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trillion of securities are on loan globally, with about US$22 trillion available for loan and around US$100 trillion in issue. Securities on loan are split equally between government bonds and equities/corporate bonds – around 45% of these are North American, 35% are European and 20% are from the rest of the world.
VI. Taiwan and the Development of an SBL System
This final section before some concluding remarks and recommendations are offered will look at several key issues, namely, (1) the development of Taiwan’s securities borrowing and lending system; (2) the key goals that Taiwan hopes to achieve from its establishment; (3) the current status and obstacles that Taiwan’s SBL system faces amid the global financial crisis and its failure to achieve developed market status by important global rating organizations such as the FTSE Group.
Securities Lending and Taiwan’s “SBL”
The system that was created by the TWSE is officially known as the “Securities Borrowing and Lending System”, or “SBL”. While the name may differ from what is used in other countries, it still refers to the same basic system of securities lending found around the world. Also, while much of Taiwan’s SBL system will appear similar to other securities lending systems in other countries, there are also some differences in terms practices and regulations. Therefore, this is a similar situation when looking at Taiwan’s stock market as a whole, where it shares many similarities yet also some localized differences with other stock markets both regionally and globally.
Generally speaking, Taiwan’s SBL is a centralized system that is limited to qualified institutional investors, with transaction types falling into three categories, which will be explained in greater detail later in this section.
Despite the fact that Taiwan’s SBL system can trace its origins back to as early as 1996 when the system was created for settlement purposes, most of the information on Taiwan’s experience comes from government-related sources. For this, the Taiwan Stock Exchange Corporation provides a good overview of its development, key regulatory changes and the stages of development. Important milestones include 2003 when the SBL system was opened officially, and 2007 when securities firms were allowed to participate.
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Also, an excellent background to Taiwan’s overall financial and capital market development is offered by Semkow (1994) in his work, Taiwan’s Capital Market Reform. This work gives the reader a better understanding of Taiwan’s securities markets in relation to the overall, larger capital market, including key legal changes as well as various liberalization efforts, such as those involving the securities and bond markets in Taiwan.
Another important issue in understanding the development of Taiwan’s SBL and the TWSE overall involves how it is classified by various market rating organizations.
Regarding Taiwan’s push to gain developed market status as given by the FTSE Group, formerly a joint venture between the Financial Times and the London Stock Exchange, several key milestones have also been seen. Most recently, in March 2009, the FTSE Group stated in its FTSE Country Classification Report that although Taiwan had made a number of changes which have been implemented, the Group did not make any changes to its assessment of Taiwan relevant to the Quality of Market criteria at that interim point (FTSE Group 2009). Earlier, and perhaps of greater importance, was the FTSE Group’s upgrading of South Korea to developed market status in September 2008, while it decided to not upgrade Taiwan from advanced emerging market status. At the time, FTSE Group officials such as Jerry Moskowitz had estimated that the upgrade South Korea had been given would help the increase of the flow of funds into that market, perhaps by as much US$25 billion in new funds, which helps Taiwan to get another benchmark of possible benefits from reaching developed market status (Lesova 2008).
Finally, this section will look at the current status of Taiwan’s SBL system and also some of the key obstacles it faces in opening the system up fully. This has become more challenging with the onset of the global financial crisis, as potential lenders and intermediaries, including agents, asset managers, custodian banks and prime brokers, among others, suddenly saw the system’s development come to a halt with the decision by Taiwan’s FSC to curtail short selling in late 2008. While the ban has been lifted, it remains to be seen how much of an impact the decision has had on SBL development and in attracting foreign institutional investors (FINIs) to enter the system. In addition, as the global financial crisis is still ongoing, the threat of Taiwan re-imposing a ban on shorting still exists.
Recognizing Initial Taiwan SBL Drawbacks
When looking at the obstacles securities lending systems across Asia faced, Heath (2004) identified several key drawbacks to Taiwan’s SBL system as they appeared at
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the time. Despite Taiwan appearing as a lucrative target for SBL participants, he pointed out that institutional investors were hampered by not being able to borrow securities by holding options or futures, as well as being restricted in their use of collateral. Meanwhile, a unique ID system used in Taiwan (as well as in South Korea then) was implemented so that regulators could track down short selling by requiring foreign institutional investors to cite their ID number on every transaction as well as requiring every such custodian to hold their securities in a separate account.
Since that time, however, Taiwan has made progress in loosening restrictions for foreign institutional investors, as we will see in this section. As we will see below, Taiwan’s development of its SBL system is still very much a work in progress, with most of the research being offered coming directly from those institutions directly involved in its establishment and development.
Formation of Taiwan’s SBL: Margin Trading Status Begins in Taiwan
With a relationship between margin trading and securities lending, often the liberalization of margin trading goes hand in hand with the creation of a securities lending system. Recognizing the inconvenience of limits in margin trading, which help to make better use of available resources, the offering of securities lending and financing services with the necessary capital and shares provides investors with regulated credit lines. Taiwan, is therefore not different as both margin trading and securities lending are allowed in the market. However, it should be pointed out that while margin trading was allowed beginning in 1980, securities lending was not started until 16 years later in 1996, when the TWSE introduced a Settlement Coverage System. For margin trading, the securities finance company (SFC) began margin trading that same year in 1980, while securities firms could act as agents of the SFC, with qualified securities firms being allowed to conduct margin trading on their own by 1990. Also, securities firms could apply to the SFC to borrow stocks for refinancing in margin trading.
However, as Yang (2008) points out and Heath also discussed, Taiwan’s regulators placed some key restrictions on margin sales, including on participants, with it limited to domestic individual investors, while dealers, mutual funds and FINIs were excluded. Also, trading volume was restricted, as for each stock, the margin purchase and margin sale each could not exceed 25% of its outstanding shares. For trading value, the maximum margin sale was NT$40 million for each account, while the maximum margin sale on each stock was NT$10 million per account. Finally, regulators set price restrictions as well, with a margin sale order not being able to be
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placed at a lower price than the closing price of the previous day.
Taiwan’s SBL System is launched
In fact, Taiwan’s SBL system can trace its roots back to 1996 as a Settlement Coverage System was established, although much of its important activity begins several years later, in 2003, as Yang shows.
It was in May of that year in which the TWSE announced the regulations governing the securities borrowing and lending, to meet the needs of qualified institutional investors with the TWSE serving as an intermediary. These regulations became effective from June 30 the same year, and have a history of two and a half years (Huang 2006).
TWSE officials such as Yang have offered the key points of the SBL market’s development, noting that after the SBL system was launched in 2003, the purpose test and onshore collateral requirements were removed two years later, with ceilings set for short selling also coming in the same month. Two years after that, in May and November 2007, price restrictions were removed for designated stocks, with securities firms being allowed in July 2007 to conduct SBL acting as lending principles.
Also, in 2005, by the May order of Taiwan’s FSC, the TWSE announced the lifting of several key restrictions on the SBL system. Included in the deregulations were: (1) the earlier requirement that an SBL transaction has to be in connection with a “strategic purpose” was abolished. That is, holding long positions would from then on no longer required; (2) the On-shore collateral requirement imposed upon negotiated transactions where the borrower and the lender involved had to be both foreign investors was relaxed; and (3) the “total short selling volume limit” was adopted. In addition, other supporting measures were: (1) daily maximum shares of short sold borrowed securities could not exceed 3% of outstanding shares per lending securities;
(2) maximum shares of short sold borrowed securities could not exceed 10% of outstanding shares per lending securities; and (3) the total volume of short sold borrowed securities and short sold margin transactions could not exceed 25% of outstanding shares per lending securities (Taiwan Stock Exchange 2005).
The TWSE also announced it would monitor the 3% daily shares available for short selling and disclose the remaining shares to securities firms via its computer trading system.
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Later, in 2007, another revision was made for the SBL system, this time regarding taxation issues that had caused a dispute. In this, the Ministry of Finance (MoF) issued new tax measures for Taiwan’s securities lending system. In order to resolve disputes over tax issues connected with securities borrowing and lending transactions, the MoF issued a letter of interpretation on August 20, 2007 to clarify the relevant tax issues. Provisions regarding taxation on compensation paid for entitlements on loaned securities were brought into conformity with the principle of actual benefit received.
Income tax from that point on was to be assessed on the securities lender based on the taxable proceeds received by the lender for entitlements, thus resolving the double taxation issue. (SFB Newsletter 2007).
Meanwhile, the various reforms to the system apparently have helped Taiwan’s SBL system steadily increase its volume during the period from 2004 until 2008, as shown in Table 1. During this time, total value traded in the SBL system has risen from approximately US$2.5 billion in 2004 to around US$13.8 billion by 2008. The same steady upward trend was also seen in terms of total transactions, which more than doubled during the period, and also total volume traded, with 9.7 billion shares being traded by 2008. Of the five years, only volume and total trading value figures dipped slightly in 2005 before returning back to normal.
From all these developmental and regulatory changes that took place, it is important to next look at what the Taiwan SBL system has become. Figure 3 illustrates the architecture of Taiwan’s SBL System.
In terms of transaction types, the TWSE states Taiwan’s SBL system provides three kinds, including: Fixed-rate transactions, competitive auction transactions and negotiated transactions. Fixed rate transactions set a fee rate at 3.5% per annum, whereas competitive auction transactions have fee rates determined by bids and offers.
Finally, negotiated transactions allow the participants to establish the fee rate on their own. Table 2 lists the various transaction types found in Taiwan’s SBL system. In terms of SBL trading volume for 2007, Yang found that competitive auction transactions accounted for 41% of all transactions while negotiated transactions accounted for 59% of them.
The TWSE manages collateral in fixed-rate and competitive auction transactions, while it acts as guarantor in these two types of transactions as well.
Starting in July of that same year, qualified securities firms and securities finance
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companies were allowed to conduct SBL business acting as a principal. Investors thus had additional options, not only borrowing from the existing TWSE SBL system but also from securities firms and securities finance companies that are qualified.
Securities lending and the impact on corporate governance in Taiwan
Faulkner has written extensively on the relationship of securities lending and corporate governance. However, with corporate governance an increasingly important issue for Taiwan companies, it is important to examine how securities lending is impacting the development of improved corporate governance in Taiwan.
In the view of the Organization for Economic Cooperation and Development (OECD), a definition on corporate governance is offered:
“Procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation – such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision-making.” (OECD.org)
It can be expected that as securities lending becomes more prevalent in the Taiwan market, so will the issue of corporate governance. This, however, should not be seen as an obstacle to the development of either the SBL system or corporate governance in Taiwan. Instead, an active SBL system will put the issue of corporate governance in the spotlight, thus compelling regulators to provide better oversight, to the benefit of both lenders and borrowers, as well as the market on the whole.
Future prospects for Taiwan’s SBL System
From the view of the TWSE, there at least three major prospects that it would like to see materialize for its SBL system. They include (1) for a pre-arranged negotiated transaction, a borrower can short on day T though actual transfer of securities occurs on T+1; (2) finding a method to solve late return of stocks for lenders selling lent stocks; and (3) the streamlining of pledge procedures, such that TDCC participants can directly get access to the pledge system to carry out the pledge.
However, while the TWSE may have immediate, internal goals for the SBL system it has created, as we will discuss in the final part of this section, the improvements it plans to implement will hopefully play an even more important role for Taiwan’s stock markets on an even broader scale.
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More recently, Yang points to several future plans that the TWSE has in mind for its SBL system. First, the exchange hopes to further ease required qualifications of SBL participants. This includes the goal of allowing all foreign institutional investors to be able to make SBL trades. Second, the ratio for SBL collateral will be decreased. The TWSE expects to implement this after the stock market’s stability has been restored.
With the Taiwan stock market’s performance during the second quarter of 2009 indicating that it has begun to achieve that goal, this second objective will be expected by securities lending participants to be implemented sometime during 2009 or 2010.
Finally, a long-term goal of the TWSE is to allow local custodian banks to act as agents in the SBL system. Should all these goals be achieved, Taiwan’s SBL system will further attract participation by foreign investors.
Table 3 offers all look at the ability of Taiwan’s SBL system in terms of foreign institutions’ participation.
Taiwan and the FTSE
More recently, Taiwan’s SBL system has begun to gain more attention as the TWSE moves to have its rating upgraded by the FTSE Group. The FTSE classifies countries into three categories, including developed, advanced emerging and secondary emerging within its Global Equity Index Series.
In general, an upgrade from the FTSE in a country’s market status will help that country typically attract more buying from funds benchmarked to the FTSE indexes and also increase the chances of larger index compiler MSCI Barra following suit afterward. It is estimated that around US$2 trillion to US$2.5 trillion in assets are to be linked to FTSE indexes, most of it in developed market indexes, compared to US$3 trillion for the MSCI. Thus, gaining upgrade to ‘developed’ market status opens the door for a market such as Taiwan to potentially attract several trillion US dollars in funds from around the world.
In addition, some industry officials argue that such an upgrade may have an immediate impact on a given market like Taiwan. When interviewed by Reuters (2007), one local fund manager commented that Taiwan’s market could be driven up about three percent to five percent in the short run, with the MSCI likely adjusting its rating as well.
Recent Developments in Taiwan’s Goal of Developed Market Status
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In a more recent round, September 2008 upgrading round by the FTSE, Taiwan was noted for some improvement but still did not make it to its ultimate goal of
“Developed Market Status”, unlike it close rival, South Korea, which finally achieved the status. Instead, Taiwan was placed on the FTSE’s Watch List for another 12-month period, along with Greece and China’s A shares (FTSE 2008).
Meanwhile, in its report regarding upgrades, Mark Makepeace, the Chief Executive of the FTSE Group said:
“Congratulations to South Korea on attaining promotion to Developed market status. FTSE would also like to congratulate Taiwan on the progress it has made in implementing market reforms over the last twelve months. We will continue working with the Taiwan authorities and market participants through our engagement programme, and hope to achieve the remaining reforms required by international investors.” (FTSE 2008).
Makepeace went to note that Taiwan had substantially improved access to its market for foreign investors, but that no change would be made at that time to Developed market status.
However, from the FTSE’s most recent, March 2009 six-month review point, we can see from Table 4 (FTSE 2009) that some of few obstacles left preventing Taiwan from joining its South Korean rival were the still-restrictive nature of its securities lending market and also its short selling activities.
It should be noted that between the September 2008 review and the more recent, March 2009 announcement, a great deal had happened not only in the Taiwan market, but around the world. Most importantly, Taiwan’s FSC banned short selling in the face of the global financial crisis, first forbidding the shorting of 150 companies in the Taiwan 50 Index, the Taiwan Mid-Cap 100 Index and the Taiwan Information Index, from September 22 through October 3, 2008, then expanded it to all forms of short selling from the start of October before finally lifting it on November 28, 2008 (Reuters 2008). Some analysts estimate that as a result, the TWSE lagged behind its Dow Jones Industrial Average counterpart by around 5% from the ban during that period.
There have been other positive developments for the TWSE, in addition to the FTSE’s
There have been other positive developments for the TWSE, in addition to the FTSE’s