The upcoming short-term bonds about to dethrone CPs in local capital market

  The nation’s financial regulators are now engrossed in adopting electronically traded short-term bonds which will exercise a huge reform on current short-term financial market. Early in October last year, the Financial Services Commission announced its plan to introduce short-term bonds less than a year maturity as early as 2011. The top regulator speculated that the new bonds will not only facilitate corporate funding but also enhance investors’ confidence in the capital market.

  The Short-term Borrowing  Act, which is currently on evaluation by the Regulatory Reform Committee and the Ministry of Government Legislation, specifies what the ready-to-be-launched financial tool would be like. According to the law, the key feature of the bond would be the simplicity of issuance and circulation. Unlike an ordinary bond which requires complex procedures to be sold, a company will be able to issue the new bond just by filling in the issuing number, the date, and the sum of amount.

  The upcoming bond is quite distinct from commercial paper which has been often used by cash-strapped companies to raise funds for short period. Defined as an unsecured promissory note with a fixed maturity of 1 to 365 days, commercial paper has been widely used by local companies to finance payroll, rent or other expenses.  Its annual issuance reaches as much as 70 trillion won ($6 billion), undoubtedly playing the most significant role in local short-term financial market.

  But unlike regular bonds which are under rigorous financial regulations, commercial papers often cause troubles in the market due to its issuing process. According to the current law, a company about to issue a commercial paper is exempted from getting the resolution of the board of directors, listing itself at the Financial Supervisory Service, and submitting the financial statement to the FSC. This simple procedure has helped companies to promptly raise funds, however, deprived investors of the chances to overhaul the financing status of their debtors and stalled the regulators from analyzing the short-term liquidity of the market.

   This problem caused the nation’s top regulator to come up with an alternative. “There have been numerous cases of failing firms raising funds by issuing commercial paper over their capacity and inflict heavy loss to the creditors. That’s why the regulators are trying to adopt the new system. The envisioned short-term bonds are expected to enhance transparency and efficiency in the local short-term financial market,” said an official who spoke on the condition of anonimity.

  As the new system would come into effect by next year, all eyes are now on its heavy impact on the current market and its participants.  Particularly, there are some disputes on whether it will facilitate corporate funding as  intended. A number of industry watchers argue that companies would be reluctant at issuing the new bond as they should disclose their financial status as prescribed in the law. On the other hand, the ones who welcome the decision say that the increased transparency of the new bonds will entice more investors to the market and eventually let companies borrow money more easily.

  While the impact of the short-term bonds on entrepreneurs has no consensus, experts mostly agree that it will bring about some positive changes to the market. First of all, the elevated circulation of the short-term bonds will have a huge impact on local call market. Unlike United States where only must-deposit-payment reserves institutions such as commercial banks are allowed to participate in the call market, Korea has opened its door for other financial institutions, which eventually set some limit on the central bank’s monetary policy. But if the new bonds succeed in boosting short-term financial market, the government will allocate the call market only to commercial banks and make the other institutions raise funds by the short-term market, according to experts. In consequence, the central bank would be able to use full weight of its power.

  Also, the electronically trading system will not only prevent counterfeiting but also enhance the efficiency of issuance and circulation of bonds. “By the adoption of the efficient trading system, about 25.6 billion won ($22.6 million) is expected to be saved,” said Lee Su-hwa, the head of the state-run Korea Securities Depository which will manage the entire process of the new bond.

  Among all the outcomes that the new bond will bring about, nothing would be more significant than the improved transparency of the short-term financial market. At around the time of the implementation of the new law, companies in need of issuing bonds will be mandated to register the specification of the issuance to the FSS beforehand. By this compulsory procedure, investors will be able to see through the companies’ financial status and decide whether the company would be able to pay back the debt. “The introduction of the short-term bonds will strengthen investors’ rights and interests by improving transparency in the market,” noted Hwang Sae-un, a researcher at the Korea Capital Market Institute.

  The short-term bond is forecast to absorb much of the demand for prevailing commercial paper, and gradually replace it in the short-term financial market, according to the FSC. Taking Japan’s case into account, the expectation seems rational. Once almost reaching 8 trillion yen ($88.5 billion) in 2003, the sum of issued commercial papers rapidly decreased to 39.1 billion yen in 2007 and there has not been any issuance of commercial paper with more than 6 month maturity since 2006. On the other hand, the sum of issued short-term bonds sharply increased from 110 billion yen in 2003 to 11.4 trillion yen in 2007.  “We’ll see the same case here in Korea. The commercial paper will soon vanish and the new bond will take its place,” said Hwang at KCMI.

  The introduction of the short-term bonds was first devised as a measure to boost local short-term financial market by the Presidential Transition Committee in February, 2008. In May of the same year, the FSC put the right hand to the work by forming a task force team, and finally came up with the legislation in about one and half years later.

By Nam Won-chul(


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