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Taiwan Bond & Private Repo Market

Taiwan Bond & Private Repo Market. Taiwanese Government Bond Market. Holders of Government Bonds. *. * Only 4 insurance companies are licensed government bond auction dealers since 2001. . Date: 2006 Source: CBC. Over-the-Counter Phone Quotation .

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Taiwan Bond & Private Repo Market

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  1. Taiwan Bond & Private Repo Market

  2. Taiwanese Government Bond Market Holders of Government Bonds * * Only 4 insurance companies are licensed government bond auction dealers since 2001. Date: 2006 Source: CBC

  3. Over-the-Counter Phone Quotation Electronic Bond Trading System (EBTS) Period: 2006 Source: GreTai Securities Market, KGI Securities Break Down of Trading Volume

  4. Total Trading Volume* *means the sum of transactions through Over-the-Counter Phone quotation and EBTS Period: 2006 Source: GreTai Securities Market, KGI Securities Break Down of Trading Volume

  5. Taiwanese Government Bond Market Monthly Turnover of Government Bonds Unit:NT$ Billion * Government bonds only ** Repo volume (of government, corporate and supranational NT$ bonds) Source: Statistics from OTC

  6. Government Bond Market Government Bond Outright / Repo Market Phase I (1988~2000) : Repo Development Period (Stimulate liquidity and encourage market participation) Average daily outright trading volume: NT$ 32 Billion Average daily repo trading volume: NT$ 182 Billion Average daily outright trading volume: NT$ 6 Billion Average daily repo trading volume: NT$ 72 Billion In Billion NTD Period: 1993.1 to 2000.12 Source: GreTai Securities Market

  7. Government Bond Market Government Bond Outright / Repo Market Phase II (2001~Present) : New Product Development Period (Rely on ample liquidity of repo and outright transactions) Average daily outright trading volume: NT$ 182 Billion Average daily repo trading volume: NT$ 177 Billion In Billion NTD Period: 2001.1 to 2006.12 Source: GreTai Securities Market

  8. Private Repo Market Taiwanese Bond Repo Market Composition Stage 2 2004 According to asset management companies and securities houses estimations~ • Repo Counterparties Composition Repo Bond Fund 70~80% Individual 0~5% Corporation 10~15% Financial Institution 10~15% Individual 50~55% Corporation 20~30% Financial Institution 10~15% • Bond Fund Investors Composition Booming Period of Bond Fund RP End Investor Simulation Individual 35~50% Corporation 25~40% Financial Institution 15~25% 1997 Stage 1 According to 3 major bill houses’ experience~ Brewing period of Bond Fund RP Counterparties Composition Individual 50~60% Corporation 10~20% Financial Institution 20~30% 1994 Birth of Bond Fund Before Birth of Bond Fund

  9. Private Repo Market Taiwanese Bond Repo Market Composition Stage 3 current According to asset management companies and securities houses estimations~ • Repo Counterparties Composition Repo Bond Fund 50~55% Individual 10~15% Corporation 15~20% Financial Institution 15~20% Post-Bond Fund Period Individual 40~45% Corporation 30~40% Financial Institution 15~20% • Bond Fund Investors Composition Individual 30~40% Corporation 30~45% Financial Institution 20~30% • RP End Investor Simulation 2004 • Bond fund size dropped to NT$ 1.10 trillion on the end of 2006 from NT$2.47trillion in 2004

  10. Private Repo Market Background of Taiwanese 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. Private Repo Regulation Regulation for Securities Dealers’ Repo Counterparties Rules Governing Over-the-Counter RP/RS Transactions by Taiwan GreTai Securities Market 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. • 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. Taiwanese Bond Repo Market Limitation on Amount of Outstanding Repo for Financial Institutions Securities Houses: • 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 Banks: • No limit • Required to maintain 7% liquidity reserve requirement on outstanding repo agreements Bill Finance Companies: • Total reverse repo positions should be no more than 4 times net worth • Total liability should be no more than 14 times net worth

  13. Private Repo Regulation Taiwanese Bond Repo Market Practices Acceptable Repo Collateral (not stipulated by authority*) Value of Repo/Reverse Repo Collateral • Government Bonds • Corporate Bonds (including Convertible Bonds) • Bank Debentures • Supranational Bonds • Securitization Products • 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. *The authority is GreTai Securities Market (OTC), which is governed by the Securities and Futures Bureau (SFB).

  14. Taxation Business Tax Securities Transaction Tax Capital Gains Tax Interest Income Tax None None None Government & CorporateBond • Accrued basis for institutional investors • Cash basis for individual investors* Supranational Bond • Offshore interest income for individual investors is exempt from income tax. • Accrued basis for institutional investors. Repo • If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals • Accrued basis for institutional investors None as long as no dividend/interest paid** Bond Fund * 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.

  15. Taiwanese Government Bond Market Volatility of 10Yr Government Bonds Max = 30.7 bps Min = 0.05 bps Average = 3.5569 bps Period: 2002 to 2006 Source: KGI Securities

  16. Repo Market in U.S. U.S. Government Securities Dealers’ RP & RS Average Daily Outstanding as a % of U.S. Treasury Securities Outstanding $ Billion * 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

  17. Repo Market in U.S. Position of Investment Banks Classification Source: Annual reports of Merrill Lynch and Lehman Brothers

  18. Vitalizing REPO

  19. Vitalizing REPO Long Position • Spread Trade • Matching Long Term Bond with Private REPO. • 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.

  20. Vitalizing REPO Short Position • Use REPO as a channel to borrow bond. • Use borrowed bond to sell short in secondary market 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. 2006.12.31 2005.12.31 2004.7 deadline for bond funds to dispose of structured bonds deadline of bond funds transformation UIT event “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 puttingtotal redemptions at over NT$200bn,or around 10% of total market fund size, in the week following the incident.

  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. The total size of bond funds is shrinking continuously Bond fund size Repo rate Unit: NT$ trillion Unit: % Source：KGI Securities Source：KGI Securities • 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 toprevent 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

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