CONTENTS I. KOREAN ECONOMY & CAPITAL MARKET OVERVIEW II. OTC MARKET OPERATION BY KOFIA

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2 CONTENTS I. KOREAN ECONOMY & CAPITAL MARKET OVERVIEW 1 Korean Economy and Capital Market 2 Equity Market 3 Bond Market 4 Derivatives Market 5 Fund Market 6 Trust Market 7 Real Estate Trust Market 8 Advisory and Discretionary Market 9 Pension Market II. OTC MARKET OPERATION BY KOFIA 1 K-OTC 2 FreeBond 31 33

3 I. KOREAN ECONOMY & CAPITAL MARKET OVERVIEW 1 Korean Economy and Capital Market 2 Equity Market 3 Bond Market 4 Derivatives Market 5 Fund Market 6 Trust Market 7 Real Estate Trust Market 8 Advisory and Discretionary Market 9 Pension Market This report has been written and published by KOFIA for reference purposes only. KOFIA has worked to ensure that the information contained herein has been obtained from reliable sources, is up-to-date and accurate. However, KOFIA does not guarantee the accuracy, adequacy or integrity of the data or information published in this report. Information, comments and recommendations found in the report are not to be construed as investment advice. KOFIA does not assume any responsibility for any losses and damages that could result from the use of any information herein. This report may be used without acquiring prior permission, provided that it is appropriately quoted.

4 Korean Capital Market Annual Review Korean Economy and Capital Market 1 Korean Economy and Capital Market The Korean capital market in 215 was marked by further recovery and growth, a trend that has continued since the 28 global financial crisis. Despite persistent low interest rates and a stock market correction in China, Korea s economy and the capital market performed well compared to many other advanced nations. Key capital market indicators demonstrate this trend very well. The total volume of financial assets in Korea reached KRW 14,6tn at the end of 215, a 7.7% yearon-year growth. This is a continuation of the steady increase in asset volume seen since 28. Cash and deposits once again made up the largest share of total asset volume in 215, standing at just over 19%, while stocks stood at slightly under 17%, bonds at 16.5%, and funds at nearly 3%. Insurance/ pensions and loans accounted for 7% and 17.5%, respectively. Overall, financial investment instruments took up 36.2% of the total financial asset volume, a 3.8%p increase from 28. Graph 1-1. Annual Financial Asset Volume Cash/Deposits Equities Bonds Investment funds Insurance/Pensions Loans Other 16, 14, 12, 1, 8, 6, 4, 2, Source : The Bank of Korea, Flow of Funds Korea s stock market capitalization as of late 215 was KRW 1,448tn, an increase of 8.3% year-on-year, and outstanding bond issuance stood at KRW 1,713tn, jumping 7.7% from the same time a year earlier. The ratio of Korea s stock market capitalization to GDP was 92.9%, and the ratio of bond market capitalization to GDP was 19.9%. Put into a global context, these percentages are substantially lower than those of other advanced economies. The stock market capitalization to GDP ratio was 139.7% in the US, 136.1% in England, and 118.7% in Japan, while the bond market capitalization to GDP ratio marked 25.6%, 24.4% and 271.1%, respectively, in these countries. 1,7 1,6 1,5 1,4 1,3 1,2 1,1 1, 9 8 Graph 1-2. Size of the Capital Market in Korea Stock market capitalization Outstanding bond issues Source : The Bank of Korea, Korea Financial Investment Association

5 Among the financial sectors, the banking industry boasts the largest amount of total assets and equity capital. At the aggregate level, the securities sector comes in third next to life insurance. Table 1-1. Size of Financial Sectors (Units: # of companies, KRW tn, %) Banking Life insurance Non-life insurance Credit card Securities Asset management No. of companies Total assets 2, Equity Capital Net profit ROE Statistics as of 215 Source : Financial Supervisory Service, Monthly Financial Statistics Bulletin Corporate financing through the Korean capital market (stocks and bonds) in 215 reached KRW 131tn, up 7.5% from the previous year. Market-based financing increased by 38.9% year-onyear, amounting to KRW 8tn. Both IPOs and paid-in capital increases once again showed better results than the year before; in particular, IPOs raised 1.7 times more capital, backed by offerings from industry giants such as Mirae Asset Life Insurance (KRW 3bn) and DoubleU Games (KRW 277.7bn). A 6% increase was witnessed for capital raised in the bond market. Issuance of corporate bonds diminished, while issuance of financial bonds, ABS and bank bonds increased. Graph 1-3. Corporate Financing via the Capital Market Paid-in capital increases(rights offerings) IPOs Bank bonds ABS Financial bonds Corporate bonds Source : Financial Supervisory Service, Monthly Financial Statistics Bulletin Non-financial assets including real estate accounted for 63.1% of household assets, whereas the share of financial assets was 36.9%. Although the proportion of non-financial assets remains greater than financial assets, the latter is on the rise. Table 1-2. Household Non-Financial & Financial Assets Nonfinancial assets (Unit: %) Financial assets Source : The Bank of Korea, National Balance Sheet 4 5

6 Korean Capital Market Annual Review Korean Economy and Capital Market Among financial assets, cash and deposits take up the largest share at 43.1%, but their percentage continues to diminish. Financial investment instruments such as stocks, bonds and funds account for 25%, with the share of stocks and bonds slowly expanding. Graph 1-4. Breakdown of Household Financial Assets (%) Other Insurance/Pensions Investment funds Bonds Equities Cash/Deposits Source : The Bank of Korea, Flow of Funds Foreign-held listed stocks were worth KRW 42.4tn in 215, down slightly from a year earlier, comprising 29.1% of total market capitalization. In the bond market, foreign-held listed bonds were worth KRW 11tn, and mostly consisted of government and special bonds. The proportion of listed bonds held by foreigners represented 6.5% of the total, which also fell slightly compared to the previous year. Graph 1-5. Trends in Foreign Investment Stock market capitalization (left) Share (right) (%) Outstanding bond issues (left) Share (right) (%) Source : Korea Exchange, Shareholdings by Investor Group Financial Supervisory Service, Monthly Financial Statistics Bulletin

7 2 Equity Market In 215, the equity market in Korea displayed vibrant growth in terms of the trading amount, which was largely attributable to changes in both external and domestic conditions. While QE policies increased liquidity globally, domestic developments such as an upward adjustment of the price limit on equities to ±3%, and the adoption of the Market Maker System for low-liquidity issues added vigor to the market. Specifically, the KOSPI index hovered at around 2,pts as of late 215, with the trading amount making a recovery, moving from its level of less than KRW 1,tn to KRW 1,327tn in 215. As opposed to the KOSPI, which is often said to be trapped in a narrow band, the KOSDAQ index gained 25.7% year-on-year to reach pts, coupled with an 81% surge in the trading amount to KRW 874tn. (Historical background) The Korea Stock Exchange was first established in 1956, with only 12 companies listed and the total trading amount barely reaching KRW 39mn. However, the stock market achieved remarkable qualitative and quantitative growth over the next six decades, in tandem with the real economy. In particular, multiple stock markets began to coexist after the over-the-counter stock market overhaul in 1996 and subsequent establishment of the KOSDAQ market. Graph 2-1. Stock Market Development 1,8 1,6 1,4 1,2 1, KOSPI Trading amount (left) KOSPI (right) (pt) 2,5. KOSDAQ Trading amount (left) KOSDAQ (right) 1, 9 2, , , (pt) Source : Korea Exchange In the KOSPI market, the total number of listed companies as of late 215 was 77, with 3 de-listings being carried out. Market capitalization recorded KRW 1,243tn, a 4.2% increase year-on-year. Meanwhile, in the KOSDAQ market, the total number of listed companies was 1,152, with market capitalization recording KRW 22tn. An increase of 91 listed companies and a 4.9% gain in market capitalization over the previous year demonstrated the vibrancy of SME and venture business financing. Graph 2-2. Listed Companies & Market Capitalization 1,3 KOSPI Market capitalization (left) No. of listed companies (right) (Companies) 9 25 KOSDAQ Market capitalization (left) No. of listed companies (right) (Companies) 12 1,25 1,2 1,15 1,1 1,5 1, Source : Korea Exchange 6 7

8 Korean Capital Market Annual Review Equity Market Individual investors made up the largest portion of the Korean stock market, followed by foreign investors and institutional investors. Looking first at the KOSPI market, individual investors accounted for 46.5% of the total trading amount, while foreigners took up 28.7%. Institutional investors, including investment trusts, pension funds and mutual aid associations, assumed 23.5%. Up to 213, individual investors made up more than half of the trading amount, but since then, the market has become somewhat balanced as foreign investment continues to grow. In contrast, the KOSDAQ market is still dominated by individual investors, who make up approximately 9% of the total trading amount. While the proportion of foreign and institutional investments has grown over the past five years, it is still significantly low, with each comprising about 5% of the market. Graph 2-3. Stock Market Investor Type Breakdown (%) KOSPI Foreign Individual Non-financial companies KOSDAQ Foreign Individual Non-financial companies Pension funds and mutual aid associations Pension funds and mutual aid associations Other financial institutions Investment trusts (%) Other financial institutions Investment trusts Source : Korea Exchange Total standby liquidity reserves, including client money, cash management accounts (CMAs) and margin accounts, recorded KRW 79.7tn, a gain of 18% from the previous year s KRW 67.6tn. In particular, client money held by securities companies as stand-by capital for future stock purchases escalated 29.6% from the previous year to KRW 2.9tn, illustrating a huge capital inflow into the stock market. Graph 2-4. Standby Liquidity Reserves Client Money

9 Meanwhile, the balance for margin accounts grew 28.5% from the previous year to KRW 6.5tn. The KOSDAQ outpaced the KOSPI in terms of the margin account balance, owing to stronger demand for loans from investors seeking short-term profit due to the KOSDAQ s high-volatility nature. Consequently, the KOSPI and KOSDAQ market assumed a KRW 3tn and 3.5tn margin account balance, respectively Margin Account Balance KOSDAQ KOSPI The balance for CMAs increased 12.8% compared to the previous year, recording KRW 52.3tn in 215. RPtypes took up the largest share of the CMA balance, at more than 6%. 6. CMA Balance Other Merchant bank-type MMF-type RP-type Source : Korea Financial Investment Association The total number of securities companies in Korea as of late 215 was 56, dropping by two from the year before. This number peaked in 213 at 62, and then began to drop over the next two years. This was mostly due to corporate restructuring and the re-organization of securities companies during the period, following a prolonged market recession. Out of those six companies, two closed due to sustained losses, three were involved in strategic M&As, and one filed for bankruptcy. Interestingly, while the overall number of securities companies fell, equity capital continued to grow. Their total equity capital as of late 215 was KRW 46tn, an average increase of KRW.82tn per company. This demonstrates the trend of securities companies growing in size through paid-in capital increases and strategic M&As Graph 2-5. No. of Securities Companies & Equity Capital Total equity capital (left) Number of companies (right) (Companies) 65 Source : Financial Supervisory Service, Monthly Financial Statistics Bulletin

10 Korean Capital Market Annual Review Equity Market Securities companies recorded KRW 3.2tn in net profit, a whopping 91.1% increase compared to the previous year's KRW 1.7tn. Despite suffering a net loss of KRW.2tn in 213 due to the market slowdown, as trading amounts started to increase and brokerage commission profits improved accordingly, their net profit continued to rise, recording its highest level since 27. Profitability at securities companies improved, with ROE growing for two consecutive years. ROE hit 6.9% in 215, a 2.9%p rise compared to the year before. Graph 2-6. Securities Companies Net Profit & ROE Net profit (left) ROE (right) (%) Source : The Bank of Korea, Flow of Funds In 215, brokerage commission profits for securities companies surged by 32.6% year-on-year to KRW 7.9tn, but trading profits fell by 9.1% to KRW 4.2tn. Brokerage commission profits, which account for the largest proportion of total commission profits, climbed 36.5% compared to the previous year owing to a rise in trading amounts, recording KRW 4.6tn in 215. This is equivalent to 58% of total commission profits. The second largest source of commission profits was investment banking services, including securities underwriting and advisory services, and M&A business activities. Here, commission profits increased 32.4% year-on-year to KRW 1.2tn. Income from asset management services, such as fund distribution, investment advisory services, discretionary investment services and investment trust services recorded KRW.9tn. Table 2-1. Profit Structure at Securities Companies 214 (A) 215 (B) Growth (B-A) (Unit: KRW tn) Source : FSS Financial Statistics Information System and Press Release Growth Rate Commission Profits % Brokerage % IB Services % Asset Mgmt.Services % Trading Profits % Stocks % Bonds % Derivatives % Although brokerage commissions still make up the largest portion of the commission income structure, profits from IB services and asset management services demonstrated steady growth. On the other hand, securities companies saw a KRW 1.tn drop in bond trading profits compared to the previous year, as bond interest rates fell at a slower pace in 215. This led to trading profits for securities companies to drop to KRW 4.2tn in 215, a decline of 9.1% from 214.

11 3 Bond Market Trading activity in the Korean bond market was up compared to 214. This was partly due to the Bank of Korea s decision to lower the base rate twice from 2% to 1.75%, and then to 1.5% during the first half of the year, and a surge in demand for safer assets due to heightened global financial volatility and the possibility of a US interest rate hike. Another key factor was the introduction of the Performance-Based Market Making System, which channeled liquidity into the market and fueled the growth of market-listed bonds. While total trading volume took a slight downturn in 214 due to reduced interest rate volatility, it rebounded in 215, jumping 6.5% year-on-year to reach approximately KRW 7,tn. The OTC market made up around 8% of the total bond trading volume, but this figure has been dropping over the years. To compare, the OTC sector took up 9.5% of total trading volume in 21. 8,. 7,. 6,. 5,. 4,. 3,. 2,. 1,.. Graph 3-1. Annual Bond Trading Volume Source : Korea Financial Investment Association (OTC), Korea Exchange (Exchange) Exchange OTC An analysis of trading volume by bond type shows that the proportion of Korea Treasury Bond (KTB) trading has been on a steady upward trend since the 2s generally, and currently represents a dominant share of the secondary bond market at 6%. Improvements in government policies to nurture the KTB market, such as the introduction of fungible issues in May 2 and the increase in KTB issuance, greatly aided this growth. Meanwhile, as government and public bonds have come to represent a bigger slice of the pie, the proportion of corporate bonds, including ABS, has comparatively diminished. In 2, corporate bonds accounted for 14.7% of the total volume of trading, but this figure started to slide down in 24, to a mere 2.7% at the end of 215. Graph 3-2. Annual OTC Trading Volume by Bond Type Municipal bonds Corporate bonds Special bonds Financial bonds Monetary Stabilization Bonds Government bonds 7,. 6,. 5,. 4,. 3,. 2,. 1, Source : Korea Financial Investment Association 1 11

12 Korean Capital Market Annual Review Bond Market Another conspicuous trait of the Korean bond market is the more pronounced concentration on KTBs in the exchange-traded market compared to the OTC market. Bond types (aside from government and public bonds) only account for a paltry %-2% of the entire exchange-traded market. This is a result of a government requirement that Primary Dealers (PDs) trade the benchmark index of government bonds on the exchange market, although the relevant policy was abolished in July 28. Nowadays, institutional investors the main participants in the Korean bond market usually trade bonds other than KTBs, such as MSBs, special bonds, financial bonds and corporate bonds, on the OTC market, with the exchange rarely used Graph 3-3. Annual Exchange-Traded Volume by Bond Type Municipal bonds Corporate bonds Special bonds Financial bonds Monetary Stabilization Bonds Government bonds Source : Korea Exchange Most bond trading in the Korean OTC market is conducted by domestic institutional investors. A breakdown of trading volume by investor type demonstrates that securities companies make up the largest share with 6%, followed by banks, AMCs, insurance companies, and funds/mutual aid associations. Overall, domestic institutional investors comprised 95% of total trading volume. In 215, trading among securities and insurance companies dropped by a small margin (-2.6%p and.1%p, respectively), while trading volume for banks (+.8%p), AMCs (+2.3%p) and foreign investors (+.4%p) increased. Graph 3-4. Annual OTC Trading Volume by Investor Type (%) Other Individual Foreign Funds/mutual aid associations AMCs Banks Securities Insurance Source : Korea Financial Investment Association

13 In 215, net foreign buying of Korean bonds reached KRW 34.4tn, a KRW 5.6tn (-14%) decrease from the previous year. In terms of bond types, purchases of KTBs fell by KRW 12tn (-63.2%) to KRW 7.1tn, whereas buying of MSBs gained KRW 6.5tn (+34.2%), reaching KRW 27.6tn. Graph 3-5. Net Foreign Buying of Korean Bonds MSBs KTBs Other Source : Korea Financial Investment Association As part of its reform plan to expand foreign exchange liquidity, the Korean government started granting tax exemptions to foreigners in 29 on interest income and capital gains for KTB and MSB investments. Although this tax exemption was repealed in 211, net foreign buying of Korean bonds continued to climb due to global central banks efforts to diversify foreign currency investment assets and prospects for a stronger Korean won. As a result, the outstanding amount of foreign-held domestic bonds reached KRW 11.4tn at the end of Graph 3-6. Korean Bonds Held by Foreign Investors Source : Financial Supervisory Service 12 13

14 Korean Capital Market Annual Review Derivatives Market 4 Derivatives Market The Korean derivatives market has achieved spectacular growth since the establishment of the KOSPI 2 options market in To date, a total of 31 products have been listed, with six de-listed. Furthermore, the KRX has been the top global performer every year from 21 to 211, aside from 2 years, in terms of trading volume. In recent years, however, the market has suffered a sharp downturn due to heavier regulations and reduced volatility. As such, throughout 214 and 215, there has been an initiative to reinvigorate the exchange-traded derivatives market and reclaim its former glory. New product listings, such as the mini KOSPI 2 futures options, volatility index sector index products, and ETNs bore fruit, with market volume rebounding by 11.5% to record KRW 1,153tn. For its part, the OTC derivatives market saw sluggish growth in 214 owing to the low interest rate trend, but the size of the market expanded by 13.9% in 215 compared to the previous year, posting KRW 12,273tn. Graph 4-1. Annual Trading Amount of Exchange-Traded Derivatives 16, 14, 12, 1, 8, 6, 4, 2, Graph 4-2. Annual Trading Amount of OTC Derivatives 16, 14, 12, 1, 8, 6, 4, 2, Source : Korea Exchange, Financial Supervisory Service On top of this, structured products such as ELS and DLS have proven to be promising investment options for investors in the current economic environment. First introduced in Korea in 23, the issuance volume of these mid-risk, mid-return products increased by a multiple of 3 in just over a decade, going from KRW 3.5tn to an impressive KRW 11tn in 215. Specifically, the value of ELS and DLS issuance was KRW 76.9tn and KRW 24.1tn, respectively. Graph 4-3. Annual Volume of ELS Issues Graph 4-4. Annual Volume of DLS Issues Private Public Private Public Source : Korea Exchange

15 After reaching a peak in 211, activity in the Korean exchange-traded derivatives market has been losing vigor due to tightened derivatives market regulations, contraction of the spot market, and reduced volatility. The main cause behind the dampened exchangetraded derivatives market was an 86% drop in KOSPI 2 futures and options trading over the past five years. This trading accounted for 95% of total trading volume in 211. The total trading volume of exchange-traded derivatives in 215 was approximately 79 million contracts, a nearly 8% decrease from the 211 figure of 3.93 billion contracts. (mn contracts) Graph 4-5. Exchange-Traded Derivatives Trading Volume Contracts Source : Korea Exchange An analysis of the KOSPI 2 futures market shows that the daily average trading amount recorded KRW 18.9tn, down 58.3% compared to 211, while the daily average trading amount for the KOSPI 2 options market fell 57.8% in the same period to KRW 743bn Graph 4-6. KOSPI 2 Futures Daily Average Trading Amount (KRW bn) Graph 4-7. KOSPI 2 Options Daily Average Trading Amount Source : Korea Exchange 14 15

16 Korean Capital Market Annual Review Derivatives Market The global market has grown by 13.6% since 211, backed by increasing derivatives trading in emerging economies and a bullish global stock market. However, in that same time, the Korean market experienced a sharp decline, mainly due to a dramatic downturn in the number of retail investors brought on by stronger entrance barriers such as the option multiplier increase from KRW 1, to KRW 5, and margin requirements imposed on call options. (tn contracts) Graph 4-8. Global vs Domestic Derivatives Market Trading Volume Global Korea Source : Futures Industry Association, Korea Exchange It is noteworthy that foreign investors have taken the lead as retail and institutional investors have pulled back. Institutional investors in particular have left the market in response to a suspension of tax breaks on arbitrage trading which led to a considerable drop in stock-related derivatives trading for hedging purposes. The drop in participation of domestic retail and institutional investors led to an increase in the proportion of foreign investment. These new investors were more involved in high frequency trading (HFT) with long-term strategic investment plans, wielding greater influence on the KOSPI 2 futures options markets, Korean Treasury Bond (KTB) futures market, and USD futures market. Graph 4-9. Trading by Investor Type KOSPI 2 Futures KOSPI 2 Options 3 Year Government Bond Futures Foreign Institutional Retail (Unit : 1, contracts) US Dollar Futures 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, ,, 3,5, 3,, 2,5, 2,, 1,5, 1,, 5, , 35, 3, 25, 2, 15, 1, 5, , 7, 6, 5, 4, 3, 2, 1, Source : Korea Exchange

17 The OTC derivatives market is valued at KRW 12,273tn. OTC derivatives with an underlying currency account for the largest share, a staggering 74.8%, while those using interest rates came in second, at 23.29%. Graph 4-1. OTC Derivatives Trading by Product Type Credit Commodities FX 14, 12, 1, 8, 6, 4, 2, Interest rate Equities Graph OTC Derivatives Trading by Product Type in 215 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, Equities Interest rate FX Commodities Credit Source : Financial Supervisory Service The total number of futures companies in Korea as of late 215 was six, down by one from the year before. Total assets for futures companies stood at KRW 3.8tn, a KRW 1.2tn (+47.5%) rise from the previous year. Equity capital was steady at KRW.41tn. Net profit for futures companies in 215 was KRW 1.65bn, a five-fold gain from the previous year. The ROE also increased 2.1%p to 2.6%. Graph No. of Futures Companies &Total Assets Total assets (left) Equity capital (left) Number of companies (right) (KRW 1bn) Graph Net Profit & ROE Net profit ROE(%) Source : Korea Financial Investment Association 16 17

18 Korean Capital Market Annual Review Fund Market 5 Fund Market Korea s asset management industry continued to be in the spotlight in 215, as pension assets have increased amidst the prolonged low interest rate environment and aging population. Over the year, both the government and industry players focused on facilitating and ensuring the steady growth of the asset management market. Notable developments in 215 included the announced legislation on adopting the Individual Savings Account (ISA) system and reforming the fund taxation system as well as private fund regulatory regime, with about 1 new asset managers expected to join the market. Owing to these efforts, total fund AUM in Korea surpassed pre-crisis levels. As shown in the charts, total fund AUM reached KRW 421tn for 12,721 funds in late 215. Low global interest rates and the Chinese economic slowdown prompted passive investor sentiment with a stronger preference for safe assets. As such, the most substantial net asset growth was seen in money market funds (MMFs) and bond funds, which increased by nearly KRW 11tn and KRW 14tn, respectively. Persistent low rates also boosted demand for alternative investments, with investors seeking to diversify their investments in the search for higher returns. Graph 5-1. Fund AUM Public funds Private funds Graph 5-2. Total Number of Funds 14, Public funds Private funds 12, 1, 8, 6, 4, 2, Source : Korea Financial Investment Association Total fund market NAV as of late 215 was KRW 413tn, a 9.8% rise from the previous year. This growth enhanced profitability for asset management companies, despite new competition entering the market, and business performance continued the growth trend that began in 211. Graph 5-3. Net Profit & ROE of Asset Management Companies (%) Net profit (right) ROE (left) (KRW bn) Source : Korea Financial Investment Association

19 With the drop in NAV for equity funds tapering off, aggregate NAV has grown significantly. In particular, a stronger preference for safe assets led to greater investment in bond funds and MMFs, while at the same time, special asset funds and other forms of alternative investment also attracted investors. *The NAV for equity funds, bond funds, MMFs, real estate funds, and special asset funds grew by KRW 1.6tn, KRW 16.7tn, KRW 1.8tn, KRW 6.2tn, KRW 8.6tn, respectively, while for derivatives funds it fell by KRW 2.4tn Graph 5-4. Investment by Fund Type (NAV) Special asset Fund of funds Real estate Derivative MMF Bond Stock Source : Korea Financial Investment Association Table 5-1. Fund Types by Investment Asset S ec u ri t i e s Asset Type Bond Equity Hybrid-Equity Hybrid-Bond Investment Contract Securities Fund of Funds MMF Qualifications 6% or more of total assets invested in bonds 6% or more of total assets invested in equity securities Maximum proportion of equity is at least 5% of total assets Maximum proportion of equity is less than 5% of total assets 6% or more of total assets invested in investment contract securities (if less than 6%, categorized as hybrid-equity funds) 4% or more of total assets invested in collective investment schemes No requirements on proportions of individual security types; assets invested primarily in short-term products such as call loans, CPs and CDs Real Estate Special Asset Mixed Asset 5% or more of total assets invested in real estate, including loan grants for real-estate development corporations and investments in any other real-estate related securities prescribed by the Presidential Decree 5% or more of total assets invested in assets other than securities and real estate A collective investment scheme not subject to requirements imposed on securities, real estate and special asset funds 18 19

20 Korean Capital Market Annual Review Fund Market Funds were mostly distributed by securities companies and banks. As of late 215, securities companies accounted for 67.18% of total distributions, followed by banks at 24.64%, insurance companies at 2.2%, and other institutions at 6.16%. To improve accessibility for general investors, the Korean government approved mutual savings institutions such as the National Agricultural Cooperative Federation, National Federation of Fisheries Cooperatives, Mutual Savings Bank, and the Post Office as fund distributors in April 216. They will start selling funds as soon as the approval process is completed. Graph 5-5. Distribution by Institution Type (%) Securities companies Banks Insurance companies Other Source : Korea Financial Investment Association As of late 215, investments by financial institutions accounted for 57.3%, a 5.5%p rise from the previous year. Meanwhile, other institutions and retail investors made up 14.4% and 28.4% of fund investments, respectively. The proportion of funds distributed to financial institutions has been growing ever since the global financial crisis. Graph 5-6. Distribution by Investor Type (%) Financial Institutions General institutions Individual Source : Korea Financial Investment Association Investments in overseas funds, which have been dropping since the crisis, have enjoyed a slight Graph 5-7. Overseas Investment Fund AUM rebound recently due to prolonged stagnation in the domestic stock market Source : Korea Financial Investment Association

21 Due to the persistent low interest rate environment, investor interest in mid-risk, mid-return investment products such as ETFs has been steadily growing. At the end of 215, the Financial Services Commission (FSC) announced its plan to develop the ETF market, with support from the Korea Exchange. In the first half of 216, various new ETF products, such as overseas ETFs with tax benefits, smart beta/strategic ETFs, and new growth industry ETFs, were launched. Active bond ETFs are set to launch in the second half of the year Graph 5-8. ETF AUM ETF Source : Korea Exchange As of late 215, bonds made up the largest share of fund investments, at 38.9%. Noticeably, investments in other assets accounted for a considerable 26.3%, which reflects the recent surge in demand for alternative investments and the consequent rise in NAV for real estate and special asset funds. Graph 5-9. Fund Investment by Asset Type (%) Other Call Loans Deposits CP Bonds Equities Source : Korea Financial Investment Association In Korea, small funds are defined as public openend funds launched more than a year ago, with an outstanding balance of less than KRW 5bn. The Korean financial authorities launched a project to reduce the number of small funds in the market to help eliminate inefficiency and rebuild market trust, with significant progress being made so far. Graph 5-1. Number of Small Funds 3, 2,5 2, 1,5 1, Public open-end funds (left) Small funds (left) Ratio (right) (%) Source : Korea Financial Investment Association 2 21

22 Korean Capital Market Annual Review Fund Market The Enforcement Decree of the Restriction of Special Taxation Act, enacted on February 5, 216, permits a tax exemption for trading and FX gains or losses on overseas-listed equities in overseas equity funds. The exemption is in effect for a maximum of ten years and applies to accounts opened between February 29, 216 and December 31, 217. This is anticipated to promote investment in overseas equity funds, which have experienced a drop in recent years Graph Overseas Equity Fund AUM AUM Source : Korea Financial Investment Association The number of asset management companies has grown steadily, with a total of 87 companies (65 domestic, 22 foreign) operating as of late 215. In 216, a large number of new, professional private investment companies entered the market. (Historical background) Korea s asset management industry was first governed by the Securities Investment Trust Act (enacted on August 4, 1969), and later by the Indirect Investment Asset Management Act (enacted on January 5, 24). Currently, it is governed by the Financial Investment Services and Capital Markets Act (FSCMA, enacted on February 4, 29). The FSCMA provides that a collective investment scheme may invest in any asset that has value," and the scope of acceptable investments for each type of investment scheme is also greater than with former regulations. Graph Number of Asset Management Companies 1 Total Domestic Foreign Source : Korea Financial Investment Association In addition, restrictions on the scope of collective investment businesses were lifted considerably. The FSCMA approves companies to engage in up to six different types of financial investment businesses at once, making it possible for them to conduct both securities and asset management business activities at the same time. Furthermore, constraints on the distribution of collective investment securities were relieved by including licensees of both investment trading and investment brokerage in the definition of entities that can distribute collective investment securities as part of their business activities.

23 6 Trust Market Korea s trust market has demonstrated solid growth over the years, with the total value of trust contracts recording KRW 62tn at the end of 215, an increase of 1.2% year-on-year. The market has been growing steadily at an annual average rate of 11.1% since 212. Banks took up 47.9% of market share (KRW 288.1tn), followed by securities companies at 27.8% (KRW 167.4tn), real estate trust companies at 23.3% (KRW 14tn), and insurance companies at 1.1% (KRW 6.5tn). Graph 6-1. Trust AUM by Business Type Real estate trust companies Insurance companies Securities companies Banks Source : Financial Supervisory Service Money trusts accounted for 53.6% of the market and increased by 12% from the end of the previous year to KRW 322.4tn. The value of specified money trusts, including retirement pensions, was KRW 37.6tn, while unspecified money trusts recorded KRW 14.9tn. Non-money trusts registered growth of 8% year-onyear to KRW 279tn, constituting 46.4% of the market. Of these, real estate trusts accounted for KRW 171.6tn. Graph 6-2. Trust AUM by Asset Type Real estate trusts Marketable securities trusts Monetary bond trusts Retirement pension trusts Specified money trusts (excluding retirement pensions) 7 Other Unspecified money trusts Source : Financial Supervisory Service 22 23

24 Korean Capital Market Annual Review Trust Market The total value of specified money trusts grew by 12.6% compared to the end of the previous year, owing to a KRW 13.9tn gain in retirement pension trusts, a KRW 7.3tn gain in trusts investing in derivatives-linked products offered by banks, and a KRW 9.5tn gain in regular deposit-type trusts offered by securities companies. Specifically, banks enjoyed greater demand for trusts that invest in derivatives-linked products such as equity-linked securities (ELS) and derivatives-linked securities (DLS), on the back of the persistent low interest rate environment. Securities companies similarly saw higher demand for regular deposittype trusts in which foreign currency deposits with relatively higher prospective interest rates, such as the yuan, are incorporated Graph 6-3. AUM for Major Specified Money Trust Products Regular deposit-type trusts Derivatives-linked product trusts Bond trusts Source : Financial Supervisory Service, Korea Financial Investment Association In 215, 45 in-house trust companies (2 securities firms, 19 banks, 6 insurance companies) and 11 specialized real estate trust companies were authorized to conduct business and provide related services. Table 6-1. No. of Trust Companies Category Securities In-house Bank Insurance Subtotal Real estate trust companies Total

25 7 Real Estate Trust Market Real estate trusts are trusts which use real estate properties as the asset, and allow real estate owners to pay trust fees and assign a trustee the right to manage, dispose of, or develop the real estate for a set period. Real estate trusts reached KRW 171.6tn in value at the end of 215, with real estate trust companies accounting for 81.5% of the total, or 139.9tn, a KRW 14.6tn (11.7%) increase from the end of the previous year. This increase was mainly because the amount of management-type and leverage-type land trusts each stood at KRW 34.8tn and KRW 3.7tn, posting respective growth rates of KRW 6.7tn (24.9%) and KRW.7tn (2.6%) from a year before. Graph 7-1. AUM of Real Estate Trust Companies Sales/management trusts Collateral trusts Disposition trusts Management trusts Land trusts Source : Financial Supervisory Service On the back of improved business conditions in real estate, such as the low interest rate and deregulation of reconstruction and redevelopment, real estate trust companies recorded an operating revenue of KRW 559.1bn in 215, up KRW 113.5bn (25.5%) from a year earlier. Net income also increased by KRW 74.1bn (5.%), reaching a record high of KRW 222.2bn. Graph 7-2. Real Estate Trust Companies Profit Operating revenue Operating costs (KRW bn) Operating profits Net income Source : Financial Supervisory Service 24 25

26 Korean Capital Market Annual Review Advisory and Discretionary Market 8 Advisory and Discretionary Market As of 215, 367 companies were registered as an investment advisory business in Korea, recording KRW 13.4tn in total assets with advisory contracts. The government recently released a preliminary announcement of legislation on amending laws governing financial advisory services in order to promote industry growth and assist the public with accumulating wealth. The main details of the announcement include lowering the entry barrier* for becoming a financial advisor, introducing IFAs (Independent Financial Advisors) and robo-advisors, and stepping up investor protection by highlighting the importance of the duty of explanation in the financial advisory business. Graph 8-1. Volume of Assets in Advisory Contracts Contracted assets Source : Korea Financial Investment Association, FreeSIS *Lowering the minimum capital requirement from KRW 5mn to 1mn At the end of 215, the number of companies registered as a discretionary investment business was 346, with the total volume of assets in discretionary investment contracts amounting to KRW 54.3tn. The volume of contracted assets in securities companies wrap accounts reached KRW 89.4tn, jumping KRW 17.8tn year-on-year, and continues to rise due to increasing demand for wealth management services. 5 Graph 8-2. Volume of Assets in Discretionary Investment Contracts Contracted assets in discretionary investments Contracted assets in wrap accounts Source : Korea Financial Investment Association, FreeSIS

27 9 Pension Market Retirement Pensions Korea s low birthrate and rapidly aging society have led to calls for a stronger retirement pension system that ensures post-retirement income security and financial protection. Accordingly, in August 214, the Korean government introduced a policy roadmap designed to help wage earners prepare for life after retirement, with a focus on the retirement pension system. Taking a quick look at the statistics for the pension market, total contributions stood at over KRW 1tn in 214, with a subscription rate of 5%. This is quite remarkable, considering the system had only been introduced a decade ago. In 215, the government raised the tax deduction limit by KRW 3mn for Individual Retirement Pension (IRP) accounts, which further stimulated the market as contributions reached just over KRW 126tn and are expected to continue to grow in the future. (KRW tn,%) Graph 9-1. Growth of Pension Reserves & Subsciption Rate Reserves Subscription rate Source : Ministry of Employment and Labor Korea s pension system offers three tiers of coverage: the National Pension Service (tier 1), retirement pension system (tier 2), and personal pension system (tier 3). Severance payments were first introduced in 1961 to promote post-retirement financial security, and the retirement pension system was later introduced in 25 with the establishment of the Act on the Guarantee of Workers Retirement Benefits. Retirement pensions can be divided into Defined Benefit (DB), Defined Contribution (DC), and Individual Retirement Pension (IRP) plans. As of 215, DB plans accounted for 68.3%, followed by DC plans (22.5%) and IRPs (9.2%). Although DBs currently claim the lion s share of the market, the proportion of DC plans is on the rise. Graph 9-2. Retirement Pension Plans by Pension Type (%) IRP DC DB Source : Ministry of Employment and Labor 26 27

28 Korean Capital Market Annual Review Pension Market Around 45 entities in the banking, insurance, and securities sectors are conducting retirement pension business, with banks making up the greatest percentage of the market (5.1%) with KRW 63.3tn as of 215. Other market participants include insurance companies, securities companies, and the Korea Workers Compensation & Welfare Service, with 31.8% (KRW 4.1tn), 17.4% (KRW 22.tn) and.7% of the market share, respectively. Management of pension reserves is focused mostly on investments in principal-protected products. Principal-protected products take up the greatest share with KRW 112.7tn (89.2%), with investment-type products and other investments, such as standing capital, accounting for smaller shares, with KRW 8.6tn (6.9%) and 5tn (4.%), respectively. In order to diversify pension reserve investments, which are overly concentrated on principalprotected products, the government carried out regulatory measures such as lifting regulations on the management of pension reserves (ceiling on maximum investment proportion in risky assets raised from 4% to 7%) in 215. Furthermore, it has recently set out to adopt fund-type(trust-based) retirement pensions. Personal Pensions Graph 9-3. Pension Market Share by Financial Institution (%) Korea Workers Compensation & Welfare Service Securities companies Insurance companies Banks Graph 9-4. Management of Pension Reserves (%) Other Investment type Principal-protected type Source : Ministry of Employment and Labor First adopted in 1994, personal pensions are products that provide tax benefits at year-end tax deductions. The personal pension market is growing by more than 1% each year, and cumulative reserves marked KRW 18.6tn at the end of 215. Graph 9-5. Annual Pension Reserves Volume Reserves Source : Financial Supervisory Service

29 As of 215, the insurance sector holds the greatest amount of reserves with KRW 81tn (74.6%), followed by the banking sector (KRW 15.3tn, 14.1%), the securities sector (KRW 8.8tn, 8.1%), and other sectors (KRW 3.5tn, 3.2%). Meanwhile, tax deferral on money transfers between personal pensions and IRPs was granted in July 216. This will allow financial consumers to engage in better-integrated management of pension assets and enjoy greater post-retirement income through the enhanced profitability of pension assets. Graph 9-1. Pension Reserves by Financial Institution Category Insurance Banking Securities Other Total Reserves Share (%) Source : Financial Supervisory Service Efforts for regulatory improvements are also underway, such as establishing a Personal Pension Act to streamline complex pension policies and providing pension subscribers with protection throughout the entire process of subscribing to, managing and collecting pensions, by taking into account the long-term nature of pension plans

30 II. OTC MARKET OPERATION BY KOFIA 1 K-OTC 2 FreeBond

31 1 K-OTC Role and Functions KOFIA's K-OTC system facilitates the trading of all types of unlisted stocks in Korea. It is comprised of the K-OTC Market and K-OTCBB. The K-OTC Market handles OTC trading of companies which are either registered themselves or designated by KOFIA, pursuant to the FSCMA, and the K-OTCBB is a bulletin board for trading of all types of unlisted stocks. Chart 1-1. K-OTC Structure K-OTC Market K-OTCBB (Registered companies + designated companies) (A bulletin board for stocks of unlisted companies free from specific regulations related to entrance and disclosure) Background and History In March 2, KOFIA established the first over-the-counter market (third market) in Korea in accordance with the Plan to Establish an Over-the-Counter Stock Market announced by the Ministry of Finance and Economy (currently the Ministry of Strategy and Finance) in May The name of this market was later changed to FreeBoard, and in 214 and 215, respectively, the K-OTC Market and K-OTCBB were established to facilitate the transparent and convenient trading of all types of unlisted stocks, including those of SMEs. Chart 1-2. K-OTC Market Stock market Primary market Secondary market Securities market KOSDAQ market K-OTC market Operated by Korea Exchange Operated by Korea Financial Investment Association Private OTC markets 3 31

32 Korean Capital Market Annual Review K-OTC Market System The K-OTC Market is separated into two divisions: one for registered companies, and the other for designated companies. Registered companies must meet the outlined requirements, while designated companies are selected by KOFIA. Transactions are conducted via the market, with investors trading stocks through securities companies on it just as they would on the KRX. K-OTCBB is a bulletin board for posting quotations for stocks of unlisted companies that meet the minimum requirements and are not traded on listed markets or the K-OTC Market. Investors may trade stocks through negotiations between securities companies. Chart 1-3. K-OTC Market Trading Process Chart 1-4. K-OTCBB Trading Process Negotiate transaction terms Settlement, transfer of stock Securities company A Notification of execution Order Order Execution K-OTC trading platform Order Execution Securities company B Notification of execution Order Securities company A Notification of execution Order Quotation Report of execution K-OTC Bulletin Board Quotation Report of execution Securities company B Notification of execution Order Investor 1 Investor 2 Investor 1 Investor 2 Indices and Statistics A total of 128 companies (86 designated, 42 registered) were trading on the K-OTC market as of 215, a 9.4% (11 additional companies) rise from the previous year, and the market capitalization as of the end of 215 was KRW tn. Table 1-1. Registration (Designation) & Cancellation of Companies Category No. of companies Newly registered/ designated Registration/Designation cancelled Market capitalization Issues from Mirae Asset Life Insurance, C-Tri, etc. offset the impact of Samsung SDS s listing and subsequent exit from the K-OTC in 214. Consequently, the daily average trading volume increased by 33, shares (15% ) from the previous year to reach 55, shares in 215, and the 215 daily average trading amount remained around the same level as the previous year, at KRW 896mn. Graph 1-1. Trading Volume & Amount Daily average trading volume (Unit: 1 shares) Daily average trading amount (Unit: KRW mn) Annual trading activities

33 2 FreeBond Introduction In the past, one-on-one voice trading was the predominant form of bond market interaction in Korea, but the development of information technology transformed the landscape, with young brokers actively utilizing online messenger programs that could record conversations and enabled faster communication. Messenger trading expedited bond transactions and was not subject to physical or spacial restrictions, thus playing a significant role in the development of the secondary bond market in Korea. However, relying solely on private messenger systems has several potential weaknesses. First of all, it may not be conducive to optimal pricing, as counterparties will be limited to personal networks. Also, there is always a possibility that the bond market may crash due to messenger program technical failures. Last but not least, there are structural limitations, as the lack of a centralized and dedicated bond trading system makes it impossible to reflect all of the various demands of market participants. In response to these various shortfalls, in October 29, the Korean financial authority announced plans to revamp the secondary market for bonds, which would focus on the introduction of a centralized bond trading system. KOFIA subsequently established and launched FreeBond. Concept and Composition FreeBond is a platform that enables financial investment companies and key market participants to search quotations and negotiate prices with counterparties, thus facilitating bond trading and brokerage in the overthe-counter (OTC) bond market. Here, market participants refers to brokers, dealers, managers, and traders who specialize in bond trading. Market participants must apply for and receive approval from KOFIA in order to use FreeBond. One of the most discernible qualities of FreeBond is its ability to be tailored to the various needs and demands of market participants. This is made possible because it is run by KOFIA, which is in a position to engage in continuous communication with interested parties

34 Korean Capital Market Annual Review FreeBond Chart 2-1. Workflow Bond Market Participant Bond Trading System (Messenger, Trading Board) 1 Quotation Search and Order Execution Market Participant Bond Information Service (BIS) Information Vendors 2 Quotation Information Reporting 3 Quotation Information Disclosure and Sharing 2 Quotation Information Transfer Bond Quotation System (BQS) 1 Market participants search for quotations and execute trades on FreeBond 2 Quote prices and other information are automatically transferred to KOFIA s Bond Quotation System (BQS) 3 Aggregated information is disclosed in real time on KOFIA s Bond Information Service (BIS) and through information vendors FreeBond is divided into two parts: the trading board (T-Board) and a messenger service. T-Board (1) provides market participants with quotation information and serves as a platform for bond trading, allowing counterparties to make orders, negotiate, and confirm trades. It also offers book building and Qualified Institutional Buyer (QIB) services and features information checking and analysis functions. The second part of FreeBond, the FreeBond-exclusive instant messenger system (2+3), replaces private messengers. Along with offering basic online messenger services, it also hosts an array of functions conducive for bond trading, such as group chat, 1:N chat, and the ability to save 1:1 chatroom settings.