Korean regulatory reforms announced in response to the 11 November mini-crash are an important step toward the creation of a more resilient financial system, but will require adjustments by the institutional market in the short term, sources say.
“The regulations that we are going to implement are intended to prevent speculative and arbitrage transactions and abnormal transactions. We don't think institutional trading will be negatively impacted,” said Ernst Lee, a spokesperson for Korea's Financial Services Commission (FSC).
“There has not been much resistance from the market in accepting these regulations. In Europe and America, there's a very strong trend by regulators toward product standardisation. In Korea, we do give the freedom in the ”manufacturing' of the product, but the new measures represent minimum protection and guidelines that the market has to accept to secure transparency and stability in the market.”
Anshuman Jaswal, senior analyst, capital markets at Celent, said institutional market participants might find the new changes slightly difficult to cope with initially. “But our experience has been that if the financial system becomes more robust as a result of such changes, both institutional and retail investors do not mind incurring some costs,” he said. “Similarly, we do not see this becoming a deterrent in the development of the institutional market and these measures would indeed become standard in exchanges worldwide.”
On 11 November 2010, the expiry of KOSPI options and a huge foreign sell order drove market turnover to an 18-month high of 9.3 trillion Korean won. A single trade that went through in the last minute of activity made up about 14% of total KOSPI volume that day, and caused the index to plunge 2.4% to 1,916.57. Following an investigation into Wise Asset Management and Deutsche Bank's brokerage unit, the Financial Supervisory Service (FSS) and the FSC jointly issued “regulatory follow-up measures for November 11 stock market plunge” on 11 January 2011 that stated foreign investors of Deutsche Bank's South Korean securities unit held about 43,000 contracts and Wise Asset Management about 35,000 contracts on 11 November.
The FSC/FSS statement announced revisions to margin rules and the requirement for KRX members to set daily order limits for each of their qualified institutional clients based on their total assets, size of assets under management, credit worthiness, and other financial conditions under new guidelines to be developed by the Korea Financial Investment Association, a non-profit self-regulatory organisation whose role is to ensure the fair trading of securities and investor protection, as well as helping to develop the country's capital markets and investment services industry.
The new rules would also require pre-trade margin deposits for qualified institutional investors with less than 500 billion Korean won in total assets or financial investment managers with less one trillion won in collective investment assets. Currently, most qualified institutional investors are allowed to put up deposit margins post-trade. Under the new rules, speculative positions in options and futures for institutional investors will be limited to a maximum of 10,000 contracts per day, with no limit imposed on hedging and arbitrage positions in options and futures. Currently, the cap on investors' positions applies only to speculative futures contracts, with institutional investors being limited to 7,500 contracts per day and retail investors restricted to 5,000 contracts after the end of the trading day. On option expiry dates, positions in KOSPI 200 options and futures for an institutional investor will be limited to 10,000 contracts, regardless of the nature of such positions (speculative, hedging and arbitrage trading). This is the equivalent of about 1.3 trillion won in spot-market trade.
“The announcement we made on post-trade margin payment, setting daily order limits, the position cap and reporting of larger holdings has stabilised market conditions. Transparency is something we expect to improve,” said the FSC's Lee.
Celent's Jaswal said the Korean measures are similar to those being adopted by some exchanges in the west, and already in place in Indian exchanges. “The idea is to reduce systemic risk and I believe they should go some way in ameliorating the same. This is not a fool-proof solution, but it is important if the financial system has to be made safer, and has to be complemented with other measures to improve accountability and transparency in the capital markets,” he said.
On 31 January, the KRX released its “amendment of program trading rules and random-end rules for KRX stock markets” which reaffirmed the FSC/FSS measures. On 9 February, this was followed by the “revision of regulations related to ex-post margin system and position limit”.
The revision of position limits will be put into practice on 7 March 2011 and the new ex-post margin system will take effect on 28 March.
“Most of these moves look prudent,” one head of Asian trading at a global buy-side investment firm commented. “If Wise Asset Management had to put the margin upfront, they probably wouldn't have made the size bet that they did.”
The Korean market as a whole is highly retail-dominated although there has been growth in institutional trading in recent years. According to a KRX study, the number of participants in the derivatives market using systemic trading methods, including algorithmic trading, increased in 2009 with 35% of domestic institutional investors and 76.5% of foreigners utilising DMA and algorithmic trading.