual investors seems to be due to the difficulty in the stock borrowing, which is essential for short selling. The only way for individual investors to borrow stocks is through the margin service provided by securities companies. Stocks that can be borrowed through the margin service are limited in terms of label and quantity. 
Short selling in Japanese stock market is quite active. As of 2017, proportion of the short selling in the Japanese stock market reached 38.7%. As compared with the fact that the proportion of short selling in the KOSPI is only 5.5% at the same time, we can see that the short selling in Japanese stock market is very active.

In order for the margin trading system to develop symmetrically both for the long and the short, it is necessary to add significant system improvement. The margin trading short is the only stock borrowing vehicle that individual investors can rely on. The following approaches can be considered for enhancing the accessibility to the short selling.

First, it is necessary to establish a centralized stock lender. The role of brokerage firms plays a large role in the stock lending. However, their role could be limited due to the difficulties in risk management. A centralized stock lending can be more useful when we consider the economies of scale.

There is also a need to increase utilization of the collaterals from the long and design alternative lending sources. Stocks that can be used as financing resources for the short are limited only to stocks explicitly agreed for lending by the margin long holders. It is crucial to find alternative ways to supply for lending. Stock borrowing in B2B market can be a primary consideration. If stock lenders can borrow stocks by their own credit and use the stocks as lending resources, it could help significantly in resolving the asymmetry of the margin trading system. We can also consider mechanisms to increase individual investors’ agreement by enhancing financial incentives and utilization of collateral through the standard terms of condition.