Taiwan
13 September 2011
As Asia’s economic growth continues to attract the world’s attention, SLT looks at Taiwan – the most popular equity market for securities lending in the region
Image: Shutterstock
Taiwan’s economy is “like a lava cake – hot on the inside”, writes Nomura analyst Jesse Wang. Despite global headwinds, the banking sector remains resilient, property prices will likely be sustained and though the technology sector is sure to hit a soft patch, the investment firm remains positive in the long-term. The economy is expected to grow a healthy 4.8 per cent this year, according to government figures.
Still, as global risk aversion weighs on markets, a short selling imbalance has been increasing in the last few weeks. That might have something to do with the fact that Taiwan’s market is driven by the technology sector, indicating it will be this key export market that takes a hit as downside risks to the economy increase, says Wang.
There is currently $22.4 billion of Taiwanese equity lendable, according to Data Explorers, of which 13 per cent, worth $5.1 billion, is out on loan, making it the highest utilised Asian equity market.
Research from Data Explorers shows that the three most borrowed names are Gintech (solar cell manufacturer), MediaTek (semiconductor design and sales) and Macronix (semiconductor manufacturer) with between 3.7 and five per cent of their shares out on loan respectively.
“The export sector, which is technology product driven, will be hit earlier as compared to other countries…but in terms of domestic demand, there are many policy tools for Taiwan to adopt to support the domestic economy,” Wang says.
It helps that the country is debt averse - its debt to GDP ratio is at 34 per cent, while corporates are net cash. Meanwhile, as central banks in China and India struggle to put a lid on overheating economies, Taiwan’s inflation remains below two per cent.
Some of those policy tools, with major implications, are directly related to the improvement of the cross-state relationship with China under the leadership of the Taiwanese government, the Kuomintang (KMT).
After the 2008 election, Taiwan has consistently improved the island’s relationship with China and made notable advancement on trade. Opening the country’s borders to China’s tourists, for example, is a significant step for the economy, says Wang.
“If Taiwan chooses to further liberalise the economic relationship with China, there will be increasing peace dividends…just look at the tourism business, there are about 30 million [tourists] visiting Hong Kong, but…less than two million visiting Taiwan,” he says.
Another significant achievement is the conclusion of the Economic Cooperation Framework Agreement (ECFA), which will see tariffs between the two countries drop from 10 per cent now to zero over the next 10 to 15 years.
“This will promote Taiwan as the official manufacturing sector for China, because all the products which are produced in Taiwan can be distributed or sold into China without any tariff charges,” says Wang.
And it is the financial sector which has so far been most impacted by liberalisation policies, giving Taiwanese banks more flexibility to do business in China. Previously, explains Wang, Taiwanese banks could only set up a branch in China, now they can also set up wholly-owned subsidiaries and engage in merger and acquisitions activities.
“Essentially, there has been stable, continuous deregulation that allowed Taiwan to benefit from China’s stronger growth,” Wang says, adding that a risk factor to these policies could be the outcome of a presidential election scheduled for January 2012.
In terms of securities lending, Wang says that the more liberalised and the more the cross-state relationship develops, the more the securities lending market will expand. However, Nomura is not a major player in the securities lending market, though the firm has been in Taiwan for 16 years and remains among the top foreign firms in terms of market share.
Big brokers tend to have large inventory books because of proprietary trading positions, they have the inventory to utilise as the foundation of the securities lending business…[not having] inventory is essentially the barrier for any company that wants to lend in this space,” he notes.
The Taiwan Stock Exchange (TWSE) launched a centralised Securities Borrowing and Lending (SBL) system in June 2003 to meet the needs of qualified institutional investors with the TWSE serving as an intermediary. Starting in 2007, qualified securities firms and securities finance companies were allowed to conduct SBL business acting as principal, providing investors with additional options.
Both lenders and borrowers are subject to Articles of the Taiwan Stock Exchange Corporation Securities and Borrowing Lending Regulations and are subject to regulation by the Securities and Futures Bureau as part of the Financial Services Commission – the country’s financial regulator.
In an SLT panel debate in February, Zubair Nizami, then senior securities lending trader at Northern Trust but now at Robeco, described the country as having one of the most vibrant developing markets.
“Participation by both offshore and onshore lenders has grown over the past few years as a result of the gradual liberalisation of securities borrowing and lending regulations. As more lenders enter this market, overall liquidity in the Taiwanese SBL market is likely to increase,” Nizami said on the panel debate.
Wayne Chang, assistant manager, clearing department at Taiwan Stock Exchange, says this stems from benefits such as multiple access to SBL transactions, demand for fund raising through convertible bonds or Global Depository Receipts (GDRs) and the relatively flexible framework for conducting SBL and short sales.
Participants can access the market through the fixed-rate and competitive bidding (3.5 per cent lending fee with initial and maintenance requirements at 140 and 120 per cent respectively), with the TWSE guaranteeing the trade by acting as a CCP, but in negotiated trades, the counterparties assume default risk and have full discretion to negotiate their collateral ratio. In addition, qualified securities firms can lend to borrowers with the same initial and maintenance requirements.
The SBL market is dominated by negotiated trades, says Chang, because counterparties can deal with each other not unlike they do in other developed markets. But some market participants point out that there are inefficiencies stemming from practice of matching and transfer of securities through brokers who have access to the exchange system for both the borrowers and lenders – a process that applies to every SBL transaction.
There are three ceilings adopted to monitor the volume of short selling borrowed shares over the whole market: the daily maximum for short selling of borrowed stocks cannot exceed three per cent of outstanding shares per lending stock, maximum for short selling of borrowed stocks cannot exceed 10 per cent of outstanding shares per lending stock. The total volume of short selling borrowed stocks and margin short sales cannot exceed 25 per cent of outstanding shares per stock.
TWSE discloses the maximum shares for SBL short sales on a daily basis on their website and monitor and disclose the remaining available shares for SBL short sales on a real-time basis.
“As [with] most emerging markets, the Taiwan stock market is vulnerable to sharp market disruption, so it makes sense to put a ceiling for total short [sales] and all short [sales] must be covered,” Chang writes in an email.
“We leverage on the ID system, under which every investor is given an ID number, to monitor all short sell[ing] activity on a daily basis without bringing too much inconvenience to our market participants,” he says, noting that whenever there is a market crash, SBL and short selling becomes a scapegoat.
“However, the Exchange, which operates the trading market and provides SBL platform at the same time, will strive to keep both markets open, fair and orderly,” he writes.
FINIs dominate the SBL market, accounting for over 85 per cent of total trading value, while the largest lenders are domestic and foreign sovereign funds, insurance companies and asset managers. Foreign banks and prime brokers represent the largest borrowers.
On the competitive bidding side of the SBL market, Chang admits that the collateral ratios are criticised as being high when compared to 105 to 110 per cent in other markets, but in general does not see barriers to entry.
As a major participant in the custodian banking market, HSBC Taiwan processes upwards of an average 100 SBL trades per day on behalf of clients. Although the SBL transactions are predominantly for short selling, clients also arrange foreign overseas financing using Taiwan equities as collateral.
Eric Jai, senior vice president of HSBC sub-custody and clearing notes that China’s overall economic growth will prompt more trading in the market. However, HSBC is working with regulators to review the SBL market structure in order to simplify the transfer of securities.
“The additional costs that result from the current SBL market structure represent barriers to participation - clients without a large inventory in the market may find it is not profitable due to the additional costs,” says Jai.
“For the last three years, HSBC has been working with the government to upgrade the system. In other markets, there is a bulk transfer capability in the exchange system which allows custodian banks to act as intermediaries. This greatly simplifies the process,” he adds.
Still, as global risk aversion weighs on markets, a short selling imbalance has been increasing in the last few weeks. That might have something to do with the fact that Taiwan’s market is driven by the technology sector, indicating it will be this key export market that takes a hit as downside risks to the economy increase, says Wang.
There is currently $22.4 billion of Taiwanese equity lendable, according to Data Explorers, of which 13 per cent, worth $5.1 billion, is out on loan, making it the highest utilised Asian equity market.
Research from Data Explorers shows that the three most borrowed names are Gintech (solar cell manufacturer), MediaTek (semiconductor design and sales) and Macronix (semiconductor manufacturer) with between 3.7 and five per cent of their shares out on loan respectively.
“The export sector, which is technology product driven, will be hit earlier as compared to other countries…but in terms of domestic demand, there are many policy tools for Taiwan to adopt to support the domestic economy,” Wang says.
It helps that the country is debt averse - its debt to GDP ratio is at 34 per cent, while corporates are net cash. Meanwhile, as central banks in China and India struggle to put a lid on overheating economies, Taiwan’s inflation remains below two per cent.
Some of those policy tools, with major implications, are directly related to the improvement of the cross-state relationship with China under the leadership of the Taiwanese government, the Kuomintang (KMT).
After the 2008 election, Taiwan has consistently improved the island’s relationship with China and made notable advancement on trade. Opening the country’s borders to China’s tourists, for example, is a significant step for the economy, says Wang.
“If Taiwan chooses to further liberalise the economic relationship with China, there will be increasing peace dividends…just look at the tourism business, there are about 30 million [tourists] visiting Hong Kong, but…less than two million visiting Taiwan,” he says.
Another significant achievement is the conclusion of the Economic Cooperation Framework Agreement (ECFA), which will see tariffs between the two countries drop from 10 per cent now to zero over the next 10 to 15 years.
“This will promote Taiwan as the official manufacturing sector for China, because all the products which are produced in Taiwan can be distributed or sold into China without any tariff charges,” says Wang.
And it is the financial sector which has so far been most impacted by liberalisation policies, giving Taiwanese banks more flexibility to do business in China. Previously, explains Wang, Taiwanese banks could only set up a branch in China, now they can also set up wholly-owned subsidiaries and engage in merger and acquisitions activities.
“Essentially, there has been stable, continuous deregulation that allowed Taiwan to benefit from China’s stronger growth,” Wang says, adding that a risk factor to these policies could be the outcome of a presidential election scheduled for January 2012.
In terms of securities lending, Wang says that the more liberalised and the more the cross-state relationship develops, the more the securities lending market will expand. However, Nomura is not a major player in the securities lending market, though the firm has been in Taiwan for 16 years and remains among the top foreign firms in terms of market share.
Big brokers tend to have large inventory books because of proprietary trading positions, they have the inventory to utilise as the foundation of the securities lending business…[not having] inventory is essentially the barrier for any company that wants to lend in this space,” he notes.
The Taiwan Stock Exchange (TWSE) launched a centralised Securities Borrowing and Lending (SBL) system in June 2003 to meet the needs of qualified institutional investors with the TWSE serving as an intermediary. Starting in 2007, qualified securities firms and securities finance companies were allowed to conduct SBL business acting as principal, providing investors with additional options.
Both lenders and borrowers are subject to Articles of the Taiwan Stock Exchange Corporation Securities and Borrowing Lending Regulations and are subject to regulation by the Securities and Futures Bureau as part of the Financial Services Commission – the country’s financial regulator.
In an SLT panel debate in February, Zubair Nizami, then senior securities lending trader at Northern Trust but now at Robeco, described the country as having one of the most vibrant developing markets.
“Participation by both offshore and onshore lenders has grown over the past few years as a result of the gradual liberalisation of securities borrowing and lending regulations. As more lenders enter this market, overall liquidity in the Taiwanese SBL market is likely to increase,” Nizami said on the panel debate.
Wayne Chang, assistant manager, clearing department at Taiwan Stock Exchange, says this stems from benefits such as multiple access to SBL transactions, demand for fund raising through convertible bonds or Global Depository Receipts (GDRs) and the relatively flexible framework for conducting SBL and short sales.
Participants can access the market through the fixed-rate and competitive bidding (3.5 per cent lending fee with initial and maintenance requirements at 140 and 120 per cent respectively), with the TWSE guaranteeing the trade by acting as a CCP, but in negotiated trades, the counterparties assume default risk and have full discretion to negotiate their collateral ratio. In addition, qualified securities firms can lend to borrowers with the same initial and maintenance requirements.
The SBL market is dominated by negotiated trades, says Chang, because counterparties can deal with each other not unlike they do in other developed markets. But some market participants point out that there are inefficiencies stemming from practice of matching and transfer of securities through brokers who have access to the exchange system for both the borrowers and lenders – a process that applies to every SBL transaction.
There are three ceilings adopted to monitor the volume of short selling borrowed shares over the whole market: the daily maximum for short selling of borrowed stocks cannot exceed three per cent of outstanding shares per lending stock, maximum for short selling of borrowed stocks cannot exceed 10 per cent of outstanding shares per lending stock. The total volume of short selling borrowed stocks and margin short sales cannot exceed 25 per cent of outstanding shares per stock.
TWSE discloses the maximum shares for SBL short sales on a daily basis on their website and monitor and disclose the remaining available shares for SBL short sales on a real-time basis.
“As [with] most emerging markets, the Taiwan stock market is vulnerable to sharp market disruption, so it makes sense to put a ceiling for total short [sales] and all short [sales] must be covered,” Chang writes in an email.
“We leverage on the ID system, under which every investor is given an ID number, to monitor all short sell[ing] activity on a daily basis without bringing too much inconvenience to our market participants,” he says, noting that whenever there is a market crash, SBL and short selling becomes a scapegoat.
“However, the Exchange, which operates the trading market and provides SBL platform at the same time, will strive to keep both markets open, fair and orderly,” he writes.
FINIs dominate the SBL market, accounting for over 85 per cent of total trading value, while the largest lenders are domestic and foreign sovereign funds, insurance companies and asset managers. Foreign banks and prime brokers represent the largest borrowers.
On the competitive bidding side of the SBL market, Chang admits that the collateral ratios are criticised as being high when compared to 105 to 110 per cent in other markets, but in general does not see barriers to entry.
As a major participant in the custodian banking market, HSBC Taiwan processes upwards of an average 100 SBL trades per day on behalf of clients. Although the SBL transactions are predominantly for short selling, clients also arrange foreign overseas financing using Taiwan equities as collateral.
Eric Jai, senior vice president of HSBC sub-custody and clearing notes that China’s overall economic growth will prompt more trading in the market. However, HSBC is working with regulators to review the SBL market structure in order to simplify the transfer of securities.
“The additional costs that result from the current SBL market structure represent barriers to participation - clients without a large inventory in the market may find it is not profitable due to the additional costs,” says Jai.
“For the last three years, HSBC has been working with the government to upgrade the system. In other markets, there is a bulk transfer capability in the exchange system which allows custodian banks to act as intermediaries. This greatly simplifies the process,” he adds.
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