1 taiwan bond & private repo market. 2 date: 2006 source: cbc * * only 4 insurance companies are...

1

Taiwan Bond

&

Private Repo Market

2

39 39 42 43 4538 38 36 38 35 35 34 36 40

5 55 5 5

5 5 5 34 3 3 4

5 6 5 4 38 11 16

10 12 1213

1721 18 22

21 20

50 50 49 47 47 49 46 43

28 29 32 29 26 27

2

1113

0%

20%

40%

60%

80%

100%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Bank Securities Bill Finance Insurance Non-GB Dealer

Date: 2006 Source: CBC

*

* Only 4 insurance companies are licensed government bond auction dealers since 2001.

Taiwanese Government Bond MarketHolders of Government Bonds

3

Bill Finance,16.38%

Banks,15.14%

SecuritiesHouses,68.48%

BillFinance,29.95%

Banks,27.02%

SecuritiesHouses,43.03%

Period: 2006Source: GreTai Securities Market, KGI Securities

Over-the-Counter Phone Quotation Electronic Bond Trading System (EBTS)

Break Down of Trading Volume

4

Break Down of Trading Volume

Bill Finance,29.22%Banks, 26.39%

SecuritiesHouses, 44.39%

Total Trading Volume*

*means the sum of transactions through Over-the-Counter Phone quotation and EBTS Period: 2006Source: GreTai Securities Market, KGI Securities

5

* Government bonds only** Repo volume (of government, corporate and supranational NT$ bonds)Source: Statistics from OTC

Unit:NT$ Billion

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1997

/01

1997

/03

1997

/05

1997

/07

1997

/09

1997

/11

1998

/01

1998

/03

1998

/05

1998

/07

1998

/09

1998

/11

1999

/01

1999

/03

1999

/05

1999

/07

1999

/09

1999

/11

2000

/01

2000

/03

2000

/05

2000

/07

2000

/09

2000

/11

2001

/01

2001

/03

2001

/05

2001

/07

2001

/09

2001

/11

2002

/01

2002

/03

2002

/05

2002

/07

2002

/09

2002

/11

2003

/01

2003

/03

2003

/05

2003

/07

2003

/09

2003

/11

2004

/01

2004

/03

2004

/05

2004

/07

2004

/09

2004

/11

2005

/01

2005

/03

2005

/05

2005

/07

2005

/09

2005

/11

2006

/01

2006

/03

2006

/05

2006

/07

2006

/09

2006

/11

Outright Trading Repo.

Taiwanese Government Bond MarketMonthly Turnover of Government Bonds

6

Phase I (1988~2000) : Repo Development Period (Stimulate liquidity and encourage market participation)

Government Bond Outright / Repo Market

Government Bond Market

0

2,000

4,000

6,000

8,000

10,000

1993

/01

1993

/04

1993

/07

1993

/10

1994

/01

1994

/04

1994

/07

1994

/10

1995

/01

1995

/04

1995

/07

1995

/10

1996

/01

1996

/04

1996

/07

1996

/10

1997

/01

1997

/04

1997

/07

1997

/10

1998

/01

1998

/04

1998

/07

1998

/10

1999

/01

1999

/04

1999

/07

1999

/10

2000

/01

2000

/04

2000

/07

2000

/10

Monthly Outright Trading Volume Monthly Repo Trading Volume

Average daily outright trading volume: NT$ 6 Billion

Average daily repo trading volume: NT$ 72 Billion

Period: 1993.1 to 2000.12 Source: GreTai Securities Market

In Billion NTD

Average daily outright trading volume: NT$ 32 Billion

Average daily repo trading volume: NT$ 182 Billion

7

Phase II (2001~Present) : New Product Development Period (Rely on ample liquidity of repo and outright transactions)

Government Bond Market

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2001

/01

2001

/03

2001

/05

2001

/07

2001

/09

2001

/11

2002

/01

2002

/03

2002

/05

2002

/07

2002

/09

2002

/11

2003

/01

2003

/03

2003

/05

2003

/07

2003

/09

2003

/11

2004

/01

2004

/03

2004

/05

2004

/07

2004

/09

2004

/11

2005

/01

2005

/03

2005

/05

2005

/07

2005

/09

2005

/11

2006

/01

2006

/03

2006

/05

2006

/07

2006

/09

2006

/11

Monthly Outright Trading Volume Monthly Repo Trading Volume

Average daily outright trading volume: NT$ 182 Billion Average daily repo trading volume: NT$ 177 Billion

Period: 2001.1 to 2006.12 Source: GreTai Securities Market

In Billion NTD

Government Bond Outright / Repo Market

8

Taiwanese Bond Repo Market Composition

Booming Period of Bond Fund

Brewing period of Bond Fund

Private Repo Market

Birth of Bond Fund 19941994

19971997

20042004

Before Birth of Bond Fund

Stage 1Stage 1

According to 3 major bill houses’ experience~

RP Counterparties CompositionIndividual 50~60%Corporation 10~20%Financial Institution 20~30%

According to asset management companies and securities houses estimations~

Bond Fund Investors Composition

RP End Investor SimulationIndividual 35~50%Corporation 25~40%Financial Institution 15~25%

Individual

0~5%

Repo

Corporation

10~15%

Financial Institution10~15%

Bond Fund

70~80%

Individual

50~55%

Repo Counterparties Composition

Corporation

20~30%


Stage 2 Stage 2

9

Taiwanese Bond Repo Market Composition

Post-Bond Fund PeriodPost-Bond Fund Period

Private Repo Market

20042004

currentcurrent Stage 3Stage 3

According to asset management companies and securities houses estimations~

Bond Fund Investors

Composition

Individual

10~15%

Repo

Corporation

15~20%


Bond Fund

50~55%

Individual

40~45%

Repo Counterparties Composition

Corporation

30~40%


RP End Investor SimulationIndividual

30~40%

Corporation

30~45%


Bond fund size dropped to NT$ 1.10 trillion on the end of 2006 from NT$2.47trillion in 2004

10

Background of Taiwanese Repo Market

Private Repo Market

RP transactions are de facto tax-free for individuals if the maturity of RP doesn’t cross the interest-paying date. With the high credit protection and tax advantage, repo was the preferred money market instrument for high new worth individuals before the birth of bond funds.

The investment strategy of Taiwanese bond funds is more similar to that of money market funds. Currently, Taiwanese bond funds allocate more than half of their assets in repo transactions.

Accordingly, bond funds had replaced repo as the main tax shelter instrument for high net worth individuals and corporations, because of their high liquidity and attractive returns. However, after the bond fund crisis happened in 2004, some institutional investors withdrew from bond funds to prevent from eventful and capricious risk of bond funds.

Directly and indirectly, individuals and corporations provide 60% to 85% liquidity for Taiwanese bond repo market. The ample liquidity from the repo market encourages securities and bill houses to participate in outright trading.

11

Regulation for Securities Dealers’ Repo Counterparties

Private Repo Regulation

Article 3 Before entering into a RP/RS transaction with a securities dealer, a client

shall provide his/her personal ID card or a copy of his/her business

license [whichever is relevant], then sign the RP/RS Master Agreement.

Opening a securities account is not required.

Rules Governing Over-the-Counter RP/RS Transactions by Taiwan GreTai Securities Market

A securities dealer can be a bank, bill house, or securities house; however, banks and

bill houses are normally licensed to do fixed income related securities business rather

than equity business.

A securities dealer is permitted to engage in repo transactions with individuals,

corporations, financial institutions, and any other juristic person according to the above

regulation.

In other words, individuals and corporations are free to engage in repo transactions

with securities dealers.

12

Total repo or total reverse repo position shall not exceed 6 times net worth

Repo on non-government bonds + other outstanding liabilities shall not exceed 4 times net worth

Securities Houses:

No limit Required to maintain 7% liquidity reserve requirement on

outstanding repo agreementsBanks:

Total reverse repo positions should be no more than 4 times net worthTotal liability should be no more than 14 times net worth

Bill Finance Companies:

Taiwanese Bond Repo MarketLimitation on Amount of Outstanding Repo for Financial Institutions

13

*The authority is GreTai Securities Market (OTC), which is governed by the Securities and Futures Bureau (SFB).

Taiwanese Bond Repo Market Practices

Government Bonds

Corporate Bonds (including

Convertible Bonds)

Bank Debentures

Supranational Bonds

Securitization Products

Acceptable Repo Collateral(not stipulated by authority*)

Securities houses can design their own credit policies, as long as the total market value of underlying securities is kept at a minimum of 90% of total repo liabilities.

Value of Repo/Reverse Repo Collateral

Private Repo Regulation

14

* Note that individuals’ first NT$270,000 interest income are exempt from tax.** Bond fund itself is subject to 10% withholding tax on coupon received.

Business Tax

Business Tax

SecuritiesTransaction

Tax

SecuritiesTransaction

Tax

Capital Gains Tax

Capital Gains Tax

Interest Income Tax

Interest Income Tax

NoneNone

RepoRepo

Bond FundBond Fund

Supranational Bond

Supranational Bond

1. Offshore interest income for individual investors is exempt from income tax.

2. Accrued basis for institutional investors.

1. Offshore interest income for individual investors is exempt from income tax.

2. Accrued basis for institutional investors.

1. If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals

2. Accrued basis for institutional investors

1. If repo tenor doesn’t cross the coupon payment day, not subjected to interest income tax for individuals


None as long as no dividend/interest paid**

None as long as no dividend/interest paid**

NoneNone


2. Cash basis for individual investors*

Government & Corporate Bond

Government & Corporate Bond

NoneNone

Taxation

15

Taiwanese Government Bond MarketVolatility of 10Yr Government Bonds

Period: 2002 to 2006 Source: KGI Securities

High/Low Spread

0.0000

5.0000

10.0000

15.0000

20.0000

25.0000

30.0000

35.000001

/08/

2002

01/1

1/20

02

01/0

2/20

03

01/0

5/20

03

01/0

8/20

03

01/1

1/20

03

01/0

2/20

04

01/0

5/20

04

01/0

8/20

04

01/1

1/20

04

01/0

2/20

05

01/0

5/20

05

01/0

8/20

05

01/1

1/20

05

01/0

2/20

06

01/0

5/20

06

01/0

8/20

06

01/1

1/20

06

01/0

2/20

07

Date

Bp

s

Max = 30.7 bps Min = 0.05 bps Average = 3.5569 bps

16

24

.8%

29

.4%

35

.0%

42

.8%

41

.2%

43

.5%

51

.6%

62

.8%

70

.2%

87

.4%

11

0.8

%

11

3.6

%

18

.7%

21

.7%

26

.7%

33

.6%

32

.4%

33

.1%

37

.9%

46

.7%

50

.2% 63

.3%

79

.4%

75

.6%

4283.84165.83943.6

3574.93204.9

2967.52966.93281.0

3355.53456.8

3459.73307.2

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%19

95

1996

1997

1998

1999

2000

*200

1

2002

2003

2004

2005

2006

.09

0

500

1000

1500

2000

2500

3000

3500

4000

4500

RP RS Treasury Securities

Repo Market in U.S.Repo Market in U.S.

U.S. Government Securities Dealers’ RP & RS Average Daily U.S. Government Securities Dealers’ RP & RS Average Daily Outstanding as a % of U.S. Treasury Securities OutstandingOutstanding as a % of U.S. Treasury Securities Outstanding

* Corporate securities are included from July 2001.

Figures cover financing involving government, federal agency, and federal agency MBS securities.

Source: Federal Reserve Bank of New York and U.S. Treasury

$ Billion

17

Repo Market in U.S.Repo Market in U.S.

Merrill LynchMerrill Lynch Lehman BrothersLehman Brothers

In Billion

as Dec. 2005

As % of Total

Assets

As % of Total Equity

In Billion

as Dec. 2005

As % of Total

Assets

As % of Total

Equity

RP (Liability) 272.30 39.98% 764.89% 116.16 28.33% 691.84%

RS (Asset) 234.30 34.40% 658.15% 106.20 25.90% 632.52%

Total Assets 681.02 100% 1,913% 410.06 100% 2,442.3%

Total Equity 35.60 5.23% 100% 16.79 4.09% 100%

ClassificationClassification

Position of Investment BanksPosition of Investment Banks

Source: Annual reports of Merrill Lynch and Lehman Brothers

18

Vitalizing REPO

19

Long Position

1. Spread Trade

• Matching Long Term Bond with Private REPO.

2. Use REPO as a channel of future funding.

• Expect bond yield to drop in near future but don’t have enough funding.

• Hold a certain of bond in portfolio.

• Use Bond in portfolio to fund current buying until obtaining new fund.

2.1 Use REPO to leverage our portfolio holding.

Vitalizing REPO

20

Short Position

1. Use REPO as a channel to borrow bond.

• Use borrowed bond to sell short in secondary market

Vitalizing REPO

Enhance bond holding return

• By lending out the holding of bond in portfolio, bond holder can enhance return by collecting fee.

21

Appendix: Bond Fund Crisis (UIT Event)

22

“Crisis of confidence” in the domestic bond funds market and thereafter

In the week of 12 July 2004, United Securities Investment Trust (UIT) adjusted its bond portfolio by reducing exposure in certain areas such as illiquid CBs and structured notes, and as a result, posted a drop in NAV for its three bond funds. UIT was worse hit, and the effects were felt throughout the industry with estimates putting total redemptions at over NT$200bn, or around 10% of total market fund size, in the week following the incident.

2004.7 2005.12.31 2006.12.31

UIT event deadline for bond funds to dispose of structured bonds

deadline of bond funds transformation

23

“Crisis of confidence” in the domestic bond funds market and thereafter

In order to deal with the fallout from the overinvestment in structured products over previous years and to rehabilitate confidence in the Taiwanese asset management industry, the following policy measures and initiatives had been announced:

Bond funds are prohibited from purchasing any structured bonds anymore.

Bond funds are required to dispose of all their structured bonds by the end of 2005.

Bond funds are required to migrate themselves into one of the following three types of funds: Quasi money market funds：

• Bonds make up less than 30% of the assets.

• The tenor of each bond in the assets should not be more than five-years.

• Mark-to-market requirement is waived.

•Weighted average duration of the bonds in the assets should be less than three years. Pure bond funds：

Bonds weigh at least 50% of total assets. They are required to mark-to-market on daily basis. Status-Quo bond funds： (Not favored by FSC)

Bonds weigh 30% to 50% of the assets. Bonds that are purchased by such funds after the beginning of 2006 will have to mark to market.

24

0.5

0.7

0.9

1.1

1.3

1.5

1.7

2003

/01

2003

/04

2003

/07

2003

/10

2004

/01

2004

/04

2004

/07

2004

/10

2005

/01

2005

/04

2005

/07

2005

/10

2006

/01

2006

/04

2006

/07

2006

/10

The total size of bond funds is shrinking continuously

Until the end of 2006, quasi money market funds account for 94.82% of the total bond fund size while pure bond funds and status-quo bond funds account for 0.99% and 4.19% respectively.

The returns of quasi money market funds in general are less attractive than the rising repo rates.

Besides less attractive returns, some institutional investors also withdrew from bond funds to prevent from eventful and capricious risk of bond funds.

Bond fund size dropped to NT$ 1.16 trillion on the end of September 2006 from the top in 2004

0.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.5

2004

/01

2004

/03

2004

/05

2004

/07

2004

/09

2004

/11

2005

/01

2005

/03

2005

/05

2005

/07

2005

/09

2005

/11

2006

/01

2006

/03

2006

/05

2006

/07

2006

/09

SourceSource：： KGI SecuritiesKGI Securities SourceSource：： KGI SecuritiesKGI Securities

Unit:Unit: %Repo rateBond fund size Unit:Unit: NT$ trillion

1 taiwan bond & private repo market. 2 date: 2006 source: cbc * * only 4 insurance companies are...

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