Jong-Hyung Lee

Securities Lending & Borrowing Team

Korea Securities Depository

Korean SLB Market & KSD SLB Service

E-Mail : sbl@ksd.or.kr

2

SLB Transaction - Overview

� Definition

� The lending of securities by an institution to another for a certain fee

� Legal Characteristics

� Ownership of the loaned securities is transferred from the lender to

borrower

� Lender is entitled to all economic benefits from the loan securities

excluding voting rights

� Function

� Settlement coverage

� Means of arbitrage

� Means to enhance capital market stability and efficiency

Transaction Flow - Settlement Coverage

Non Member

Stock

Brokerage

Member

Stock

BrokerageBuy

Sell

Non

Member

Stock

Brokerage

Institutional settlementSettle

Instruction

mismatch or

time lagCustodianForeigner

Borrow stockLender

Intermediary

KSD

Sell order

Transaction Flow - DR Arbitrage

BorrowerLender

Cost Neutral

Investment maturity: 10 days

Currency exchange risk: Hedged

Current Stock Price: 103,000 Won

ADR Price: 99,000 Won

AssumptionAssumption

ADR

Spot Market

Long

Borrow underlying stock

Short borrowed stock

DR conversion to stock

Return borrowed stock

Transaction Flow - CB/BW Arbitrage

BorrowerLender

Cost Neutral

Investment maturity: 10 days

Current Stock Price: 103,000 Won

Conversion Price: 99,000 Won

AssumptionAssumption

CB

Spot Market

Long

Borrow underlying stock

Short borrowed stock

CB conversion to stock

Return borrowed stock

Transaction Flow - Futures Arbitrage

BorrowerLender

Cost Neutral

Investment maturity: 20 days

Current KOSPI 200 Index: 110

KOSPI 200 Futures Index: 108

AssumptionAssumption

Futures

Spot Market

Long

Borrow underlying stock

Short borrowed stock

Settlement by Index

Return borrowed stock

Backwardation (Basis -2)

7

SLB Market - Development

� SLB market opened (Aug. 1996)� KSD is firstly authorized as SLB intermediary

� KSFC (July 2000) and securities companies are allowed to act as SLB intermediary. (Sep. 2000)

� SBL by Foreign investors was allowed (July 1998)� Non-residents first began SLB transaction in Nov. 2001

� Approval system changed into Prior reporting system from Jan. 2006

� Borrowing limit without BOK Prior reporting increased to KRW 50 billion from KRW 10 billion from Jan. 2008

� Securities borrowing by indirect investment vehicles and banks was allowed (May 2006)

� Foreign currency & Foreign securities added as eligible SLB collateral from April. 2008

8

SLB Market - Growth

<SLB Balance(Stock)>

0

100

200

300

400

500

600

700

S-

96

F-

97

J-

97

D-

97

M-

98

O-

98

M-

99

A-

99

J-

00

J-

00

N-

00

A-

01

S-

01

F-

02

J-

02

D-

02

M-

03

O-

03

M-

04

A-

04

J-

05

J-

05

N-

05

A-

06

S-

06

F-

07

J-

07

D-

07

million shares

Total KSD Securities Companies

9

SLB Market -

Growth (C

ont’d

)

<SLB Transactio

n Volume(Stock)>

0

50

100

150

200

250

96/09

97/02

97/07

97/12

98/05

98/10

99/03

99/08

00/01

00/06

00/11

01/04

01/09

02/02

02/07

02/12

03/05

03/10

04/03

04/08

05/01

05/06

05/11

06/04

06/09

07/02

07/07

07/12

million shares

Total

KSD

Securitie

s Companies

10

SLB Market –

SLB & KOSPI

KOSPI

(Unit : 1

00 millio

n KRW)

2005. 0

1~

2007. 1

2

0

500

1000

1500

2000

2500

2005 1

2005 2

2005 3

2005 4

2005 5

2005 6

2005 7

2005 8

2005 9

2005 10

2005 11

2005 12

2006 1

2006 2

2006 3

2006 4

2006 5

2006 6

2006 7

2006 8

2006 9

2006 10

2006 11

2006 12

2007 1

2007 2

2007 3

2007 4

2007 5

2007 6

2007 7

2007 8

2007 9

2007 10

2007 11

2007 12

0 50,000

100,000

150,000

200,000

250,000

11

SLB Market - SLB & KOSPI (Cont’d)

KOSPI (Unit : 100 million KRW)

2008. 06. 02 ~ 2008. 06. 30

255,000

260,000

265,000

270,000

275,000

280,000

285,000

290,000

2008/ 06 / 0220

08/ 06 / 0320

08/ 06 / 0420

08/ 06 / 0520

08/ 06 / 0920

08/ 06 / 1020

08/ 06 / 1120

08/ 06 / 1220

08/ 06 / 1320

08/ 06 / 1620

08/ 06 / 1720

08/ 06 / 1820

08/ 06 / 1920

08/ 06 / 2020

08/ 06 / 2320

08/ 06 / 2420

08/ 06 / 2520

08/ 06 / 2620

08/ 06 / 2720

08/ 06 / 30

1550

1600

1650

1700

1750

1800

1850

1900

12

SLB Market – SLB & Market volume

1.4%12,326,358170,8312005

2.7%12,759,944348,8182006

4.1%18,622,701760,9642007

Ratio (Value)

Market VolumeSLB VolumeYear

(Unit: 100 million KRW)

13

SLB Market - Regulations (Intermediaries)

� Securities Companies, Korea Securities Finance Corporation (KSFC) and KSD are allowed to act as SLB intermediaries

� SLB Regulations for Securities Companies� Regulation on the Supervision of Securities Business

– Method of Brokerage: Direct & Indirect intermediation

– Collection of Collateral: Securities & cash

– Administration of Collateral: Directly or entrust to KSD, trust company, etc

– Delivery of Securities : DVP by KSD book-entry transfer

– Disclosure of Transaction Details: KSDA disclosure & FSC reporting

� KSDA Standard Agreement on Loan Transactions for Securities

� KSFC and KSD SLB operations are conducted according to internal regulations� KSD Regulation on Intermediation of Securities Lending & Borrowing Transactions

� The SLB business of KSD and KSFC will be directly regulated by FSS with the enactment of Capital Market Consolidated Act from Feb. 2009

14

SLB Market – Regulations (Participants)

� Participants Regulations & SLB Scope

LendingRegulation on the

Supervision of Insurance

Business

Insurance

Company

Lending / BorrowingSecurities & Exchange ActSecurities

Companies

Lending (within 50% of total

asset value)

Borrowing (within 20% of

total asset value)

Indirect Asset Management

Act Enforcement Decree

Fund

Lending

Borrowing for hedging, fail-

cover & arbitrage

MoFE OrdinanceBanks

ScopeRegulationParticipant

15

SLB Market - Regulations (Short Sale)

� Stock Short Sale Restrictions

� Only “covered” short sale is allowed

– Sale which delivery is possible by T+2

– Sale of borrowed securities

– Sale of securities which return is confirmed by settlement date

� Up Tick Rule

� Short sale allowed when the trade price is not lower than the

previously traded price

� Up tick rule exemptions

– Index arbitrage transaction

– ETFs sale & arbitrage transaction

� Bond Short Sale Restrictions

� Only securities companies can sell short

16

KSD SLB Service - Timeline

0% of collateral level allowed for customized transactionsDec. 2002

Intermediary fee is reduced (5%→2%)Nov. 2001

Loan term of settlement coverage transaction shortened

(T+5 →T+2)Mark-to-market applied to bond collateral

July 2001

Bid-offer and customized transactions introduced

Rollover service introduced Mar. 2000

Eligible securities expanded to listed bondsSep. 1998

Eligible securities expanded to KOSDAQ stocksNov. 1997

KSD opened SLB market for the first time in Korea

� eligible securities : KOSPI stocks only

� fee rate : fixed fee rate in accordance with loan term

� transaction type : settlement coverage transaction only

Aug. 1996

17

KSD SLB Service - Timeline (Cont’d)

Lowered collateral level for securities companies

� 102% →100% ( only in case of bond SBL transaction)Jun. 2005

SLB service revised

� Rollover for settlement coverage transaction introduced

� Eligible securities expanded to ELW

� Securities borrowings by funds and banks allowed

July 2006

Provided SLB consulting service for Thai Securities

MarketJun. 2005

Adjusted hair-cuts ratio for security collateralFeb. 2004

Partial return service introducedJuly 2003

Arranged transaction introducedFeb.2003

18

KSD SLB Service - Timeline (Cont’d)

Foreign currency collateral system launched

� USD & Treasury bonds added as eligible collateral for SLB

transactionApril 2008

SLB fee calculation method revised

� Transaction based monthly calculation replaced with mark-to-

market method

New bond SLB transaction type launched

� T+1 settlement transaction added

Jan.2008

19

KSD SLB Service - Overview

� Market Participants

� Lenders : Foreign investors, Institutional investors including

investment-trust companies, banks, insurance companies,

mutual funds and pension funds

� Borrowers : Foreign investors, Securities companies, etc.

� Intermediary : KSD

� Advantages of KSD’s SLB Service

� Access to wide range of lenders and borrowers

� Collateral management and corporate actions know-how

� Guarantee of settlement by KSD ensures stable SLB

transactions (customized transactions excluded)

20

KSD SLB Service - Eligible Securities

� Stocks

� KRX listed stock

� Bonds

� Listed bonds (Government bonds, municipal bonds, special

bonds, corporate bonds etc)

� Exchange Traded Funds (ETF)

� Equity Linked Warrants (ELW)

21

KSD SLB Service -Transaction Type

� Settlement-Coverage transaction

� Used to cover market settlement fails.

� Bid-Offer transaction

� Anonymous transactions with KSD as counterparty.

� Customized Transaction

� The lender and borrower decides the conditions and transacts

via KSD.

� The lender is the pledgee for the collateral.

� Arranged Transaction

� The lender and borrower decides the conditions and transacts

via KSD.

� KSD is the pledgee for the collateral and guarantees settlement.

22

KSD SLB Service - Transaction Type (Cont’d)

PossiblePartial

Return

― Application and consent 3 business day prior to the maturity date

― In settlement coverage transactions, application and consent is possible

until the maturity date

Rollover

- Both borrower and lender

- In case of recall, the borrower must return the

shares within 3 business days (4 business days for

recalls after 12:00p.m.)

Only for borrower Early

Termination

Lender KSD Pledgee

Mutual

agreement 100~110% according to participants credit rate

Collateral

rate

Decided between trade parties Bid-offer Bid-offer(25% max)Fee rate

1 year 3 business days Period

Investment strategyFail coverage Objective

Customized Arranged Bid-Offer Settlement Coverage

Division

23

KSD SLB Service - Transaction Flow

KSDBorrower Lender

Borrower

A/C Book

Lender

A/C Book

1)Application1)Application

2)Collateral

3)Matching

Report

4)Credit (+) 4)Debit (-)

3)Matching

Report

1) Application and Matching: Trades are matched when the conditions of the

lender and borrower are met

2) Collateral: The borrower provides the required collateral in cash or

securities to the pledgee

3) Matching Report: The lender and borrower are notified of the trade details

as soon as the trade is matched

4) Delivery: Once the collateral is pledged, the SLB securities are transferred

by book-entry from the lender’s account to the borrowers account

24

KSD SLB Service - Collateral Management

� Collateral Requirement

� Borrowed securities

� Rights from borrowed securities (Rights issue, bonus shares,

dividends, etc)

� Fees (SLB fee+ intermediary fee)

� Collateral Ratio

� The collateral ratio is 100~110% depending on the participants

credit status rated by KSD (excepting customized transactions)

� Pledgee

� Customized Transactions: Lender

� Bid-offer, settlement coverage, arranged transactions: KSD

25

KSD SLB – Collateral Management (Cont’d)

� Eligible Collateral and Evaluation Rate

� KRX-listed stocks : 70% ~ 80% of previous day’s closing price

� Bonds (BBB or higher) : 80% ~ 100% of market price

� ETFs : 80% of previous day’s closing price

� Cash : 100%(Rebate is paid to borrower)

� Marking-to-market

� Collateral is marked-to-market daily to account for the changes in

the price of the loan securities and collateral securities

� Exchange of Collateral

� When the collateral securities loses value or liquidity due to

bankruptcy, composition, liquidation of the issuer.

� When submission of the securities is required due to maturity, stock

split & merger, etc.

26

KSD SLB Service - Termination

� Return at Maturity

� Borrower must return the same amount of the same securities at

the end of the SLB period

� Cash return is possible in case of bond SLB transactions when it

is difficult to return the securities, but an additional charge (1% of

previous day’s market price) must be paid

� Early return

� Lenders or borrowers can terminate SLB transactions at any

time during the SLB period by recalling or returning the securities

� Rollover

� Rollover is possible with the consent of the lender

27

KSD SLB Service - Corporate Actions

� Principle

� The lender is entitled to all economic benefits from the loan

securities excluding voting rights. (Lenders cannot exercise

voting rights since ownership is transferred to the borrower, so

the securities must be recalled in order to exercise voting rights.)

� Cash Dividends, Bond Interest, Payment for Fractional

Shares

� The borrower pays the economics benefits of the loan securities

to KSD, who then relays it to the lender

� Stock dividends, Bonus Shares

� The borrower must deliver the shares to the lender within 3

business days of the listing date

28

KSD SLB Service - Default

� Default Events

� The borrower is unable to return the loan securities or deliver the

entitlements derived from the loaned securities

� The borrower is unable to supplement insufficient collateral

� Default Rules

� Customized Transactions : The lender liquidates the collateral to

cover the loss

� Bid-offer, Arranged of Settlement Coverage Transactions : KSD

liquidates the collateral to settle the transaction, and afterwards

claims indemnification from the borrower

29

KSD SLB Service - Fees

� SLB Fee

� Fee paid by the borrower to the lender via KSD

– Closing price of the previous day x quantity x fee rate x SLB period /

365

� In case of settlement coverage transactions, a fee of KRW 30,000

is collected in case the SLB fee is KRW30,000 or less

� Intermediary fee

� Fee paid by the borrower and the lender to KSD, the intermediary

– SLB fee x 2%

– The intermediary fee is 2bp per annum in case the SLB fee rate is less

than 1%

� If the SLB fee is KRW 30,000, the borrowers pays KRW 3,000 as

the intermediary fee

30

KSD SLB Service - Taxation

� KSD withholds taxes on SLB income and delivers them to

the National Tax Service (NTS)

� Non-residents are taxed according to rates set by tax treaties

between their country of residence and Korea.

� Taxes are imposed on

� Bond interest (interest income)

� Stock dividends (dividend interest income)

– Manufactured dividend payments of SLB transaction between non-

residents are exempt from withholding tax.

� Interest on cash collateral (interest income)

� SBL fees (other income)

31

Statistics - Transaction Amount

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

(Million Shares)

2003 2004 2005 2006 2007

<SLB Volume>

Local Foreign

56%

57%

82%

90%

91%

32

Statistics - Transaction Amount (Cont’d)

0

10

20

30

40

50

60

70

80

KRW 1000 Billion

2003 2004 2005 2006 2007

<SLB Value>

Local Foreign

65%

64%83%

89%

90%

33

Statistics - Transaction by SLB Type

<Local Investors>

23.7% 27.1%

46.1%

3.1%

CustomizedCustomizedCustomizedCustomized ArrangedArrangedArrangedArranged BidBidBidBid----OfferOfferOfferOffer Fail CoverFail CoverFail CoverFail Cover

Year 2007

34

Statistics - Transaction by SLB Type (Cont’d)

<Foreign Investors>

94.3%

1.7%

3.9% 0.1%

CustomizedCustomizedCustomizedCustomized ArrangedArrangedArrangedArranged BidBidBidBid----OfferOfferOfferOffer Fail CoverFail CoverFail CoverFail Cover

Year 2007

35

Statistics - Top 5 SLB Stocks

11,847 (0.7%)KT Corp.184,805 (5.2%)Korea Exchange

Bank

10,766 (0.7%)Hynix

Semiconductor282,562 (5.1%)

HynixSemiconductor

5,693 (0.4%)KEPCO363,413 (3.9%)KIA Motor

4,469 (0.3%)Shinhan Financial

Group460,875 (3.7%)

Woori Financial Group

3,958 (0.2%)Woori Financial

Group552,772 (3.2%)LG.Phillips LCD

VolumeStockVolumeStock

LocalRank

Foreigner

Year 2007 (Unit: Thousand Shares)

36

Statistics - Lending Ratio

0.2%1,6285,079,000Other

Local1.3%9,74675,054,457

Securities Company

0.1%9051,561,979Bank

13.6%103,482322,929,615Sub-Total

100%760,9641,693,098,998Total

86.4%657,4821,370,169,383Foreign

5.6%42,45397,220,721Asset

Management

6.4%48,750144,013,458Pension Funds

Ratio (Value)

Value (100 million won)

Volume (Shares)

Division

Year 2007

37

Statistics - Borrowing Ratio

0.0%2601,780,350Other

Local8.6%65,129134,724,865

Securities Company

0.5%3,9473,288,059Bank

9.3%70,688142,986,470Sub-Total

100%760,9641,693,098,998Total

90.7%690,2761,550,112,528Foreign

0.2%1,3523,193,196Asset

Management

---Pension Funds

Ratio (Value)

Value (100 million won)

Volume (Shares)

Division

Year 2007

38

SLB market – Issues

� Foreign Ownership Limit

� Foreigners are not allowed to borrow securities that are subject to

ownership limits for foreigners from local investors.

� FSS regulation on foreigners’ securities trading

� Prior Reporting System

� Foreigners who want to borrow securities exceeding KRW 50

billion from local lenders should declare the details to BOK before

actual borrowing

� Institutional investors needed to actively participate in SLB

market

� Borrowing by indirect investment vehicles is limited to 20% of total

asset value of each fund

� Unclear regulatory treatment for SLB transactions by banks

39

SLB market – Issues (Cont’d)

� SLB Market Segmentation

� Korean SLB market is divided by several SLB intermediaries.

� Rules or regulations can be different for each intermediary.

� Recall request for shareholders’ meeting

� Long-term borrows may be difficult

� High concentration of end-of-year recalls by major lenders limits

stock availability

40

SLB Market - Future prospect

� Improvement of SLB Environment for Foreign Investors

� Limit for borrowing from residents is expected to increase

� Prior-reporting is expected to be replaced by post-trade reporting

or abolished

� F/X market is scheduled to further liberalize by 2009

� Achievement of More Balanced Market

� Not only foreigners but local institutional investors will proactively

respond to the growing Korean SLB market

� Further growth of SLB market

� Growth of hedge fund with the enactment of Capital Market

Consolidated Act (from Feb. 2009~)

� Establishment of SLB system for individual investors

41

Thank you.