The Korean Over-the-Counter Derivatives Markets

The Korean Over-the-Counter Derivatives Markets

       Options are one of financial derivatives. Nowadays options are considered as an attractive investment target although their payoff structure is relatively complicated compared to other financial commodities such as fixed income, forwards, futures and swaps. However, like other financial commodities, options are traded inside and outside market. Trading inside market has many benefits such as reducing counterparty risk, clearing easily and increasing efficiency of transactions.

       From the perspective of efficiency and safety, it is essential to handle the OTC contracts as transactions traded inside market. Thus, financial authorities try to include more and more OTC derivatives into the inside market derivatives. Some OTC contracts, however, are too complex to be traded inside market and all of OTC contracts cannot be traded as standard form. It is reason why financial authorities make infrastructure of OTC markets and form standard contract ways.

 
G20 Statement Description

       In the G20 Pittsburgh Summit on Sep. 25th 2009, the statement about OTC derivatives markets was announced. The G20 leaders requested Financial Stability Board (FSB) and members to enforce a system for improving transparency of market, soothing system risk, and preventing unfair transaction. The details are as follows. At the end of 2012, at the latest, all standardized OTC derivatives deals such as IRS, CRS, DRS should be concluded on change or in the electronic trading platform and should be cleared through the CCP (central counterparty) clearing house. And all OTC derivatives should be reported to trade repository. The derivative commodities which are not reported should be subjected to the capital requirement law rigorously.

The current state-quo of Korean OTC derivatives markets

       Korea is still lagging behind in the area of OTC derivatives markets compared to developed countries both in quantity and in quality. Owing to under-developed dealer market led by domestic financial companies, the role of agent is restricted to as an end user or just selling and distributing not developing and supplying. Furthermore, the main financial infrastructure which is debated internationally is still not propagated. OTC derivatives CCP clearing house and electronic trading platform don’t exist. But the financial authorities operate a separate financial derivatives reporting system. The Bank of Korea manages the foreign exchange system and the Financial Supervisory Service (FSS) collects and compiles the reports on derivatives transactions.

The short- and long-term policy of Korea

       In line with the global effort to increase transparency and efficiency of OTC derivatives trading, Korea plans to build trading infrastructures for OTC derivatives. The FSC’s Capital Markets Division will form a task force (TF) with academics and related institutions to monitor global discussions and exemplary cases in advanced countries so that specific plans to introduce trading infrastructures for OTC derivatives and to revise related laws and regulations by 2010.

       It is said that this financial crisis was expanded by the failure of supervising and difficulties of management ex post facto which was caused by the specification of OTC derivatives markets such as complexity and uncertainty. To ensure more effective and efficient supervision over the whole markets, policy coordination among supervisory authorities across the globe is needed. And the contracts of OTC derivatives should be standardized, which will help financial authorities prevent the rise in numbers of poorly run financial institutions and handle post-crisis issues.

       Moreover, we must provide legal grounds. The FSC is working on laying the legal foundation to introduce CCP clearing house in capital market law within 2 years, 2012. Thus this law should be amended. Following this rule, financial authorities select operating body and start services. It may be too much to apply this rule to all OTC derivatives. Thus financial authorities apply this rule to relatively liquid and easily standardizable commodities in the early stage.

Conclusion

       Establishing OTC derivatives infrastructure is urgently needed. As OTC derivatives contracts are getting complex and complicated, we need to be better prepared now by making legal basis, establishing transaction system, and expanding facilities. At the same time, we must focus on the effective risk management, abundant liquidity, and efficient supervisory.

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