South Korean securities companies’ assets have more than tripled in years based on financial deregulation and the government’s policy for investment banking growth acceleration. The increase in assets has come with expanded derivatives-linked securities (DLS) and shadow banking in the real estate sector though.
Their DLS that topped 100 trillion won have unexpectedly acted as a foreign exchange market disruptor. Although securities companies were not major players in the forex market, their U.S. dollar demand for additional margin payment broke the balance of supply and demand in the market. Besides, unlike banks, securities companies are subject to no regulation in relation to foreign currency liquidity. Local financial authorities are likely to introduce regulations targeting them in the near future.
The won-dollar exchange rate soared in March this year and this has to do with the U.S. dollar demand. Usually, securities companies obtained the U.S. dollar by one-day forex swap trading. However, they suddenly and sharply increased their target volume, and then the CRS rate dropped. In the CRS market for exchange between different currencies, interests are exchanged before maturity and nominal principals denominated in the currencies are exchanged at the maturity based on the exchange rate fixed at the time of contract conclusion. A securities company that needs the U.S. dollar conducts swap dealing to receive the U.S. dollar by giving the won.
Securities companies’ U.S. dollar demand increased a lot, leading to an increase in swap basis and a decrease in CRS rate. The won-dollar exchange rate was about to top 1,300 won per U.S. dollar. Then, foreign exchange banks suspended their U.S. dollar supply to avoid risks. The local foreign exchange authorities made an announcement on March 18 on a 25 percent expansion of banks’ foreign exchange position limit and signed a US$60 billion currency swap deal with the United States the next day.
Securities companies’ currency-related OTC derivatives trading balance has substantially increased along with DLS issuance, too. Specifically, the trading balance skyrocketed from 11 trillion won to 263 trillion won from 2009 to 2019.
As mentioned above, foreign currency liquidity regulations are yet to be put into effect despite the huge risks related to securities companies’ foreign currency financing. “It is no exaggeration to say that won liquidity ratio compliance is the only liquidity regulations targeting securities companies,” the financial authorities explained, adding, “Foreign currency liquidity management is absolutely necessary for U.S. dollar-based margin payment.”