FIMA Research Center University of Hawai’i 1

S. Ghon Rhee, K. J. Luke Distinguished Professorof International Finance and Banking

University of Hawai’i

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1. Benchmark Interest Ratesa. Deposit interest rates are serving as benchmark?b. Deposit interest rates are one of the last set of interest rates under controlc. Why very little differences are observed between savings bonds and book-entry bond yields?Savings Bonds: Syndicated Underwriting

Book-Entry Bonds: Uniform Price Auction Method

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Bond Issues in 2001 (Billion RMB)

T-BondsRMB 488.40

(64%)

F-BondsRMB 259.00

(34%)

E-Bonds RMB 14.70

(2%)

Bond Balance in 2001 (Billion RMB)

F-BondsRMB 853.45

(34%)

E-BondsRMB 100.86

(4%)

T-BondsRMB 1561.80

(62%)

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Unit: Billion yuan

Assigned IssueType Secondary Market Amount

Book-Entry 308.35Bonds

Inter-Bank Market 212.35Exchange Market 96.00

Savings Bonds OTC Market 180.00Total 488.35

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2. Multipartite Structure of Government Bond Markets a. Dual Supervisory Structure of Primary Market

T-Bonds and E-Bonds: MOFF-Bonds: PBC

b. Tripartite Structure of Secondary MarketInter-Bank Market under PBCOver-the-Counter (OTC) Market under PBCExchange Market under CSRC

C. Meaning of the OTC Market in China?

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(1996-2001)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

1996 1997 1998 1999 2000 2001

Spot Inter-Bank Spot Exchange REPO Inter-Bank REPO Exchange

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3. Secondary Markets: Money Marketrather than Bond MarketInter-bank Market: REPOs are bond collateral

loans among banksExchange Market: REPOs are short-term

loans among securities companies

Money Market in China has been developedwithout T-Bills and the financing function forcorporate working capital is missing the working capital needs of corporationsFinancing the working capital needs ofcorporations

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4. Missing Links in the Market

a. T-Bills: Maturity Structure of Bonds Issued in 2001

2 years: 4% of total issues3 years: 34% 5 years: 21%7 years: 14% 10 years: 16%

15 years: 3% 20 years: 8%

b. Interest Rate Risk Hedging InstrumentsBond Futures: Banned in 1995Short-term Interest Rate Futures: Not Available

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4. Missing Links in the Market-Continued

c. Foreign Participation in Primary and Secondary Marketsd. Asset-Backed and Mortgage-Backed Securities

e. Municipal Bonds Revenue Source: 1/2 from Municipal Governments Expenditures: 2/3 by Municipal Governments

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Make T-Bond Yields Serve as Benchmark InterestRates

a. Stop MOF’s practice of setting a range of bidding spreads at the primary market auctionb. Introduce T-Billsc. Create Balanced Maturity Structured. Make all T-bond issues fungible

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A Comprehensive Plan for the Government BondMarket Development Will Be Useful to EliminateMultipartite Structures in Primary and SecondaryMarkets

a. Regulatory Harmonization and Functional Delineation among PBC, MOF, and CRSCb. Consolidation of PBC’s Primary Market for F- Bonds and MOF’s Primary Market for T-Bonds and E-Bondsc. Consolidation of Inter-Bank Market and Exchange Market

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Under the current structure, PBC does not serveas “ears and hands” of MOF.a. PBC as the Fiscal Agent for All Government Bonds?b. CSRC as the Market Regulator for Both Primary and Secondary Market?c. Clearing & Settlement by PBC: DVP for All Government Bondsd. Fungible Issuese. Regularity of Issue Cycle

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Mere functional integration cannot achieveconsolidation of three markets into a singlemarketa. Inter-bank market will remain as money market because commercial banks don’t have incentives for spot market transactions b. Exchange market has limitations because automated trading system can not offer pre-trading negotiations and personalrelationships among bond dealers……Korea’s Experience c. OTC market should trade book-entry bonds (not savings bonds) with all types of financial institutions participating

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Unit: $ billion

Exchange Market . Year Gov’t Bonds Corp Bonds Total OTC Market1997 $0.14 $2.25 $2.39 $82.271998 5.42 7.46 12.88 359.171999* 248.87 10.32 259.19 658.322000 18.58 2.88 21.46 736.362001 9.45 1.56 11.01 1,066.44

*KSE Introduced inter-dealer broker system for governmentbond trading in March 1999

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a. Introduction of Financial Futures and Optionsb. Active Trading of Treasury Securities on a

When-Issued Basisc. Expansion of REPO transactionsd. Introduction of the Separate Trading of

Registered Interest and Principal of Securities(STRIPS)

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a. Bond futures market (1986)b. Primary dealer system (1987)c. Interdealer broker network (1987)d. Purely competitive auctions (1987)e. REPOs (1991)f. STRIPS (1991)

Brossard, Philippe, 1998, The French Bond Market: Enhancing Liquidity, Apaper presented at a World Bank Workshop on the Development ofGovernment Bond Markets, June 11-12, Seoul, Korea.

Australia: Reserve Bank Information and Transfer System

Hong Kong: Central MoneyMarkets Unit

Japan: BOJ Financial Network System(BOJ-NET)

Singapore: Government Book-Entry System

China: China Government Securities DepositoryTrust & Clearing Co.

� Most advanced markets allow trading during theperiod between the time a new issue isannounced and the time it is actually issued.a. Ranging from one week to two-weeks (US market)b. As short as two days (France)

� When-issued trading functions like trading in aforward market.

� Major Benefitsa. Minimize price and quantity uncertainties.b. Lower underwriting riskc. Increase revenue from the new issue

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1. Interest Rate Risk Hedging InstrumentsIs Repeat of Pre-1995 Bubble Valid Concern?

2. PBC-Based C&S SystemClearing: Multilateral netting basis

Settlement: DVP through PBC-wire system Anonymity

Is China Government Securities Depository Trust &

Clearing Co. up to the Task?

3. Introduction of When-Issued Trading

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Bonds648.4 (6%)

Cash1255.1 (11%)

Stocks867.8 (8%)

Margin Deposits221.6 (2%)

Insurance193.2 (2%)

Bank Deposits

8,051.3 (71%)

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� By introducing STRIPS, the MOF canprovide the market with highly liquid zero-coupon bonds and notes.

� As a result, STRIPS will:a. expand the investor baseb. improve tracking of effective yield curvec. allow institutional investors to reduce reinvestment risk.

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3. Bond Fund a. Types and Amount of Assets held by Individual Investors

b. Institutionalization of Individual Bond Holdings

4. Inter-Dealer Broker System a. Brings market makers together

b. Disseminates to the market via telephone, screen or a combination of the two

c. Promote secondary market liquidity, depth, transparency

5. STRIPS

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