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1
Taiwan Bond
&
Private Repo Market
2
39 39 42 43 4538 38 36 38 35 35 34 36 40
5 55 5 5
5 5 5 34 3 3 4
5 6 5 4 38 11 16
10 12 1213
1721 18 22
21 20
50 50 49 47 47 49 46 43
28 29 32 29 26 27
2
1113
0%
20%
40%
60%
80%
100%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Bank Securities Bill Finance Insurance Non-GB Dealer
Date: 2006 Source: CBC
*
* Only 4 insurance companies are licensed government bond auction dealers since 2001.
Taiwanese Government Bond MarketHolders of Government Bonds
3
Bill Finance,16.38%
Banks,15.14%
SecuritiesHouses,68.48%
BillFinance,29.95%
Banks,27.02%
SecuritiesHouses,43.03%
Period: 2006Source: GreTai Securities Market, KGI Securities
Over-the-Counter Phone Quotation Electronic Bond Trading System (EBTS)
Break Down of Trading Volume
4
Break Down of Trading Volume
Bill Finance,29.22%Banks, 26.39%
SecuritiesHouses, 44.39%
Total Trading Volume*
*means the sum of transactions through Over-the-Counter Phone quotation and EBTS Period: 2006Source: GreTai Securities Market, KGI Securities
5
* Government bonds only** Repo volume (of government, corporate and supranational NT$ bonds)Source: Statistics from OTC
Unit:NT$ Billion
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
1997
/01
1997
/03
1997
/05
1997
/07
1997
/09
1997
/11
1998
/01
1998
/03
1998
/05
1998
/07
1998
/09
1998
/11
1999
/01
1999
/03
1999
/05
1999
/07
1999
/09
1999
/11
2000
/01
2000
/03
2000
/05
2000
/07
2000
/09
2000
/11
2001
/01
2001
/03
2001
/05
2001
/07
2001
/09
2001
/11
2002
/01
2002
/03
2002
/05
2002
/07
2002
/09
2002
/11
2003
/01
2003
/03
2003
/05
2003
/07
2003
/09
2003
/11
2004
/01
2004
/03
2004
/05
2004
/07
2004
/09
2004
/11
2005
/01
2005
/03
2005
/05
2005
/07
2005
/09
2005
/11
2006
/01
2006
/03
2006
/05
2006
/07
2006
/09
2006
/11
Outright Trading Repo.
Taiwanese Government Bond MarketMonthly Turnover of Government Bonds
6
Phase I (1988~2000) : Repo Development Period (Stimulate liquidity and encourage market participation)
Government Bond Outright / Repo Market
Government Bond Market
0
2,000
4,000
6,000
8,000
10,000
1993
/01
1993
/04
1993
/07
1993
/10
1994
/01
1994
/04
1994
/07
1994
/10
1995
/01
1995
/04
1995
/07
1995
/10
1996
/01
1996
/04
1996
/07
1996
/10
1997
/01
1997
/04
1997
/07
1997
/10
1998
/01
1998
/04
1998
/07
1998
/10
1999
/01
1999
/04
1999
/07
1999
/10
2000
/01
2000
/04
2000
/07
2000
/10
Monthly Outright Trading Volume Monthly Repo Trading Volume
Average daily outright trading volume: NT$ 6 Billion
Average daily repo trading volume: NT$ 72 Billion
Period: 1993.1 to 2000.12 Source: GreTai Securities Market
In Billion NTD
Average daily outright trading volume: NT$ 32 Billion
Average daily repo trading volume: NT$ 182 Billion
7
Phase II (2001~Present) : New Product Development Period (Rely on ample liquidity of repo and outright transactions)
Government Bond Market
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
2001
/01
2001
/03
2001
/05
2001
/07
2001
/09
2001
/11
2002
/01
2002
/03
2002
/05
2002
/07
2002
/09
2002
/11
2003
/01
2003
/03
2003
/05
2003
/07
2003
/09
2003
/11
2004
/01
2004
/03
2004
/05
2004
/07
2004
/09
2004
/11
2005
/01
2005
/03
2005
/05
2005
/07
2005
/09
2005
/11
2006
/01
2006
/03
2006
/05
2006
/07
2006
/09
2006
/11
Monthly Outright Trading Volume Monthly Repo Trading Volume
Average daily outright trading volume: NT$ 182 Billion Average daily repo trading volume: NT$ 177 Billion
Period: 2001.1 to 2006.12 Source: GreTai Securities Market
In Billion NTD
Government Bond Outright / Repo Market
8
Taiwanese Bond Repo Market Composition
Booming Period of Bond Fund
Brewing period of Bond Fund
Private Repo Market
Birth of Bond Fund 19941994
19971997
20042004
Before Birth of Bond Fund
Stage 1Stage 1
According to 3 major bill houses’ experience~
RP Counterparties CompositionIndividual 50~60%Corporation 10~20%Financial Institution 20~30%
According to asset management companies and securities houses estimations~
Bond Fund Investors Composition
RP End Investor SimulationIndividual 35~50%Corporation 25~40%Financial Institution 15~25%
Individual
0~5%
Repo
Corporation
10~15%
Financial Institution10~15%
Bond Fund
70~80%
Individual
50~55%
Repo Counterparties Composition
Corporation
20~30%
Financial Institution10~15%
Stage 2 Stage 2
9
Taiwanese Bond Repo Market Composition
Post-Bond Fund PeriodPost-Bond Fund Period
Private Repo Market
20042004
currentcurrent Stage 3Stage 3
According to asset management companies and securities houses estimations~
Bond Fund Investors
Composition
Individual
10~15%
Repo
Corporation
15~20%
Financial Institution15~20%
Bond Fund
50~55%
Individual
40~45%
Repo Counterparties Composition
Corporation
30~40%
Financial Institution15~20%
RP End Investor SimulationIndividual
30~40%
Corporation
30~45%
Financial Institution20~30%
Bond fund size dropped to NT$ 1.10 trillion on the end of 2006 from NT$2.47trillion in 2004
10
Background of Taiwanese Repo Market
Private Repo Market
RP transactions are de facto tax-free for individuals if the maturity of RP doesn’t cross the interest-paying date. With the high credit protection and tax advantage, repo was the preferred money market instrument for high new worth individuals before the birth of bond funds.
The investment strategy of Taiwanese bond funds is more similar to that of money market funds. Currently, Taiwanese bond funds allocate more than half of their assets in repo transactions.
Accordingly, bond funds had replaced repo as the main tax shelter instrument for high net worth individuals and corporations, because of their high liquidity and attractive returns. However, after the bond fund crisis happened in 2004, some institutional investors withdrew from bond funds to prevent from eventful and capricious risk of bond funds.
Directly and indirectly, individuals and corporations provide 60% to 85% liquidity for Taiwanese bond repo market. The ample liquidity from the repo market encourages securities and bill houses to participate in outright trading.
11
Regulation for Securities Dealers’ Repo Counterparties
Private Repo Regulation
Article 3 Before entering into a RP/RS transaction with a securities dealer, a client
shall provide his/her personal ID card or a copy of his/her business
license [whichever is relevant], then sign the RP/RS Master Agreement.
Opening a securities account is not required.
Rules Governing Over-the-Counter RP/RS Transactions by Taiwan GreTai Securities Market
A securities dealer can be a bank, bill house, or securities house; however, banks and
bill houses are normally licensed to do fixed income related securities business rather
than equity business.
A securities dealer is permitted to engage in repo transactions with individuals,
corporations, financial institutions, and any other juristic person according to the above
regulation.
In other words, individuals and corporations are free to engage in repo transactions
with securities dealers.
12
Total repo or total reverse repo position shall not exceed 6 times net worth
Repo on non-government bonds + other outstanding liabilities shall not exceed 4 times net worth
Securities Houses:
No limit Required to maintain 7% liquidity reserve requirement on
outstanding repo agreementsBanks:
Total reverse repo positions should be no more than 4 times net worthTotal liability should be no more than 14 times net worth
Bill Finance Companies:
Taiwanese Bond Repo MarketLimitation on Amount of Outstanding Repo for Financial Institutions
13
*The authority is GreTai Securities Market (OTC), which is governed by the Securities and Futures Bureau (SFB).
Taiwanese Bond Repo Market Practices
Government Bonds
Corporate Bonds (including
Convertible Bonds)
Bank Debentures
Supranational Bonds
Securitization Products
Acceptable Repo Collateral(not stipulated by authority*)
Securities houses can design their own credit policies, as long as the total market value of underlying securities is kept at a minimum of 90% of total repo liabilities.
Value of Repo/Reverse Repo Collateral
Private Repo Regulation
14
* Note that individuals’ first NT$270,000 interest income are exempt from tax.** Bond fund itself is subject to 10% withholding tax on coupon received.
Business Tax
Business Tax
SecuritiesTransaction
Tax
SecuritiesTransaction
Tax
Capital Gains Tax
Capital Gains Tax
Interest Income Tax
Interest Income Tax
NoneNone
RepoRepo
Bond FundBond Fund
Supranational Bond
Supranational Bond
1. Offshore interest income for individual investors is exempt from income tax.
2. Accrued basis for institutional investors.
1. Offshore interest income for individual investors is exempt from income tax.
2. Accrued basis for institutional investors.
1. If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals
2. Accrued basis for institutional investors
1. If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals
2. Accrued basis for institutional investors
None as long as no dividend/interest paid**
None as long as no dividend/interest paid**
NoneNone
1. Accrued basis for institutional investors
2. Cash basis for individual investors*
Government & Corporate Bond
Government & Corporate Bond
NoneNone
Taxation
15
Taiwanese Government Bond MarketVolatility of 10Yr Government Bonds
Period: 2002 to 2006 Source: KGI Securities
High/Low Spread
0.0000
5.0000
10.0000
15.0000
20.0000
25.0000
30.0000
35.000001
/08/
2002
01/1
1/20
02
01/0
2/20
03
01/0
5/20
03
01/0
8/20
03
01/1
1/20
03
01/0
2/20
04
01/0
5/20
04
01/0
8/20
04
01/1
1/20
04
01/0
2/20
05
01/0
5/20
05
01/0
8/20
05
01/1
1/20
05
01/0
2/20
06
01/0
5/20
06
01/0
8/20
06
01/1
1/20
06
01/0
2/20
07
Date
Bp
s
Max = 30.7 bps Min = 0.05 bps Average = 3.5569 bps
16
24
.8%
29
.4%
35
.0%
42
.8%
41
.2%
43
.5%
51
.6%
62
.8%
70
.2%
87
.4%
11
0.8
%
11
3.6
%
18
.7%
21
.7%
26
.7%
33
.6%
32
.4%
33
.1%
37
.9%
46
.7%
50
.2% 63
.3%
79
.4%
75
.6%
4283.84165.83943.6
3574.93204.9
2967.52966.93281.0
3355.53456.8
3459.73307.2
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%19
95
1996
1997
1998
1999
2000
*200
1
2002
2003
2004
2005
2006
.09
0
500
1000
1500
2000
2500
3000
3500
4000
4500
RP RS Treasury Securities
Repo Market in U.S.Repo Market in U.S.
U.S. Government Securities Dealers’ RP & RS Average Daily U.S. Government Securities Dealers’ RP & RS Average Daily Outstanding as a % of U.S. Treasury Securities OutstandingOutstanding as a % of U.S. Treasury Securities Outstanding
* Corporate securities are included from July 2001.
Figures cover financing involving government, federal agency, and federal agency MBS securities.
Source: Federal Reserve Bank of New York and U.S. Treasury
$ Billion
17
Repo Market in U.S.Repo Market in U.S.
Merrill LynchMerrill Lynch Lehman BrothersLehman Brothers
In Billion
as Dec. 2005
As % of Total
Assets
As % of Total Equity
In Billion
as Dec. 2005
As % of Total
Assets
As % of Total
Equity
RP (Liability) 272.30 39.98% 764.89% 116.16 28.33% 691.84%
RS (Asset) 234.30 34.40% 658.15% 106.20 25.90% 632.52%
Total Assets 681.02 100% 1,913% 410.06 100% 2,442.3%
Total Equity 35.60 5.23% 100% 16.79 4.09% 100%
ClassificationClassification
Position of Investment BanksPosition of Investment Banks
Source: Annual reports of Merrill Lynch and Lehman Brothers
18
Vitalizing REPO
19
Long Position
1. Spread Trade
• Matching Long Term Bond with Private REPO.
2. Use REPO as a channel of future funding.
• Expect bond yield to drop in near future but don’t have enough funding.
• Hold a certain of bond in portfolio.
• Use Bond in portfolio to fund current buying until obtaining new fund.
2.1 Use REPO to leverage our portfolio holding.
Vitalizing REPO
20
Short Position
1. Use REPO as a channel to borrow bond.
• Use borrowed bond to sell short in secondary market
Vitalizing REPO
Enhance bond holding return
• By lending out the holding of bond in portfolio, bond holder can enhance return by collecting fee.
21
Appendix: Bond Fund Crisis (UIT Event)
22
“Crisis of confidence” in the domestic bond funds market and thereafter
In the week of 12 July 2004, United Securities Investment Trust (UIT) adjusted its bond portfolio by reducing exposure in certain areas such as illiquid CBs and structured notes, and as a result, posted a drop in NAV for its three bond funds. UIT was worse hit, and the effects were felt throughout the industry with estimates putting total redemptions at over NT$200bn, or around 10% of total market fund size, in the week following the incident.
2004.7 2005.12.31 2006.12.31
UIT event deadline for bond funds to dispose of structured bonds
deadline of bond funds transformation
23
“Crisis of confidence” in the domestic bond funds market and thereafter
In order to deal with the fallout from the overinvestment in structured products over previous years and to rehabilitate confidence in the Taiwanese asset management industry, the following policy measures and initiatives had been announced:
Bond funds are prohibited from purchasing any structured bonds anymore.
Bond funds are required to dispose of all their structured bonds by the end of 2005.
Bond funds are required to migrate themselves into one of the following three types of funds: Quasi money market funds:
• Bonds make up less than 30% of the assets.
• The tenor of each bond in the assets should not be more than five-years.
• Mark-to-market requirement is waived.
•Weighted average duration of the bonds in the assets should be less than three years. Pure bond funds:
Bonds weigh at least 50% of total assets. They are required to mark-to-market on daily basis. Status-Quo bond funds: (Not favored by FSC)
Bonds weigh 30% to 50% of the assets. Bonds that are purchased by such funds after the beginning of 2006 will have to mark to market.
24
0.5
0.7
0.9
1.1
1.3
1.5
1.7
2003
/01
2003
/04
2003
/07
2003
/10
2004
/01
2004
/04
2004
/07
2004
/10
2005
/01
2005
/04
2005
/07
2005
/10
2006
/01
2006
/04
2006
/07
2006
/10
The total size of bond funds is shrinking continuously
Until the end of 2006, quasi money market funds account for 94.82% of the total bond fund size while pure bond funds and status-quo bond funds account for 0.99% and 4.19% respectively.
The returns of quasi money market funds in general are less attractive than the rising repo rates.
Besides less attractive returns, some institutional investors also withdrew from bond funds to prevent from eventful and capricious risk of bond funds.
Bond fund size dropped to NT$ 1.16 trillion on the end of September 2006 from the top in 2004
0.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.5
2004
/01
2004
/03
2004
/05
2004
/07
2004
/09
2004
/11
2005
/01
2005
/03
2005
/05
2005
/07
2005
/09
2005
/11
2006
/01
2006
/03
2006
/05
2006
/07
2006
/09
SourceSource:: KGI SecuritiesKGI Securities SourceSource:: KGI SecuritiesKGI Securities
Unit:Unit: %Repo rateBond fund size Unit:Unit: NT$ trillion