Securities Markets

October 2010

Korea Exchange

Table of Contents
I. II.

Investment and Securities Markets Floating New Securities (Primary Market) Creating Demand for Securities (Secondary Market)

III.

I. Investment and Securities Markets

Investment and Financial Assets

Essential nature of investment Reduce current consumption

Consume more in the future

Real Assets Assets used to produce goods and services Financial Assets Claims on real assets

Investment and Financial Assets

Consumption Timing
Allocation of Risk Separation of Ownership and Management - Agency Issues

Players in the Financial Markets

Business Firms net borrowers
Households net savers Governments can be both borrowers and savers

Investment Bankers-intermediary

General Classification of A Securities Market

Short-term (Money Market)

CDs, CPs, T-Bills Repos, etc.

Securities Market

Long-term (Capital Market)

Primary Market Secondary Market

Exchange Market OTC Market

Primary Market
ISSUERS INVESTOR

Money Securities

- Corporations, Government

(Money Demanders)

-Individuals, Institutionals

(Money Suppliers)

Payments
(Underwriters)

Subscriptions

INTERMIDIARIES
Underwriting
-Securities Firms, Investment Banks

Sales

Structure of a Securities Market

Securities

Securities

ISSUERS
Fund

INVESTORS

INVESTORS
Fund

Primary Market

Secondary Market

Secondary Market
Regulatory Bodies

Investors (buy-side)

Brokers

Exchange

Brokers

Investors (sell-side)

Securities Depository Banks

Regulation & Supervision

Cash Flow

Securities

Roles of a Securities Market

Mobilizing industrial funds

Pool small & short-term savings and make them available for large & long-term use by corporate sector

Diversified financing choices at lower costs

Equity financing, debt financing Companies can set their own interest rates

Providing a conduit for savings to the public

Diversified investment vehicles - stocks, bonds, derivatives, etc.

Roles of a Securities Market

(contd)

Change of ownership structure and management pattern

Privatization is central to transitional countries economic reforms and developments Shareholders wealth-maximization bring about changes in management patterns

Redistribution of national wealth

Wide distribution of corporate shares induces redistribution of corporate profit

Roles of a Securities Market (contd)

Attracting foreign capital

Credible and well regulated emerging markets

Providing liquidity for savers

Easy conversion of financial instruments into cash

Alleviating poverty issue

Economic growth supported by efficient allocation of resources reduces unemployment, enabling poverty alleviation

Policy Goals in Fostering a Securities Market

Improving corporate financial status

High leverage leads to financial distress and riskier investments

Lowering cost of capital of corporations

Improving corporate governance Enhancing financial market efficiency Ensuring economic equity

Supply-side Policies

Incentives to Go Public
To

issuers

Lower

corporate taxes Preferential bank loans Protection of founders interests ownership ceilings, restrictions on M&A, etc.
To

investors

Discounted

public offering prices Lower income tax on dividend income

Supply-side Policies (contd)

Compulsory to Going Public

Governments order to go public Disadvantages to firms reluctant to go public surcharge in income tax restrictions on loans & borrowings accounting of interest payable (not tax deductible), etc.

Supply-side Policies (contd)

Privatization of SOEs through public offerings

Large-sized SOEs with high profitability & growth potential Full or partial sell-out Discounted selling prices Target middle- & low-income people

Demand-side Policies

Investment Trusts

Convert small investment funds into industrial funds Encourage indirect investments

Securities savings scheme

Eligible for low income bracket people Total investment amount is limited Proceeds is tax deductible

Demand-side Policies (contd)

Employees Stock Ownership Plan (ESOP)

Employees become shareowners of their own companies Certain portion of shares is assigned to employees Companys financial support Employees increased commitment to productivity

Opening securities market to foreigners

Foreign capital inflow Transfer of modern investment techniques

II. Floating New Securities

II. Floating New Securities

Economy Size, Development, Growth Rate

Degree of Market Economy and Corporatization

Attitudes of Business People

Government Enticement including Interest and Tax Policies

II.1. Countries in Transition

State is the only Supplier of Securities

Privatization is Difficult and a Slow Process

Initially the Market is not a Source of Company Financing but a Source of Income for the State
Need for Clear Method of Valuation

II.1. Countries in Transition (contd)

Clear Legal and Institutional Framework to decide the # of Shares available to the Public Listing Privatized Companies As Demand goes up, Share Prices rise. With Government Incentives, then more listing. Need for Good Infrastructure and Regulatory Framework (Underwriting, Broking, Listing) Having Adequate # of Shares to Trade is more Important than the # of Investors

II.1. Countries in Transition

Poland
Go slow, Listing initially only 5 Stocks with High Listing Requirements, a few Years Later, very active IPO Market

Czech

(more politically stable and economically promising)

Listing hundreds companies, however, only 40 Stocks are Active.

Why?
Transparency and the Difference between well Regulated versus Lax Regulation

II.2. Taxation Policies

In Korea, stock market boom in 1984 and 1988. As stock prices rise, the cost of capital declines, which should lead to rising investment opportunities and the need for funds. However, few IPOs and little new financing. Why?
Interest rate ceiling, government implicit loan guarantees, and favorable tax treatment of debt. In 1988 new listing started to pick up.

II.2. Taxation Policies

Few listings until 1987 in Indonesia, Malaysia, and Taiwan because of too high dividends, and manipulated IPO Prices In Korea, Companies tried to match dividend yield to interest rate, which hurt their Financial positions. This forced Companies to stay away from issuing New Shares.

II.3. Maximize floating share

Cross-Shareholding among Chaebols

Percentage of Shares floated out of issued Shares

Monitoring of the # of Shareholders stipulated in the Listing Requirements

II.4. Going public

In rapidly growing Economies, Investments greater than internal Financing Sources

Separation of Ownership and Management. Taxes on transferring Shares must be given special Treatment. Sale of Shares in the Bull Market brings large Cash Flow above Book Value. Capital Gains Issue must be closely examined.

II.4. Going public

Initially Business Owners will be concerned with High Dividend Requirements, Losing Management Control to Outside Shareholders. It may be reasonable for the Government to provide Tax Credit, Financial Support, Corporate Control Protection, and others to encourage Public Offering. Sometimes coercive measure must be taken.

II.5. Incentives for voluntary going public

Tax Incentives : lower Corporate Tax Rate,

Installment Payment of Corporate Taxes, Accelerated Asset Depreciation

Preferential Treatment in Bank Loans and Foreign Funds

Protection of Control of the Firm

II.6. Compulsory measures to go public

Enactment of special Law Force Companies to go public
If violated, no Interest Tax Deductibility, surcharge on Corporate Tax and Individual Income Tax of Shareholders, Restriction on Bank Loans and Issuance of Bonds

Qualified Firms must register and disclose Corporate Information, which encourage sound management. Prerequisite for going pubic

II.7. Going public of joint venture companies

JV with foreigners ownership less than 50% This may spark other Firms to go public.

II.8. Underwriting
In Korea, when the Primary Market was yet developed, Korea Investment Corporation (1968) was established to promote issuance and distribution of shares. Roles of KIC
underwriting, trading, market stabilization, sales agency of stocks owned by the government and private corporation, credit analysis

II.9. Tax incentives (Korea)

Up to 16.6% lower Corporate Tax Rate Additional Depreciation / Bad Debt Allowances Lending restrictions to selected closely held Companies

III.
Creating Demand for Securities

Some factors
# of financially sophisticated individuals with cash to invest # of institutional investors including insurance companies, pension and mutual funds

Relative attractiveness of securities to other investment alternatives

Rules on foreign portfolio investment

III.1. Enhancing Investor Confidence

Lack of securities demand :
lost confidence, inadequate regulations, few institutional investors

Strong supervision :
insider trading issues, stock market manipulations

Exogenous factors :
political instability, social culture, education

Endogenous factors :

inadequate regulatory environment

III.1. Enhancing Investor Confidence

Availability of Corporate Information
Competent securities companies: research on markets and
stocks Information dissemination communication system, research on microstructure of the market Mandatory information disclosure rules in the listing requirements Accounting and auditing practices: only large blue-chip companies may survive When demand for securities is greater than the supply, issuing firms take the situation granted.

III.4. Proper regulation

Deregulating in areas that inhibit operation of an efficient market Strong regulation and supervision in areas that protect shareholders

III.5. Institutional investors

Mutual funds, pension funds, university endowments, insurance companies

In emerging markets, institutional investors play a small role whereas it is contrary in developed markets. It could be due to investment restriction. Nevertheless, they play an important role as liquidity providers

III.6. Institutional investors (contd)

Positive functions
Supplying long-term funds

Stabilizing the market during turmoil

Investment vehicle for small investors Country funds attract overseas funds Educated and knowledgeable investors force the market efficient Monitoring listed companies as influential investors

III.6. Institutional investors (contd)

Negative functions
Enormous power to move the market

Dry up liquidity if stocks were held for a long time

Incentive for government to intervene in management to move the market

III.6. Institutional investors

Popularize
Who can be called institutional investors Minimize restrictions Tax exemption on dividend income

III.7. Retail Investors

Despite of their small ownership in the market, very active in trading Introducing securities savings: preferential treatment (tax deduction, guaranteed return rates) for small investors who fall under certain criteria
Wealth building tool for low income people Accumulating industrial funds Enlarging the investor base

III.7. Retail Investors (contd)

Introducing Employee Share Ownership Plan (ESOP)
As employee shareholders, companies become more stable in their operations and deter any hostile takeover threats Companies allow partial payment or provide loans for stock purchase

Preferential tax treatment

In Korea, the tax rates vary; minority versus majority shareholders or dividend-paying corporations is listed or unlisted. No capital gains taxes on listed securities but not unlisted securities

III.7. Retail Investors

Margin transaction
In Korea, until 1996 it was restricted by the SEC because of its speculative nature. Types of securities credit in Korea: by securities companies to investors for margin trading, by the Korea Securities Finance Corporation to underwriting companies, securities collateral loans by securities trust company

III.8. Foreign investors

From investable fund surplus market to deficit market either directly or indirectly Their contributions: additional resources, modern management know-how and technology, improvement in the market efficiency and service qualities Factors attracting: consistent and predictable regulatory environment, deregulated capital market, width and depth of the market, fit with the global market

III.8. Foreign investors

Factors to be concerned about: repatriation of investment proceeds, voting rights, trading hours, tax consequences Adverse factors: low EPS, high inflation, uncertain exchange rates, unreliable macroeconomic policies and inconsistent regulatory changes, political uncertainty

Kamsahamnida Thank you very much for your attention

Good Luck!

Korea Exchange