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observation status for the 2010 annual review for possible upgrade to developed market status. This followed the MSCI’s re-weighting of the Taiwan stocks in its MSCI AC Asia ex Japan by one full percentage point a month earlier, in May (Liu 2009).
It is significant that the MSCI listed as the reasons why it did not include Taiwan in its upgrade to developed market status along with Israel, which did get promoted, as being due to the absence of a convenient foreign exchange conversion mechanism and the restriction on having a foreign investors’ identification system. This indicates that in the view of the MSCI, Taiwan’s SBL system was not an obstacle to being considered as a developed market. Such a view could mean, during the FTSE’s subsequent reviews, that one of the key factors keeping Taiwan from developed market status, restrictions in Taiwan’s SBL, may now no longer exist.
Given the fact that further bans on shorting were not implemented, it is likely that regulators in Taiwan may see that it is not necessary to repeat the measures in the future, especially as Taiwan’s stock market has appeared to have rebounded during this most recent quarter.
Therefore, from this, and if expressed objectives of officials at the TWSE are true, it can be expected that Taiwan will continue to open up its securities markets, particularly its securities lending market. Still, it is likely that SBL in Taiwan faces more obstacles, despite some promising trends.
For example, while Taiwan’s market showed a remarkable rebound during the end of the first quarter and the start of the second quarter of 2009 due to rapidly improving cross-Taiwan Strait ties, thus bringing in new foreign investment interest, it has at the same time caused the entire financial sector to possible enter into a period of consolidation. This, along with the continued global economic downturn and tighter credit, may continue to hinder the ability of SBL officials to fully empower this important market tool. Therefore, it is not certain that Taiwan has made or even will be able to make the necessary changes in its securities markets that FTSE is requesting. Thus, in the final section of this paper, some conclusions as well as recommendations are offered as to what the next steps for Taiwan’s SBL system should be.
VII. Conclusions and Recommendations
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During economic downturns, it is often common for regulators and market participants to try to find those market players or activities which may have directly or indirectly caused bubbles to burst, share prices to fall or markets to collapse. As the above research shows, short selling has often been accused of playing a direct role or at least taking advantage of a market downturn. The same has often been the case for securities lending. Moreover, as securities lending increases in popularity in markets around the world, it is likely that such criticism will only increase.
Certainly, the securities lending industry could help it avoid being targeted by implementing some of the suggestions that researchers have made, particularly in the areas of transparency. Also, with increasing regulation being sought for related activities such as short selling and market players such as hedge funds, it is likely that governments will play their part in helping the securities lending industry become more accepted.
Still, with organizations such as the Asian Development Bank advocating faster development of securities lending in markets in Asia, it can be argued that securities lending plays a positive role in the market and should be encouraged, not restricted.
The same, therefore, should be said about Taiwan, which is seen currently as a developing market due to a few aspects which are still in need of upgrading before it can achieve developed market status.
It is recommended that Taiwan continues to aggressively expand its SBL system, as there are several benefits that Taiwan would enjoy from doing so. First, encouraging securities lending would, as many have suggested, increase liquidity in the market.
This may face obstacles in the near term given the tightened credit situation at many lending institutions. However, with an anticipated economic recovery for Taiwan’s economy to be seen in either the second half of 2009 or by 2010, this situation looks to improve. This loosened credit environment would help market players make greater use of cash collateral transactions.
Secondly, a stronger SBL system would help raise the level of Taiwan’s market in the view of foreign investors. With Taiwan being compared, albeit slightly unfavorably, with South Korea’s stock exchange, it will need to further expand its SBL scheme if it hopes to compete for capital flowing into Asia. The TWSE has already shown a clear trend of increasing funds flowing into Taiwan and its SBL system; further expansion of the scheme, particularly at a time when Taiwan’s stock market is being viewed as
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one of the hottest markets in the world, would only continue this upward trend.
A related benefit from a possible upgrade by either the FTSE or MSCI involves the competitiveness of Taiwan’s stock market regionally. Taiwan’s companies have for many years been in competition with South Korean companies to attract foreign investors as well as sales and clients. Moreover, while South Korean firms, often belonging to large business groups known as the chaebol, have easier access to capital, Taiwan’s small- and medium-size enterprises, or SMEs, have problems in raising capital (Heath 2004). This is even more serious in a tight credit market. However, as securities lending allows greater liquidity for often harder to find shares, such SMEs’
shares would see greater demand.
Fourth, as one of the benefits of securities lending and short selling plays in a market is by deflating unnecessarily inflated share prices, further development of SBL activities could help ensure the TWSE does not see the kinds of bubbles that occurred in Hong Kong’s property market when it grew closer economically to China, as well as the bubble that has been built in China’s Shanghai bourse. Though opponents may argue that short sellers only drive down a share price, many have argued instead that under a well-regulated market, share prices are often seen as more indicative of actual value and thus attract more players into the market.
This is especially important as Taiwan continues to open its market to Chinese investment as well as tries to attract Taiwan overseas capital in its stock market.
Already in 2009, Taiwan’s stock exchange index, or TAIEX, has seen rapid gains during the second quarter as money from foreign investors around the world targeted shares in Taiwan. With regulators such as the FSC concerned that volatile, short-term capital, or “hot money”, had entered Taiwan, having a balance provided by an effective SBL system could help keep share prices in check.
Finally, a more active SBL system will have an impact on improving corporate governance. As voting rights must be addressed by lenders and borrowers, it can be argued that a greater concern will be placed on corporate governance, of which Taiwan as well as many countries in the region is trying to improve. As Raaijmakers (2005) suggests while initially such corporate governance issues are complicated by securities lending as institutional investors lose their voting rights during the lending period, empowering Taiwan’s SBL system will only push regulators and participants to call for greater measures regarding corporate governance. Thus, greater activity would create greater oversight that would better ensure shares were not being
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borrowed for the purposes of voting.
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References:
Asian Development Bank (1999). Rising to the Challenge in Asia: A Study of Financial Markets. Vol 1. Manila: ADB.
Burke, K., Martello, G. (1997) The Evolution of Securities Lending, in Fabozzi. F., ed.
(1997). Securities Lending and Repurchase Agreements. New Hope, PA: Frank J.
Fabozzi Associates.
Chen, I.Y.J. (2008). Current SBL Mechanism in Taiwan. Taiwan Stock Exchange Presentation Delivered on January 24, 2008.
Choudhry, M. (2006). An Introduction to Repo Markets. Third Edition. West Sussex, England: John Wiley & Sons.
Clunie, J. “Market imperfections, securities lending, and short selling”. Journal of Financial Transformation.
Data Explorers. (2008). The State of Our Industry. Corporate Presentation Delivered on October 15, 2008.
Davies, P. “Former Wall Street Workers To Face Charges in Brooklyn”. Wall Street Journal. September 21, 2007.
eSecLending Corporate Website (2009). URL: http://www.eseclending.com
Fabozzi, F., ed. (1997). Securities Lending and Repurchase Agreements. New Hope, PA: Frank J. Fabozzi Associates.
Faulkner, M., Stopford Sackville, C.L. (1997). Finding A Route to Market: An Institutional Guide to the Securities Lending Labyrinth, in Fabozzi. F., ed.
(1997). Securities Lending and Repurchase Agreements. New Hope, PA: Frank J.
Fabozzi Associates.
Faulkner, M. (2004) An Introduction to Securities Lending. ISLA.
Faulkner, M. (2008). Securities Lending & Corporate Governance. ISLA.
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FTSE Group. FTSE Global Equity Index Series Country Classification. September 2008.
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ISLA. (2008). Securities Lending and Short Selling. Position Paper.
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Liu. P. MSCI Announces Candidacy of Taiwan for Developed Market Status. CENS.
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Miller, K.A. (1997) The US Dollar Repo Market, in Fabozzi. F., ed. (1997). Securities Lending and Repurchase Agreements. New Hope, PA: Frank J. Fabozzi Associates.
Ministry of Finance issues new tax measures for securities lending system. Securities and Futures Bureau Newsletter. October 1, 2007.
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Ofek, E., Richardson, M., and Whitelaw, R. (2003). Limited arbitrage and short sales restrictions: Evidence from the options markets. Journal of Financial Economics.
Raaijmakers, Geert TMJ. (2005). Securities Lending and Corporate Governance.
Maastricht University Faculty of Law, the Netherlands.
RPT-Taiwan re-imposes short-selling ban on 150 stocks. Reuters. September 21, 2008.
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Rule, D. (2008). On Loans: An Overview of the Securities Lending Market. Canadian Investment Review. Fall 2008.
S. Korea, Taiwan miss FTSE upgrade again. Reuters. September 21, 2007.
Securities Lending, Liquidity and Capital-Based Finance. State Street White Paper.
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Yang, L.C. (2008). An Overview of SBL Development in Taiwan. Taiwan Stock Exchange Presentation Delivered on January 24, 2008.
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Appendix: Tables and Figures
Figure 1: Transactions collateralized with other securities or assets
Source: An Introduction to Securities Lending (Faulkner 2008)
Figure 2. Transaction collateralized with cash
Source: An Introduction to Securities Lending (Faulkner 2008 )
Figure 3: Taiwan SBL Market Structure
Source: Current SBL Mechanism in Taiwan (Chen 2008)
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Table 1: Taiwan SBL Trading Amounts (2004 – 2008)
Year 2004 2005 2006 2007 2008
Total
Source: The Taiwan SBL Market (Yang 2009)
Table 2: Transaction Types in Taiwan’s SBL System Transaction
Negotiated Negotiable Negotiable 6 months and one-time rollover permitted
Lender NA
Source: The Taiwan SBL Market (Yang 2008 )
Table 3: Foreign Institutions’ Participation in Taiwan’s SBL System Foreign Investors’ Trading
Volume
Total SBL Trading Volume
Ratio of Foreign Investors to Total SBL Trading Volume
Lend Borrow Lend Borrow
2004 6 3,007 3,049 0.2% 98.6%
2005 45 2,232 2,275 2.0% 98.1%
2006 664 2,658 2,761 24.0% 96.3%
2007 3,482 5,684 5,739 60.7% 99.0%
Source: The Taiwan SBL Market (Yang 2008 )
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Table 4: FTSE Quality of Markets Criteria (Asia Pacific) as at March 2009 for Taiwan, South Korea
Criteria
South Korea (Developed)
Taiwan
(Advanced Emerging) World Bank GNI Per Capita Rating, 2007 High High Market and Regulatory Environment
Formal stock market regulatory authorities actively monitor market (e.g., SEC, FSA, SFC)
Pass Pass
Fair and non-prejudicial treatment of minority shareholders
Pass Pass
Non or selective incidence of foreign ownership restrictions
Pass Pass
No objection to or significant restrictions or penalties applied on the repatriation of capital and income
Pass Pass
Free and well-developed equity market Pass Pass Free and well-developed foreign exchange market Restricted Restricted Non or simple registration process for foreign
investors
Pass Pass
Custody and Settlement
Settlement - Rare incidence of failed trades Pass Pass Custody-Sufficient competition to ensure high
quality custodian services
Pass Pass
Clearing & settlement - T + 3 , T + 7 for Frontier Pass Restricted
Stock Lending is permitted Pass Restricted
Settlement - Free delivery available Pass Pass Custody - Omnibus account facilities available to
international investors
Pass Pass
Dealing Landscape
Brokerage - Sufficient competition to ensure high quality broker services
Pass Pass
Liquidity - Sufficient broad market liquidity to support sizeable global investment
Pass Pass
Transaction costs - implicit and explicit costs to be reasonable and competitive
Pass Pass
Short sales permitted Pass Restricted
Off-exchange transactions permitted Restricted Restricted
Efficient trading mechanism Pass Pass
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visibility and timely trade reporting process Derivatives
Developed Derivatives Market Pass Pass
Size of Market
Market Capitalisation $mn (as at 31st Dec 2008) 470,797 356,711 Total Number of Listed Companies (as at 31st
Dec 2008)
1789 718
Source: FTSE Group