Globalization of Korea’s

Foreign Exchange System

Seoul Asian Financial Forum

June 4, 2012

Michael Hellbeck

COO & Head of Regulatory Affairs Standard Chartered Bank Korea

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Agenda

Introduction to Standard Chartered

Korea’s Foreign Exchange System

Proposed Measures

3 3 3

Standard Chartered Bank – key facts

150+ years of History

75 countries, 85,000 employees

1,700 outlets & branches

listed on the London, Hong Kong

and Mumbai stock exchanges

Market capitalisation:$56.1bn*

Strong presence in Asia, Africa, and

Middle East

* Updated As of May 2nd, 2012

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Franchise positioned for growth

Large branch network 379 branches including

11 SME/PrB hub centers 10 WB branches and 6 PB centres

6,408 staff

Consumer Banking > 4.5m customers

> 1.7m Internet Banking

Wholesale Banking Growing number of

corporate relationships

Largest dealing room in Korea

Financial Holding Company

Branch network

(6)

(199)

(13)

(13)

(16)

(14)

(2)

(75)

(5)

(10)

(19)

(3)

(4)

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Agenda

Introduction to Standard Chartered

Korea’s Foreign Exchange System

Proposed Measures

6 6 6

Korea’s Status in the World

GDP 11th largest

Trade > USD 1 trillion = 9th largest

FX Reserves > USD 317bn = 7th largest

Current Assessment of the FX Market

Thin and narrow market relative to global FX market

Korea returned to “real demand principle” in 2010 (corporates can only hedge underlying proven exposures)

Banks subject to tight FX derivatives position caps

Still many restrictions for capital account and current account transactions

Emergence of a large offshore NDF market (world’s largest) due to onshore restrictions

Korea has a low proportion of overseas investments (9.6% in 2010) compared to Japan (22%) and Canada (39%), partly due to “home bias”

One directional FX market as a result of unbalanced capital flows “one way bet”?

Korea: Big Economy – Small Currency

7 7 7

Korea remains classified as “Emerging Market” (MSCI EM Index) due to lack of full convertibility of KRW and lack of offshore KRW settlement ability EM investors tend to behave differently from Developed Markets investors

Contributes to higher capital flow volatility

Where we are right now

No clear road-map for development of FX Markets

No plan for liberalization of FX regulations

Korean Won is still not an international currency (offshore settlement not allowed)

Korean Won only partially convertible (subject to many limits and restrictions)

Korea: Big Economy – Small Currency

8 8 8

1994: Foreign Exchange Reform Plan announced

1996: OECD membership

Dec 1997: Free-Floating Exchange Rate system introduced

May 1998: Ceiling on foreign investment in Korean equities abolished; bond markets open to foreign investment

April 1999: Introduction of FX Transaction Act – Liberalization of current account transactions

1999: “Real Demand Principle” for FX Forward and Derivatives was abolished

2002: “Plan for Development of Korean FX Market” announced – full liberalization of FX regulations by 2011

June 2005: “Overseas Investment Activation Plan”

May 2006: Accelerated “Foreign Exchange Liberalization Plan” in 2 phases, targeting internationalization of KRW and full liberalization of FX transactions by 2009 (instead of 2011)

Nov 2007: MoFE announces “Measures to establish market friendly FX transaction system”

Korea: Historic Review of FX Liberalization

9 9 9

Oct 2008: Government announces to postpone indefinitely the 2nd stage of FX Liberalization Measures

Jan 2010 – 2012: Introduction of Macro-Prudential measures aimed at reducing ‘speculative’ inflows and outflows of foreign exchange Return to the “real demand principle” for companies (hedging limited to 100% of underlying exposure)

Companies can only borrow FX loans / issue FX bonds onshore only for purpose of overseas usage

Cap on Banks’ FX Forward Position

Strengthened FX Liquidity ratios for Korean banks (preventing currency and maturity mismatches)

Re-introduction of Withholding Tax on interest and capital gains on Korean bond investments held by foreign investors (aimed at reducing excessive inflows of “hot money”)

Bank Levy on offshore borrowings

Unintended Consequences: Build-up of a sizable offshore NDF Market in response to onshore restrictions

Bank Levy impact on supply of trade finance

Policy measure proved effective as “stop gap” measures

FX restrictions may give illusion of absolute control over FX capital flows

FX Policy Measures since 2008 Financial Crisis

10 10 10

The FX derivatives cap on Banks and the return to the real demand principle for

FX hedging has led to a significant drop in FX Derivatives Balances of Korean

Banks and Corporates

Effect of FX Policy Measures since 2008

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Korea’s share in the global daily FX spot turnover was only 1.5% in 2010 (source:

BIS), much less than AUD (7.6%) or CAD (5.3%) or even NZD (1.6%), which

seems disproportionate to the size of Korea’s economy

Interbank FX Market Turnover

(daily averages, USD 100mn unit) 2008 2009 2010 2011

Q1 Q2 Q3 Q4

Spots 78.1 58.3 76.6 90.6 82.2 92.5 96.8 90.4

Forwards 9.1 4.6 1.8 1.2 1.3 1.0 1.5 0.8

FX Swaps 92.3 105.3 101.9 104.6 106.6 103.6 106.3 101.9

Other derivatives (including currency

swaps, currency options, etc) 21.3 14.9 14.3 16.5 15.8 17.7 17.0 15.2

Total Onshore Interbank FX

Transaction Volume 200.8 183.1 194.6 212.9 205.9 214.8 221.6 208.3

Total Offshore NDF Transaction

Volume 94.3 48.7 54.4 61.3 54.1 61.8 69.5 57.0

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Triggers of the 1997 Crisis included Currency and maturity mismatches

Overreliance on external short-term debt

Insufficient FX reserves (smaller than s-t debt)

Excessive leverage of ‘Chaebols’

Weak banking system

Triggers of the 2008 Crisis included Sudden withdrawal of portfolio investors due to global

risk aversion

Withdrawal of short term loans due to global banks’ de-leveraging in 4Q2008

Both saw abrupt and massive outflow of capital, leading to sudden currency depreciation and drop in FX reserves Capital flows are pro-cyclical (surge during boom,

reverse during slow-down)

Korea was vulnerable due to significant reliance on short-term external debt

Flashback: Korea’s Experience with FX Shocks

13 13 13

Sufficient FX reserves compared with historic peak foreign capital outflow of USD 57bn in

2008, when foreign investors withdrew USD 16bn of lending and USD 41bn worth of equity

investments.

Rising FX Reserves since 1997

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External Debt Profile Improved

Between 2008 to end of 2011, total S-T external debt declined from an all-time high of USD

190bn to USD 136bn. Korean banks’ portion reduced from USD 67bn to USD 56bn,

whereas foreign bank branches cut down their S-T offshore borrowings from USD 94bn

down to USD 44bn.

15 15 15

External Debt profile now more stable

Total external debt of USD 398.4bn < FX reserves (USD 317bn) + Currency Swap

lines (USD 130bn)

S-T external debt ratio now down to 34%

Financial Safety Net in place

USD 317bn FX reserves > short-term debt of USD 136bn

Oct 2011: FX Currency Swap Lines with Japan USD 70bn and China USD 60bn

Changmai Initiative: Multi-lateral swap lines

Korean Banking system more resilient

FX Liquidity conditions have improved

More term funding

Sound risk management

Corporate Sector de-leveraged

Lessons learnt

Can Korea’s withstand another FX shock?

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Agenda

Introduction to Standard Chartered

Korea’s Foreign Exchange System

Proposed Measures

17

Globalize Korea’s FX System

Continue the FX liberalization path step by step

- Remove remaining FX restrictions for inflows and outflows

- Change all “prior reporting” items to BoK and MoSF into “post

facto reports to FX Banks”

Allow offshore settlement of Korean Won

- This will support Korean importers and exporters by reducing

exchange risks

- Learn from the RMB experience

Achieve Full Convertibility through full liberalization of the FX Market

Pursue Internationalization of the Korean Won (= creating demand for

Korean Won)

Attain “Developed Market” Status in MSCI Index

Use Macro-prudential measures to curb capital flows only on

temporary basis, not permanent basis

Eliminate onshore restrictions that have caused offshore NDF market

rise

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Risks and Benefits of KRW Globalization

Reduce exchange rate risk of

enterprises

Deepening of FX market

Korea would be more resilient to

external shocks

Increase demand for KRW by

residents and non-residents

Koreans deserve to use their

currency without restriction as

they deem fit

Foreign Currency hoarding in case of a crisis

“Burnt” by previous crisis experience

Speculative FX trading activity Increased capital flow volatility

Risks Benefits

Disclaimer

• The information and opinions in this report were prepared by Standard Chartered

or one of its affiliates (collectively “Standard Chartered"). The information herein is

believed to be reliable and has been obtained from public sources believed to be

reliable. Standard Chartered makes no representation as to the accuracy or

completeness of such information.

• Opinions, estimates and projections in this report constitute the current

judgment of the author as of the date of this report. They do not necessarily

reflect the opinions of Standard Chartered and are subject to change without

notice.

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trading strategy.

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