(gyun jun) derivatives spot_ transaction tax ramifications

7/31/2019 (Gyun Jun) Derivatives Spot_ Transaction Tax Ramifications

1/7

July 31, 2012

Samsung Securities (Korea) www.samsungpop.com

All material presented in this report, unlessspecifically indicated otherwise, is under copyrightto Samsung Securities. None of the material, norits content, nor any copy of it, may be altered inany form or by any means, transmitted, copied, ordistributed to any other party, without the priorexpress written permission of Samsung Securities. This memorandum is based upon informationavailable to the public. While we have taken allreasonable care to ensure its reliability, we do notguarantee that it is accurate or complete. Thismemorandum is not intended to be an offer, or asolicitation of any offer, to buy or sell the securitiesmentioned herein. Samsung Securities. shall notbe liable whatsoever for any loss, direct orconsequential, arising from any use of thismemorandum or its contents. Statements, if any,relating to affiliates of Samsung Securities. are

also based upon information available to the publicand do not necessarily represent the views of themanagement of such affiliates.

This report has been prepared without anyundue external influence or interference, andaccurately reflects the views of the analyst(s)covering the company or companies herein.

DERIVATIVES SPOT

Transaction tax ramificationsDerivativesSpot Derivatives transaction tax to drive down market liquidity: With a transaction taxon derivatives expected in 2H12 or early next year, we take a detailed look at the

potential ramifications. While opinions over the impact of taxing financial products vary greatly, one thing is clear: the introduction of a derivatives transaction tax will take a tollon the liquidity of derivativesjust as the 2010 imposition of a transaction tax on publicoffered mutual funds led to a rapid cut in index funds average equity turnover ratio,and capital-gains tax (from 2010) on overseas equity-type ETFs caused a speedy declinein ETF liquidity.

Retail portion of investors expected to rise: In the Kospi 200 index futures market,scalpers who place more than 5,000 orders per day account for 60% of the number of orders and 50% of trading value. The imposition of a tax on derivatives transactions

would deal a blow to their trading, driving down index futures trading volume by asmuch as 70%, according to our simulation. Furthermore, if the scalper portion of traders (mostly foreign investors) falls, the retail-investors portion would risemeaningmarket reactions to news of a crisis in the financial system or stock market could bemore volatile. The new tax would also take a toll on program trading which accountedfor 15% of daily Kospi trading value this year y triggering a reduction in arbitragetrading, and in turn stock market liquidity. This would suggest that any increase ingovernment tax revenue resulting from a derivatives transaction tax would be offset y adecline in tax revenue from stock transactions.

Profitability of securities firms under threat: Taxing derivatives transactions couldput a dent in the profitability of securities firms, which saw little growth in overall feeincome from financial products over FY09-11 (with a drop in equity fees overshadowing

increases in futures and options fees). Foreign firms would suffer a decline infutures/options fee income, while domestic firms would incur heavier transaction costsin prop trading of futures/options for DLS-hedging.

Ideas to minimize market shock: Regulators need to consider ways to minimize theimpact on market liquidity from a derivatives transaction tax, such as: 1) allowing agrace period and raising tax rates gradually; 2) achieving a consensus on capital gainstaxes; 3) applying different rates for qualified foreign institutional investors; 4) taxingfutures transaction on income earned in the daily mark-to-market process and allowingsecurities firms to defer taxes in the case of losses, and taxing options when they aresettled on expiry.

AnalystsGyun [email protected] 2020 7044

Trisha [email protected] 2020 7823


2/7

July 31, 2012

Derivatives Spot

2

History of discussion on derivatives transaction tax

The imposition of a derivatives transaction tax has been discussed in earnest this year.Proponents of such a tax argue that: 1) it is unfair to levy taxes only on equitiestransactions; 2) there are no grounds for exempting derivatives trading income from tax;

and 3) it would help curb market speculation.Kospi 200 index futures listed in 1996, Kospi 200 index options in 1997, and 3-year KTBfutures in 1999. To help the derivatives market take root, the government exempted suchcontracts from transaction taxes. While calls for derivatives taxation have been heardsince 2000, taxes have never been introduced because of a failure of the government andmarket players to reach consensus on the ramifications of taxation.

Since the 2008 financial crisis, restrictions on derivatives trading have tightened aroundthe world. With the EU deciding to introduce a financial transaction tax in 2011, calls fortaxation on derivatives regained momentum in Korea. On several occasions, marketparticipants have engaged in speculative derivatives trading eg , in a 2010 DeutscheSecurities options imbroglioand efforts to crack down on them have ensued eg ,strengthened ELW trading regulations, an increase in contracts multiplier, and investors being required to report large positions (over 5,000 contracts).

The government is now discussing the introduction of a derivatives transaction tax (vs aderivatives income tax). The details are still being hammered out, including the rate of thetax (eg , 0.1-1.0bps on futures trading), the target of the tax ( eg , Kospi 200 index product)and a temporary grace period.

The impact of transaction taxes on financial products (including derivatives) has beenhotly debated both in the real world and academia. Proponents say that such taxes boosttax revenue, while opponents argue that they drive investors away from the market orcause them to reduce their trading. While all market participants agree that such taxescause the liquidity of financial products to fall, they differ over the magnitude of such a fall.Some maintain that market volatility drops due to declines in speculation, but others

claim that reduced liquidity leads to a spike in volatility. Some contend that taxationdampens price efficiency, triggering transaction-cost hikes and expansions of bid-ask spreads, while others assert that market efficiency improves on the prevention of noise.

While it has yet to impose a derivatives transaction tax, Korea in 2010 imposed: 1) atransaction tax on publicly offered mutual funds; and 2) capital gains tax on overseasequity-type ETFs.

The transaction tax on publicly offered mutual funds in 2010 (and on private placementfunds in 2009) led to a rapid decline in funds average equity turnover ratio, with indexand arbitrage trading funds taking the biggest hits. The average turnover ratio of indexfunds, which seek enhanced yields via spot/futures arbitrage trading, plunged due toincreased transaction costs.

During the 2Q-4Q09 grace period, index funds turnover ratios hit 760%. In 1Q10 whenthe grace period ended, however, that figure plunged to 134%or one-fifth the leveldriving overall stock market liquidity down.

Quarterly turnover ratio of Kospi 200 index funds(%) 1Q10 4Q09 3Q09 2Q09

Average 134.99 675.67 683.80 936.56

Max 1,120.40 9,288.32 5,408.17 9,084.12

Min 0.10 1.09 0.00 0.14

Note: Only funds with AUM of KRW10b or more included; ETFs excludedSource: Kofia, Zeroin

De r iva t ive s t r a n sa c t io n t a x u n d e rse r io u s c o n s id e r a t i o n th i s y ea r

Calls for der ivatives taxations in c e 20 0 0 u n a n s w e r e d

Ar o u n d th e wo r ld , d e r iva t ive st ra d ing res t r ic t ions t igh ten

Tax on der iva t ives to take thef o r m o f t r a n sa c t io n t a x ( vsin c o m e t a x )

Ram ifica t ions o f der iva t ivestaxa t ion s t i ll ho t ly deba tedwo r ld wid e

Tran sac t ion tax on pub l ic o ffe r ingfu n d s i n t r o d u c ed

index fun ds tu r no ver r a t iodown to on e- fi fth o f p r ev ious leve l


3/7

July 31, 2012

Derivatives Spot

3

According to Joon-seok Kims masters thesis (Hanyang University, 2011) on the impactof a futures transaction tax on stock and futures markets, the introduction of a capital-gains tax for overseas equity-type ETFs dealt a blow to the trading volume and value of those ETFs subject to the taxation. ETFs not subject to the tax showed no significantchange in trading volume or value, and thus the liquidity of the Kospi 200 constituents was unaffected. Based on the two examples above, it is reasonable to expect new taxes toslash the liquidity of given financial products.

Changes in liquidity after introduction of capital-gains tax on overseas equity-type ETFsTrading volume (no of shares) Trading value (KRWm)

Before After Before After

7 ETFs subject to new tax 81,273 20,206 1,371 347

50 ETFs not subject to the new tax 8,272,478 7,404,379 113,957 101,056

Kospi 200 constituents 107,620,000 105,034,000 4,502,321 4,480,029

Source: Joon-seok Kim, Masters thesis (Hanyang University, 2011)

Ramifications for derivatives market

The introduction of a derivatives transaction tax would likely affect scalpers in the Kospi200 index futures and options markets, leading to a reduction in the liquidity of thesemarkets. According to Korea Capital Market Institute, investors placing over 10,000orders per day accounted for only 0.08% of total investors (see table below), butrepresented 4.3% of total trading volume and accounted for 18.6% of the total number of ordersvs the respective 12% and 11% for investors who place less than 50 orders per day (86% of total investors). This breakdown remains unchanged as of recently.

Investor breakdown by the number of orders and trading volumeNo of orders per day No of accounts Portion of no of orders (%) Portion of trading volume (%)

10,000 or more 5 18.68 4.33

5,000~10,000 10 13.78 9.25

1,000~5,000 70 30.17 36.16

50 ~1,000 806 25.83 37.70

Less than 50 5,430 11.54 12.56

Total 6,321 100.00 100.00

Note: Nov 26, 2010 Dec 2, 2010Source: "Situation and characteristics of high-frequency trading", "Perspective", Korea Capital MarketInstitute, 2011

The new tax would likely cause a fall in the trading frequency (and trading portion) of scalpers, and subsequently the total trading volume of other investors. If investors placingover 1,000 orders per day (accounting for 62% of the total number of orders and 49% of trading volume) face a derivatives transaction tax, the impact on their trading volumecould be considerable. As seen in the chart below, the new taxation would have a greaterimpact on heavy traders, slashing their trading volume by a massive 70%.

Investor breakdown by the number of orders and trading volumeNo of orders per day

Drop ratio of trading(%)

Portion of no of orders(%)

Portion of trading volume(%)

10,000 or more 50.0 9.34 2.17

5,000~10,000 40.0 8.27 5.55

1,000~5,000 30.0 21.12 25.31

50 ~1,000 15.0 21.96 32.05

Less than 50 5.0 10.96 11.93

Total - 71.65 77.00

Source: Korea Capital Market, Samsung Securities

Furthermore, the new tax could alter the composition of investors. If the portion of trading by scalpers (mostly foreign investors and prop traders at securities firms) declines

following the introduction of the tax, the retail portion of investors would risemeaningmarket reactions to news of a crisis in the financial system or stock market could be more volatile.

Capi ta l-ga ins ta x on over seasequ i ty- type ETFs ba d fo r ETFliquidity

Der iva t ives t ra nsa c t ion tax tored uce l iqu id i ty o f der iva t ives

Dr o p in p o r t i o n o f sc a lp e r swou ld : 1) s lash overa l l t r a d ingv olu m e b y a m a ss ive70%(accor d ing to ours im u la t i o n ) ; a n d 2 ) r a i se t h ere ta i l por t ion o f investo rs


4/7


5/7

July 31, 2012

Derivatives Spot

5

Equities still generate most of the fee income at Korean and foreign securities firms,though foreign players earn a greater portion of fees from derivatives than domestic firms.Over FY09-11, domestic and foreign securities firms earned a respective 84.7% and 74.8%of their fee income from equity transaction, and 12.4% and 20.1% from futures/options.

Futures and options accounted for 63% of financial market transactions in FY11, but amarginal 13% of securities brokers overall fee income.

At the lowest tax rates (0.1bps for futures and 1bp for options), we estimate that taxrevenues would be similar to the fee income securities firms earn on futures and optionstransactionsfirms charge fees of 0.15-2.0bps on futures and 2-4bps on options.

Foreign securities firms would likely be more affected than domestic ones if transactiontaxes dampen futures/options transactions, as they have higher portions of sophisticatedinvestors sensitive to transaction costs who might withdraw investments. But domesticfirms would still be affected, given the growing portion of fees they earn fromfutures/options transactions (12.7% in FY11, vs 10.3% in FY09). Domestic firms wouldalso incur heavier transaction costs in prop trading of futures/options for DLS-hedging.

If derivatives transaction taxes reduce their fee income and operating profits, securitiesfirms might pay less in corporate taxes.

Minimize the market shock

The KSE indirectly charges transaction and clearance fees on investors (of 0.00021% and0.00004104% for futures and 0.010944% and 0.00171% for options, respectively)included in fees investors pay to securities firms. The derivatives transaction tax, however, would be a direct tax on investors, and such taxes generally meet strong resistance.

We believe a more reasonable approach would be a capital gains-based tax, such as thoseapplied in most advanced countries.

Uncertainty that taxation might spread to derivatives products beyond Kospi 200 futures

and options is likely to impact market sentiment as wellas it could hinder growth in themarkets for single stock options, Treasury futures, and US dollar futures.

If they do impose a transaction tax, regulators need to introduce it in a way thatminimizes market shockby increasing rates in a gradual manner that allowsparticipants to adjust, for example.

To reduce speculation and encourage institutional investors to use derivatives for risk management, we believe the following approaches should be considered: 1) applying alower tax rate ( eg , 30-50%) to qualified foreign institutional investors; 2) exemptinghedging and arbitrage trading; and 3) subjecting domestic institutional investors todifferentiated tax rates to encourage them to increase their use of derivatives productsexcluding prop trading, such investors account for only about 3% of the Kospi 200 futures

and options markets.Kospi 200 futures are marked to market and incur settlement income every day. Taxingequity trading when equities are sold is similar to taxing capital gains. Thus, levying tax onincome in the process of daily marking to market could be an alternative to taxingtransactions. Taxes could be deferred if the mark-to-market process led to losses. Kospi200 options have no daily mark-to-market system, and could be taxed according toincome on expiry or settlement. Such methods might lead to a capital gains tax system being introduced faster in the derivatives market than in the spot market.

At lowest r a tes , tax revenu e to bes imi la r to secur i t ies f i rm s feein c o m e

Tr a n sa c t io n t a x t o h u r t b o thd o m e s t ic a n d f o r e ign se c u r i t ie sf i r m s

Re d u c e d f e e in c o m e m a y r e su l t inl es s c o r p o r a t e t a x r e v e n u e

Direc t tax l ike ly to m eet wi ths t r o n g r e s i s t a n c e

Co n se n su s o n c a p i ta l ga in s t a xn e e d s t o b e r e a c h e d

Taxat ion cou ld h in der d er iva t ives

m a r k e t gr o w t h

Ho w to m in im iz e m a r k e t sh o c k :1) Gr a d u a l in c r e a se i n r a t e s

2 ) L o we r r a t e s f o r QFI I s ; h e d g in ge x e m p t io n s

3 ) : Ta x fu tu r e s o n in c o m e f r o md a i ly m a r k in g to m a r k e t , o p t io n swh e n se t t le d o r l iq u id a t e d

Fo r e ign f i r m s g e n e r a t e g r e a t e rp o r t i o n o f f e e i n c o m e f r o mf u tu r e s / o p t io n s t h a n d o m e s t icc o u n t e r p a r t


6/7

July 31, 2012

Derivatives Spot

6

Glob al Disclosu r es & Discla im er sG e n e r a l

This research report is for information purposes only. It is not and should not be construed as an offer or solicitation of an offer to purchase or sell any securities or other financial instruments or to participate in any trading strategy. This report does not provide individually tailored investment advice. Thisreport does not take into account individual client circumstances, objectives, or needs and is not intended as recommendations of particular securities,financial instruments or strategies to any particular client. The securities and other financial instruments discussed in this report may not be suitable for allinvestors. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein andinvestors should seek the advice of a financial adviser.

This report may not be altered, reproduced, distributed, transmitted or published in whole or in part for any purpose. References to "Samsung Securities" arereferences to any company in the Samsung Securities, Co., Ltd. group of companies.

Samsung Securities and/or other affiliated companies, its and their directors, officers, representatives, or employees may have long or short positions in any of the securities or other financial instruments mentioned in this report or of issuers described herein and may purchase and/or sell, or offer to purchase and/orsell, at any time, such securities or other financial instruments in the open market or otherwise, as either a principal or agent. Any pricing of securities or otherfinancial instrument contained herein is as of the close of market for such day, unless otherwise stated. Opinions and estimates contained herein constitute our

judgment as of the date of this report and are subject to change without notice.

The information provided in this report is provided "AS IS". Although the information contained herein has been obtained from sources believed to be reliable,no representation or warranty, either expressed or implied, is provided by Samsung Securities in relation to the accuracy, completeness or reliability of suchinformation or that such information was provided for any particular purpose and Samsung Securities expressly disclaims any warranties of merchantability orfitness for a particular purpose. Furthermore, this report is not intended to be a complete statement or summary of the securities, markets or developmentsreferred to herein.

Samsung Securities does not undertake that investors will obtain any profits, nor will it share with investors any investment profits. Samsung Securities, itsaffiliates, or any of its and their affiliates, directors, officers, employees or agents disclaim any and all responsibility or liability whatsoever for any loss (director consequential) or damage arising out of the use of all or any part of this report or its contents or otherwise arising in connection therewith. Information andopinions contained herein are subject to change without notice. Past performance is not indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or financial instrument mentioned in this report. For investment advice, trade execution or otherenquiries, clients should contact their local sales representative. Any opinions expressed in this report are subject to change without notice and may differ or becontrary to opinions expressed by other business areas or groups of Samsung Securities. Any analysis contained herein is based on numerous assumptions.Different assumptions may result in materially different results. Samsung Securities is under no obligation to update or keep current the informationcontained herein. Samsung Securities relies on information barriers to control the flow of information contained in one or more areas or groups withinSamsung Securities into other areas or groups of Samsung Securities. Any prices stated in this report are for information purposes only and do not represent

valuations for individual securities or other financial instruments. Samsung Securities makes no representation that any transaction can or could have beeneffected at those prices and any prices contained herein may not reflect Samsung Securities internal books and records or theoretical model-based valuationsand may be based on certain assumptions. Different assumptions by Samsung Securities or any other source may yield substantially different results.

Additional information is available upon request.

F o r r e p o r t s t o b e d i s tr i b u t e d t o U S :

Securities research is prepared, issued and exclusively distributed by Samsung Securities Co., Ltd., an organization licensed with the Financial Supervisory Service of South Korea. This research may be distributed in the United States only to major institutional investors as defined in Rule 15a-6 of the U.S.Securities Exchange Act of 1934, as amended, and may not be circulated to any other person otherwise. All transactions by U.S. investors involving securitiesdiscussed in this report must be effected through Samsung Securities (America) Inc., a broker-dealer registered with the U.S. Securities & ExchangeCommission and a member of the Financial Industry Regulatory Authority/SIPC, and not through any non-U.S. affiliate thereof. The analysts listed [on thefront of this report] are employees of Samsung Securities Co., Ltd., or a non-U.S. affiliate thereof, and are not registered/qualified as research analysts underapplicable U.S. rules and regulations and may not be subject to U.S. restrictions on communications with covered companies, public appearances, and tradingsecurities held by a research analyst account.

F o r r e p o r t s t o b e d i s tr i b u t e d t o U K :

This report is not an invitation nor is it intended to be an inducement to engage in investment activity for the purpose of section 21 of the Financial Servicesand Markets Act 2000 of the United Kingdom ("FSMA"). To the extent that this report does constitute such an invitation or inducement, it is directed only at (i)persons who are investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order2001 (as amended) of the United Kingdom (the "Financial Promotion Order"); (ii) persons who fall within Articles 49(2)(a) to (d) ("high net worth companies,unincorporated associations etc.") of the Financial Promotion Order; and (iii) any other persons to whom this report can, for the purposes of section 21 of FSMA, otherwise lawfully be made (all such persons together being referred to as "relevant persons").

Any investment or investment activity to which this report relates is available only to relevant persons and will be engaged in only with relevant persons.Persons who are not relevant persons must not act or rely on this report.

F o r r e p o r t s t o b e d i s t r i b u t ed t o K o r e a :

This report is for private circulation only, not for sale, and is issued and distributed only to persons permitted under the laws and regulations of Korea.

F o r r e p o r t s t o b e d i s tr i b u t e d t o S i n g a p o r e :

This report is provided pursuant to the financial advisory licensing exemption under Regulation 27(1)(e) of the Financial Advisers Regulation of Singapore andaccordingly may only be provided to persons in Singapore who are "institutional investors" as defined in Section 4A of the Securities and Futures Act, Chapter289 of Singapore. This report is intended only for the person to whom Samsung Securities has provided this report and such person may not send, forward ortransmit in any way this report or any copy of this report to any other person.

Analyst Certif ication

The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of thecompensation of such analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research report.The analyst(s) principally responsible for the preparation of this research report receives compensation based on determination by research management andsenior management (not including investment banking), based on the overall revenues, including investment banking revenues of Samsung Securities Co., Ltd.

and its related entities and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations.Copyright 2010 Samsung Securities Co., Ltd. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the prior writtenconsent of Samsung Securities America Inc.


7/7

For more information, please call our sales representatives:

LONDON NEW YORK HONG KONG SHANGHAI TOKYO

Samsung SecuritiesEurope Limited21F Tower 42,

25 Old Broad Street,London EC2N 1HQTel. 44-207-786-7879Fax. 44-207-786-7818

Samsung SecuritiesAmerica Limited1330 Avenue of the Americas

26th FloorNew York, NY 10019Tel: 1-212-972-2220Fax: 1-212-972-3900

Samsung SecuritiesAsia Limited26/F, Three Exchange Square

8 Connaught Place, Central,Hong KongTel: 852-3411-3888 (general)Fax: 852-2528-3396

Samsung Securities ShanghaiRepresentative Office#2601, Shanghai International

Trading CenterNo 2201, Yan An West Road,Shanghai, ChinaTel: 86-21-6270-4168 (372)

Samsung Securities TokyoRepresentative Office#106-8532 Tokyo, Japan

Minato-ku Roppongi,Roppongi T-cube 3-1-1, 19FTel: 81-3-6234-2792

10th Fl., Samsung Main Bldg. 250, 2-Ga, Taepyeong-Ro, Jung-Gu, Seoul, Korea 100-742 Tel: 822 2020 8051 / Fax: 822 2020 7804

(gyun jun) derivatives spot_ transaction tax ramifications

Documents