Investors temporarily deposit their funds with a securities company in order to engage in transactions. Securities firms are required to keep the standby funds, i.e., investor deposits, separate from their own assets so as to prevent the diversion of client money and protect it from bankruptcy.
Some argue that Korea should move from a centralized system for the management of investor deposits to a decentralized one, which has been adopted by many advanced countries. This argument highlights the need to examine whether the existing centralized system ensures efficiency and stability in the management of investor deposits, and achieves the purpose of the asset segregation to protect client money.
This study compares how the volatility of investor deposits and the performance of a trust institution(s) are affected by the two different systems, centralized and decentralized management systems. The finding is that the volatility of aggregate investor deposits managed by a single trust institution was lower than that of investor deposits multiple trust institutions hold and manage. It is attributed to the low correlation between investor deposit withdrawal rates of individual securities companies. That is, the alleviated volatility of investor deposit withdrawal rates stems from the economies of scale achieved in the centralized system.
The theoretical model finds that the lower volatility of investor deposits under the centralized system allows the trust institution to reduce the proportion of optimal liquid assets and thus achieve a relatively high return on investment. This implies that the investment performance of the trust institution will be higher under the centralized system, assuming that the same level of liquidity is secured. The simulation analysis in this study also suggests that a trust institution could benefit more from the centralized system for the management of investor deposits in terms of both profitability and liquidity than the decentralized system.
This study is limited only to the volatility of investor deposits and the operational efficiency of trust institutions as a means to assess the merits of the current centralized management regime for investor deposits. Further work is needed to fully describe and understand the various aspects of the client assets regime in Korea.