11. Session 5 Jeong KOR PPT

ADB-OECD Workshop on Enhancing Fin

ancial Accessibility for SMEs

2013/3/7 Session 5

1

The Potency of the SME Bond

Market in Korea

HeeJoon Jeong(Jeonju University, Korea)7 March 2013

The First ADB-OECD Workshop on

Enhancing Financial Accessibility for SMEs

6-7 March 2013

Auditorium C-D, ADB HQ, Manila

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3

Recent Development in SME Bond Market2

1

1.1 Introduction 1.2 Before the Asian Financial Crisis1.3 After the Asian Financial Crisis

Overview

2.1 Worsened Market Situation for SME Bond Issuance2.2 Vicious Circle of SME Bond Markets2.3 Bond Market and Capital Structure of Firms

Policies and Future Development

3.1 Qualified Institutional Buyer (QIB) System3.2 Listing for the Small Size Public Offering3.3 Fund Specialized in SME Bond Investment

Development of Korean Bond Market



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Overview

1

1.1 Introduction 1.2 Before the Asian Financial Crisis1.3 After the Asian Financial Crisis

Development of Korean Bond Market

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I. Development of Korean Bond Market

1. Introduction

The SME bond market is actually the part of corporate bond markets.

To understand the present situation of the corporate bond market, it is

necessary to know its past and the whole bond market.

Bond markets in Korea started in early 1950s.

The corporate bond markets emerged actually in 1972 with the introduction of public offering issuance

History of Korean Bond markets can be classified into several sub periods according to various perspectives.

The most generally accepted historical classification in Korea is the period before Asian financial crisis in late 1990s and the period after the crisis.

(2) Historical Classification

(1) Background



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Until the late 1960s : the corporate bonds had been intermittently issued in private placement. But the issuance amount was not significant.

1968, The Capital Markets Promotion Act : enacted to vitalize corporate financing with the securities issuance by public offering.

: Based on the act, the Public Corporation for Investment Development was established in order to implement the primary capital market promotion policy.

1972, Introduction of Public Offering: non-guaranteed corporate bond was issued in the form of public offering for the first time in Korea.

: However, during the period, it was not easy for the business firms to issue the corporate bonds with their own credits.

2. Before the Asian Financial Crisis


(1) Market Development

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<Figure 1> Overall Outstanding of Listed Bonds(1972-1997)

The average growth rate of corporate bond before the Asian Financial Crisis : 57.0% per annum

The average growth of public bond : 38.2% per annum these growth rates have diminished to mid 20% in 1990s.

6.8 4.2

11.7

23.7

29.7

40.6

55.6

65.0 64.8 60.7

57.0 59.1

55.8

60.5

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39.9

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50.2 47.6

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Corporate Bond(A) Public Bond(B) A/(A+B)%

Trillion KRW %

Source : KRX



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<Figure 2> Corporate Bond Issued and the Share of Guaranteed Bonds(1972-1997)

The introduction of repayment guarantee system : steady but remarkable growth of outstanding amount in corporate bond: During 1980s, the share of guaranteed bond above 90% on average The increase of non-guaranteed bonds in mid 1990 : by relaxation of issuance amount limitation and the improved market conditions

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49 51

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Guaranted(A) Non-Guaranted(B) A/(A+B)%

Trillion KRW %

Source : FSS

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The Financial Authorities in Korea have implemented several policies to support the bond issuance of SMEs, especially located in local provinces.


The non listed companies began to be permitted to issue corporate bond with registration.

Korea government strengthened credit support through Credit Guarantee Fund as well as the SME Specialized Bank.

The system put priority on the capital market financing of SMEs and manufacturing companies.

1981 : The Strengthened Support of Credit Guarantee

1991 : Corporate Bond Issuance Scoring

system

1977 : Expansion of Corporate Bond Issuance Qualification

(2) SME Bond Issuance Support Policy



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<Figure 3> Issuance Amount and Ratio by firm size (1980-1997)

The issuance proportion of SMEs in the overall corporate bond markets have been more than 10% until 1996 and was highest in 1992(28.2%)

The issuance proportion of SMEs continued to decrease up to 5.8% in 1997

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15.8

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19.9

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12.9 11.2 11.3

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Large Industry(A) S & M Industries(B) B/(A+B)(%)

Trillion KRW %

Source : FSS

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(3) Limitation

Limitation (제목확인)


Corporate bond market basically has been fostered in order to complement as well as to compete the indirect finance system represented by commercial banks.

But, during the period, the most of repayment guaranty for corporate bond was made based on the loan experiences of bank sectors rather than in accordance with the credit evaluation by underwriting securities companies.

It means that the corporate bond market in those days had its limitation as a dependent entity and

that the securities industry could not stand on its own feet.

The dependency of direct finance sector(securities industry) on the indirect finance sector(commercial banks) worked against the SME bond financing after the Asian Financial Crisis.



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3. After the Asian Financial Crisis


(1) Doldrums of Corporate Bond Market

<Figure 4> Overall Outstanding of Listed Bonds(1972-1997)

Rapid decrease in corporate bond issuance .(Crowding Out Effect): due to the increase in public bond, especially treasury bonds The proportion of corporate bond : highest in 1979(65%) and maintained over 40% before the crisis : continued to decline to about 11% until Global Financial crisis in late

2000s. : since the Global Financial crisis, it recovered to 15% level.

38.4 35.8 30.5 30.1 28.0 25.1 22.4

17.5 14.9 13.0 11.4 11.2 13.3 13.3 14.4 15.3

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Corporate_Non-Financial(A) Corporate_Financial(B) Public Bond(C) A/(A+B+C)%

Trillion KRW %

Source : KRX

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<Figure 5> Bank Loan to Enterprises and Outstanding of Corporate Bond(2003-2012)

Total loan to the business firms by commercial banks was about two times the total outstanding of (non financial) corporate bonds at 2003. The ratio of loan to outstanding continued to increase to 5.3 in 2008. Since then, the ratio has declined but still remains 3.2 at the end of 2012.

(2) Deepened Concentration of Commercial Bank Based Corporate finance

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Bank Loans to Corporates(A)

Outstanding of Corporate

Bonds(B)

A/B

Trillion KRW A / B

Source : Bank of Korea, KRX



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87.2

31.5

5.0 8.6

1.6 1.7 1.3 0.7 0.8 0.9 0.5 0.5 0.1 0.2 0.2 0

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Guaranted(A) Non-Guaranted(B) A/(A+B)%



The Asian Financial Crisis induced the bankruptcy of many business firms and the financial institutions which guaranteed the corporate bonds With this, the issuance of corporate bonds rapidly decreased. Furtherer, only the business firms with reliable credit could issue their corporate bonds(guaranteed bonds : only more or less 1% since 2000).

<Figure 6> Issuance of the Guaranteed and the Non Guaranteed (1997-2011)

(3) Fundamental Change in the Credit Structure of Corporate Bond Issuance

Trillion KRW %

Source : FSS

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0%

20%

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100%

1999

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2012

B<=

BB

BBB

A

AA

AAA

Big companies with high credit rate came to acquire more proportion of the bond issuance in total. This makes it more difficult for low credit rate business firms, which are mostly SMEs, to finance in the bond market. The low grade issuance(≤BB) account for 2~3 % only among the credit products.

<Figure 7> Ratio of (Non-financial) Corporate Bond Issuance by Credit Level(1999-2012)

(4) Issuance Bipolarization of Non-Guaranteed Corporate Bond among Credit Levels

Source : KOFIA



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AAA AA A BBB BB B<=

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Recently, in contrast to the continuous decrease of BBB grade, higher investment grades (AAA, AA, A) have increased their issuance proportion, which reached 94% of total credit issuance in 2012. This polarization among the credit levels are also reflected in the overall outstanding change.(Overvaluation Problem of credit rating in Korea.)

<Figure 8> Ratio of (Non-financial) Corporate Bond Outstanding by Credit Level(1999-2012)

(4) Issuance Bipolarization of Non-Guaranteed Corporate Bond among Credit Levels

%

Source : KOFIA

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(5) Introduction of ABS and SME Bonds

During the early 2000s, the corporate bonds with low credit rates could be issued more actively than the other period in 2000s. Introduction of ABS(Asset Back Securities) in late 1990s: Low credit SME bonds were widely used as underlying assets for the ABS,

increasing bond demand in primary market as well as secondary market.

<Figure 9> Issuance of ABS and Speculative Grade Corporate Bond(2000-2012)

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ABS Corporate Bond Ratio of Speculative Bonds(%)

Trillion KRW %

Source : FSS, KOFIA



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<Figure 10> ABS Issuance Structure and Credit Enhancement

(5) Credit Enhancement _ Introduction of ABS and SME Bonds(Continued)

External credit enhancements: made by Credit Guarantee Fund to increase demand for ABSs Subordinated Tranches with high repayment risks : underwritten by the financial institutions.

These credit enhancements for ABS were structurally different from the guaranty of corporate bonds However, they made very similar effects for the low credit SMEs.

Underlying Assets

(SME bonds)

External credit enhancements

SeniorSPC

Subordinated

Underwriters

PublicInvestors

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Recent Development in SME Bond Market2

Overview

2.1 Worsened Market Situation for SME Bond Issuance2.2 Vicious Circle of SME Bond Markets2.3 Bond Market and Capital Structure of Firms



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1. Worsened Market Situation for SME Bond Issuance

II. Recent Development in SME Bond Market

The proportion of SMEs bond issuance among the total corporate bond market

: about 5% in late 1990, continued to decline : fell down to less than 1% among the total issuance in 2003. In spite of recovery of corporate bond market in late 2000s,

the issuance proportion of SMEs still remains as before

<Figure 11> Corporate Bond(Non Financial) Issuance and SMEs share(1999-2012)

4.9 2.3 3.4 4.4 0.6 0.6 1.0 1.4 2.3 2.4 1.1 0.8 0.8 0.4

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Large Industry(A) S & M Industries(B) B/(A+B)(%)

Trillion KRW %

Source : FSS

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2. Vicious Circle of SME Bond Markets


(1) Doldrums of Corporate Bond Transaction

The slump in the SME bond primary market is directly reflected on the secondary trading

: The proportion of corporate bond trading volume among the whole secondary bond market has decrease and stays 3% level from the mid 2000s

<Figure 12> Corporate Bond(Non Financial) Trading Volume (2000-2012)

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Total Trading Volume(A)

Corporate Bond Trading Volume(B)

B/A(%)

Trillion KRW %

Source : KOFIA



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(2) Bipolarization among the Credits in the Secondary Market

Proportion of low grade(≤BB) among the whole corporate bond trading volume,

: about 9% in 2000, more or less 1% since 2004. 0.1% since 2011. The bipolarization(expansion of above BBB and contraction of BBB)

among the investment credit rates also happens in the secondary market since mid-2000s

<Figure 13> Secondary Trading shares by Credit (2000-2012)

8.9 5.0 1.9 1.4 0.5 0.1 0.7 1.1 2.0 1.0 0.2 0.1 0.1

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BBB

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AAA

%

Source : KRX

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(3) Vicious Circle of Poor Circulation in SME bond Market

When the corporate bond market volume was not so big and the financial institutions are effectively controlled by policy makers, : the government policy for the SME financing tended to work well.

When financial institutions are privatized and market size became big enough,: government intervention come to have its limitation.: For the healthy circulation of money in the SME bond market the market mechanism need to work well

Dilemma on Ambivalent Development Phrase : The Bond market in Korea is too big and decentralized for the

government to effectively control and implement its policy: The Bond market in Korea is still small and less experienced for the

market mechanism to work well based on credit structure.

Vicious Circle of Poor Circulation



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(3) Vicious Circle of Poor Circulation in SME bond Market

Doldrums in the Primary Bond

Market(Difficulty in

Debt Financing)

Slump in the Secondary

Bond Market(Poor Trading

Volume)

Shortage of Bond Demand

Malfunctioningof Price

Discovery Mechanism

Limited Number of Market Players

Underdeveloped Investment Banking

Poor institutional disposal process for the bankrupted and distressed bond

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3. Bond Market and Capital Structure of Firms

Bipolarization among the Credits in the Secondary Market

The (Corporate bond/ Total debt) ratio tends to decline as the debt financing of the business firms tend to rely on the bank loans.

This phenomenon is more severe in the SMEs. : (Corporate bond/ Total debt) ratio of SMEs has been very low

compared to that of large firms and tends to get lower. : Since 2007, the ratio has been 1~2% level.

<Figure 14> (Corporate bond/Total debt) Ratio of Business Firms by Size (2000-2011)

13.7

17.6 16.8

13.7 13.6 14.2 14.6 13.8

10.4 11.2 10.7

11.5

3.0 4.3

2.8 2.6 2.1 1.6 2.1 1.9 1.1 1.5 1.6 1.4

0

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20

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2001

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2011

Large

S & M

Source : Bank of Korea

%



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Overview

3 Policies and Future Development

3.1 Qualified Institutional Buyer (QIB) System3.2 Listing for the Small Size Public Offering3.3 Fund Specialized in SME Bond Investment

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: Benchmarked the Rule 144A in U.S. which has facilitated the financing of prominent foreign enterprises and SMEs in U.S. by exempting the strict registration process on SEC.

1. Qualified Institutional Buyer (QIB) System

III. Policies and Future Development

(1) The Purpose and Introduction(May 2012)

: A professional investors’market specialized in SME bonds

: to expand financing opportunities for SMEs by increasing the liquidity of their bonds and thus decreasing financing cost.

(2) Institutional Background

(3) Eligible Securities

The fixed income securities issued by the SMEs through private placement

: should not exceed 500 billion KRW(Asset size of an enterprise): not to be listed on the exchange: Only Straight Bond(Ⅹ : Option embedded securities such as CB, BW)



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1. Qualified Institutional Buyer (QIB) System


(4)QIB

Definition

QIBs refer to the professional institutional investors who meet a certain level of size(accredited investors), and market savvy(sophisticated investor) enough to take risks with respect to the investment on the eligible securities(SME bonds).

Category

QIBs include banks, insurance companies, financial investment business entities and so on.

The detailed lists

specified in Enforcement Decree of the Financial Investment Services and Capital Markets Act, Regulation on Securities Issuance and Disclosure

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1. QIB System_contiuned


(5) System Structure

System Structure

The securities issued through privately placement have one year transaction limitation in secondary market.(restricted securities)

The eligible securities can be traded without restriction only when the securities are traded only to QIB or between QIBs in the trading platform designated by the financial authorities (Financial Services Commission)

It actually means “FreeBond” operated by KOFIA(Korea Financial Investment Association) in which most of OTC bond transactions are made.

Exceptionally

The designated trading platform

In principle



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How much the QIB system contributes the SME financing depends on : the credit risk management ability of Investment Bankers and

institutional improvement of the system

Credit Risk Management of Investment Bankers : It is required for the investment bankers in Korea to have improved

ability to manage credit risks involved in SME bond investment.

Required Institutional Improvement: Option embedded bonds need to be included in the eligible securitiesfor investors to have stock related return incentive.: The QIB system need to be linked to the stock exchange systems (FreeBoard, KONEX) for investors to easily realize stock related returns.


1. QIB System_contiuned (6) Recent Status

The issuance and trading volume through QIB system is not significant. In spite of its purpose, the benefit from liquidity advantage and eased registration process for the privately placement bond seems not to be attractive enough to attract the investors in the market

(7) Future Development

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<Figure 15> Issuance Amount by Credit

Level(2001-2012)

1. QIB System_contiuned (8) Private Placement Bond Market

Issuance amount of privately placed bond(6 trillion KRW) is quite smaller than that of publically offered bonds(198 trillion KRW) : 2012 However, the proportion of issuance amount and frequency in low grade is much bigger than that of public offerings.

<Figure 16> Proportion of Issuance Frequency(2001-2012)

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%

Source : KOFIA Source : KOFIA



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2. Listing for the Small Size Public Offering


Small Size Public Offering is a way of public offering less than KRW 1Billion without filing a registration statement.

This offering is exempt from filing a registration statement but is required to file simplified reporting documents such as, but not limited to, financial statements, information on the issuer, and the way of soliciting, etc.

Bonds issued through the Small Size Public Offering also can be listed on the KRX(Korea Stock Exchange), which is helpful to the secondary trading of SME bonds

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In the early 2000s, high yield fund which invested the ABSs of which underlying assets were the bonds issued by low credit enterprises regardless of asset size.

High Yield Bond Fund

Recently, the bond funds specialized mainly on SME bond investmentare being designed and planned to launch in near future. The future of these funds is likely to depend on how to take the default risks with portfolio management based on market mechanism (without credit support and intervention of financial authorities)

Bond Fund Specialized in SME Bond Investment

3. Fund Specialized in SME Bond Investment



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Thank You

HeeJoon JeongE_Mail : [email protected]

11. Session 5 Jeong KOR PPT

Documents

Transcript of 11. Session 5 Jeong KOR PPT