2. securities markets[1]

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Securities Markets

October 2010

Korea Exchange



Table of ContentsI. Investment and Securities Markets

II. Floating New Securities(Primary Market)

III. Creating Demand for Securities(Secondary Market)



I. Investment and Securities Markets



Essential nature of investment• Reduce current consumption•

Consume more in the future

Real Assets• Assets used to produce goods and services

Financial Assets• Claims on real assets

Investment and Financial Assets



• Consumption Timing

•

Allocation of Risk• Separation of Ownership and Management

- Agency Issues

Investment and Financial Assets



General Class i f icat ion o fA Secu ri t ies Market

Short-termMoney Market)

Long-termCapital Market)

SecuritiesMarket Primary

Market ExchangeMarket

OTCMarket

SecondaryMarket

CD s, CPs, T-BillsRepos, etc.



ISSUERS (Money Demanders)

- Corporations, Government

INVESTOR (Money Suppliers)

-Individuals, Institutionals

INTERMIDIARIES (Underwriters)

-Securities Firms,Investment Banks

M oney

Securities

SubscriptionsPayments

Sales Underwriting

Primary Market



Securities Securities

INVESTORSISSUERS INVESTORS

Fund Fund

Primary Market Secondary Market

Struc tur e o f a Secu ri t ies Market



Regulatory Bodies

Investors(buy-side)

Investors(sell-side)Brokers BrokersExchange

Banks

Regulation Supervision Cash Flow Securities

Securities Depository

Secondary Market



Mobilizing industrial fundsPool small & short-term savings and make them availablefor large & long-term use by corporate sector

Diversified financing choices at lower costsEquity financing, debt financing… Companies can set their own interest rates

Providing a conduit for savings to the publicDiversified investment vehicles - stocks, bonds,derivatives, etc.

Roles o f a Secu ri t ies Mark et



Change of ownership structure andmanagement pattern

Privatization is central to transitional countries’economic reforms and developments

Shareholders wealth-maximization bring aboutchanges in management patterns

Redistribution of national wealth Wide distribution of corporate shares inducesredistribution of corporate profit

Roles o f a Secu ri t ies Mark et(cont’d)



Attracting foreign capitalCredible and well regulated emerging markets

Providing liquidity for savers Easy conversion of financial instruments into cash

Alleviating poverty issueEconomic growth supported by efficient allocation ofresources reduces unemployment, enabling povertyalleviation

Roles o f a Secu ri t ies Mark et (cont’d)



Pol icy Goals in

Fos ter ing a Secu ri t ies Mark et

Improving corporate financial status

High leverage leads to financial distress and riskierinvestments

Lowering cost of capital of corporations Improving corporate governanceEnhancing financial market efficiencyEnsuring economic equity



Sup ply-s ide Pol ic ies

Incentives to Go Public

To issuers

Lower corporate taxesPreferential bank loansProtection of founders’ interests – ownershipceilings, restrictions on M&A, etc.

To investorsDiscounted public offering pricesLower income tax on dividend income



Supp ly-s id e Pol ic ies (cont’d)

Compulsory to Going Public

Government’s order to go public

Disadvantages to firms reluctant to go publicsurcharge in income taxrestrictions on loans & borrowingsaccounting of interest payable (not tax deductible),etc.



Supp ly-s id e Pol ic ies (cont’d)

Privatization of SOEs through public offeringsLarge-sized SOEs with high profitability & growthpotential

Full or partial sell-outDiscounted selling pricesTarget middle- & low-income people



Dem and -sid e Pol ic ies

Investment TrustsConvert small investment funds into industrialfundsEncourage indirect investments

Securities savings schemeEligible for low income bracket peopleTotal investment amount is limitedProceeds is tax deductible



Dem and -sid e Pol ic ies (cont’d)

Employees Stock Ownership Plan (ESOP)Employees become shareowners of their own companiesCertain portion of shares is assigned to employees

Company’s financial support Employees’ increased commitment to productivity

Opening securities market to foreignersForeign capital inflowTransfer of modern investment techniques



II. Floating New Securities



II. Floating New Securities

Economy Size, Development, Growth Rate

Degree of Market Economy and Corporatization

Attitudes of Business People

Government Enticement including Interest andTax Policies



II.1. Countries in Transition

State is the only Supplier of Securities

Privatization is Difficult and a Slow Process

Initially the Market is not a Source of CompanyFinancing but a Source of Income for the State

Need for Clear Method of Valuation




(cont’d)

Clear Legal and Institutional Framework to decidethe of Shares available to the Public

Listing Privatized Companies

As Demand goes up, Share Prices rise.With Government Incentives, then more listing.Need for Good Infrastructure and RegulatoryFramework (Underwriting, Broking, Listing)

Having Adequate of Shares to Trade is more

Important than the of Investors




PolandGo slow, Listing initially only 5 Stockswith High Listing Requirements,a few Years Later, very active IPO Market

Czech (more politically stable and economically promising)Listing hundreds companies, however,only 40 Stocks are Active.

Why?Transparency and the Difference between wellRegulated versus Lax Regulation



II.2. Taxation Policies

In Korea, stock market boom in 1984 and 1988.As stock prices rise, the cost of capital declines,which should lead to rising investmentopportunities and the need for funds. However,few IPOs and little new financing. Why?

Interest rate ceiling, government implicit loanguarantees, and favorable tax treatment of debt.In 1988 new listing started to pick up.



II.3. Maximize floating share

Cross-Shareholding among Chaebols

Percentage of Shares floated out of issued Shares

Monitoring of the of Shareholders stipulated inthe Listing Requirements



II.4. Going public

In rapidly growing Economies, Investmentsgreater than internal Financing Sources

Separation of Ownership and Management.Taxes on transferring Shares must be givenspecial Treatment.

Sale of Shares in the Bull Market brings largeCash Flow above Book Value.Capital Gains Issue must be closely examined.



II.4. Going public

Initially Business Owners will be concerned withHigh Dividend Requirements, Losing ManagementControl to Outside Shareholders.It may be reasonable for the Government toprovide Tax Credit, Financial Support, CorporateControl Protection, and others to encourage Public

Offering.Sometimes coercive measure must be taken.



II.6.

Compulsory measures to go public Enactment of special Law Force Companies to gopublic

If violated, no Interest Tax Deductibility, surchargeon Corporate Tax and Individual Income Tax ofShareholders, Restriction on Bank Loans andIssuance of Bonds

Qualified Firms must register and discloseCorporate Information, which encourage soundmanagement.Prerequisite for going pubic



II.8. Underwriting

In Korea, when the Primary Market was yetdeveloped, Korea Investment Corporation (1968)was established to promote issuance anddistribution of shares.

Roles of KICunderwriting, trading, market stabilization,

sales agency of stocks owned by the governmentand private corporation, credit analysis



II.9. Tax incentives (Korea)

Up to 16.6% lower Corporate Tax Rate

Additional Depreciation / Bad Debt Allowances

Lending restrictions to selected closely held

Companies



III.Creating Demand for Securities



Some factors

of financially sophisticated individuals withcash to invest

of institutional investors including insurancecompanies, pension and mutual funds

Relative attractiveness of securities to other

investment alternatives

Rules on foreign portfolio investment



III.1.

Enhancing Investor Confidence Lack of securities demand :lost confidence, inadequate regulations, few institutionalinvestors

Strong supervision :insider trading issues, stock market manipulations

Exogenous factors :political instability, social culture, education

Endogenous factors :inadequate regulatory environment



III.1. Enhancing Investor Confidence

Availability of Corporate Information

Competent securities companies: research on markets andstocks

Information dissemination communication system, researchon microstructure of the market

Mandatory information disclosure rules in the listingrequirements

Accounting and auditing practices: only large blue-chipcompanies may survive

When demand for securities is greater than the supply,issuing firms take the situation granted.



III.4.

Proper regulation

Deregulating in areas that inhibit operation ofan efficient market

Strong regulation and supervision in areas thatprotect shareholders



III.5. Institutional investors

Mutual funds, pension funds, universityendowments, insurance companies

In emerging markets, institutional investors play

a small role whereas it is contrary in developedmarkets. It could be due to investment restriction.Nevertheless, they play an important role asliquidity providers



III.6.

Institutional investors (cont’d)

Positive functions

Supplying long-term funds

Stabilizing the market during turmoil

Investment vehicle for small investors

Country funds attract overseas funds

Educated and knowledgeable investors force the marketefficient

Monitoring listed companies as influential investors



III.6.

Institutional investors(cont’d)

Negative functions

Enormous power to move the market

Dry up liquidity if stocks were held for a long time

Incentive for government to intervene in management tomove the market



III.6.

Institutional investors

Popularize

Who can be called institutional investors

Minimize restrictions

Tax exemption on dividend income



III.7.

Retail Investors

Despite of their small ownership in the market, veryactive in trading

Introducing securities savings: preferential treatment(tax deduction, guaranteed return rates) for smallinvestors who fall under certain criteria

Wealth building tool for low income people Accumulating industrial funds Enlarging the investor base



III.7.Retail Investors

(cont’d) Introducing Employee Share Ownership Plan (ESOP)

As employee shareholders, companies become more stable in

their operations and deter any hostile takeover threatsCompanies allow partial payment or provide loans for stock

purchase

Preferential tax treatment

In Korea, the tax rates vary; minority versus majorityshareholders or dividend-paying corporations is listed orunlisted.

No capital gains taxes on listed securities but not unlisted

securities



III.7.Retail Investors

Margin transaction

In Korea, until 1996 it was restricted by the SEC because ofits speculative nature.

Types of securities credit in Korea: by securities companiesto investors for margin trading, by the Korea Securities FinanceCorporation to underwriting companies, securities collateralloans by securities trust company



III.8.Foreign investors

From investable fund surplus market to deficitmarket either directly or indirectly

Their contributions: additional resources, modernmanagement know-how and technology,improvement in the market efficiency and servicequalities

Factors attracting: consistent and predictableregulatory environment, deregulated capital market,width and depth of the market, fit with the globalmarket



III.8.Foreign investors

Factors to be concerned about: repatriation ofinvestment proceeds, voting rights, trading hours,tax consequences

Adverse factors: low EPS, high inflation, uncertainexchange rates, unreliable macroeconomic policiesand inconsistent regulatory changes, political

uncertainty



Kamsahamnida

Thank you very much for your attention

Good Luck!

Korea Exchange

2. securities markets[1]

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