台灣進入已開發國家之有價證券借貸系統之發展 - 政大學術集成

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(1)國立政治大學商學院國際經營管理碩士學程 International MBA Program College of Commerce National Chengchi University 碩士論文治. 政. 大. 立Master’s Thesis. ‧ 國. 學 ‧. 台灣進入已開發國家之 io. sit. y. Nat. 有價證券借貸系統之發展 n. er. Securities Lending and Taiwan’s Goal of al iv n Ch i U Achieving Developed Status e n g c hMarket. Student: Chris Cottorone Advisor: Professor Joseph Hu. 中華民國九十八年六月 June 2009 1 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(2) 台灣進入已開發國家之有價證券借貸系統之發展 Securities Lending and Taiwan’s Goal of Achieving Developed Market Status. 研究生：陳歷世. Student: Chris Cottorone. 指導教授：扈企平. Advisor: Joseph Hu. 學. 國立政治大學. 商學院國際經營管理碩士學程碩士論文. Nat. sit. y. ‧. io. A Thesis. er. ‧ 國. 立. 政治大. n. Submitted a to International MBA Program v. i. l. n C hChengchi University National i U e ngch. in partial fulfillment of the Requirements for the degree of Master in Business Administration. 中華民國九十八年六月 June 2009 2 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(3) Acknowledgements In the writing and submission of this thesis, I would first and foremost like to thank my thesis advisor, Dr. Joseph Hu, whose strong knowledge and experience in the securities industry helped provide a context within which this work could be placed. His constructive comments regarding not just the direction and content of this paper but also the mechanics needed to complete my thesis helped immensely. Also, I would like to thank my colleagues, Peter Griffith, David Tung and Charles Yang, for their helpful support and insight into the development of Taiwan’s securities borrowing and lending industry. Particularly in the case of Peter Griffith, who helped discuss some of the ongoing developments within this still-growing industry during a period of great change and challenge, I owe a debt of gratitude for his patience and concern over the completion of this paper.. 立. 政治大. ‧. ‧ 國. 學. In addition, I would like to thank the entire staff at National Chengchi University’s College of Commerce Library, who helped ensure that I was able to locate and use some of the key works that discuss the securities lending industry in particular as well as the entire financial industry. Along those lines, I would like to thank Ms. Lichi Ho, whose careful advice on completing the MBA thesis helped ensure the process was both clear and efficient.. sit. y. Nat. n. al. er. io. Finally, I would like to thank my wife, Jackie, and my son, Daniel, who was born during the time I began to consider writing on securities lending as well as when I was starting my involvement with the financial industry. Their support and understanding not only helped me make important progress in my research both for this paper and also in my new field, but also helped remind me of the main reason I originally decided to pursue an International MBA – for their benefit.. Ch. engchi. i Un. v. 3 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(4) Table of Contents Acknowledgements I. Overview and Purpose of Paper……………………………………………….5 Thesis Structure II. Review of Related Literature…………………………………………………..7 III. Securities Lending and Mechanisms…………………………………………..8 What is Securities Lending? Origins of Securities Lending Types of Securities Lending Transactions Repo Motivations for Borrowing Securities Securities Lenders and Intermediaries Securities Lending Portfolios Electronic Securities Lending IV. The Debate on Securities Lending and Short Selling…………………………16 Securities Lending, Short-selling and the Global Financial Crisis Role of Securities Lending Bans on Short-selling in the Aftermath of the Global Financial Crisis Market Myths V. Securities Lending and its Impact on Global Capital Markets ……………….20 Securities Lending as Part of Capital-based Market Finance Securities Lending and Liquidity VI. Taiwan and the Development of an SBL System……………………………..23 Securities Lending and Taiwan’s “SBL” Recognizing Initial Taiwan SBL Drawbacks Formation of Taiwan’s SBL: Margin Trading Status Begins in Taiwan Taiwan’s SBL System is launched Transaction Types in Taiwan’s SBL System Future prospects for Taiwan’s SBL System Taiwan and the FTSE Recent Developments in Taiwan’s Goal of Developed Market Status VII. Conclusions and Recommendations………………………………………….31 References………………………………………………………………………….35 Appendix…………………………………………………………………………. 38. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. 4 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(5) I.. Overview and Purpose of Paper. This paper intends to look at the debate concerning the merits of securities lending, the development of the securities lending system in Asia with particular regard to the case of Taiwan and the impact that the introduction of a securities borrowing and lending system (SBL) may have on Taiwan’s chances to gain developed market status. In addition, it should be noted that much of the above is discussed within the context of the global financial crisis in which a key activity of securities lending – short selling – has been restricted periodically. Also, the paper will try to answer how much of an impact the SBL system has had so far on the Taiwan Stock Exchange (TWSE), as well as how much its development may have been hampered by the Taiwan regulator’s ban on short selling, which was implemented during the latter part of 2008.. 立. 政治大. ‧. ‧ 國. 學. The purpose of this paper is to argue whether Taiwan, should continue to build its SBL industry if it hopes to add liquidity to the market, attract foreign investors and ensure bubbles do not appear. Taiwan is currently ranked as a developing market yet nearly at developed market status. This last point is especially important as Taiwan and China increasingly loosen restrictions on cross-Taiwan Strait investment, thus creating the possibility of bubbles forming. Such formation of bubbles could be similar to those that occurred when Hong Kong’s property market began to take off rapidly in the period after a Closer Economic Partnership Agreement was signed with China in June 2003.. er. io. sit. y. Nat. al. n. iv n C Many scholars and industry expertshsuch e nasgFaulkner c h i U(2004) have argued a securities. lending system is one of the key components in improving a given securities market’s liquidity as well as the level of its development. Still, there is great debate on the effect securities lending can have on stock exchanges, despite the securities lending industry having a history that dates back to the 17th century (Burke, Martello 1997). Proponents of securities lending view the activity as, among other things, an effective way to increase liquidity and hold overly inflated stock prices in check. However, critics of securities lending see the industry, along with its included practice of short selling, as a means for market manipulators to drive down share prices. Against the backdrop of this debate is the effort put forth by the Taiwan Stock Exchange, which has been working hard to move up from its current advanced emerging market status to developed market status as rated by the London-based FTSE Group. With an active securities lending system being one of the FTSE Group’s 5 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(6) requirements of attaining such developed market status, the Taiwan Stock Exchange in 2003 launched a centralized SBL system. Later, qualified foreign institutional investors (QFII) were allowed to participate in its SBL system. However, not long after this important development, the debate on the negative impact of securities lending and short selling began to surface again amid the most-recent global financial crisis. During this time, many regulatory agencies around the world placed temporary bans on short selling amid fears of falling share prices. Such measures included those undertaken by Taiwan’s Financial Supervisory Commission (FSC), thus thwarting the development of a securities lending system just at a time when foreign investors were beginning to take a closer look at the country’s SBL system and with a genuine need for increased liquidity in the market. Another consideration to be kept in mind and will be dealt with in the section on securities lending and the development of global capital markets is that institutions in developing markets such as Taiwan may often turn to their stock markets for capital, as opposed to taking on debt in the form of loans or convertible bonds. With a vibrant debate on the positive and negative effects of securities lending on the overall stability and development of a given stock market, it is important to consider how a possible over-reliance on using securities markets may have for institutions in Asia.. 立. 政治大. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. Thesis Structure The structure of this paper from this section forward therefore begins with a review of important works which provide a better understanding of the various sections in this paper.. Ch. engchi. i Un. v. Afterward, a look will be given at securities lending and mechanisms used to help better understand the various types of transactions, the motivations for borrowing or lending securities, and some recent developments in securities lending that will likely have an impact on the industry’s operation. In the next section, the debate on securities lending is examined. The debate centers on the role that securities lending has on markets. It also points to aspects related to liquidity, among others, while those arguing against the industry often look at the activities short sellers have conducted in some markets, as well as questioning how the securities industry is run. However, there are some areas where both sides are critical of the industry, which will also be discussed. In the next two sections, a look at the international development of the securities 6 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(7) lending industry is offered. In the first of these sections, there will be a look at the industry and its development from a global vantage point, followed by, in the following section, the development of securities lending in Taiwan. Specifically, this section looks at the progress Taiwan is making in achieving its goal of being named as developed market. In the final section, some conclusions and recommendations are offered regarding Taiwan’s continued efforts towards achieving its goals of developed market status. These main recommendations call for Taiwan to continue to expand upon its SBL system, as it would allow increased liquidity into the market; raise the level of Taiwan’s market in the view of global rating organizations such as the FTSE and MSCI; enable Taiwan to better compete with one of its main rivals, South Korea and its KOSPI Index, in attracting foreign investment capital; help prevent bubbles do not form in share prices; and, finally, help improve the level of Taiwan’s corporate governance.. 學. ‧ 國. 立. 政治大. II. Review of Related Literature. ‧. n. al. er. io. sit. y. Nat. With the onset of the recent global financial crisis in the latter half of 2008, a growing list of journal articles and reports have looked at the securities lending industry as well as the impact it has on securities markets. However, studies on the securities lending industry and the role it plays in financial markets have existed for years. Faulkner and others have helped investors and scholars to better understand the origins of the market that has been created to lend and borrow securities. Most of the related literature starts with the securities lending industry as it pertains to the United States or the United Kingdom, and then branch off into other regions such as Asia.. Ch. engchi. i Un. v. For the purposes of this paper, sources were sought which could fulfill certain key objectives. First, as the securities industry is less well known to many institutional as well as retail investors, works that provide an overview of the industry’s development and processes were used. Perhaps one of the key works in this group includes the several essays found in Fabozzi’s Securities Lending and Borrowing (1997). Also, to give an explanation of the key differences between securities lending (which is more focused on securities) and repo markets (which deals with bonds), works offered by scholars such as Choundry’s (2006) help provide a context to see the key differences in the processes and issues involved in securities lending.. 7 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(8) Also, articles that dealt more directly with the debate involving the impact securities lending has on financial markets were sought. Such works are increasing in number, particularly from advocacy organizations such as the International Securities Lending Association (ISLA) and its regionally focused counterpart, the Pacific Asian Securities Lending Association (PASLA), as well as from proprietary sources which offer securities lending services to both lenders and borrowers. Related to this exists more recent articles which deal with the relationship that is being drawn between the global financial crisis that began in the second half of 2008 and the possible link short selling may have had in driving down already plummeting share prices. Finally, to provide a background to the development of Taiwan’s financial and capital markets, its securities industry, and more importantly, the development of its SBL system, several works were reviewed to gain a better overall understanding of Taiwan’s capital market development in general, its securities market, and securities lending in Taiwan. The latter component is primarily discussed by domestic organizations such as the TWSE, while some international organizations such as ISLA or PASLA have offered brief looks at Taiwan’s SBL system in relation to its counterparts elsewhere in Asia.. 立. 政治大. ‧. ‧ 國. 學. sit. y. Nat. n. al. er. io. III. Securities Lending and Mechanisms. Ch. i Un. v. With this paper focused on the securities lending industry, its impact on securities markets in general and the Taiwan market in particular, it is important to provide a better understanding of the mechanisms involving securities lending and the players involved in securities lending transactions. It should be mentioned at the onset that just as each given market may have its own characteristics, so do the securities lending industries as they are found in the U.S., England, and Australia or even in Taiwan. For the most part, much of the literature that seeks to explain the historical development of the securities lending industry as well as the current state of it deal with it from an American or British perspective, as the two nations have led its development for much of the latter half of the twentieth century and even much of this century. However, as the securities lending industry continues to grow in importance as a possible means to help markets run more efficiently, its development in countries such as Taiwan needs further understanding.. engchi. 8 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(9) What is Securities Lending? Securities lending is an investment strategy in which investors make short-term loans of their securities to generate incremental revenues from their portfolios. The securities lent typically include a broad array of equities as well as fixed income securities, including government and agency securities and corporate bonds. Small cap stocks, growth stocks, global equities and government bonds are generally among the most attractive to securities borrowers and lenders. From the lender side, the motivation to participate in securities lending includes to increase overall performance of one’s portfolio, to offset expenses associated with maintaining a portfolio, to maximize opportunities to leverage their portfolio, to finance fund-specific projects, and to retain ownership benefits – except the right to vote. Lenders, such as large pension funds, often view the activity favorably as it allows them to gain benefits on shares they hold in the long-term when they lend them out, at a fee.. 立. 政治大. ‧. ‧ 國. 學. Conversely, the borrower side is usually comprised of broker-dealers with proprietary trading desks and prime brokerage units supporting hedge fund activities. Generally, they borrow securities to facilitate sophisticated trading and arbitrage strategies, and to cover shorts and prevent fails, to engage in strategies such as risk arbitrage and pairs trading, to participate in dividend arbitrage and other financing activities, to finance inventory and manage balance sheets, to act as an intermediary – as with agent banks and prime brokerage (eSecLending 2009). As such, hedge funds have helped spur the growth of securities lending in recent years, as they seek to borrow shares they do not own yet believe they may be able to use to short.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. Origins of Securities Lending Securities lending – or the temporary transfer of securities on a collateralized basis – can trace its origins back as far as the 17th century, while by 1607 short selling, or the selling of a stock that one does not own for the purpose of making a profit should the share price go down, was going on and thus gave rise to securities lending (Burke, Martello 1997). Primarily, such trading activity was focused in Europe, first most notably in the Netherlands and later in the England. More specifically, as Faulkner discusses, the practice of securities lending began informally, carried out between brokers who had insufficient share certificates to settle their old bargains, commonly because their selling clients had misplaced their certificates or simply not provided them to their broker by the settlement date of the 9 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(10) transaction. Some industry experts and scholars point out that a clarification is needed when understanding and providing a definition of securities lending. As such, Faulkner clarifies by first pointing out that ‘securities lending’ is misleading and factually incorrect, as in many jurisdictions such as England, the transaction commonly referred to as ‘securities lending’ is in fact a disposal (or sale) of securities linked to the subsequent reacquisition of equivalent securities by means of an agreement. From this, these transactions are collateralized and a ‘rental fee’ is charged, related transaction details are discussed and are dealt with under the terms agreed upon between the parties. While securities are described as being ‘lent’, it is very likely that the securities are borrowed and then sold or lent to even more parties.. 政治大 From this, Faulkner lists some consequences arising from this clarification which 立 include:. ‧ 國. 學. ‧. 1. Absolute title over both the securities on loan and the collateral received passes between the parties; 2. The economic benefits associated with ownership – e.g., dividends, coupons, etc. – are ‘manufactured’ back to the lender, meaning the borrower is entitled to these benefits as owner of the securities but is under a contractual obligation to make equivalent payments to the lender; 3. A lender of equities surrenders its rights of ownership, e.g., voting. Should the lender wish to vote on securities on loan, it has the contractual right to recall equivalent securities from the borrower.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. This final consequence involves the issue of corporate governance, or the relationship between all the stakeholders in a given company. The issue of corporate governance can therefore be important in the securities lending transaction as in some cases, share are borrowed (in actually, sold to a ‘borrower’) not primarily to cover shorts, but instead to vote in corporate board elections. In markets where corporate governance is weaker or still developing, such as in some Asia markets including Taiwan, securities lending can also compel both lenders as well as regulatory authorities to consider how transactions are being conducted with respect to a given company’s governance and voting rights. Types of Securities Lending Transactions 10 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(11) While participants may understand that, in reality securities are being sold, the issue of collateral, commonly used in financial borrowing transactions, becomes important in distinguishing the types of securities lending transactions. Most securities loans are collateralized with either other securities or with cash deposits. If a lender takes securities as collateral, they are paid a fee by the borrower. Conversely, if they receive collateral in the form of cash, they pay the borrower interest, albeit at a rebate rate that is lower than the market rates, so that they can reinvest the cash to make a return. It is here that we begin to see how securities lending attracts participants from the lending side. Meanwhile, to arrive at such an agreement, pricing is negotiated between the parties and most often takes into account factors such as supply and demand for particular securities, collateral flexibility, size of any manufactured dividend and the likelihood of the lender recalling the securities early.. 立. 政治大. ‧. ‧ 國. 學. It also should be noted that along with securities lending, sale and repurchase (repo) and buy-sell back transactions, which will be dealt with later in this paper, are used for the temporary transfer of securities against cash. In general, though, securities lending is more likely to be motivated by the desire to borrow specific securities and repo, and buy-sell backs by the desire to borrow cash – but this boundary is less clear.. y. Nat. sit. n. al. er. io. For the first type of transaction mentioned above, namely transactions collateralized with other securities or assets, Faulkner points out that non-cash collateral is usually drawn from government bonds, corporate bonds, convertible bonds, equities, letters of credit, certificates of deposit, delivery by value, or warrants, among others. Once the eligible collateral is agreed upon by the respective parties, other factors are considered, such as notational limits, initial margin, or concentration limits. Figure 1 illustrates a transaction process with collateral being held by a tri-party agent.. Ch. engchi. i Un. v. Regarding those transactions involving non-cash collateral, industry scholars point out that within the securities lending industry a debate exists as to whether lenders who are flexible in the range of non-cash collateral they are willing to receive are actually rewarded with correspondingly lower fees. While some feel that such lenders are rewarded with lower fees, others argue that the fees remain largely static but that borrowers are more prepared to deal with a flexible lender and thus balances out and overall revenue rises. Meanwhile, for securities lending transactions which are collateralized with cash, not 11 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(12) only has cash been an integral part of securities lending activities, this second type of transaction is particularly seen in the securities lending industry in the United States. Researchers point out two important considerations when looking at this cash collateral component with respect to the U.S. First, the distinctions between securities lending and cash reinvestment has resulted in a blurring in the U.S. as securities lending has nearly become synonymous with cash reinvestment. A related second point to this is that, given that the important role U.S. custodian banks play in the securities lending industry is significant, the practice of using cash as collateral for reinvestment purposes has therefore become more prevalent in securities lending industries around the world. Figure 2 illustrates transactions that use cash as collateral. An important distinction between such cash-based transaction as opposed to other forms of non-cash collateral can be found in the fact that in the former transaction, revenue is generated from the difference, or the ‘spread’ between interest rates that are paid and received by the lender.. 立. 政治大. ‧ 國. 學. ‧. Repo A brief understanding of a related activity, a repurchase agreement or ‘repo’, should be offered as repos and securities lending, share many similar practices and functions. However, these similarities may also create some confusion as to the key features of the respective activities.. n. er. io. sit. y. Nat. al. Ch. i Un. v. Repos are a form of short-term borrowing for dealers in government securities, whereby the dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. In this regard, the actual repo transaction is very similar to one which is conducted in the securities lending industry, though the main difference is that in the former, government securities are lent and in the latter, corporate securities, or stocks, are lent to borrowers. Also, the period of time of borrowing is often shorter in a repo transaction.. engchi. Another difference between repo and securities lending is that repos are often classified as a money-market instrument. They are usually used to raise short-term capital. While it has been seen that securities lending, particularly as it is done in the U.S. market, is increasingly using cash for collateral, repo instead focuses on the use of cash in the transaction between lender and borrower.. 12 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(13) Choudhry (2006) presents some of the important characteristics of repo, with the different types including (1) classic repo, or what is often known as “repo trade”; (2) Buy/Sell-back repo; (3) stock loan or securities lending; (4) collateralized loan; and (5) total return swap, with classic repo being the most prevalent activity of the five types. However, some experts such as Miller (1997) do not include the final total return swap as one of the types of repo. Meanwhile, Miller goes on to list the main participants’ uses of global repo markets, including first, to fund leveraged traders, especially dealers, in their normal trading and distribution efforts; second, to provide flexible, highly secure and high yielding investments for cash-rich investors; third, to lend securities that others need to enhance portfolio yields; fourth, to provide an efficient means to borrow securities against short positions; and fifth, to earn net interest income by trading repos in a “matched book”, whereby a matched book is one which involves the borrowing and lending of securities to make a spread between the bid and offered rates.. 立. 政治大. ‧. ‧ 國. 學. From this, he further goes on to separate the activities of borrowers of cash, who tend to fall into three major categories, including dealers needing to fund inventories; highly leveraged traders and speculators, such as hedge funds, needing to fund trading positions; and fully paid portfolio holders, such as security lenders, that lend securities which are in demand and then reinvest the cash generate at higher yields. On the other side are lenders, with them falling into two broad categories, including cash-rich accounts such as money market mutual funds, and security lenders reinvesting cash generated from lending securities.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. Motivations for Borrowing Securities The motivations behind borrowing help further explain how securities lending works. A central argument put forth by proponents of securities lending is that such activity increases liquidity in securities markets. As Faulkner points out, if Initial Public Offerings are frequent and mergers and acquisitions activity is high, then the securities lending business benefits. Conversely, when such activity is depressed, then there are fewer trading opportunities, less demand, and fewer specials. An example of the latter situation could be seen during the first few years of this decade due to a global economic downturn following the burst of the Dot.com boom as well as from the effects of the September 11, 2001 terrorist attacks. Moreover, during these depressed times, investors as well as regulators often are more concerned about the role of securities lending, such as 13 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(14) whether it is linked to the decline of an issue’s share value or whether it should be discouraged. Also, it is important to understand that as markets differ, so may motivations to borrow from market to market. Most experts agree, however, on several key motivations to borrow securities, including borrowing to cover a short position (settlement coverage, naked shorting, market making, arbitrage trading), borrowing as part of a financing transaction motivated by the desire to lend cash, and borrowing to transfer ownership temporarily to the advantage of both lender and borrower (tax arbitrage, dividend reinvestment plan arbitrage). Securities Lenders and Intermediaries Having gained a better understanding on the motivations behind borrowing securities, it is important to look at the various types of securities lenders and intermediaries.. 立. 政治大. ‧. ‧ 國. 學. The supply of securities into the lending market comes mainly from the portfolios of beneficial owners, such as pension and other funds, and insurance companies. Underlying demand to borrow securities begins largely with the trading activities of dealers and hedge funds.. n. al. er. io. sit. y. Nat. Still, a number of intermediaries exist. The intermediaries’ importance in the market partly reflects the fact that securities lending is a secondary activity for many beneficial owners and underlying borrowers. Intermediaries provide valuable services, such as credit enhancement and the provision of liquidity, by being willing to borrow securities at call while lending them for term. They also benefit from economies of scale, including the significant investment in technology required to run a modern operation.. Ch. engchi. i Un. v. If we further look at who the intermediaries are, they can include custodian banks and asset managers lending securities as agents on behalf of beneficial owners, alongside the other services provided to these clients. Agents agree to split securities lending revenues with lenders and may offer to protect them against certain risks, such as borrower default. An additional category that Faulkner points out includes dealers trading as principals. Dealers shuttle between lenders and borrowers, but they also use the market to finance their own wider securities trading activities. They may seek returns by taking collateral, counterpart credit or liquidity risk, for example, by lending securities to a client for a period of time while borrowing them on an open basis with a risk of early recall by the lender. Through their prime brokerage 14 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(15) operations, they also meet the needs of hedge funds and the borrowing of securities to finance their positions has grown rapidly. For beneficial owners, there are a number of different possible routes into the market. These include using an agent (custodian bank, asset manager or specialist) to manage a lending program, auctioning a portfolio to borrowers directly, selecting one principal borrower, establishing an ‘in-house’ operation and lending directly, or some combination of these strategies. Securities Lending Portfolios Often, State Street, among others, have categorized securities lending into three types of portfolios, including a collateral investment, or ‘asset’, portfolio; a funding or ‘liability’, portfolio; and an integrated portfolio.. 政治大 The collateral reinvestment portfolio, or asset portfolio, consists of a set of securities, 立 each with a specified yield and expected term to maturity. The investor is long in this. ‧ 國. 學. portfolio, as the portfolio is the receiver of the yield.. ‧. For the funding portfolio, or liability portfolio, it consists of a set of securities, each with a specified cost — also referred to as the rebate rate — and term to maturity, whether overnight or a return date agreed upon at the time the loan is initiated. The investor is short this portfolio, as the portfolio is the payer of the yield.. er. io. sit. y. Nat. al. v. n. Finally, the third portfolio type is an integrated portfolio which represents the combination of the funding and reinvestment portfolios. Through its analysis, a practitioner can quantify the offsets (hedges) that exist in the portfolio as well as the residual risk.. Ch. engchi. i Un. Electronic Securities Lending A final issue dealt with in this section involves the rise of electronic securities lending. This form of lending has gained an increasing amount of attention for the role that it may possibly play in the development of securities lending on the whole. The fact that those who are involved in the development of electronic securities lending platforms also were affected during the global financial crisis alongside other non-electronic securities lending organizations indicates that such digital lenders will increasingly be viewed just as other real-world lenders.. 15 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(16) As eSecLending’s Simon Lee pointed out in a roundtable discussion, it was a misconception that eSecLending or similar organizations are electronic trading platforms, as he believed that it was an agency lender in much the same vein as other agent lenders. In this way, it also had loans open to Lehman Brothers, which went bankrupt at the height of the global financial crisis in 2008. Lee went on to admit that the bank’s default was a strong testament to the fundamentals of securities lending as it is a collateralized transaction (Financial News 2008). However, it is interesting to note that what is also being seen by some in the electronic form of securities lending, as Brian Lamb of EquiLend revealed, is that as volatility increased in the market, so did the volumes on electronic platforms. Nevertheless, it was questionable if this was a positive for electronic securities lenders as while their volumes may have increased as volatility increased, in the long run they expected to see decreased lending and borrowing should such volatility continue.. 立. 政治大. ‧ 國. 學. IV. The Debate on Securities Lending. ‧. In the aftermath of the global financial crisis, which began to impact markets globally particularly in the second half of 2008, many governments and regulatory agencies began to take closer looks at the activities of short sellers, a closely related activity with securities lending. Moreover, many countries, including Taiwan, for various periods of time placed outright bans on short selling, thus curtailing securities lending activities almost entirely during the restricted periods.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. Meanwhile globally, securities lending organizations, individual firms and proponents have sought to explain how this downturn has impacted upon the practice of securities lending. Some key challenges that the industry currently faces have been offered by organizations such as Data Explorers (2008), a research organization that provides quantitative measurement of securities lending, performance and risk. In a 2008 conference on the state of the securities industry, the organization placed rebuilding client trust and confidence as the key challenge for the industry. Also, as the result of a likely greater call for transparency within the industry, engaging policy makers globally was seen as the second greatest challenge, followed by the related desire to increase regulatory certainty and thus reduce risk. Still, the bans on short selling and the impact that securities lending has on markets, however, is a debate that has origins which began much earlier. Critics of short selling 16 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(17) in general and securities lending in particular have argued that such activities help drive down share prices unfairly. Nevertheless, organizations such as ISLA have produced several important papers on the actual impact securities lending has on a given securities exchange (ISLA 2008). Such proponents of short selling and securities lending have also been actively trying to draw a distinction recently between short selling, which is often permitted in securities markets, and naked shorting, where sellers do not own or are not in possession of the shares they are selling, which is often illegal. Considerably more has been written to defend securities lending and short selling, while much of the existing literature or reports that are critical of securities lending comes in from regulatory officials or high-profile cases involving short sellers. However, for those who support securities lending, advocates such as David Rule of ISLA address the debate directly, citing a variety of related research which makes a case against constraining short sales and securities lending. Interestingly, authors such as Ofek and Richardson (2003) have looked at the possible link that short selling constraints may have had on allowing the internet bubble to grow due to overpriced internet stocks and the inability of short sellers to bring them back into equilibrium price.. 立. 政治大. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. Conversely, ISLA found that regulatory agencies often will point to several key concerns, including (1) a need to impose an uptick or zero-tick rule to prevent prices from being driven down; (2) the potential for market abuse by ‘bear raiders’ who encourage false rumors to manipulate share prices; and (3) the risk of settlement disruption, including the problems associated with naked short sales.. Ch. engchi. i Un. v. In addition, in the past few years an increasing number of high-profile cases involving securities lending participants have captured headlines, thus further creating unwanted attention to the industry. This attention has not only come from regulators, but also from law enforcement officials (Davies 2007). This trend may be important for foreign institutions such as those in Taiwan, given that as securities lending grows, regulations may lag while rules and procedures may be unclear. This may increase the chances of not only offshore investors but also local borrowers and lenders running into problems, either of a regulatory or even a legal nature. Securities Lending, Short-selling and the Global Financial Crisis While the above title may indicate the three components are related, in fact there has been great debate on the relationship of the first two, securities lending and 17 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(18) short-selling, with the third, the global financial crisis which took place in large part in the second half of 2008. Still, it is understandable if some believe there is a link among the three activities. As Dyson (Financial News 2008) discussed in a roundtable format in the months following the downfall of Lehman Brothers, the prime brokerage’s bankruptcy was the result of the credit crisis. Also, he pointed out that Lehman Brothers was often in the top five of borrowers related to securities lending, with there being high demand for securities on the back of its substantial prime brokerage business. Certainly, regulators from various countries appeared to make such a connection as they enacted measures to curb short-selling, and with it, securities lending activities which they believed would help reduce pressure on plummeting share prices. As a result, in the final months of 2008 the securities lending industry saw bans placed on short-selling in several markets, thus effectively stopping securities lending activities during the bans.. 立. 政治大. ‧ 國. 學. ‧. Role of Securities Lending As Clunie points out, securities lending has an important role to play in the creation of an efficient market, as in finance theory, asset pricing models such as the Capital Asset Pricing Model and Arbitrage Pricing Theory assume that securities can be “sold short.” That is to say, securities can be sold, even when they are not owned “long”. Short sellers borrow shares, so that they can deliver title for the shares sold short. The securities are subsequently re-purchased at some future date to close out the position. Short selling provides investors with a mechanism for acting on apparent overvaluations in security prices. Contrast this to a world without short-sellers, where an overvalued security can only be sold by an existing holder of the security.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. However, as he also continues, the association between securities lending and short selling is of special interest to regulators, market participants, and academics, because of its impact on prices and market liquidity, and because of its role in the process of arbitrage. Bans on short-selling in the aftermath of the global financial crisis In the months following the financial meltdown that took place in global markets and resulted in the bankruptcy of Lehman Brothers, as well as a consolidation within the financial industry, Australian regulators banned short-selling of every stock in that country until January 2, 2009. In the U.S., the Securities and Exchange Commission 18 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(19) did the same for nearly 900 financial companies starting from October; while England’s regulator banned shorting in 32 names (Financial News 2008). Meanwhile, Taiwan in September 2008 also imposed its own ban on short selling in the face of the global economic meltdown. The ban included shares of 150 companies on the Taiwan 50 Index, the Taiwan Mid-Cap 100 Index and the Taiwan Information Index. Originally intended to last until early December of that year, the ban on short sales was argued by many investors to have helped the TWSE see a drastic reduction in trading volume during that time. Since the various governments, however, have pumped in hundreds of billions of dollars into their respective economies, and with markets stabilizing, such short-selling bans have gradually been lifted. Nonetheless, from much of the literature written by proponents of securities lending, the entire industry is aware that its activities will continue to be under the watchful eyes of regulators around the world for some time.. 立. 政治大. ‧ 國. 學. ‧. Market Myths Some would argue that much of the fear of short selling and, to a lesser extent, securities lending, is drawn from a lack of fully understanding the industry. In some case, distaste for securities lending is even sometimes borne out of myths surrounding how the industry operates. Faulkner and Stopford Sackville (1997) point out several key myths that exist in the securities lending market. It is important to dispel such myths when markets such as Taiwan begin to evaluate the pros and cons of creating their own securities lending markets.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. One such myth involves the belief that everyone should lend their available securities. However, as portfolios’ attractiveness varies over time, the need or ability to lend from them changes. Thus, while it is important to be an informed observer, as Faulkner and Stopford Sackville recommend, this does not mean all should lend. Another myth that has received even more attention is that lending carries no risk. However, with the onset of the global financial crisis, this myth has become especially apparent as lenders found themselves with either share that had rapidly dropped in price as collateral, or, in the case of cash collateral, challenges with regards to their reinvestment strategies. Interestingly, another myth that should have been shatter-proof is the belief that cash 19 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(20) is the only form of safe collateral. However, as globally we enter a period of depreciation for the US dollar, among other securities, this no longer holds true. Moreover, Faulkner and Stopford Sackville pointed to this more than a decade before the onset of the global financial crisis when they pointed out that the benefits of having cash of collateral only exist if it has been managed and invested to produce a yield. In addition, cash reinvestment itself is not without risks. In fact, as they reveal, significant losses in the securities lending industry are often associated almost exclusively with the taking of cash as collateral.. V.. Securities Lending and its Impact on Global Capital Markets. While Taiwan is the primary focus of this paper, it is but one of the many nations around the world that have created securities lending systems with a primary purpose help increase liquidity in their securities markets. Moreover, as securities markets, especially in Asia, play an important role as one of the often-used ways firms try to obtain capital, a look at how securities lending has impacted financial and capital markets in an international sense is necessary to put both the development of securities lending markets as well as that of Taiwan’s experience in context.. 立. 政治大. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. Within Asia, established securities lending markets (in terms of the amount of lendable assets) exist in Japan, Australia and Hong Kong, with other growing markets, such as in South Korea and Singapore (Spitalfields 2008) have made important gains recently. Meanwhile, it is important to note that Taiwan, despite a relatively newer system, ranked third in Asia (ex-Japan, Australia and Hong Kong) in 2008 in terms of the amount of lendable securities, slightly ahead Thailand, New Zealand and Indonesia.. Ch. engchi. i Un. v. When looking at Asia on the whole, as Heath (2004) points out key obstacles still exist. Compounding the problem of the pace of development includes the increased presence of hedge funds in Asia, who often use securities lending to cover short positions. Another obstacle can be found in the acceptance of using digitized systems to settle securities lending transactions, although this is a problem not solely limited to Asia. Finally, regulatory obstacles remain in various amounts around the region, thus making it difficult for lenders to take full advantage of opportunities that may exist in the various countries’ bourses. Securities Lending as Part of Capital-based Market Finance 20 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(21) In the view of State Street, it may not be so surprising that the rise of securities lending has followed the rise of capital-based finance globally, as capital markets eclipsed traditional, bank-dominated financial systems. It is estimated from data collected that during the 1990s total global securities market capitalization grew at a compound rate of nearly 11% a year to well over US$60 trillion worth of stocks and bonds by the year 2000, or nearly twice that of global GDP, with much of the growth coming from New York and London. It was also during this period that such markets saw their respective securities lending industries make the greatest strides forward. It should also be said that few people are arguing that capital markets are the only future for financing economic growth. Yet, it is known that that having both advanced capital markets and strong banking systems gives nations greater competition in the ability to provide capital and correspondingly reduces the need to rely on one system only, as State Street researchers discuss. Moreover, while capital markets and securitization may have experienced some problems over the past year or so, few are arguing that nations are better off solely with traditional, bank-led financing of an economy’s capital needs.. 立. 政治大. ‧ 國. 學. ‧. From this perspective, it can be then seen that liquidity, or the ability to buy or sell substantial investment positions quickly, smoothly and with minimal impact on a market is perhaps, as State Street researchers argue, the single-most important quality that a successful securities market must foster. It is from this idea that leads organizations such as the FTSE to view securities lending, which enhances market liquidity, as a key component in the development of a financial market as the level of liquidity in a market may help define the “maturity” of a given market.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. The importance of securities lending on financial markets, particularly in Asia, was echoed by the Asian Development Bank (1999), when it included their development as one of its key recommendations on improving clearing and settlement in the region. Surprisingly, in its report, ADB noted that Taiwan and Korea had in the 1970s set up SBL systems that were similar to that of Japan. Thus, as State Street findings indicate, proponents view securities lending as greatly enhancing market liquidity as it expands the total supply of assets available in a market to support trading and settlement, as the outstanding stock of assets in effect do “double duty”. Another contribution that securities lending provides to capital markets is that by 21 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(22) turning existing stocks and bonds into financing sources for further transactions, it also minimizes trading friction, improving efficiency, reducing settlement fails and lower transaction costs across an entire capital market. Also, research has shown that in many nations through the 1980s and 1990s, new or revitalized capital markets began their economic “take-offs” by first attracting increased attention from domestic investors and from the most venturesome of foreign investors. From this, it is this first wave of inward investment that makes an emerging marketing actually “emerge”. To continue growing, a capital market needs to draw investment that is more stable and longer term – from larger investors who are typically much more risk-averse than the pioneers. As these changes take hold and investment in a given market rises, further pressures build – for better data, for greater transparency, and for the creation of risk mitigating products that increasingly larger investors need to hedge their investment exposures. The demand for means to hedge exposures is particularly acute, among global pension funds – which State Street estimates at managing upwards of US$13 trillion worldwide as of 2001 – where asset strategies are typically quite rigid.. 立. 政治大. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. Bound by fiduciary standards of prudence, many institutional investors are virtually obliged to use derivatives, repos and other instruments to manage their investment exposures. The rise of markets in derivatives instruments depends on the ability of players in the real or “underlying” securities markets to engage in hedging and securities lending. This, in turn, sustains liquidity amid rising transaction volumes. Also, in markets where securities lending is underdeveloped – or explicitly discouraged by regulatory or cultural barriers – evolution to a world-class level is simply stunted, at least until these barriers are removed. Thus, some argue a new consensus is unfolding, namely the ability to borrow securities as an indispensible element in the development of advanced, effective capital markets.. Ch. engchi. i Un. v. Securities Lending and Liquidity In terms of market significance, as Faulkner points out, if the derivatives market is the engine, then securities lending is the much-needed oil. However, as expensive oil, which draws institutions from their core activities toward the less familiar world of securities lending, where being an expert is rewarded accordingly. As such, securities lending experts focus upon matching supply and demand in lendable securities. This liquidity can be measured, too. Spitalfields Advisers estimate that around US$6 22 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(23) 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.. 立. 政治大. ‧. ‧ 國. 學. 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.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. 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.. 23 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(24) 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).. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. i Un. v. 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.. engchi. 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 24 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(25) 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.. 政治大 Formation of Taiwan’s SBL: Margin Trading Status Begins in Taiwan 立 With a relationship between margin trading and securities lending, ‧. ‧ 國. 學. 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.. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. 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 25 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(26) 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).. 政治大. 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.. 立. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. 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).. Ch. engchi. i Un. v. 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.. 26 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(27) 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.. 立. 政治大. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. 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.. Ch. i Un. v. 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.. engchi. 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 27 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(28) 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:. 政治大. “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). 立. ‧. ‧ 國. 學. n. al. er. io. sit. y. Nat. 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.. Ch. engchi. i Un. v. 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. 28 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(29) 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.. 政治大. Table 3 offers all look at the ability of Taiwan’s SBL system in terms of foreign institutions’ participation.. 立. ‧. ‧ 國. 學. 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.. sit. y. Nat. n. al. er. io. 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.. Ch. engchi. i Un. v. 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 29 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).

(30) 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).. 立. 政治大. ‧. ‧ 國. 學. 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.. n. al. er. io. sit. y. Nat. 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.. Ch. engchi. i Un. v. 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 comments. In June 2009, MSCI announced that it was placing the TWSE on 30 IMBA Thesis Draft. Chris Cottorone (tainanchris@yahoo.com).