Ratio No. Corp. Name ORD ISIN Exchange DR Type (ORD:DR)
25 21 Hanatour Service Inc. KR7039130000 1:5 LONDON GDR
LONDON, January 22, 2019 26 22 Kumho Tire Co., Inc. KR7073240004 1:6 GDR Termination of the Program
27 S-Oil Corporation KR7010950004 1:2 OTC, December 6, 2018 23 ADR S-Oil Corporation Termination of 28 KR7010951002 1:2 PRF the Program
LuxX, December Hyundai 18, 2017 29 24 KR7004020004 1:1 GDR Steel Co., Ltd. Termination of the Program
December 17, 2017 30 25 BNB Sungwon Co., Ltd. KR7015200009 10:1 ADR 067
Source: Korea Securities Depository. 01 Establishment of Infrastructure for Cross-border Securities Issuance
In the early days, local banks were in charge of the custody of underlying shares for the issuance of overseas DRs in Korea, but the KSD directly opened its depository accounts for overseas DRs, not through a broker, creating the unique model in the world for CSD functions as a custodian for DRs underlying shares.
For the custody of underlying shares for overseas DRs, the KSD doesn’t have the exclusive rights by laws, thus competing with the global giants of local custody services, such as Citibank Korea, HSBS Seoul, Deutsche Bank, and Standard Chartered Bank Korea. However, the KSD maintains a 100% market share in the custody services of the underlying shares for the overseas DR.
There are some reasons behind this. Overseas depositaries have greatly enhanced the stability of their assets by opening a depository account in KSD, a legal ledger by the Capital Market Act in Korea. In addition, the KSD supports prompt DR conversion to underlying shares, as well as withholding tax. [Figure 1-17] Characteristics of KSD’s Custody Service for DR Underlying Shares
Unique model that CSD functions as a Custodian for DR underlying shares DR Depositary
e.g.) HSBC Seoul, Citibank Korea, Local Custodian Deutsche Bank, Standard Chartered Bank
DISINTERMEDIATION by KSD's custody service - Direct access to CSD KSD (CSD) - Custody a/c as a participant's a/c and legal ledger
Source: Author’s own.
3.2.2. Advantages of KSD’s Custody of DRs’ Underlying Shares 068 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market The advantages of the KSD as the CSD, directly serving as the custodian of DRs’ underlying shares, are as follows.
First, under the tax laws in Korea, foreign investors need to submit an “Application for Restricted Tax Rate” to the tax authorities to reduce the dividend income. However, the exception is applied when the KSD is the custodian of the underlying shares. The KSD earned the trust from the tax authorities by thoroughly handling the dividend withholding of each country for overseas beneficial owners. As a result, overseas DR depositaries no longer need to submit an application for Restricted Tax Rate for each of the hundreds of thousands of overseas beneficial owners when they use the KSD as their custodian of DR underlying shares. Exemption from the Submission of Application for Restricted Tax Rate
Article 138-7 of the Enforcement Decree of the Corporate Tax Law (Special Cases concerning Withholding Procedures to Apply Restricted Tax Rates under Tax Treaties to Foreign Corporations) (1) Where a real beneficiary of any domestic source income that intends to apply the restrictive tax rates under Article 98-6 (1) of the Act, he/she shall submit a request for application of restrictive tax rates to the domestic source income in the form stipulated by Ordinance of the Ministry of Economy and Finance to the relevant person liable for withholding before receiving the relevant domestic source income: Provided, That a request for application of restrictive tax rates may not be submitted with respect to the domestic source income paid to a foreign securities depository referred to in subparagraph 5 of Article 296 of the Financial Investment Services and Capital Markets Act through an account opened at the Korea Securities Depository under Article 294 of the same Act.
Second, the KSD has fully supported an arbitrage trade exploiting the price differences between overseas markets and the Korean market by establishing the Straight Through Processing (STP) conversion and cancellation procedures between DRs and underlying shares through complete automation. As CSD efficiently completes the whole procedures of 069 conversion and cancellation through book-entry transfer, domestic and foreign investors CHAPTER can carry out arbitrage trades by taking advantage of the price differences between markets. 01 Establishment of Infrastructure for Cross-border Securities Issuance Third and last, the payment of dividends through local custodians used to take a maximum of more than 10 days to calculate the withholding tax. However, with the automatic system of processing dividend withholding, KSD can distribute the dividends to investors in Korean won immediately after receiving them from overseas.
With these advantages, the KSD could win the competition in the custody service for overseas DRs’ underlying shares and has carried out the service in the Korean market with a 100% market share.
3.2.3. Factors to Consider When KSD Serves as a Custodian of Overseas DR's Underlying Shares
Despite the above advantages, the fundamental reason that KSD has been able to successfully carry out the custody service is that it has not involved frequent foreign exchange, transfer of funds, arrangement of loans for settlement funds, and derivatives for collateral services.
In general, a bank functions as a local custodian because it can provide various cash management services, including integrated money exchange and settlement for numerous transactions in the secondary market, such as the exchange market and securities collateral loans.
The KSD is not a bank under Korea’s Banking Act, so it cannot have its own fund account. Moreover, it is not allowed to have a payment account at the central bank other than a money account for the simultaneous settlement of transactions in the securities market.
Therefore, the local custodian services for transactions in the secondary market could not be efficiently carried out by KSD. It has only strengths in the custody service for overseas DR underlying shares, which does not involve frequent transfers of funds.
Accordingly, the KSD as the CSD lacks the efficiency in the custodian services for transactions in the secondary market and is only able to respond to the custody of overseas DRs’ underlying shares efficiently.
070 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 4. Recommended Infrastructure Model for Cross-border Securities Issuance
4.1. Suggested Infrastructure Model for Cross-border Securities Issuance by Foreign Companies in the Mongolian Capital Market (Inbound)
4.1.1. Reinforcing Investor Protections through MDRs Issued by MCSD
According to Article 14.1 of the Law of Mongolia on the Securities Market, it seems that MDR issuance can be done by only a person with a custodian license. In Korea, only the KSD, as the CSD, is allowed to issue a KDR to protect investors.
Unlike the advanced countries such as the US, UK, and Luxembourg markets, in which commercial banks such as Citibank N.A., Bank of New York Mellon, JP Morgan Chase, and Deutsche Bank are issuing DRs, a country in the early stages of the Cross-border securities issuance could benefit from DRs issued by a public institution with public interests for introducing a reliable system to protect investors.
In addition, the issuance of MDRs by the MCSD, which manages all investors’ accounts as the final electronic registration agency for securities, will increase the efficiency in issuing and distributing MDRs. Since the abovementioned global major DR depositaries are not likely to expand their DR issuance services in the Mongolian stock markets, the government- driven entity such as the MCSD would be the proper alternative to issue MDRs in Mongolian market. In addition, as the final and only electronic registration agency for securities in Mongolia, the MCSD can easily issue and distribute MDRs by using its electric registration books.
Accordingly, it seems necessary to allow the MCSD to issue MDRs by revising the relevant laws and regulations for reinforcing the protection of investor rights.
4.1.2. Introduction of MCSD’s Substantive Review of Eligibility for Issuing Foreign Shares and MDRs
As reviewed in Chapter 3, in Korea, the KSD is committed to protecting investor rights by substantively reviewing the issuance and deposit eligibility for issuing foreign shares and KDRs prior to listing on the exchange. However, the MCSD in Mongolia seems to have insufficient protections for investor rights in issuing foreign shares and MDRs. 071 CHAPTER Meanwhile, ERD’s Securities Prospectus approved by the MSE and FRC has mainly reviewed only a company’s corporate governance, such as the board of directors and 01 Establishment of Infrastructure for Cross-border Securities Issuance disclosures, not the protections for shareholders that are required in the country of trading.
Therefore, for the issuance of the securities of foreign corporations that intend to issue foreign shares or MDRs in the Mongolian market, the MCSD, the CSD in Mongolia, needs to introduce a substantive review system for issuance eligibility. The foreign shares of a foreign company that do not pass the substantive review should not be issued. In this case, the MCSD should perform the role of the final gateway to protect investor rights by inducing the company to issue MDRs instead. Furthermore, the FRC and the Mongolian Stock Exchange are advised to adopt the MCSD’s substantive review on the shareholders rights and obligations as the prerequisite in accepting the securities prospectus of the foreign companies’ securities issuance.
To this end, it is required to introduce a practical review system suitable for the Mongolian market. Refer to “Checklist for Overseas Corporations to Issue Foreign Shares and KDRs in Korea” presented in Section 3.1.4. 4.1.3. Establishing Procedures for the Stable Exercise of Rights from Foreign Shares and MDRs
As discussed in Chapter 2, protections for investors in exercising the rights of foreign shares issued by ERD, such as the voting rights for shareholders’ meetings and the procedures for record date setting, dividend payment, and dividend income withholding, seem to be very insufficient.
In particular, there seems to be a very serious error in determining who will receive the dividends, because of the discrepancies between the legal record date in Canadian and the record date in the Mongolian market regarding dividend payments for the shares issued by ERD.
① Record Date of Canada ② Payable Date of Canada 072 = Record Date and Payable Date of Mongolia Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Source: Author’s own.
As shown in [Figure 1-18], the record date for shareholders to receive dividends in Canada is , whereas, in Mongolia, the record date is . Therefore, a shareholder who ① ② was eligible for the dividends as of but has traded the shares between and cannot ① ① ② receive the dividends based on the record date of . ②
To resolve this problem, it is necessary to issue MDRs, set a separate “MDR record date” in accordance with the MDR deposit agreement, and then match the recipients of dividends between the two countries. Thus, the MCSD is required to revise related laws and regulations to prepare the procedures for exercising rights.
4.1.4. Blanket Conversion of ERD Shares to MDRs
As mentioned in Chapter 2, as the part of ERD shares have been listed and the shares cannot move between markets, the price gap between Canada and Mongolia is significantly widening, violating the principle of one price for one product. This also results in depriving the investors of opportunities for arbitrage trades exploiting the price differences between the markets.
On the other hand, it is very uncertain whether the MCSD is recognized as an effective registrar under Canadian law, and the legality and effectiveness of ERD shares issued by the MCSD are also questionable. In this situation, it is also uncertain whether investors who have acquired ERD shares in the Mongolian market can exercise shareholders’ rights, such as minority shareholders’ rights, against ERD.
To solve the problems, such as depriving new investment opportunities from investors and investors’ legal instability, it is necessary to make a blanket conversion of ERD shares to MDR when an appropriate and efficient MDR issuance system is introduced in the Mongolian capital market. In order to make a blanket conversion of ERD shares to MDR, the public disclosure system and the close cooperation between the MCSD and the local custodians would be critical. In addition, in this case, the cost of issuing shares and MDRs should be reasonably set considering additional services for the issuing companies.
4.1.5. Extension of Education for Market Stakeholders on the Issuance of Foreign Shares and MDR
Education on the issuance of foreign shares and MDRs should be extended to the 073 employees of issuing companies, policy supervisors, marketers, and legal and accounting CHAPTER personnel to legally and effectively issue foreign shares and MDRs and to protect the exercise of investor rights in the Mongolian market. 01 Establishment of Infrastructure for Cross-border Securities Issuance
Unlike the issuance of domestic shares, issuing foreign shares and MDR is accompanied by many challenges, such as conflicts of law, differences in trade and distribution, distinctions in shareholders’ rights and obligations, procedures for movement between markets, and differences in partial and full listings. Therefore, it is necessary to increase the awareness of issuing Cross-border securities through specialized and extensive training sessions.
4.1.6. Tax Reduction for Mongolian Subsidiaries When a Company Issuing MDRs of Foreign Shares Listed on the Overseas Market
Currently, all blue-chip shares except ERD are listed on overseas markets, such as Canada and Hong Kong, in the form of paper companies. To effectively induce such blue- chip companies to return to the Mongolian market, it is necessary to provide benefits to the subsidiaries that are the business entities in Mongolia.
If securities are dual-listed on an overseas market and the Mongolian market, benefits such as corporate tax reduction can be considered for subsidiaries in Mongolia. Through such an incentive, if a number of blue chips can be returned to the Mongolian market and listed on the Mongolian Exchange, investors can obtain new investment opportunities, not only investment opportunities in the Mongolian market but also in inter-market arbitrage. However, the new investment opportunities will be created only when the infrastructure for reasonable and efficient issuance and trading is established to protect investor rights.
4.2. Suggested Infrastructure Model for Cross-border Securities Issuance by Mongolian Companies in the Overseas Capital Market (Outbound)
• MCSD’s Custody of the Underlying Shares for Overseas DRs in the Cross-border Securities Issuance Market
If applying Korea’s experiences, in particular KSD’s custody service for overseas DRs’ underlying shares, to the Mongolian capital market would be most desirable for the development of the market. However, it is doubtful whether an overseas DR depositary such as Citibank will appoint the MCSD, which has no experience in the Cross-border securities 074
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market issuance, as the custodian of underlying shares.
As discussed in Sections 3.2.3 and 3.2.4, there are many advantages when the CSD serves as the custodian of overseas DR underlying shares. However, considering the MCSD’s human resource and international business capabilities, it is not likely to be recognized as an eligible custodian for a global DR depositary within a short period.
Nevertheless, the MCSD needs to participate in the custody services for overseas DR underlying shares to encourage Mongolian companies to issue and efficiently trade overseas DRs in the long term. It can be considered that local private custodians such as Golomt Bank take charge of the local custody services in the Cross-border securities trading market, and the MCSD is responsible for the local custody services in the Cross-border securities issuance market.
5. Implementation Plan
5.1. Target Tasks and Roadmap for Implementation
The target tasks to build infrastructure for efficiently issuing Cross-border securities and their roadmap for the next 5 years are shown in the following table.
Target Tasks and RoadmapTarget Tasks 2021 2022 2023 2024 2025
Revising Laws Related to MDR Issuance
Introducing a Substantive Review System for the Issuance Eligibility of Foreign Shares and MDR (MCSD)
Preparing an MDR Deposit Agreement for Foreign Companies
Preparing Detailed Procedures for Issuing MDRs by Foreign Companies
Preparing Procedures for Exercising the Rights of MDRs Issued by Foreign Companies
Preparing Procedures for the Conversion and Cancellation of MDRs Issued by Foreign Companies 075 CHAPTER Establishing a Fee System for MDRs Issued by Foreign Companies 01 Establishment of Infrastructure for Cross-border Securities Issuance Making a Blanket Conversion of ERD Shares to MDRs
Extending Education to Market Shareholders
Introducing a Tax Reduction on the Issuance of MDRs
Attracting Overseas Blue-Chip Companies by Expanding the Issuance of MDRs
Implementing MCSD’s Custody Services for Overseas DRs’ Underlying Shares
Source: Author’s own.
5.2. Conclusion
Introducing an MDR issuance system in the Mongolian capital market for enticing overseas blue-chip companies to dual-list on the Mongolian securities market will bring dynamics to the Mongolian securities market and enable Mongolian investors to enjoy arbitrage trades taking advantage of the price differences between markets, as well as new investment opportunities in the Mongolian market.
Meanwhile, Mongolia’s CSD will also be able to secure new revenue sources by creating business opportunities, rather than limiting itself to the existing work as CSD.
From the perspective of the Mongolian government, the listing of blue-chip companies on the Mongolian market will provide a foundation for the Mongolian stock market to grow into an attractive market for investors domestic and overseas. Thus, it is expected that this will promote domestic investments and induce overseas investors to enter the Mongolian capital market, laying a small foundation for solid economic growth in Mongolia.
076 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market References
Choi, Kyung Ryul, Current Status and Challenges of Issuing Overseas DRs by Korean Compa- nies, KSD, 2001.
Erdene Resource Development Corp, Prospectus, 2018.
Ernst & Young Global Limited, Mongolia Reforms Its Key Tax Legislation, 2019.
Integrated Legal Information System, https://www.legalinfo.mn/annex/details/8191?lawid= 13108.
Kim, Jae Woong, Plan for Establishing the Services of the KDR Depositary, KSD, 2006.
Kim, Jae Woong, Plan for fee reorganization for the KDR Depositary, KSD, 2013.
Kim, Jae Woong, Cross-border Securities Issuance (Mongolia Dual-listing Seminar), KSD, 077
2018. CHAPTER
Minister of Finance of Mongolia, Law of Mongolia on the Securities Market (revised version), 01
2013. Establishment of Infrastructure for Cross-border Securities Issuance
Mongolian Central Securities Depository (MCSD), Mongolian Capital Market (Mongolia Dual Listing Seminar), 2018.
National Statistics Office of Mongolia, http://nso.mn.
Regulatory Agency of Government National Development Agency, http://nda.gov.mn/1506. html.
The Financial Regulatory Commission of Mongolia, Resolution of the Financial Regulation Commission No. 06. Approving the “Regulation on Securities Registration (Listing Proce- dure)”, 2014.
Thomson Reuters Practical Law, https://ca.practicallaw.thomsonreuters.com/1-570-0171?tran- sitionType=Default&contextData=(sc.Default)&firstPage=true&bhcp=1. Appendix Deposit Agreement
Korea Securities Depository
As Depositary
078 And Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
[ ]
As Company
And
Owners and Beneficial Owners of
Korean Depositary Receipts DEPOSIT AGREEMENT
For the Issuance of Korean Depositary Receipts for Which the Underlying Securities are Shares of the Company
This DEPOSIT AGREEMENT (this “Agreement”) is entered into as of [ ] by and among the following parties:
1. [Company], a corporation established and existing under the laws of [ ] with its reg- istered head office at [ ] (the “Company”),
2. The Korea Securities Depository, a special organization established and existing under the laws of the Republic of Korea (“Korea”) with its address at 23, 4-gil, Yeouinaru-ro, Youngdeungpo-gu, Seoul, Korea (the “KSD”), and
3. Owners and beneficial owners of the Korean Depositary Receipts (“KDRs”) (as defined hereinafter). 079 CHAPTER WITNESSETH 01
WHEREAS the Company has issued shares (the “Shares”) in [ ] (the “Share Issuance Establishment of Infrastructure for Cross-border Securities Issuance Country”) and desires to (i) have KSD issue in Korea the Korean Depositary Receipts (the “KDRs”) for which the underlying shares are the Shares issued by the Company and (ii) list the KDRs on the Korea Exchange; and
WHEREAS KSD desires to issue the KDRs in accordance with the terms and conditions of this Agreement and the methods and procedures stipulated in the Regulation on the Issuance of Korean Depositary Receipts (the “KDR Regulation”),
NOW, THEREFORE, in consideration of the foregoing premises, the parties hereby agree as follows:
CHAPTER 1 GENERAL PROVISIONS
Article 1 Definition
Unless otherwise defined herein, the following terms shall have the following meanings:
1. “KRX” shall mean the Korea Exchange, a corporation established under the Financial Investment Services and Capital Markets Act (the “FSCMA”) that opens and operates the KOSPI Market, the KOSDAQ Market, and the Derivatives Market pursuant to the FSCMA.
2. “Korean Business Day” shall mean any day on which banks are open for business in Korea. “Business Day” shall mean any day on which banks are open for business in both Korea and the Share Issuance Country.
3. “Issuance Certificate” is the document issued by the Depositary to prove the issuance of all KDRs.
4. “Dividends, etc.” shall mean dividends, distributions, stock dividends, stock from bo- nus issuance and other assets distributed by the Company with respect to the Shares.
5. “Custodian” shall mean the entities appointed, changed, or added by the Depositary as agent of the Depositary pursuant to Article 38 of this Agreement and shall include any sub-custodian of the Custodian. 080 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 6. “Approved Total Number of KDRs” shall mean the maximum number of KDRs is- suable by the Depositary at the same time as determined or revised by the Company pursuant to Article 9 hereof.
7. “Preemptive Right” shall mean the preemptive right or any other right, regardless of title, to preemptively subscribe to or purchase shares newly issued or already held by the Company in the capacity of a shareholder.
8. “Depositary” shall mean the Korea Securities Depository, which will issue the KDRs pursuant to the FSCMA, the Enforcement Decree of the FSCMA, the KDR Regulation and this Agreement.
9. “KSD” shall mean the Korea Securities Depository, which will perform centralized custody services for and account transfers of securities pursuant to the FSCMA as the central securities depository.
10. “KDR Account Holder” shall mean a person who has opened an account with KSD to deposit securities with KSD.
11. “Deposited Shares” shall mean the Shares deposited or deemed deposited with the Depositary or Custodian pursuant to this Agreement. 12. “Participant Account Book” shall mean the account book prepared and maintained by KSD pursuant to Article 309(3) of the FSCMA for each participant who has opened a deposit account with KSD.
13. “Foreign Currency” shall mean any currency other than the Won currency.
14. “Won” shall mean the lawful currency of Korea.
15. “Shares” shall mean any shares or share certificates of the Company that have been duly issued and fully paid; provided that, if there is a replacement of the Shares due to the occurrence of any of the events set forth in Article 36 hereof, the term “Shares” shall thereafter represent the shares or share certificates replaced due to the occur- rence of such an event.
16. “Share Record Date” shall mean the record date fixed by the Company in order to de- termine the holder with rights over the Shares with respect to convening a general meeting of shareholders, granting Preemptive Rights, distributing Dividends, etc. 081 CHAPTER 17. “FSCMA” shall mean the Financial Investment Services and Capital Markets Act of Ko-
rea (Act No. 8635, enacted on August 3, 2007). 01 Establishment of Infrastructure for Cross-border Securities Issuance
18. “Taxes and Public Charges” shall mean taxes; (including withholdings), fees, duties, levies, or other assessments (including public utility charges) imposed by any na- tional government, provincial government, public agency, or similar public institu- tion based on laws, regulations, rules, and ordinances.
19. “Korean Depositary Receipts” or “KDRs” shall mean the depositary receipts issued by the Depositary for which the underlying assets are [ ] shares issued by the Company deposited with the Depositary, pursuant to this Agreement (i.e., depositary receipts for which the underlying assets are shares, among depositary receipts under the FSCMA).
20. “KDR Record Date” shall mean the record date fixed by the Depositary to determine the person entitled to exercise the rights with respect to the KDRs as the Beneficial Owners of the KDRs.
21. “Beneficial Owner” shall mean the co-owner of the deposited KDRs whose name is not registered in the Register of Holders, but who in fact is entitled to exercise all of the rights and receive all of the benefits with respect to the KDRs.
22. “Register of Holders” shall mean the registry prepared and maintained by the Depos- itary pursuant to the KDR Regulations, in which the name of the KDR holders are recorded.
23. “Register of Beneficial Owners” shall mean the registry prepared and maintained by the Depositary pursuant to Article 15 of the KDR Regulation, in which the names of the Beneficial Owners of the KDRs are recorded.
24. “Conversion Restriction Period” shall mean the period fixed pursuant to this Agree- ment during which issuance of KDRs upon the deposit of Shares or conversion of the KDRs into Shares is not allowed.
25. “Investor Account Book” shall mean the account book prepared and maintained pur- suant to Article 310(1) of the FSCMA by KSD participants who redeposit with KSD the securities deposited by their clients. 082 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Article 2 Basic Ideology
Unless the context otherwise requires, the following rules shall apply in interpreting this Agreement.
1. The attachments to this Agreement and the KDR Regulation are part of this Agree- ment.
2. The headings of the provisions herein are for the sake of convenience only and do not affect the interpretation of this Agreement.
3. A reference to a statute includes such a statute as may be amended, supplemented or replaced from time to time, and also includes all subordinate statutes including or- ders, regulations, notifications, rules and ordinances enacted based on such a statute.
4. A reference to a certain document includes such a document as amended, supple- mented or replaced from time to time.
5. A reference to a party includes the successor of such a party.
6. In the event that a deadline or the last day of a deadline does not fall on a ‘Business Day’, the deadline or the period is assumed to fall or expire on the immediately fol- lowing ‘Business Day’.
Article 3 Representations and Warrants of the Company and the Depositary
The Company and the Depositary represent and warrant as of the execution date of this ① Agreement and during the term of this Agreement as follows:
1. Each of the Company and the Depositary is a company duly organized and validly ex- isting in good standing under the laws of its country of incorporation.
2. Each of the Company and the Depositary has the full power, ability, and qualifications to execute this Agreement and perform its obligations hereunder.
3. The signatories to this Agreement are duly authorized to execute an agreement that is binding upon each of the Company and the Depositary, as applicable, and each of the Company and the Depositary has obtained its internal approvals in a lawful and 083 valid manner for the execution of this Agreement and the consummation of the trans- CHAPTER actions contemplated hereunder, and no additional actions are required with respect
thereto. 01 Establishment of Infrastructure for Cross-border Securities Issuance
4. The execution of this Agreement and the consummation of the transactions contem- plated hereunder by each of the Company and the Depositary does not violate or conflict with related laws and regulations, the articles of incorporation or constitutive documents, and any agreements, obligations, or treaties that are binding upon the Company or the Depositary, as applicable.
5. All documents submitted by the Company to the Depositary for the execution of this Agreement are valid and contain accurate description of facts.
6. No pending litigation expected to affect the effectiveness of this Agreement or the existence of the Company or procedures of insolvency, dissolution, liquidation, or bankruptcy of the Company exists or, to the Company’s knowledge, no such litigation or procedure is threatened as of the execution of this Agreement.
7. No government approval is required with respect to the execution of this Agreement and the consummation of the transactions contemplated hereunder by each of the Company and the Depositary, provided that such shall not be applicable to (i) gov- ernmental approval required with respect thereto that has already been obtained or performed, or (ii) even if governmental approval is failed to be obtained, such failure does not cause the prevention of or a material delay to the performance of the obliga- tions under this Agreement.
Other than the representations and warrants set forth in paragraph (1) of this Article, the ② Company further represents and warrants that the Company has received from the De- positary this Agreement and the KDR Regulation of the Depositary that constitutes part of this Agreement and that the Company has reviewed the contents with its independent legal advisor and thus has full knowledge thereof.
CHAPTER 2 DEPOSIT OF SHARES AND ISSUANCE OF KDRS
Article 4 Deposit of Shares
The Company may deposit newly issued Shares with the Depositary on behalf of the Ben- ① eficial Owners of the KDRs to be issued upon deposit of such Shares and may request that 084
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market the Depositary issue the KDRs with respect to the Shares so deposited by submitting the following documents to the Depositary:
1. Application for the issuance of KDRs as requested by the Depositary
2. Other documents as reasonably requested by the Depositary or the Custodian
The owner of existing Shares may deposit such Shares with the Depositary and request ② that the Depositary issue KDRs with respect to the Shares so deposited by submitting the following documents to the Depositary.
1. Application for the issuance of KDRs as requested by the Depositary
2. Other documents as reasonably requested by the Depositary or the Custodian
Article 5 Share Deposit Method
The deposit of Shares with the Depositary under paragraph or of Article 4 hereof ① ① ② shall be made by book-entry transfer to the Custodian; provided that if the deposit of Shares by book-entry transfer to the Custodian is not permitted under the laws of the Share Issuance Country, the Shares may be deposited with the Depositary in a different manner, such as the delivery of physical certificates representing the Shares. Whenever the Custodian receives Shares on behalf of the Depositary through the receipt ② of physical certificates representing the Shares or by book-entry transfer pursuant to paragraph of this Article, the Depositary shall cause the Custodian to immediately ① request the Company to have the Shares so received by the Custodian transferred to or registered in the name of the Depositary or its designated person, unless such transfer or registration is not required for the exercise of rights under the laws of the Share Issuance Country.
Any costs and expenses arising in connection with the deposit, title transfer, or registra- ③ tion of the Shares under this Article shall be borne by the person making such deposit.
The Deposited Shares shall be kept at a place designated by the Depositary. ④
Article 6 Issuance of KDRs
Upon notification by the Custodian to the Depositary of the receipt of Shares in accor- ① dance with Article 5 hereof, the Depositary shall immediately issue KDRs and register ① 085
KSD as the owner of such KDRs on behalf, and for the benefit, of the person who will ac- CHAPTER quire the rights of such KDRs. 01 Establishment of Infrastructure for Cross-border Securities Issuance No KDR shall be issued for less than one(1) unit. ②
The issuance of KDRs shall be conducted by way of entering the number of KDRs so is- ③ sued in the Register of Holders prepared and maintained by the Depositary.
No Beneficial Owner may make a request directly or through a KSD participant for the ④ issuance and delivery of KDRs in the form of physical certificates.
Article 7 Restrictions on KDR Issuance
In the event that the Deposited Shares consist of less than one (1) KDR, the Depositary ① may (i) return such Deposited Shares to the person who is to acquire the rights with re- spect to the KDRs representing such Deposited Shares or the person who deposited the Shares or (ii) dispose of such Deposited Shares in a manner determined by the Deposi- tary to be reasonable and appropriate, and deliver the proceeds therefrom, less the fees payable to, and expenses incurred by, the Depositary, to the person who is to acquire the rights with respect to the KDRs representing such Deposited Shares or the person who deposited the Shares. The Depositary may refuse the deposit of Shares or issuance of KDRs upon the occur- ② rence of any of the following events:
1. Where the relevant Shares consist of less than one (1) KDR (only the portion of the Shares consisting of less than one (1) KDR shall be refused);
2. Where the total number of KDRs, including KDRs issued upon the deposit of Shares, exceeds the Approved Total Number of KDRs;
3. Where the person who deposits the Shares and requests the issuance of KDRs fails to submit the documents set forth in paragraph or of Article 4 hereof or pay the ① ② fees and other expenses set forth in Article 44 hereof;
4. Where the delivery of the Shares is impossible due to restrictions on title transfer or book-entry transfer, etc.;
5. Where the Conversion Restriction Period is in effect; 086 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 6. Where there is a court order or a demand by the government to do so;
7. Where the Company requests the Depositary to do so in order to comply with or fol- low the articles of incorporation, related laws and regulations, an order issued by a court or the government to the Company or an action taken by the KRX or a deposit/ clearance/settlement institution (including the exchange and deposit/clearance/settle- ment institutions in Korea and the Share Issuance Country); or
8. Other cases as reasonably deemed necessary by the Depositary or the Company to deal with practical matters.
Article 8 Certificate of Issuance
Upon the Company’s request to confirm certain details of KDR issuance, the current ① status and other details of the Shares, etc., the Depositary shall deliver to the Company a Certificate of Issuance confirming the details of KDR issuance, the current status and other details of the Shares, etc.
The Certificate of Issuance shall not be used for any purpose other than to evidence the ② issuance as set forth in paragraph of this Article. ① Article 9 Approved Total Number of KDRs and Managing KDRs Issued in Excess of the Approved Total Number of KDRs
A company listing KDRs on the KRX shall list the Approved Total Number of KDRs. ①
In the event that the total number of KDRs issued under this Agreement exceeds the Ap- ② proved Total Number of KDRs, then the Depositary shall withhold the issuance for the portion exceeding the Approved Total Number of KDRs (if part of the KDRs regarding which an application for issuance is made in excess of the Approved Total Number of KDRs, then issuance of the entire amount may be withheld) and immediately notify the Company thereof.
Within 25 days from the date of receipt of the notice from the Depositary under para- ③ graph of this Article, the Company shall notify the Depositary of its change in the Ap- ② proved Total Number of KDRs or its intention not to change the Approved Total Number of KDRs.
087
The Depositary may refuse to accept Shares for deposit with respect to a portion exceed- CHAPTER ④ ing the Approved Total Number of KDRs until it receives notice from the Company indi-
cating the Approved Total Number of KDRs has changed. 01 Establishment of Infrastructure for Cross-border Securities Issuance
CHAPTER 3 TRANSFER AND CONVERSION OF KDRS
Article 10 KDR Transfer, etc.
The transfer of KDRs shall take place only by way of book-entry transfer between the ac- ① counts of KSD participants opened with the KSD.
Each person specified in the Investor Account Book and the Participant Account Book ② shall be deemed to possess the relevant KDRs.
Whenever there exists a record on either the Investor Account Book or the Participant ③ Account Book that the KDRs are subject to a pledge and the name and address of the pledgee is noted in the same account book, such KDRs shall be deemed to have been de- livered for the purpose of completing such pledge.
The issuance of KDRs shall be in accordance with Regulation S of the United States Se- ④ curities Act of 1933, as amended, that was entered into the Securities Registration at the time of the issuance. Article 11 Conversion of KDRs into Shares
The Beneficial Owners may request the Depositary to convert KDRs into Shares by sub- ① mitting the following documents:
1. Application for conversion of KDRs into Shares; and
2. Other documents as reasonably requested by the Depositary or the Custodian
Upon receipt of the request for conversion of the KDRs under paragraph of this Article, ② ① the Depositary shall restrict any disposal of such KDRs and instruct the Custodian to de- liver the relevant number of Deposited Shares to the Beneficial Owners.
The Depositary may deliver to the Beneficial Owners cash or other assets received from ③ the Company in connection with the Deposited Shares.
Any cost and liabilities arising in connection with the delivery of cash or other assets un- 088 ④ der paragraph of this Article shall be borne by the Beneficial Owners. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market ③
Article 12 Restrictions on the Conversion of KDRs into Shares
The Depositary may restrict the conversion of KDRs into Shares if any of the following events occurs.
1. Where the request for conversion is for less than one(1) Share (limited only to the portion that consists of less than one(1) Share), unless conversion for less than one(1) Share is allowed under the laws of the Share Issuance Country;
2. Where the person requesting conversion of the KDRs into Shares fails to submit the documents in Article 11 hereof or to pay the fees, transaction costs, etc.; ①
3. Where the delivery of Shares is impracticable due to restrictions on the book-entry transfer of the Shares, etc.;
4. Where the Conversion Restriction Period is in effect;
5. Where there is a court order or a demand by the government to the Depositary to do so; 6. Where the Company requests the Depositary to do so to comply with or follow the articles of incorporation, related laws and regulations, an order issued by a court or government to the Company, or an action taken by the KRX or a deposit/clearance/ settlement organization (including the exchange and deposit/clearance/settlement or- ganizations in Korea or the Share Issuance Country); or
7. Other cases as reasonably deemed necessary by the Depositary or the Company to deal with practical matters.
Article 13 Conversion Ratio of KDRs to Shares
One(1) KDR shall be converted into____ Shares (the “Conversion Ratio”). ①
The Company may adjust the Conversion Ratio in the event that either one of the number ② of the Deposited Shares or the number of the KDRs is increased or decreased due to stock dividends, bonus issues, consolidation or split of the Shares, or other similar events.
089 The Conversion Ratio shall be determined in a manner that reasonably reflects the value ③ CHAPTER of the Shares or the KDRs prior to the adjustment made to the Conversion Ratio. 01
In the event that the Conversion Ratio is adjusted pursuant to this Article, the Company Establishment of Infrastructure for Cross-border Securities Issuance ④ shall immediately make a public announcement (including public disclosure) of such ad- justment and the adjusted ratio.
CHAPTER 4 REGISTER OF HOLDERS, ETC.
Article 14 Preparation and Maintenance of the Register of Holders, etc.
The Depositary shall prepare and maintain the Register of Holders which shall state the ① following matters for each KDR holder.
1. Name, business registration number and address of KSD;
2. Type and number of the KDRs held;
3. Year, month, and date of acquisition of the KDRs; and
4. Other necessary matters The Depositary shall prepare and maintain the Register of Beneficial Owners by record- ② ing as the Beneficial Owners those who were, as of the KDR Record Date, listed on the latest register of beneficial owners available from KSD and state the following matters in such Register of Beneficial Owners:
1. Identification number, name, resident registration number, and address of the Bene- ficial Owner;
2. If a Beneficial Owner is a non-Korean, the nationality (the country of residence) of the Beneficial Owner, and the name and address of the standing proxy, if one has been appointed;
3. Type and quantity of the KDRs held by the Beneficial Owner;
4. Date on which the Beneficial Owner was added to the register;
5. Other necessary matters 090 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market If there are Beneficial Owners with the same name and the same resident registration ③ number, the Depositary shall aggregate the number of the KDRs owned by such Benefi- cial Owners whenever any rights as KDR owners are exercised.
Article 15 Consultation on Business Schedules
Prior to the occurrence of any of the following events, the Company shall consult with ① the Depositary with respect to the plan or schedule of the following matters pursuant to the general practice of the Depositary for the fixing of the Share Record Date or the Con- version Restriction Period, the protection of rights of the Beneficial Owners, etc.:
1. A general meeting of shareholders and distribution of dividends, etc.;
2. Increase or decrease in capital;
3. Consolidation or split of Shares or KDRs;
4. Merger or name change of the Company;
5. Spin-off of parts of the Company; 6. Exchange and transfer of shares; or
7. Any other matters that require a considerable preparation period for the Depositary to handle business affairs with respect to the exercise or granting of rights to the Ben- eficial Owners.
In the case of issuing Shares or KDRs or of taking care of other business matters, the ② Depositary may demand the submission of documents etc. evidencing the cause of the is- suance, and in such case, the Company shall immediately provide the Depositary with all documents as reasonably requested by the Depositary.
The Company and the Depositary shall use their best efforts to abide by the schedule dis- ③ cussed pursuant to this Article.
In the event that any day of consultation, notice, or request set forth in Article 18 through ④ Article 22 hereof is not a Korean Business Day, such consultation, notice, or request shall be made or sent on the immediately preceding Korean Business Day. 091 CHAPTER Article 16 Fixing of the KDR Record Date, etc. 01
Upon the occurrence of any of the following events, the Depositary may set a date mutu- Establishment of Infrastructure for Cross-border Securities Issuance ① ally agreed upon with the Company (or a date determined by the Depositary in the event of Item 4 below) as the KDR Record Date or the Conversion Restriction Period:
1. Where any of the events under Article 15 hereof occurs; ①
2. Other than the occurrence of any events under Article 15 hereof, where the Com- ① pany sets the Share Record Date or requests the fixing of the KDR Record Date in or- der to comply with laws or an order of a court or government.
3. Where a notice of termination of this Agreement is to be sent to the Beneficial Own- ers;
4. Where the Conversion Ratio adjusted by the Company pursuant to Article 13 hereof is notified to the Beneficial Owners; and
5. Other cases deemed necessary by the Depositary
The KDR Record Date shall be the same day as the Share Record Date; provided that if the ② two record dates should not overlap due to business customs in Korea, the KDR Record Date shall be set on a date having the same effect as the Share Record Date.
If the KDR Record Date and the Share Record Date are not the same date, no conversion ③ of KDRs into Shares shall be made for the period from the KDR Record Date to the Share Record Date, unless the Depositary and the Company agree to allow such conversion through consultation.
The Company shall make a public announcement or disclosure of the KDR Record Date ④ or the Conversion Restriction Period at least five (5) days prior to the KDR Record Date or the first day of the Conversion Restriction Period.
Article 17 Share Record Date
In the event that the Company intends to carry out any of the business matters under Article 15 hereof, the Company may not fix any date prior to the date on which the ① resolution to implement such matter is adopted as the Share Record Date, unless otherwise 092
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market agreed upon between the Company and the Depositary.
Article 18 General Meeting of Shareholders
In the event that the Company sets, or intends to set, the Share Record Date in order to ① determine the persons entitled to exercise voting rights at a general meeting of share- holders (including any case set by the articles of incorporation), the Company shall com- mence consultation with the Depositary under Article 15 at least 40 days prior to the date of such general meeting of shareholders.
If the consultation under paragraph of this Article is commenced, the Company shall ② ① inform the Depositary of the date, place, agenda items (including the substance of the agenda items and matters for reference necessary for resolution) of such general meet- ing of shareholders and the method of notification to the Beneficial Owners, and provide other information as requested by the Depositary to ensure the smooth exercise of rights or protect the interests of the Beneficial Owners.
The Company shall notify the Depositary of the matters required by Korean laws and reg- ③ ulations to be notified to the shareholders with respect to a general meeting of sharehold- ers, and the Depositary shall notify the Beneficial Owners of such matters at the request of the Company. In the event that the Company requests the Depositary to send the Beneficial Owners a ④ notice under the foregoing paragraph, the Company shall provide the Depositary with a notice of the general shareholders meeting with the matters that are required by Korean laws and regulations and that are to be notified to the shareholders in Korean and re- quest such notice to be sent at least twenty (20) days prior to the date of the general meet- ing of shareholders:
1. That the Beneficial Owner may apply to exercise voting rights through the Depositary or request a proxy from the Depositary to attend the shareholders meeting;
2. That, if the Beneficial Owner intends to apply to exercise voting rights through the Depositary, the Beneficial Owner shall make such application to KSD by indicating its approval or opposition for each agenda item in the notice and returning such notice to KSD;
3. The deadline by which the Beneficial Owner is to return the notice to KSD and that the failure to meet such deadline will result in the Beneficial Owner losing such vot- 093
ing rights or opportunity to attend the shareholders’ meeting by requesting a proxy. CHAPTER
If the agenda item of the general meeting of shareholders is the payment of Dividends 01
⑤ Establishment of Infrastructure for Cross-border Securities Issuance etc., the Share Record Date and KDR Record Date with respect to the payment of Divi- dends, etc. shall be the date previously agreed upon between the Company and the De- positary.
If the Company intends to conduct business matters other than payment of Dividends, ⑥ etc. conditioned upon a resolution of general meeting of shareholders including a change in capital or corporate organization of the Company such as capital reduction or merger / spin-off of the Company, the process of such general meeting of shareholders shall be in accordance with this Article, and the process of the business matter after the general meeting of shareholders shall be in accordance with a timeline and procedure as sep- arately determined by the Company and the Depositary through mutual agreement in order to practically protect the rights of the Beneficial Owners.
Article 19 Issuance of New Shares
In the event that the Company intends to grant Preemptive Rights to shareholders and ① issue new shares based on such Preemptive Rights, the Company shall commence consul- tation with the Depositary under Article 15 hereof at least 40 days prior to the scheduled subscription date or to the first day of the scheduled subscription period.
If the consultation under paragraph of this Article is commenced, the Company shall ② ① inform the Depositary of the type and number, value and allocation ratio, the Share Record Date, subscription date or subscription period, and the date and place of payment of the new shares and provide other information as requested by the Depositary to en- sure the smooth exercise of the rights, and the protection of interest, of the Beneficial Owners.
The Company shall notify the Depositary of the matters required by Korean laws and ③ regulations that are to be notified to the shareholders in the event it grants Preemptive Rights to the shareholders, and the Depositary shall notify the Beneficial Owners of such matters at the request of the Company.
In the event the Company requests the Depositary to send to the Beneficial Owners a no- ④ tice under the foregoing paragraph, the Company shall provide the Depositary with pro- spectuses for the subscription of new shares in Korean containing the matters required 094
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market by Korean laws and regulations to be notified to the shareholders, as well as the matters set forth in the following subparagraphs, and request that such notice be sent at least twenty (20) days prior to the subscription date:
1. That the Beneficial Owner may apply for the exercise of Preemptive Rights to the De- positary through the KDR Account Holder;
2. The method of applying for exercise of the Preemptive Rights such as the date or pe- riod for such application;
3. That failure to meet a certain deadline (being a date at least five (5) Korean Business Day prior to the subscription date or the end of the subscription period) will result in the Beneficial Owner losing such Preemptive Rights;
4. That the right to apply for the exercise of the Preemptive Rights may be assigned if such assignment is possible; and
5. The unit of KDRs one may apply for the exercise of Preemptive Rights if the subscrip- tion of one share in return for one KDR is impracticable due to the Conversion Ratio under Article 13 hereof. Article 20 Distribution of Dividends, etc.
In the event that the Company distributes Dividends etc. (such distributions shall be ① made pursuant to Article 21 hereof in the case of a bonus issuance) to the shareholders, the Company shall commence consultation with the Depositary under Article 15 hereof at least 40 days prior to the date of the general meeting of shareholders at which the res- olution to pay the Dividends etc. is adopted (or the date immediately following the date of adopting the resolution if the resolution may be adopted at a meeting of the board of directors).
If the consultation under paragraph hereof is commenced, the Company shall inform ② ① the Depositary of the distribution rate of the Dividends etc., the type and details of the as- sets to be distributed, the payment or distribution method of the Dividends etc., and the Share Record Date, and also provide other information as requested by the Depository to ensure the smooth exercise of rights and the protection of interest of the Beneficial Own- ers.
095
Upon adoption of the resolution to distribute the Dividends etc., the Company may im- CHAPTER ③ mediately notify the Depositary of the details of the payment and distribution thereof
and the Depositary shall notify the Beneficial Owners of such details at the request of the 01 Establishment of Infrastructure for Cross-border Securities Issuance Company.
In the event that the Company requests the Depositary to give notice under the foregoing ④ paragraph, the Company shall provide the Depositary with sufficient time to do so from the date of distribution of the Dividends etc.
Article 21 Bonus Issuance
In the event that the Company seeks to conduct a bonus issuance, the Company shall ① commence consultation with the Depositary under Article 15 hereof at least two (2) weeks prior to the Share Record Date for such bonus issuance.
If the consultation under paragraph of this Article is commenced, the Company shall ② ① inform the Depositary of the financial resources for the bonus issuance, the allocation rate and other details of the shares to be newly issued, the standard price and payment method of disposing of fractional shares, and any applicable taxes and tax rates, and also provide any other information as requested by the Depositary to ensure the smooth exer- cise of rights and the protection of interest of the Beneficial Owners. Upon adoption of the resolution to conduct the bonus issuance, the Company may im- ③ mediately notify the Depositary of the details regarding the allocation of the new shares to be issued, and the Depositary shall notify the Beneficial Owners of such details at the request of the Company.
In the event that the Company requests the Depositary to give notice under the foregoing ④ paragraph, the Company shall provide the Depositary with sufficient time to do so from the date of delivery of the new shares to be issued.
Article 22 Schedule for Other Business Matters
In the event that the Company intends to carry out the business matters set forth in Ar- ① ticle 15 hereof, other than those set forth in Article 18 through Article 21 hereof, the ① Company shall commence consultation with the Depositary under Article 15 hereof no later than the time that is required for the protection of the exercise of rights by the Ben- eficial Owners.
096
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market If the consultation under paragraph hereof is commenced, the Company shall inform ② ① the Depositary of the nature of the scheduled business matters, the description of the rights, and the method of exercising the rights, and also provide other information as re- quested by the Depositary to ensure the smooth exercise of the rights and the protection of interest of the Beneficial Owners.
Upon adopting the schedule for business matters and the contents thereof under the ③ foregoing paragraph, the Company shall immediately notify the Depositary of the details thereof, and the Depositary shall notify the Beneficial Owners of such details at the re- quest of the Company.
In the event that the Company requests the Depositary to give notice under the foregoing ④ paragraph, the Company shall provide the Depositary with sufficient time to do so from the date of exercise of the rights by the shareholders.
The Company shall take all measures necessary to sufficiently protect the Beneficial ⑤ Owners and their rights in practice.
CHAPTER 5 OBLIGATIONS OF THE BENEFICIAL OWNERS
Article 23 Representations and Warranties upon the Deposit of Shares and Conversion of KDRs into Shares
Each person who deposits Shares or converts KDRs into Shares pursuant to this Agree- ① ment shall represent and warrant each of the following:
1. The Shares or the KDRs have been legally and validly issued and outstanding, and the Shares have been fully paid;
2. The person depositing Shares or converting KDRs into Shares has legal and valid own- ership of the Shares or the KDRs and in order to hold the Shares or the KDRs, trans- fers or assigns all rights to the Shares or the KDRs to the Depositary;
3. The Shares or the KDRs are free and clear of any pledges and other security interests;
4. No third party has any right of first refusal or any similar rights with respect to the Shares or the KDRs;
097 5. The person depositing Shares or converting KDRs into Shares has the power and au- CHAPTER thority to deposit the Shares and request issuance of KDRs or conversion of KDRs into
Shares; 01 Establishment of Infrastructure for Cross-border Securities Issuance
6. The person depositing Shares or converting KDRs into Shares has paid all Taxes and Public Charges incurred with respect to the Shares or the KDRs;
7. The issuance of KDRs upon the deposit of Shares or the conversion of KDRs into Shares does not violate any relevant laws, regulations or the Company’s articles of incorporation, and all necessary governmental approvals and permits have been ob- tained in connection therewith;
8. There are no defects or restrictions on the transfer of rights or exercise of rights with respect to the Shares or the KDRs; and
9. The person depositing Shares or converting KDRs into Shares has read this Agree- ment and the KDR Regulations of the Depositary and thus has full knowledge of the contents thereof, and shall comply with and be bound by this Agreement and the KDR Regulations of the Depositary with respect to the issuance of KDRs upon deposit of Shares or the conversion of KDRs into Shares.
If the Company or the Depositary becomes aware of any breach of the representations ② and warranties provided under paragraph of this Article, the Company or the Deposi- ① tary may, at the expense of the person depositing Shares or converting KDRs into Shares, take any appropriate measures necessary therefor.
Article 24 The KDR Account Holders and Beneficial Owners’ Compliance with Laws
The KDR Account Holders and Beneficial Owners shall comply with the laws of the Share ① Issuance Country and Korea, the articles of incorporation of the Company, and this Agreement with respect to the ownership of KDRs and the exercise of rights thereto.
In the event that Shares are deposited or KDRs are converted into Shares in violation of ② Article 7 (Restrictions on the Issuance of KDRs) or Article 12 hereof (Restrictions on the Conversion of KDRs into Shares), the KDR Account Holders and Beneficial Owners shall comply with any measures taken by the Company or the Depositary including all mea- sures to comply with the provisions of Article 7 or Article 12 hereof, such as cancelling deposits or conversions by way of receipt of the Shares or the KDRs.
098
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Article 25 Obligations and Responsibilities of the KDR Account Holders and Beneficial Owners
Any KDR Account Holder or Beneficial Owner who fails to perform the obligations under ① this Agreement or violates relevant laws and regulations shall be liable for any and all damages incurred by the parties to this Agreement and other third parties in connection with such violation.
A KDR Account Holder or Beneficial Owner shall be liable for any Taxes and Public ② Charges to be paid by such KDR Account Holder or Beneficial Owner in connection with the KDRs or the Deposited Shares (including Preemptive Rights and dividends with re- spect thereto).
Each KDR Account Holder and Beneficial Owner shall be liable for payment of Taxes and ③ Public Charges imposed by tax authorities on the Depositary or its designated person with respect to the deposit of such KDR Account Holder’s or Beneficial Owner’s Deposited Shares in a timely manner. The Depositary may, for the purpose of paying such Taxes and Public Charges, dispose of any or all of such KDR Account Holder or Beneficial Owner’s Deposited Shares, or dividends, distributions, Shares, Preemptive Rights, and other assets paid, distributed, or allocated with respect to such Deposited Shares and may appropri- ate the proceeds therefrom to pay the Taxes and Public Charges. Each Beneficial Owner shall provide the information reasonably requested by the Depos- ④ itary in accordance with related laws and regulations and Article 27 of this Agreement ① regardless of whether he, she, or it is a Beneficial Owner at the time of such request.
Article 26 Tax Withholding and Other Taxes
The Company shall, in distributing Preemptive Rights, Dividends, etc. to the KDR Account ① Holders or Beneficial Owners, withhold the amount of Taxes and Public Charges payable to the government or other related authorities pursuant to the relevant laws and regula- tions.
The Beneficial Owners shall be liable for the payment of all taxes assessed or imposed ② with respect to the acquisition, possession or disposal of Shares or KDRs.
The Depositary shall prepare the Register of Beneficial Owners by compiling the infor- ③ mation provided by the KDR Account Holders, and provide such Register of Beneficial Owners to the Company so that the Company may properly withhold taxes. In this case, 099
the Depositary shall not guarantee the accuracy or the truthfulness of the information CHAPTER contained in the Register of Beneficial Owners including the place of residence of the
Beneficial Owners. 01 Establishment of Infrastructure for Cross-border Securities Issuance
In the event that the Company is charged unpaid taxes, additional taxes or penalty sur- ④ charges due to an error in tax withholding or the revision of related laws and regulations and pays such taxes or penalty surcharges on behalf of the Beneficial Owners, the Com- pany may not seek reimbursement of the amount of such taxes or penalty surcharges paid by the Company from the Depositary or KSD. In this case, the Depositary or KSD shall provide reasonable cooperation to the Company to enable the Company to seek re- imbursement of such payments against the Beneficial Owners.
In the event that the Depositary or its designated person is liable for the payment or ⑤ withholding of Taxes and Public Charges (excluding corporate tax payable by the Deposi- tary or the Custodian with respect to fees etc. received) imposed by tax authorities on the Depositary or its designated person as a result of the deposit of Shares or with respect thereto, the Depositary shall appropriate any cash received in relation to the Deposited Shares for the payment of such Taxes and Public Charges, and if there is any deficiency, the Depositary may sell and dispose of the Deposited Shares or shares and other assets allocated or distributed with respect to the Deposited Shares, and appropriate the pro- ceeds therefrom to pay the Taxes and Public Charges. Any amount remaining from the proceeds after the appropriation shall be distributed to the Beneficial Owners as a cash distribution.
In connection with the tax withholding under paragraph of this Article, if there is any ⑥ ① Beneficial Owner to whom a favorable tax rate may be applied under applicable tax trea- ties, such Beneficial Owner may make a request for the application of the favorable tax rate by submitting to the Company or the Depositary the documents evidencing his, her, or its entitlement to the favorable tax rate and any other documents necessary to make any reporting required under the tax treaty. The Company and the Depositary shall have no obligation to take any particular action to apply any favorable tax rate to any party that does not make the aforementioned request or submit documents evidencing its en- titlement to the favorable tax rate and any other documents as required by the Company or the Depositary that are necessary to make the relevant report under the tax treaty.
If the Company has paid or withheld relevant Taxes and Public Charges for and on behalf ⑦ of the Beneficial Owners under this Article, the Company shall as soon as practically pos-
100 sible provide the payment certificates therefor to the Depositary. If a Beneficial Owner
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market makes a request, the Depositary shall furnish to such Beneficial Owner the payment certificate received from the Company and any payment certificate with respect to any Taxes and Public Charges paid by the Depository
Article 27 Submission of Materials and Other Information
The Depositary may, if necessary under relevant laws and regulations, request former or ① current Beneficial Owners to submit information relating to, including but not limited to, (i) whether the Beneficial Owner held the KDRs for its own account; (ii) the name, resi- dent registration number, address, nationality (country of residence), etc. of any person who formerly held or currently holds rights with respect to the KDRs; and (iii) details of the rights relating to the KDRs.
The Depositary may defer any issuance of KDRs, delivery of Deposited Shares, or pay- ② ment or delivery of Dividends etc. distributed by the Company with respect to Deposited Shares to a Beneficial Owner who fails to provide the information and materials set forth in paragraph of this Article. ①
CHAPTER 6 EXERCISE OF RIGHTS RELATING TO DEPOSITED SHARES
Article 28 Right Holders and Method of Exercising Rights The Beneficial Owners recorded in the Register of Beneficial Owners as of the KDR ① Record Date shall be entitled to exercise rights as Beneficial Owners in proportion to the number of KDRs held by them with respect to the business matters for which the KDR Record Date is set and receive Preemptive Rights and Dividends, etc. (or the net proceeds from their disposal in the case of disposal thereof pursuant to this Agreement).
In the event that a Beneficial Owner is a customer of the KDR Account Holder, such ② Beneficial Owner shall exercise its rights as Beneficial Owner through the KDR Account Holder.
Article 29 Distribution of Cash Received as Dividends, etc.
In the event that the Depositary receives Dividends, etc. in cash with respect to Deposited ① Shares directly from the Company or indirectly through the Custodian, the Depositary shall immediately distribute such Dividends, etc. in cash to the Beneficial Owners in pro- portion to the number of Deposited Shares represented by the KDRs held by them after first deducting the fees payable to and related expenses incurred by the Depositary and 101
the Taxes and Public Charges payable by the Depositary or the Custodian. CHAPTER
The Depositary shall not delay any distribution under this Article without reasonable 01
② Establishment of Infrastructure for Cross-border Securities Issuance cause.
Article 30 Distribution of Shares
If the Company distributes Shares with respect to Deposited Shares for the reason of a ① stock dividend (if the Company gives the shareholders the right to choose among various types of dividends, the Beneficial Owners shall be deemed to have chosen the stock divi- dend; provided that if the stock dividend may not be selected, the Beneficial Owners shall be deemed to have selected the cash dividend), bonus issuance or any other corporate ac- tion/event having a similar effect, the Company shall issue such Shares to the Depositary or a person designated by the Depositary being recorded as the nominal holder of such Shares.
In the event of paragraph (1) of this Article, the Depository may: ②
1. issue KDRs whose underlying shares are the newly deposited Shares and have such KDRs be attributed to the Beneficial Owners in proportion to the KDRs held by them; 2. adjust the Conversion Ratio according to the adjustment of the Conversion Raito by the Company pursuant to Article 13 hereof ; or
3. dispose of the Deposited Shares and pay the proceeds therefrom to the Beneficial Owners as of the KDR Record Date.
The Depositary may dispose of a portion of the Deposited Shares or KDRs to pay the De- ③ positary’s fees and any Taxes and Public Charges required to be paid by the Depositary or the Custodian.
If fractional KDRs result from the issuance and attribution of the KDRs or the adjustment ④ of the Conversion Ratio under subparagraphs 1 and 2 of Article 30 respectively, the De- ② positary shall dispose of the number of KDRs or Deposited Shares (only if it is determined that the disposal of the KDRs is not practical) equivalent to the combined number of all such fractions and distribute the proceeds therefrom to the relevant Beneficial Owners in a cash distribution.
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Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market If Deposited Shares or KDRs are to be disposed of pursuant to subparagraph 3 of Article ⑤ 30 or Article 30 hereof, the Depositary shall dispose of the Deposited Shares or the ② ④ KDRs in a manner deemed reasonable and appropriate by the Depositary.
If any approval or permit is required in connection with the disposal of Deposited Shares ⑥ or KDRs pursuant to Article 30 hereof, the Depositary may obtain the assistance of le- ⑤ gal counsel at the expense of the Beneficial Owners to obtain such approval or permit.
Article 31 Applying to Exercise Preemptive Right
A Beneficial Owner to whom a notice under Article 19 hereof is sent shall apply for ① ④ the exercise of Preemptive Rights to the Depositary directly (if the KDR Account Holder is the Beneficial Owner) or through the KDR Account Holder no later than the date speci- fied under subparagraph 4 of Article 19 hereof. In this case, the Beneficial Owner shall ④ represent and warrant each of the items set forth in Article 23 and pay the combined ① subscription price and the Depositary’s fees and cost of such exercise.
If a Beneficial Owner fails to apply to exercise its Preemptive Rights prior to the date set ② forth in Article 31 hereof, or has made such application but has failed to pay the sub- ① scription price, the Depositary fee’s and cost of such exercise in whole or in part(if part thereof is not paid due to currency exchange reasons, Article 6 shall apply), the Beneficial Owner shall be deemed to waive its Preemptive Rights.
In the event that the Company grants Preemptive Rights to the shareholders, the Com- ③ pany may determine the Won to be the currency of the issue price of the new shares so long as it is not in violation of equal treatment of shareholders or the applicable laws and regulations.
If the Company determines a currency other than the Won to be the currency of the issue ④ price of the new shares, the Depositary may allow the Beneficial Owners to pay the issue price of the new shares in the Won or the other currency determined by the Company.
If the Depositary pays the issue price of the new shares in the Won, the Depositary shall ⑤ convert the received amount in Won into the amount in the other currency determined by the Company. If there is any balance remaining after the Depositary remits the sub- scription payment to the Company, the Depositary shall immediately return such balance to the Beneficial Owners.
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If the subscription payment paid by a Beneficial Owner to the Depositary is less than the CHAPTER ⑥ subscription price for the number of Shares applied for by such Beneficial Owner upon
exercise of its Preemptive Rights due to a change in the exchange rate, the Depositary 01 Establishment of Infrastructure for Cross-border Securities Issuance may require the Beneficial Owner to immediately pay the shortfall; provided that if the Depositary deems that the additional payment by the Beneficial Owner is not practical, the Depositary may, instead of requiring such additional payment, exercise the Preemp- tive Rights to the extent corresponding to the subscription payment received from the Beneficial Owner.
Upon receipt of the application for the subscription of new shares and the subscription ⑦ price, the Depositary shall exercise Preemptive Rights vis-à-vis the Company for and on behalf of the Beneficial Owners. The Depositary shall deposit the Shares received and is- sue KDRs in the name of the Beneficial Owners.
Article 32 Non-exercise of Preemptive Rights
In the event that Preemptive Rights cannot be exercised due to restrictions under appli- ① cable laws and regulations, measures taken by the KRX, etc., the Depositary may decide not to exercise the Preemptive Rights granted pursuant to Article 19 hereof.
If the Depositary decides not to exercise the Preemptive Rights pursuant to Article 32 ② ① hereof, the Depositary shall immediately notify the Company of the following:
1. that the Depositary has decided not to exercise the Preemptive Rights; and
2. the reason that the Depositary has decided not to exercise the Preemptive Rights.
In addition to the matters notified by the Depositary to the Company, the Company shall ③ notify or announce to (including public disclosure) the Beneficial Owners the method by which the Beneficial Owners may exercise Preemptive Rights (if the Beneficial Owners must convert KDRs into Shares in order to exercise the Preemptive Rights, such informa- tion and the method of doing so).
In the event that Beneficial Owners convert KDRs into Shares pursuant to Article 32 ④ ③ hereof, the Company shall, to the extent permitted under applicable laws and regu- lations, recognize Preemptive Rights to the extent corresponding to the ownership of shares held by the holders of such converted shares, irrespective of whether or not the Share Record Date has already passed, by acknowledging that the owners of the con- 104
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market verted Shares (the persons who were the Beneficial Owners of the KDRs) have co-own- ership of the Preemptive Rights allocated to the Depositary in proportion to the number of the KDRs held by them; provided, however, that this shall not apply to a person who is not a Beneficial Owner as of the KDR Record Date fixed for the purpose of the exercise of the relevant Preemptive Rights.
Article 33 Distribution of Other Assets
In the event that the Company intends to distribute assets other than cash, Shares or Pre- ① emptive Rights with respect to the Deposited Shares, the Depositary shall allocate such assets to each Beneficial Owner in proportion to the KDRs held by such Beneficial Owner, in a fair and reasonable manner determined by the Depositary.
If the distribution of assets under Article 33 is difficult or determined to be impracti- ② ① cable, the Depositary may, in consultation with the Company, dispose of such assets and distribute the proceeds thereof, or decide on a method of distribution determined to be fair and reasonable.
Article 34 Applying to Exercise Voting Rights
A Beneficial Owner receiving notice of a general meeting of shareholders under Article ① 18 hereof shall apply for the exercise of voting right to the KDR Account Holder or KSD ④ no later than the date specified under subparagraph 3 of Article 18 hereof by indicat- ③ ing its approval or opposition for each agenda item in the application.
The Depositary shall collect all applications for the exercise of voting rights received ② from KSD and exercise the voting rights through the Custodian, provided that the Depos- itary shall not exercise voting rights with respect to Deposited Shares for which no appli- cation was provided.
If one (1) KDR does not represent one (1) voting right due to the Conversion Ratio deter- ③ mined pursuant to Article 13 hereof, any exercise of a voting right with respect to a KDR representing less than one (1) voting right shall not be exercisable.
Upon the conversion of KDRs into Shares, the Beneficial Owners shall be entitled to ④ directly exercise the rights held by the holder of the Shares including voting rights, pro- vided that this shall not apply during the Conversion Restriction Period or where the De- posited Shares are delivered after the Share Record Date. 105 CHAPTER In the event that the Depositary is unable to exercise voting rights for which an appli- ⑤ cation for exercise was made pursuant to paragraph of this Article, due to reasons 01
① Establishment of Infrastructure for Cross-border Securities Issuance attributable to other persons or because the Company fails to include the voting rights exercised by the Depositary for whatever reasons, the Depositary shall not be held re- sponsible for such failure to exercise voting rights.
Notwithstanding Article 34 , the Depositary may delegate to a Beneficial Owner voting ⑥ ① rights corresponding to the number of KDRs owned by such Beneficial Owner.
Article 35 Exercising of Common Benefit Rights, etc.
Unless otherwise set forth in this Agreement, Beneficial Owners shall not apply to the ① Depositary to exercise shareholders’ rights for the purpose of participating in the man- agement of the Company such as the right to make a shareholder’s proposal and the right to inspect accounting books and records (referring to as “Common Benefit Rights, etc.” in this Article), or to file litigation with respect to the Company.
Beneficial Owners who intend to exercise Common Benefit Rights etc. shall convert KDRs ② into Shares and then directly exercise Common Benefit Rights etc. against the Company. Article 36 Exchange of Deposited Shares etc.
If there is a replacement of any existing Deposited Shares deposited with the Depositary ① with new deposited shares due to a stock split, consolidation, or change of type of the Deposited Shares, reduction of the Company’s capital, merger or spin-off of the Company, or any other similar reasons, such new deposited shares shall be deemed to be Deposited Shares under this Agreement.
With respect to a distribution of KDRs pursuant to paragraph of this Article, the ② ① method of disposing of fractional KDRs of less than one(1) unit, etc., set forth in para- graphs through of Article 30 shall apply. ② ⑥
Notwithstanding the provisions of paragraph of this Article, in the event that the Com- ③ ① pany merges into another company, a new company is created upon the spin-off of the Company, or the Company ceases to exist after a stock transfer, stock exchange, etc., the shares received by the Depositary as a result of the occurrence of the foregoing events shall be distributed in the manner prescribed in Article 33 hereof. 106 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market CHAPTER 7 DEPOSITARY, CUSTODIAN AND COMPANY
Article 37 Obligations of the Depositary
If the Company requests certain documents or information to be submitted to the gov- ① ernment or other relevant authorities, the Depositary shall, in the absence of justifiable exceptional circumstances, provide such documents or information as requested by the Company.
The Depositary shall maintain a copy of this Agreement at the place where it conducts its ② Depositary business, and the Depositary shall permit Beneficial Owners and other inter- ested parties to inspect such copy at all times during business hours.
The Depositary, for the benefit of the Company or the Beneficial Owners, shall perform ③ its obligations under this Agreement with such due care as required of a good manager.
Article 38 Appointment and Responsibilities of the Custodian
The Depositary may appoint a Custodian with respect to the Shares for the deposit/cus- ① tody of the Shares and the exercise of rights against the Company, and may change or add a Custodian if necessary. Any acts conducted by the Custodian under the instructions of the Depositary with re- ② spect to the deposit of Shares under this Agreement, exercise of rights to the Deposited Shares, etc. shall be deemed as acts conducted by the Depositary.
Article 39 Initiation of Legal Proceedings, etc.
If the Company and the Beneficial Owners become a party to a lawsuit or other legal proceedings involving the Deposited Shares or the KDRs, the Depositary shall not assume any obligation to partake in such legal proceedings under any circumstances, provided that the Depositary may, at its discretion, partake in such legal proceedings on the con- dition that all related expenses will be reimbursed and that an indemnity letter will be provided therefor.
Article 40 Obligations of the Company
The Company shall take the necessary measures to ensure that a person who converts ① Shares into KDRs or receives KDRs is bound by this Agreement and complies with this 107
Agreement, including disclosure of this Agreement on the website of the Company or CHAPTER through the electronic announcement system or other means. 01 Establishment of Infrastructure for Cross-border Securities Issuance The Company shall timely provide to the Depositary documents reasonably requested ② by the Depositary for submission to the Korean government or other public authorities under relevant laws and regulations or as necessary for the issuance and maintenance of the KDRs.
The Company shall maintain copies of the following documents at the office of its disclo- ③ sure agent and permit the Beneficial Owners to inspect them at any time during business hours:
1. The articles of incorporation of the Company;
2. The minutes of the general meetings of shareholders;
3. The Company’s business report, audit report, consolidated audit report and semi-an- nual and quarterly reports;
4. Reports, notices or other information (including information related to voting rights) provided in the ordinary course of business by the Company to the holders of the Shares; and 5. Matters required to be provided by the Depositary to the Beneficial Owners under relevant laws and regulations and the rules of the KRX.
In addition to the obligations set forth under this Agreement, the Company shall under- ④ take to meet the following obligations:
1. On each matter submitted to a vote of shareholders, each share shall carry one (1) vote.
2. Due to the nature of KDRs, the Company shall recognize the exercise of voting rights by the Depositary directly or through the Custodian upon application by the Benefi- cial Owners for the exercise of such rights and allow the Depositary to exercise the voting rights through one or more agents of the Depositary. If the exercise of voting rights by proxy requires separate action under the related laws and regulations such as the deposit of a letter of proxy or a delivery of a prior notice, such actions shall be deemed to have been taken by this Agreement.
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Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 3. The Company shall allow (one or more) agent(s) appointed by the Depositary for the exercise of voting rights to divide his votes. If such divided exercise of voting rights requires the delivery of a prior notice or other actions required under related laws and regulations or the articles of incorporation of the Company, such actions shall be deemed to have been taken by this Agreement.
4. The Company shall appoint a person to handle KDR-related affairs on behalf of the Company in Korea (the “Administration Agent”) and notify the Depositary of such Administration Agent and its contact information by attaching a letter of proxy or the appointment agreement. The Company shall retain the Administration Agent throughout the course of its listing on the KRX and shall not modify or terminate the Administration Agent appointment agreement without prior written consent of the Depositary.
5. The date of a shareholders meeting shall be a date no later than 90 days from the KDR Record Date but no earlier than 30 days after the KDR Record Date fixed by the Depos- itary.
6. In the event of the issuance of new shares, the subscription date or the first day of the subscription period shall be no later than 90 days from the KDR Record Date but no earlier than 30 days after the KDR Record Date fixed by the Depositary pursuant to this Agreement.
7. In the event that a Share Record Date is to be fixed for the convening of a sharehold- ers meeting, issuance of new shares, or distribution of Dividends etc., the Company shall consult with the Depositary in advance to make it possible for the Share Record Date to correspond, to the extent possible, to the relevant KDR Record Date.
8. The Company may apply to delist the KDRs or terminate this Agreement only with the approval of KDR holders representing at least 2/3 of the total number of KDRs. In this case, such approval may be obtained through a general meeting of the Beneficial Owners, etc.
Article 41 Force Majeure
If the Depositary or the Company is unable to perform its obligations under this Agree- ① ment or the performance of its obligations is delayed due to a force majeure event, the Depositary or the Company shall bear no liability to the other party (including the Benefi- 109
cial Owners) with respect to such inability to perform, or the delay in the performance of, CHAPTER its obligations. Force majeure events under this Article shall mean fire, explosion, act of
God, war, restrictions under laws and regulations, enactment or revision of the relevant 01 Establishment of Infrastructure for Cross-border Securities Issuance laws and regulations, measures of the government or the KRX, errors in the computer network (including hacking but excluding errors caused by willful misconduct or gross negligence of the relevant party), and other similar circumstances that are beyond the reasonable control of the Depositary or the Company.
In the event of a force majeure event, the Depositary or the Company shall notify the ② other party in writing thereof as soon as possible and shall use its best efforts to perform its obligations as quickly as possible upon cessation of the event of force majeure. In this case, the Company shall immediately make a public announcement of the occurrence or cessation of the force majeure event.
If a force majeure event occurs to the Depositary during the course of the issuance of ③ new shares upon the grant of Preemptive Rights by the Company to shareholders, the Company shall postpone the issuance of new shares until the cessation of the relevant force majeure event to the extent not exceeding two (2) weeks.
Article 42 Indemnification If any liability, loss, damage, or expense (including reasonable fees and expenses of legal ① counsel) arises from acts or omissions of the Depositary, the Custodian, or any of their respective officers, employees, and agents (collectively, the “Depositary Party”) under this Agreement or at the instruction or request of the Company, the Company shall indemnify the Depositary Party for such loss, damage, or expense incurred by the Depositary Party, provided that the Company shall have no obligation to indemnify the Depositary Party if (i) the liability, loss, damage, or expense arises from the gross negligence or willful mis- conduct of the Depositary Party or (ii) the liability, loss, damage, or expense arises from an omission or false statement of material information submitted in writing by the De- positary Party to the Company for the purpose of including such information in the regis- tration statement, information memorandum, preliminary information memorandum or listing application.
If any liability, loss, damage, or expense (including reasonable fees and expenses of ② legal counsel) is incurred by the Company or any of its respective officers, employees, and agents (collectively, the “Company Party”) due to (i) the gross negligence or willful 110 misconduct of the Depositary Party; (ii) a false statement of, or error in, the information
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market or omission of material information submitted in writing by the Depositary Party to the Company for the purpose of including such information in the registration statement, in- formation memorandum, preliminary information memorandum or listing application; (iii) the Depositary Party’s failure to provide any material information required in the foregoing documents; or (iv) breach of the relevant laws and regulations or this Agree- ment by the Depositary Party, then the Depositary shall indemnify the Company Party for such liability, loss, damage, or expense incurred by the Company Party; provided that the Depositary shall have no obligation to indemnify the Company Party if the liability, loss, damage, or expense arises from the gross negligence or willful misconduct of the Com- pany Party.
The party seeking indemnification under this Article (the “Indemnified Party”) shall give ③ a notice to the party obligated to indemnify (the “Indemnifying Party”) to provide indem- nification hereunder immediately upon the Indemnified Party becoming aware of the event which gave rise to the indemnification hereunder, and the Indemnified Party shall diligently cooperate with the Indemnifying Party regarding the method of indemnifica- tion and appropriate action to be taken to mitigate the cost of indemnification. The In- demnified Party shall not waive any rights against a third party, or compromise or settle any action or claim that may give rise to indemnification hereunder, without the consent of the Indemnifying Party. Article 43 Disclaimer of the Depositary
Other than the warranties expressly provided under this Agreement, the Depositary ① shall make no express or implied warranties on matters including the suitability of the purpose of the investment in the KDRs, the convertibility between or conversion period of the KDRs and the Shares, the handling of requests or applications made after ordinary business hours, confirmation of the truthfulness of information provided at the time of receipt of requests or applications or the notification or correction of errors in such information, the fact that there is no restriction on the rights of the Beneficial Owners or no disruption in the exercise of such rights, the arrival of a notice of voting rights or Preemptive Rights or the provision of a sufficient period for application of the exercise of such rights, and shall expressly disclaim all liabilities with respect to the foregoing. The Company and the holders and Beneficial Owners of KDRs shall expressly acknowledge the foregoing.
The Depositary shall in no event be liable for any special, consequential, incidental, indi- ② rect or punitive damages arising out of or in connection with this Agreement including 111
any loss or opportunity cost resulting from the investment in the KDRs, change in mar- CHAPTER ket price of the KDRs due to market conditions, etc., whether or not the Depositary was 01 aware or could be aware that such damage or loss may have been caused. In this case, it Establishment of Infrastructure for Cross-border Securities Issuance shall not be taken into account whether or not the claim for such damage or loss is based on an agreement, a breach of an agreement, a breach of legal obligations, a breach of warranties, or negligence or tort. The Company and the holders and Beneficial Owners of KDRs shall expressly acknowledge the foregoing.
Article 44 Depositary Fees
The Company shall pay the fees and related expenses listed in Schedule 1 to the Deposi- ① tary at the time specified as follows:
1. Annual fee: at the time of the initial issuance or within one (1) month from the begin- ning of the year;
2. Issuance fee: within one (1) month from the issuance date of the KDRs;
3. Custodial fee: no later than the date determined by the Depositary;
4. Other fees: no later than the date determined by the Depositary; and 5. Related expenses: no later than the date determined by the Depositary
The Beneficial Owners shall pay fees and related expenses separately determined by the ② Depositary at the time specified as follows:
1. Fee for conversion of Shares into KDRs (“KDR Conversion Fee”): at the time of submit- ting the application for the issuance of KDRs;
2. Fee for conversion of KDRs into Shares (“KDR Cancellation Fee”): at the time of the re- quest for delivery of the Deposited Shares;
3. Subscription fee: at the time of the application for subscription;
4. Other fees: no later than the date determined by the Depositary; and
5. Related expenses: no later than the date determined by the Depositary
112 In the event that the Company fails to pay fees and related expenses by the applicable
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market ③ due date specified in paragraph of this Article, the Depositary may request the Com- ① pany to additionally pay a default interest accrued on the unpaid fees or related expenses at the rate of 12% per annum for the period from the day immediately following the due date to the day on which the payment was actually made; provided that the total amount of default interest shall not exceed 12% of the amount of unpaid fees or related expenses.
In the event that the Company or the Beneficial Owner fails to pay the fees under para- ④ graph or of this Article, the Depositary may refuse to accept an application from or ① ② carry out matters as instructed by the Company or the Beneficial Owner, as the case may be.
CHAPTER 8 TERMINATION OF THE AGREEMENT
Article 45 Termination of the Agreement
The Depositary or the Company may terminate this Agreement by giving a 60-day prior ① written notice describing its intention to terminate this Agreement to the other party if it is deemed unnecessary or unreasonable to continue this Agreement.
Notwithstanding paragraph of this Article, in the event that any of the following ② ① events occurs to the Company or the Depositary, the Company or the Depositary, as appli- cable, may terminate this Agreement by giving a 30-day prior written notice describing its intention to terminate this Agreement:
1. If delisting of the Company takes place;
2. If the Company ceases to exist due to a merger/ spin-off of the Company (only when the Company does not survive as a result of the merger/ spin-off), stock transfer, stock exchange, etc.;
3. If bankruptcy or dissolution procedures (other than merger/ spinoff) are initiated pursuant to related laws and regulations, or the occurrence of any other similar event;
4. If a material obligation under this Agreement is not performed; within 30 days from the date it receives notice of the breach and demand for performance from the other party; provided that the foregoing shall be applicable only if the relevant party fails to perform such obligation while not being subject to any force majeure event; or 113 CHAPTER 5. If a force majeure event set forth in Article 41 hereof continues for three (3) months
or longer, making it impossible to achieve the purpose of this Agreement. 01 Establishment of Infrastructure for Cross-border Securities Issuance
A notice of termination of this Agreement under paragraph or of this Article shall ③ ① ② be deemed to have been received at the earlier of (i) when the receiving party receives the notice and (ii) 10 Business Days from the date on which the notice is sent.
In the event that the Company or the Depositary notifies the other party of its intention ④ to terminate this Agreement pursuant to paragraph or of this Article, the Company ① ② shall immediately send a written notice of termination to the Beneficial Owners, and the 60 days or the 30 days under paragraph or of this Article shall start on the date of ① ② delivery of such notice.
Notwithstanding anything to the contrary contained in this Agreement, in the event that ⑤ the Company or the Depositary notifies the other party of its intention to terminate this Agreement pursuant to paragraph or of this Article, this Agreement shall be termi- ① ② nated at the earlier of (i) when all KDRs are converted into Shares and (ii) the expiration of the period determined by the Depositary pursuant to Article 46 hereof. ②
The Beneficial Owners may in no event terminate this Agreement. ⑥ Article 46 Matters upon Termination
Upon the expiration of the period under paragraph or of Article 45, Shares shall ① ① ② not be converted into KDRs unless otherwise permitted by the Depositary; provided that KDRs may be converted into Shares for at least 6-months after the date of the termina- tion notice.
In the event that the Depositary sends notice of termination of this Agreement pursuant ② to Article 45, the Company shall, at its own expense, make a public announcement con- taining the information set forth below to the Beneficial Owners setting more than a six- month period. The Depositary or the Company may dispose of KDRs left unconverted into Shares, or convert such KDRs into Shares and then distribute or dispose of them prior to the expiration of the aforementioned period. If KDRs are converted into Shares to be distributed, any fractional Share resulting from the conversion may be disposed of and then distributed to the Beneficial Owners in proportion to their shareholding ratio. In this case, the fees and other expenses incurred in the distribution of the Shares may be
114 deducted from the proceeds from the disposal of the Shares. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
1. That the KDRs must be converted into Shares within a certain period of time;
2. That after the expiration of the aforementioned conversion period, the Depositary or the Company may convert the KDRs into Shares or dispose of the KDRs or the Shares without consent of the Beneficial Owners;
3. That the price at which the KDRs or the Shares are disposed of or the price at which a fractional share resulting from the conversion of the KDRs into Shares is disposed of shall be determined by the Depositary or the Company at its own discretion; and
4. That upon the disposal under item 3 of Article 46 , the Beneficial Owners may re- ② quest payment of the proceeds from such disposal.
If necessary for carrying out the procedures under paragraph of this Article, the De- ③ ② positary may restrict account transfer or disposal of the KDRs.
Upon the expiration of the period specified in paragraph or of Article 45, the De- ④ ① ② positary shall stop performing obligations, taking action or sending notice under this Agreement, including the payment of dividends to Beneficial Owners; provided that the Depositary may, at its own discretion, continue to receive Dividends, etc. distributed by the Company on behalf of the Beneficial Owners with respect to the Deposited Shares and distribute such Dividends, etc. to the Beneficial Owners so long as KDRs remain out- standing.
Article 47 Consequences of Termination
In the event of termination of this Agreement under Article 45 and Article 46, the Depositary shall not be liable for any damage or loss suffered by the Company or the Beneficial Owners as a result of the termination or after the termination (including any loss caused by the fact that the price at which the Depositary disposed of Shares or KDRs is less than the market price thereof or the fact that there was a possibility of profits due to a change in price after the termination of this Agreement or the disposal of Shares or KDRs); provided that the termination of this Agreement shall not affect the rights, obligations or liabilities accrued prior to the termination hereof.
CHAPTER 9 MISCELLANEOUS
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Article 48 Conversion of Foreign Currency CHAPTER
No interest shall accrue on any money received or distributed by the Depositary as a 01 Establishment of Infrastructure for Cross-border Securities Issuance dividend, distribution, sale price, subscription price, or any other amount regardless of title with respect to Deposited Shares or KDRs, and such money received or distributed by the Depositary may be converted into Won or other currencies in a manner as deemed reasonable by the Depositary. Any expenses relating to the conversion may be deducted from the converted amount.
Article 49 Applicability of Agreement to Beneficial Owners
A person who converts Shares into KDRs or acquires KDRs shall be deemed to become a party to this Agreement from the time of obtaining the rights to the KDRs.
Article 50 Amendments
This Agreement may be amended by any written agreement of the Company and the Depositary if determined necessary to the extent that the right to convert KDRs into Shares shall not be impaired (except as restricted for compliance with mandatory regulations). In such case, the Company shall make a public announcement (including public disclosure) thereon at its own expense, and any amendment shall not become effective until thirty (30) days have elapsed from the date of such public announcement.
Article 51 Notices
Any notice or other communication to the Company and the Depositary shall be sent to ① the respective party’s mailing address, facsimile and/or e-mail address specified below. All communication to the Depository shall be made in Korean or English. If there is any change to the information provided below, the relevant party should notify the other party in advance of such change.
Company ADDRESS: ATTN: TEL: FAX: E-MAIL:
116
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Korea Securities Depository ADDRESS: 23 Yeouinaruro 4-gil , Yeoungdeungpo-gu, 150-948, Seoul, Korea ATTN: Team Leader of Global Investment Support Team TEL: +82-2-3774-3450 FAX: +82-2-3774-3433 E-MAIL: [email protected]
In the event that the Company requests the Depositary to give notice to the Beneficial ② Owners, the Depositary shall send such notice in the same manner used by Korean com- panies to send notice to their shareholders and shall not guarantee, under any circum- stances, that the time of delivery to the Beneficial Owners will be sufficient for the exer- cise of rights or any application therefor. If anything to the contrary is set forth in this Agreement, this provision (Article 51 ) shall prevail. ②
Except as otherwise set forth in Paragraph of this Article and other provisions herein, ③ ② any notice, request, demand, report, consent, waiver or other documents or materials to be provided under this Agreement shall be given in writing (including fax and electronic mail), and shall be deemed to have been effectively delivered, (i) if delivered by fax, elec- tronic mail or other similar electronic means, when the delivery is confirmed, for exam- ple, by an acknowledgement of receipt; (ii) if delivered by certified mail, on the day the arrival is confirmed; and (iii) if delivered by in person or express courier, upon actual delivery thereof.
Article 52 Public Disclosure, Notification and Notice
The costs incurred for all such public disclosure, notifications, and notices required by ① this Agreement shall be borne by the Company; provided that in the event that the Com- pany fails to promptly give notice under Article 45 and 46 hereof, the Depositary ④ ② may give such notice at the expense of the Company.
Any public disclosure shall be made in such daily newspapers etc. as set forth by the Ar- ② ticles of Incorporation of the Company; any notification shall be made through the elec- tronic disclosure system provided by the KRX or the Financial Supervisory Service, and notices shall be sent to each Beneficial Owner and related party.
Article 53 Dispute Resolution and Governing Law
This Agreement, the exercise of the rights and performance of the obligations hereunder, ① 117 and the resolution of any disputes in connection herewith shall be construed and gov- CHAPTER erned by the laws of Korea (except for conflict of laws). 01
Whenever a dispute arises in connection with the interpretation of, the execution and Establishment of Infrastructure for Cross-border Securities Issuance ② performance of, or the exercise of the rights and performance of the obligations under this Agreement (a “Dispute”), the parties shall first use their best efforts to resolve such Dispute under the principles of mutual understanding and good faith.
Any Dispute not resolved pursuant to Paragraph shall be resolved exclusively by the ③ ② Korean court that has jurisdiction over the Depositary.
Article 54 Other Matters
The matters not set forth herein shall be settled by mutual consultation between the Company and the Depositary.
Article 55 Non-assignability
Each of the Company and the Depositary may not assign the rights and obligations hereunder to any third party, or authorize such party to act on behalf of itself without prior consent of the other party; provided that this provision shall not apply to the fees and other expenses incurred hereunder. Article 56 Counterparts
This Agreement may be executed in one or more counterparts, all of which shall constitute one and the same instrument.
Article 57 Severability
Notwithstanding any invalidity or unenforceability of any part of this Agreement, such invalidity or unenforceability shall not affect the other parts of the relevant provision or this Agreement. If this Agreement is in violation of relevant laws and regulations, the Company and the Depositary may amend this Agreement to conform to the relevant laws and regulations.
Article 58 Language
This Agreement shall be prepared in Korean. If this Agreement is translated into any other language, the Korean version shall prevail. 118 [Signature page follows] Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market IN WITNESS WHEREOF, as the Company, and the Korea Securities Depository, as the Depositary, have prepared two originals of this Agreement as of the date first above written, signed and sealed both originals of this Agreement, and have retained one original each, which shall be officially notified to, or posted on the website or in any place which may be easily found by, the holders and Beneficial Owners of the KDRs.
Korea Securities Depository
______119 Name : Name: CHAPTER Title : Title :
Date : Date: 01 Establishment of Infrastructure for Cross-border Securities Issuance
02 CHAPTER
Establishment of Infrastructure for Cross-border Securities Trading
Ki Hoon Ro (Korea Securities Depository) Heung Seok Ko (Korea Securities Depository) Hoon Kim (Korea Securities Depository) Amarbayasgalan Batbaatar (Ministry of Finance of Mongolia)
1. Introduction 2. Status of Cross-border Securities Transactions in the Mongolian Stock Market 3. Recent Trends in Cross-border Securities Transaction Infrastructure in Korea’s Cases 4. Recommendations for Establishing Cross-Border Securities Transaction Infrastructure in the Mongolian Stock Market 5. Implementation Strategy (Inbound Only)
Keywords Cross-border Securities Trading Infrastructure, Inbound, Outbound, PFMI, CSD, ICSD, Global Custodian, Local Custodian, Matching System, DVP, Affirmation, Confirmation, Corporate Action, Omgeo, PSMS. Establishment of Infrastructure for Cross-border Securities Trading
Ki Hoon Ro (Korea Securities Depository) Heung Seok Ko (Korea Securities Depository) Hoon Kim (Korea Securities Depository) Amarbayasgalan Batbaatar (Ministry of Finance of Mongolia)
Summary
This is one project within the 2019/20 KSP with Mongolia, and has been conducted under the title of “Establishment of Infrastructure for Cross-border Securities Trading”. This chapter aims to provide the government of Mongolia with practical and hands-on recommendations to build post-trade infrastructure for Cross-border transactions, resulting 121 in quantitative and qualitative market growth. CHAPTER 02 Cross-border securities transactions take place when either or both of the trading parties Establishment of Infrastructure for Cross-border Securities Trading do not reside in the country. According to the settlement models introduced by BIS, foreign investors mainly use the global custodian model for stock trading and ICSD model for bond trading to settle Cross-border transactions in an investing country. In addition, according to another report released by the ECB, most global investors prefer to use a local custodian rather than a CSD, the main reason being that a CSD cannot provide customized services or banking services, especially F/X services.
Accordingly, this report will focus on utilizing the global custodian-local custodian model and core infrastructures, which fall into three broad categories: i) Matching system for foreign investors’ transactions in the OTC market, ii) Simultaneous settlement system between foreign investors’ local custodian and securities companies, and iii) Corporate action system for foreign investors to exercise their rights as shareholders.
Since Korea first opened its stock market to foreign capital to enhance the transparency and efficiency of the market in 1992, The KSD has operated the settlement system for inbound and outbound transactions. Korea has developed an STP-based matching system and a DVP II-based simultaneous payment system to efficiently handle related tasks under the PFMI, which can be found in the US and Japan as well. In particular, Korea provides Fund-Net services to ensure the local custodian’s affirmation for foreign investors. As for outbound, the KSD has appointed custodians with global reputation and expertise as global custodians. Accordingly, The KSD has played a role as the single gateway to multiple markets, which increases efficiencies and saves costs at the same time.
Meanwhile, it seems that the Mongolian capital market has not continuously received foreign investment since it opened in 1991. One of the key challenges facing the Cross- border trading in Mongolia is the lack of professional investor or institutional investor participation. This is demonstrated by the fact that it was eliminated from the FTSE Frontier List in 2017, which was incorporated in 2012, due to the lack of global standards of the post- trade area. A series of reforms recently implemented (T+2, CCP, and DVP Ⅲ adoption, etc.) for reincorporate FTSE Frontier List seems promising, but there are still many things that need to be improved practically to support foreign investors.
The Mongolian stock market is required to review the following tasks in advance. First, MSE should revise the existing clearing membership system. MSE normally grants
122 its clearing membership to local custodians as clearing members. Second, the stock
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market market should install an affirmation system in the OTC market for foreign investors. For benchmarking, THE KSD’s Fund-Net in Korea and JASDEC’s PSMS (Pre-Settlement Matching System) in Japan are recommended. Third, a legal concept regarding the status of shareholders of foreign investors should be prepared, as there is no clear basis for foreign investors to exercise their rights in the Securities Act.
It is essential to establish low-cost and high-efficiency post-trade infrastructure as the inflow of foreign investors is a vital element for the revitalization of the Mongolian stock market. Thus, the priority task is to establish an operational plan for building Cross-border post-trade infrastructure. In this respect, this chapter presents political-level information including an infrastructure plan and long-term road map. The roadmap includes changing current clearing membership to meet global standards, facilitating mutual understand between MCSD and local custodians and getting the concept of beneficiary share holder included in the Securities Act.
1. Introduction
1.1. Background of the Study
In 1992, Korea first opened its stock market to foreign capital, restricting foreigners’ acquisition of domestic stocks to no more than 20% of each. Afterward, the acquisition limit was gradually raised. In December 1997, the limit was significantly raised, to 50%, and then practically removed in May 1998, when the stock market was fully liberalized as part of the efforts to overcome the 1997 Asian Financial Crisis. The ceiling on foreign investment in general corporations, except public corporations, was fully removed. Since 1998, foreigners have continuously increased investment in the domestic market. They have secured an important position in determining the trend of the Korean stock market as major shareholders of investment companies.
The inflow of foreign capital into the domestic securities market not only helped stabilize the small-sized Korean stock market by increasing investment capital, but also contributed to set reasonable share prices because of the stock evaluation standards newly established by highly advanced investment techniques of developed countries. Moreover, increased investor confidence in the domestic market revitalized the securities market by preventing speculative investment or capital flight, and the advancement of the market-related institutions brought about efficiency in the financial market, reducing transaction costs and resulting in quantitative and qualitative market growth. 123 CHAPTER
In contrast, the Mongolian stock market, which opened in 1991, has failed to attract 02 foreign investors’ active participation. If foreign funds enter the Mongolian stock market, Establishment of Infrastructure for Cross-border Securities Trading the stock price will increase as demand rises, and if the stock market is revitalized, the listed companies direct financial conditions will also be improved, allowing companies to raise long-term funds that are cheaper than bank loans. In this process, the Mongolian financial and securities industry would achieve constitutional improvement. To make the Mongolian capital market a friendly environment for foreign investors, this report will present i) recent international trends and Korea’s cases related to Cross-border securities transactions and, based on this, propose ii) institutional improvement direction and iii) a plan to build a post- trade infrastructure from a practical perspective.
1.2. Scope
First, the status of inbound and outbound Cross-border securities transactions will be analyzed through local consultants to understand the current status of the Mongolian stock market. The analysis will cover laws related to Cross-border securities transaction, the roles of related organizations, and market participants, such as exchanges, clearing companies, and deposit and settlement institutions, trading practices, and related statistics. Moreover, irrationality and discomfort experienced by market participants, including foreign investors, will be investigated. Second, international trends and Korean cases related to Cross-border securities transactions will be introduced. In particular, the current status of the Korean stock market infrastructure for Cross-border securities transactions will be introduced, and implications will be drawn for the Mongolian stock market.
Third and last, an infrastructure establishment plan and road map will be presented to revitalize Cross-border securities transactions in the Mongolian stock market.
1.3. Study Methods
Limited information can be obtained from the Mongolian stock market—information published on the Internet is insufficient, and it is also hard to get through literature because of the language barrier. Therefore, we acquired information through direct interviews with information sources such as local policy-makers, related organizations, and market participants. Korea Securities Depository (KSD) conducted a survey by collecting and analyzing local data from the local consultants of the Ministry of Finance of Mongolia and researchers who have been dispatched to Mongolian Central Securities Depository (MCSD) 124
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market since May 2018.
In addition, we will refer to global standard practices and data on Cross-border transaction post-trade infrastructure published by international organizations, such as the Principle for Financial Market Infrastructure (PFMI) by BIS-IOSCO, the Settlement Finality Directive (SFD; effective since May 1998) that must be complied with by the European Securities and Markets Authority (ESMA), and the European Central Securities Depositories Regulation (CSDR). We also utilize statistical data and financial trend research reports regularly published by international financial institutions such as the International Monetary Fund (IMF), World Bank, European Bank for Reconstruction and Development (EDRD), and Asian Development Bank (ADB), as well as financial trend reports published by financial research institutes locally and abroad, to analyze the trends of Cross-border transactions. In particular, we will cite various statistical data related to the Guide to Investing in Korea published by the Financial Supervisory Service (FSS) in the country. With regard to the establishment of a Cross-border transaction infrastructure and operational plans, we will utilize KSD’s literature on the establishment and improvement of infrastructure, internal regulations, and business guides. All these references will be used to prepare this report. 2. Status of Cross-border Securities Transactions in the Mongolian Stock Market
2.1. Summary
The history of major infrastructure in the Mongolian stock market is shown below.
[Figure 2-1] History of Major Infrastructure in the Mongolian Stock Market
Mongolian Stock Mongolian Securities Switched into wire Launching the MIT MSCH&CD was separated into Exchange Clearing House and transfer operation system along with two companies and Clearing was established Central Depository settlement banks house was formed as Clearing and depository Co., Ltd was found Mongolian Securities Clearing department of MSE. Company
1991* 2003** 2010 2012 2016***
1999 2007 2011 2012~2015 125 CHAPTER
Securities dematerializa- New settlement and depository Accepted as BoM participant Approach to implement T+3 tion finished system was launched by and connected to the Central settlement scheme 02
introducing E-Clearing House bank's RTGS Establishment of Infrastructure for Cross-border Securities Trading system/locally developed
* By the 22nd Resolution of the Mongolian Government of January 18th 1991. ** By the 72nd Resolution of the Mongolian Government of March 26th, 2003. *** By the 147th Resolution of the Mongolian Government of April 13th, 2015 On the Reorganization of the Central Securities Depository and Clearing & Settlement Co.,Ltd
Source: Mongolian Central Securities Depository.
As of 2020, there are two stock exchanges in Mongolia. One is the Mongolia Stock Exchange (MSE), opened in 1991, and the other is the Mongolia Securities Exchange (MSX), opened in 2015.
However, we only refer to the MSE when we talk about the Mongolian Stock Exchange or the Mongolian capital market, as only one company is listed in the MSX.
Investors’ interest in the Mongolian capital market continues to increase. The degree of investors’ interest can be determined through the increasing numbers of accounts opened by investors in the Mongolian capital market, which adopts direct registration. [Figure 2-2] Current Status of Accounts Opened in the Mongolian Stock Market (Unit: The Number of Accounts Opened)
510,267
415,816
84,823
23,571 21,691 12,530
2014 2015 2016 2017 2018 2019, 3/4quarter
Source: Mongolian Central Securities Depository.
126 As of March 2020, a total of 198 companies were listed in the MSE and managed in three Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market classifications based on the liquidity and financial soundness of the issuing company. Most transactions are known to be made in Classification I.
Classifications of Companies Listed in the MSE Category ClassificationⅠ ClassificationⅡ ClassificationⅢ No. of listed companies 14 44 140
Source: Mongolian Stock Exchange. [Figure 2-3] MSE’s Trade Summary TRADE SUMMARY (Unit: Billion MNT)
TOTAL TOTAL TOTAL TOTAL MNT 859.1 MNT 244.1 MNT 143.2 IPO. billion billion billion Secondary 1,000 market
180 Government securities No government As compared to the 800 equates to 90.0% of total trades securities were same period of 2018, issued on the total volume of trade primary market increased by 35.1% or 140 and the secondary MNT 11.5 billion. 600 market trades of Government securities mmary government equates to 6.77% of securities total trades 100 amounted to 400 13.7% of total trades 60 200
20 Government Stock 2017 2018 2019 IPO Secondary market trades of equity Secondary market trades of government securities 127
Source: Mongolian Stock Exchange (2019), MSE annual report. CHAPTER
In the third quarter of 2019, 403.7 million shares of primary and secondary stock were 02 Establishment of Infrastructure for Cross-border Securities Trading traded, with a value of MNT 103.2 billion. A total of 86.6 thousand government securities, worth MNT 8.6 billion, were traded in the secondary market. Then, a total of MNT 111.5 billion was traded in the third quarter of 2019 in MSE.
In the reporting quarter, valuation was 7.7% compared to nominal GDP calculated by the end of 2018. Here, the GDP indicators of the previous years’ valuation are calculated based on the final GDP of the year.
[Figure 2-4] Stock Market Capitalization to Nominal GDP
16% 15.2%
12% 12.1% 10.6%
8% 7.7% 7.3% 7.1% 7.5% 7.3% 5.6% 5.8% 4% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4 Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Source: Ministry of Finance of Mongolia. Foreign corporations and individuals accounted for less than 30% of the MSE transactions.
[Figure 2-5] Stock Trading Volume and Ratio of Foreign Investors (Unit: Shares)
10,000 9,237.1
8,000
6,000
3,841.6 4,000
2,000 501.9 631.6 309.7 200.0 0.0 0.0 0.0 0.0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 128 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4 3/4
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Source: Ministry of Finance of Mongolia.
[Figure 2-6] Investor Composition of MSE
17.0%
Foreign companies 32.8%
Foreign citizen
Domestic companies 12.6%
Domestic citizen
37.6%
Source: Ministry of Finance of Mongolia.
The statistics above show that foreign corporations account for 17% of the transaction volume, but the foreign corporations are mainly general manufacturing companies (Mongolian branches of foreign companies that have entered Mongolia or companies that merged with a Mongolian company), and most of the securities invested are government bonds. Meanwhile, launched in 2003, the Mongolian Securities Clearing House and Central Depository (MSCH&CD) had been in charge of post-trade processes. However, in March 2016 it was separated into the Mongolia Central Securities Depository (MCSD) and the Mongolia Securities Clearing Corporation (MSCC).
The MCSD adopts the direct registration and exceptionally allows custodians to open an Omnibus Account.1 As of March 2020, 36,475 million shares of 330 companies had been registered and issued by the MCSD.
[Figure 2-7] Role of Infrastructures in the Mongolian Stock Market
Products Government Bond Equity Commodity Participants MSE MongolBank
Mongolian Mongolian Agro Mongolian Mongolian Mongolian Trade Platform Securities Commodity Securities MongolBank Stock Exchange Stock Exchange Exchange Exchange Exchange
Securities Mongolian MSX’s MCE’s Clearing Mongolian MSX’s Settlement & Securities Settlement and Settlement Securities Settlement MongolBank Clearing 129 Organizations Clearing House Department Department Clearing House Department CHAPTER
Central Securities MONGOLIAN CENTRAL MONGOLIAN CENTRAL
Depository SECURITIES DEPOSITORY SECURITIES DEPOSITORY 02 Establishment of Infrastructure for Cross-border Securities Trading
Khan Bank Xac Bank Khan Bank Khan Bank Xac Bank MongolBank Cash Settlement Golomt Bank State Bank State Bank Golomt Bank State Bank Bank Trade and Development Bank Trade and Development Bank
Source: Mongolian Central Securities Depository.
Launched in 2016, the MSCC began the risk management based on the Principle of Financial Market Infrastructures (PFMI) from the end of March 2020, so there are a few statistics related to CCP activities. The clearing members are divided into General Clearing Members (GCMs)2 and Direct Clearing Members (DCMs)3. As of April 2020, they were recruiting clearing members. A total of 400 million MNT4 has been set as the Settlement Guarantee Fund (SGF)—a clearing fund—and the collection amount and limit for each clearing member were to be set on the completion of the recruitment.
1 The Mongolia Securities Act Article 46. 2 A clearing member that conducts clearing and settlement commissioned by other securities companies, which are non-clearing members (NCM). 3 A clearing member that conducts clearing and settlement based on the transactions of its clients. 4 The amount was calculated according to PFMI Principle 4: Credit risk. Meanwhile, the statuses of securities companies and related institutions in the Mongolian stock market are as follows.
Status of Securities Companies and Related Institutions Number # Regulated Entities of participants1 Stock exchange 2
2 Clearing house 1
3 CSD (Central Securities Depository) 1
4 Investment management 21
5 Investment funds (private) 15
6 Custodian bank 3
Securities Company (54) Business License
1 Broker 53
2 Dealer 36
130 3 Underwriter 20 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 4 Investment adviser 13
Commodity Industry Number
1 Conducting agricultural commodity trading 1
2 Agricultural commodity broker 13
3 Company providing auditing services in the securities market 58
4 Securities market valuation company 23
5 Legal services company in the securities market 31
Source: Ministry of Finance of Mongolia.
2.2. Mongolian Government’s Globalization Policy
2.2.1. Introduction of Delivery vs. Payment Settlement
Under the General Directive on Developing Economy and Society of Mongolia in 2020, the FRC is introducing T+2, CCP, and Delivery Versus Payment (DVPⅢ) Settlement scheme into the Mongolian capital market, to update the securities settlement system to global standards. Before launching the DVPⅢ, securities settlement was required to be pre-funded. 2.2.2. “National Program for the Development of the Financial Market of Mongolia till 2025”
The Government of Mongolia approved the National Program to Develop Financial Market until 2025, as per Resolution No.299 on 3 October 2017. The program was prepared under the guidance of Financial Stability Council of Mongolia by a working group that consisted of the MOF, BOM, and FRC. The program covers banking industry, insurance sector, capital market, tax environment of financial market, microfinance, market infrastructure, public financial literacy, financial access, savings insurance, and good governance in financial markets.
2.2.3. The Sustainable Development Vision 2030
The Parliament of Mongolia approved the Sustainable Development Vision 2030 with the Resolution No.19 on 5 February 2016. Under this long-term vision, various national programs have been implemented, including the National Program to Develop Financial Market until 2025. The Sustainable Development Vision 2030 aims to increase capital market’s share 131 in the financial sector to 10% by 2020 and to 16% by 2030 and decrease dominance of the CHAPTER banking sector to 90% by 2020 and to 82% by 2030. 02 Establishment of Infrastructure for Cross-border Securities Trading 2.3. The Practice of Inbound and Outbound
2.3.1. Inbound
2.3.1.1. Regulatory Framework for Cross-border Transactions
Articles 14, 15, 17, and 18 of the Securities Market Law regulate the issuance of securities by Mongolia and the issue of foreign securities in the foreign capital market in Mongolia.
A company listed in a foreign stock exchange may issue securities in Mongolia by the following steps:
i. Register and obtain your approval in accordance with the requirements of the securities trading organization.
ii. After that, the Financial Regulatory Commission will issue a permit to issue securities. iii. In accordance with the Financial Regulatory Commission and Securities Market Law and “Securities Deposit Regulations,” the securities issuer shall conclude an agreement with the securities’ issuer and register the shares.
iv. The MSCC will perform the initial market trade settlement and confirm the trade and send it to the CSD.
2.3.1.2. Market Entry Requirements (Nonresidents)
Under the Securities Market Law, nonresident issuers and domestic issuers are not distinguished, and there is no restriction on nonresident issuers. There are, however, clauses in the Securities Market Law regarding foreign exchange–listed companies trading their securities in Mongolia. The specific requirements are decided by the FRC, in accordance with the law.
On 24 November 2017, the FRC approved the Temporary Regulation on Registering Securities Offered in Mongolia by Foreign Exchange Listed Entity and Securities Offered in 132
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Foreign Country by Mongolian Exchange Listed Entity. This allows fast-tracking of public offer by foreign issuers listed in a pre-approved list of foreign exchanges by the FRC. The regulatory process is simpler because the listing request is not required to have a business and asset valuation report and underwriter’s opinion. However, it is still required to have a legal opinion by a licensed entity and an audited financial report. The documents are required to be translated to Mongolian, but only the original language version has legal authority, and it is required to be submitted as well.
Under this regulation, a foreign issuer listed in a foreign exchange can submit its request for securities listing to the FRC and the MSE at the same time, and only allowed to offer its securities on the public market after it has been approved by the FRC and after it has been registered at the FRC and the MCSD.
The FRC is required to reach a conclusion on whether to approve and register the security or not in less than 20 working days, as per the regulation. However, this deadline can be extended by another 15 working days if the FRC deems it requires additional information to reach a decision. 2.3.1.3. The Process Required for Foreign Investment to Be Made in Mongolia
Under the process required in accordance with the laws and regulations in force in Mongolia, foreign citizens and business entities are subject to the same regulation as Mongolian citizens and business entities when investing in foreign capital markets.
[Figure 2-8] Foreign Investment Process
Before the After Trading Trade /T/ Trade /T-1/ / T+1 /
Open a securities account by Take part in trading by making an order to your Ownership will transfer at the selecting the brokerage firm. brokerage firm. MCSD. Open an escrow account with 100% deposit amount will be credited to the a commercial bank. escrow account. Settlements will be made in Mongolian currency. Automatic clearing and payment will made by the MSCC.
Source: Author’s own.
2.3.2. Outbound 133 The processes required to make an investment outside Mongolia is mostly similar to the CHAPTER inbound process. To make an investment outside of Mongolia, you need to have a brokerage 02
firm or custodians to make an order. Establishment of Infrastructure for Cross-border Securities Trading
The statistics on the outbound investment made outside of Mongolia are not recorded by the government entities.
2.4. Difficulties of Inbound and Outbound Investments
One of the key challenges facing Cross-border trading in Mongolia is the lack of professional investor or institutional investor participation in the corporate bond market. As a result, retail investors are the primary participants in corporate bond market, leading to shorter maturities and the need for secured or collateralized issuance for corporate debt instruments. With lack of professional investors, it is also difficult to develop an OTC marketplace for corporate debt instruments.
Meanwhile, the questions most frequently asked or pointed out by global custodians are identified through interviews with Golomt Bank and Khan Bank, which conduct local custodian business in Mongolia. First, whether post-trade infrastructure adopts global standards is related to DVP and T+2 settlement cycle. DVP was adopted as the standard long ago, and T+2 settlement was standardized in mid-2010.5 This issue was directly connected to the Mongolian Stock Exchange’s reincorporation to the FTSE Frontier List.6 Meanwhile, some of these difficulties are believed to have already been resolved through the concerted effort of related organizations, such as the MCSD and the MSCC led by the MOF of Mongolia, with the KSD’s advice. Global standards in PMFI-based post-trade infrastructure were adopted: the settlement cycle was shifted from T+1 to T+2 at the end of March 2020; the multilateral netting system was adopted; and MSCC assumes the responsibilities of a CCP while MCSD conducts DVPⅢ connected with central bank under its responsibilities. Accordingly, in the following description, only portions that have not yet been resolved will be described.
Second, whether post-trade infrastructure adopts global standards is related to securing legal ownership of foreign investors. According to the Mongolian Securities Law, although the direct registration is adopted, there are two types7 of registration methods: securities’ central registration, and the other is securities’ particular registration. The latter is 8 134 allowed for local custodians. In other words, these provisions seem to have been made in
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market consideration of the beneficial shareholders who keep their shares in custodians, but the concept and qualifications of beneficial shareholders, and the procedures to confirm the qualifications of beneficial shareholders between MCSD (securities’ central registration) and local custodian (securities’ particular registration), have not been prepared. Therefore, foreign investors, which are the beneficial shareholders, are skeptical about securing legal ownership after trading.
Third, whether post-trade infrastructure adopts global standards is related to affirmation process performed by local custodians. Affirmation is a kind of matching activity that the local custodian compares a trading report received from the securities company with a settlement instruction obtained from the global custodian. This process is important in that the local custodian confirms the settlement data according to the transaction of foreign investors. For reference, the matching of the securities market is processed by the locked- in method, but the trade matching of foreign investors is processed by confirmation and affirmation. This is due to the proxy contracts between a local custodian and a global custodian.
5 In Europe, the conversion was made in 2014 when the CSDR was enacted and implemented, in 2017 for the US, and in 2019 for the Japan. 6 MSE was added to FTSE Frontier List but removed in September 2017 because of failure to implement T+2 and global standards in clearing and settlement. The return conditions are the implementation of the T+2 settlement system, DVP, etc. 7 Mongolia the Securities Act Article 42.2. 8 Mongolia the Securities Act Articles 46.1, 46.2. However, the Mongolian stock market adopted the method in which a local custodian directly participates in the clearing and settlement of the securities market, not indirectly as a clearing member of CCP in settlement through the securities company that has been entrusted orders from a foreign investor. This can make situations that are not suitable for the local custodian environment. Because a local custodian as an agent should follow the settlement instructions of a global custodian as the principal under the contract, which does meet the global standards of Cross-border trading and may create troubles in the contract relationship between the global and the local custodians.9
Meanwhile, the United States (Omgeo), Japan (PSMS), and Korea (Fund-Net)10 operate separate matching systems to ensure the local custodian’s affirmation for the transactions by foreign investors.
Fourth and last, CA-related processes are not standardized, which is related to the legal ownership pointed out in the second issue. The preparation of a beneficial shareholders’ register, the sum of a beneficial shareholder’s shares, which may be distributed between several local custodians, and sufficient notice period to investors are not defined. In addition, 135 agreement on the CA process is required between the MCSD and local custodians, which CHAPTER manage the details of beneficial shareholders. 02 Establishment of Infrastructure for Cross-border Securities Trading [Figure 2-9] Difficulties and Solutions for the Inbound Mongolian Stock Market
Launching new Clearing & Settlement Not adopting Global Standards system based on PFMI in PFMI-based Post Trade infrastructure However, the Clearing Membership (CCP, DVP, T+2 Settlement cycle etc) seems to be revised.
Unclearing legal basis of deposited The concept of Beneficial Sharesholders securities at Omnibus A/C opened by should be included in the Local Custodian for foreign Investor Securities Act. Market
It is necessary to create a matching No affirmation process to be performed system snd DVP II between the securities by Local Custodian company and foreign investors (Local Custodian).
Clear role assignment and practice Non-standardization of CA related standardization between CSD and processes Local Custodian is necessary.
Source: Author’s own.
9 This is because the local custodian as the member of CCP should settle on T+2 without a settlement instruction by the global custo- dian. If it does not, it may be treated as a fail or default, increasing the credit risk in the securities market. 10 In the case of Korea, confirmation of trading by foreign investors (i.e., confirmation of trading between Local Custodian and securi- ties companies) is done through Fund-Net. 3. Recent Trends in Cross-border Securities Transaction Infrastructure in Korea’s Case
3.1. Global Standards for Cross-border Securities Transaction Infrastructure
3.1.1. Key Features of Cross-border Securities Transaction Infrastructure
There are four differences in Cross-border securities trading compared to domestic securities trading.
First, the place of order for trading and the place of deposit and settlement are different. In other words, an order is placed in the investor’s country, but settlement is made in the issuing and distribution country of the securities, and foreign investors often acquire ownership and various rights related to the securities through their accounts opened directly or indirectly at global custodians. 136
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Second, securities distributed in Cross-border transactions must be eligible for deposit and settlement internationally, and the settlement currency used for Cross-border securities transactions is generally an international currency designated by the trading party or the local currency of the place of the securities being settled.
Third, regulations, applicable laws, and trading practices for securities deposit and settlement systems operated by countries around the world may differ. In recent years, there has been a movement to set a uniform standard to solve this problem from the standpoint of international jurisdiction. An example is when US and Korean investors traded German securities with Euroclear, headquartered in Belgium, as a deposit and settlement institution. Under the account agreement, the effect of real rights on the ownership or security rights of the securities, which have been deposited after settling, is subject to the laws of Belgium, where the intermediary, Euroclear, is located and the account is managed.
Fourth and last, the institutions that handle deposit, settlement, rights exercise, and payment related to international securities deposit and settlement are diversified into central securities depositories, international central securities depositories, global custodians, and local custodians.
Accordingly, there are limitations for operating the Cross-border securities transaction infrastructure as follows. First, there is a time lag between the country where the investor resides and the country where the securities invested. Necessary information must be exchanged between the settlement parties to settle international securities. However, it is difficult to secure the timeliness of information delivery, because messages can be received outside of business hours in some areas. As such, information delivery for Cross-border trading securities settlement cannot be made at the same time for the settlement parties, so the settlement parties can send necessary information with one or several days’ delay.
Second, there is a risk of nonperformance of Cross-border trading securities settlement. The transaction details should be matched within a short time after execution to minimize the risk of securities settlement.
In particular, in the case of Cross-border securities transactions, there are a wide variety of stakeholders involved in the settlement, such as securities companies, investment management companies, global custodians, and depository institutions, and there are time lags among regions, making it complicated to match and confirm transactions.
137
Accordingly, settlement institutions around the world are putting great efforts into CHAPTER developing and operating an automated matching system that can collect and deliver information such as transaction details and settlement instructions generated in each 02 Establishment of Infrastructure for Cross-border Securities Trading market online. Omgeo is one of the representative institutions. Jointly founded by the Depository Trust & Clearing Corporation (DTCC) and Thomson Financial in the US in 2001, Omgeo provides a comprehensive comparing and matching function for Cross-border securities trading and settlement.
Meanwhile, according to Omgeo11 and Global Custodian articles,12 Korea is recognized as a country with high settlement efficiency and same-day affirmation (SDA) rate of Cross- border trading.
11 Expanding Market Infrastructure through Service Providers (2012. 03). 12 https://www.globalcustodian.com/emerging-markets-achieve-positive-sda-rates/. [Figure 2-10] Relationship between Same-day Affirmation (SDA) Rate and Settlement Efficiency
100% Japan Taiwan Korea Switzerland India 90% Australia Singapore Hong Kong Netherlands France
Spnin Global Average = 80.4% 80% Germany United Kingdom China High SDA Rate High SDA Sweden 70% Canada
Italy
Brazil SDA Rate SDA 60% Market South Africa
50%
40% United States
Low SDA Rate Low SDA Global Average = 38.5% 30% -30 -35 -40 -45 -50 Efficiency Low Settlement Efficiency High Settlement Efficiency 138 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Source: Omgeo (2012), Expanding Market Infrastructure through Service Providers.
Third and last, there is a lack of uniformity in international securities deposit and settlement, which is a key infrastructure for Cross-border securities transactions. Despite the rapid integration of the global financial market, there remain between-country differences in currency, stock market structure, the procedures and practices of securities trading, and regulations and legislation. In particular, Cross-border securities settlement often requires a decision on which country’s laws should be applied first. These inefficiencies have been pointed out as a practical problem of Cross-border securities settlement.
3.1.2. Global Standards for Cross-border Securities Transaction
The following explicates the Cross-border securities settlement model announced by BIS in 1995. [Figure 2-11] Alternative Channels for Settling Cross-border Securities Trade
CSD
Local Local Local Agency Agency Agency Country of Issue Market Other Countries Global ICSD CSD Custodian
Non-resident Non-resident Non-resident Non-resident Non-resident Counterparty Counterparty Counterparty Counterparty Counterparty
Channel: (1) (2) (3) (4) (5) Direct Local Global ICSD CSD-to-CSD Access Agnet Custodian 139 Source: BIS (1995), Cross-border Securities Settlements. CHAPTER
‘(1) Direct access’ model is a form in which investors in other countries directly make a 02 Cross-border securities transaction without going through a financial intermediary. That is, Establishment of Infrastructure for Cross-border Securities Trading an investor directly manages its accounts opened in the CSD of the investing country.
‘(2) Local agent’, ‘(3) Global custodian’, and ‘(4) ICSD’ models are forms in which investors indirectly invest in foreign securities markets via intermediaries located in the investing countries. There are a few foreign stock markets (especially CSD) that allow for nonresidents to make transactions (or participate directly) as members. Oftentimes, nonresident investors designate a custodian in a foreign market to conduct investment-related activities, rather than directly performing (order) confirmations and settlements in the foreign stock market.
‘(5) CSD-to-CSD’ model is a clearing and settlement method based on the interconnection of the securities markets between specific countries. The representative examples are Hu- Gang Tung between the Shanghai Stock Exchange and Hong Kong Stock Exchange, and Shen- Gang Tung between Shenzhen Stock Exchange and Hong Kong Stock Exchange.
Cross-border securities settlement means that the transaction is made in a country where either or both of the trading parties do not reside. It has not been defined which model is the most efficient, but in general, to use the securities settlement system of the investing country, foreign investors mainly use the (3) global custodian model for trading equities and (4) ICSD model for bonds. This report will also focus on utilizing the global custodian-local custodian and ICSD models.
According to the securities service eco-system13 announced by Oliver Wiseman, the service coverage of CSD and custodian overlap.
[Figure 2-12] Securities Service Eco-system
ADJACENT CORE FUND ISSUER ADJACENT EXECUTION SERVICES CUSTODY SERVICES SERVICES SERVICES
Clearing Custody and Fund Fund Issuer Middle Office/ R&A Access Liquidity Settlement Sub-custody Admin. Services Services Reporting
Issuers Focus of the Report
Banks and Money Brokers Managers Broker Dealers Buy-side In-house Custodians rket BUY-SIDE Sell-side and Buy-side 140 In-house
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Hedge Funds Prime Brokers
CUSTOMER SEGMENTS CUSTOMER Correspondent Clearers Niche Speclalists Financial Intermediaries Information Sell-side In-house Custodians
SELL-SIDE Specialists
Market Trade Exchanges/ Central CSD Administrators Tech Providers Infrastructure Management IDBs/ECNs/ Counter-parties/ Vendors ATSs/MTFs Clearing-houses
Source: Oliver Wyman.
Then, why do Cross-border transactions require local custodians? The reason is well explained in the material14 published by ECB.
13 Securities Services: The Good Times Are Over, It Is Time To Act. 14 The Securities Industry (ECB, 2007. 08). Custody in the Electronic Age
The immobilization or dematerialization of physical securities in CSDs should, in theory, eliminate the need for any investor to use custodians or brokers to safekeep physical securities. Under immobilization or dematerialization, safekeeping is reduced to a reconciliation activity, whereby the custodian’s task is to ensure that its holdings at the CSD are equivalent at all times to the amount of securities owned by its clients. Yet investors continue to use custodians, for several reasons:
Ineligibility: Some investors and market participants are not eligible to become a member of the CSD. Some CSDs only want members that are regulated, financially sound, have robust operational capabilities, and have the ability to continuously invest in technology that ensures straight-through processing. These membership criteria are primarily designed to minimize the probability of disruption to a CSD’s smooth functioning.
Intermediation solution: Even when investors and market participants could be a direct member of the CSD, they might still decide to buy the services of a custodian with economies of scale and expertise in the procedures of the CSD, market practices and the management of securities holders’ rights and entitlements. Intermediation enables a market participant to change fixed overheads into variable costs. 141
Specialized and banking services: The custodian bank provides services that are most CHAPTER efficiently performed by the same entity that holds the securities for investors and other financial
intermediaries. These services fall into two broad categories: specialized reporting for a specific 02
client segment, such as investment funds, and banking services, such as intraday liquidity provision Establishment of Infrastructure for Cross-border Securities Trading and securities financing, which most CSDs do not provide because it involves credit exposure.
3.2. Recent Trends in Cross-border Securities Transactions in Korea
3.2.1. Inbound
Since 1992, when the Korean capital market was opened to foreigners, foreign investment in the Korean securities market has increased.
The figures below show that foreign investment in the KRX (KOSPI)15 is on the rise.
15 This report focuses on the establishment of infrastructure to support foreign stock trading in the Mongolian stock market, so the relevant statistics are presented only for stock trading in the main board market, where foreigners mainly invest. [Figure 2-13] Types of Foreign Investors and Foreign Investors by Nationality (as of the End of 2019)
40,000 Types of Foreign Investors 35,000 30,000 25,000 20,000 2019) 15,000 10,000 5,000 0 2016 2017 2018 2019
Individual Investor Institutional Investor
Foreign Investors by Nationality (as of the End of 2019)
US (15,840) 142 US Malaysia Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Japan Singapore Others (18,033) Cayman Island Germany Luxemburg Finland
Ireland Others Japan (4,170)
Cayman Island (3,595)
Source: FSS, Trends of Foreign Investors.
According to the monthly registration status of foreign investors published by the FSS in Korea, US investors account for the largest share, 32.3% (15,840 of total 48,058 investors), followed by Japanese and Caymanians.
Foreign Investors by Nationality (Unit: person)2019 Nationality End of 2016 End of 2017 End of 2018 End of End of (Increase) Nov. Dec.
US 14,383 14,909 15,446 15,802 15,840 38
Japan 3,818 3,903 4,068 4,163 4,170 7
Cayman 3,316 3,410 3,514 3,592 3,595 3 Islands
Continued2019 Nationality End of 2016 End of 2017 End of 2018 End of End of (Increase) Nov. Dec.
Luxemburg 1,837 1,951 2,089 2,219 2,223 4
Ireland 1,273 1,346 1,432 1,483 1,486 3
Malaysia 955 978 1,014 1,046 1,049 3
Singapore 765 791 820 842 845 3
Germany 649 715 745 780 783 3
Finland 14 17 28 32 34 2
Others 16,287 16,911 17,544 18,015 18,033 18
Total 43,297 44,931 46,700 47,974 48,058 84
Source: FSS, Trends of Foreign Investors.
Meanwhile, the share of foreign investors in the Korean stock market (based on market capitalization and the total number of shares issued) has been rising. 143 CHAPTER
Foreign Investor Holdings to Market Capitalization and Total Number of Shares Issued 02
Market Foreign Investor Total Number of Establishment of Infrastructure for Cross-border Securities Trading Foreign Investor Holdings' Capitalization Holdings to Market Shares Year Shares and its Percentage (Unit: Billion Capitalization (Unit: Thousand (Unit: Thousand Shares, %) Won) (Unit: Billion Won, %) Shares)
End of 2016 1,308,440 459,867 35.1% 41,031,721 6,553,659 16.0%
End of 2017 1,605,821 596,506 37.1% 42,497,825 7,110,509 16.7%
End of 2018 1,343,972 480,644 35.8% 52,094,789 11,557,557 22.2%
End of 2019 1,475,909 561,940 38.1% 55,322,658 11,598,747 21.0%
Source: FSS, Trends of Foreign Investors.
3.2.2. Outbound
Foreign currency securities investment by Korean investors began in June 1988, as some institutional investors were permitted to invest in overseas markets in accordance with “a plan for promoting investment in overseas bonds” by the Korean government. In July 1994, general investors’ investment in listed foreign currency securities was allowed, and the restriction on general investor’s investment was lifted in April 1996 after the institutional investor’s investment in foreign currency securities was fully liberalized in February 1995. Korean investment in foreign currency securities has significantly risen because of new investment alternatives to the falling Korean interest rates, spreading risk through the expansion of investments and the increased investment capacity by the expansion of the size of domestic financial institutions and pension funds.
Meanwhile, according to the statistics released by the KSD’s foreign currency securities depository system, Korean investors’ foreign currency securities status is as follows.
Foreign Currency Securities Held by Korean Investors (Unit: Q’ty (Stocks: Million shares, Bond: Face Value of USD billion), Purchase Amount (USD billion)) Stock Bond Year Q’ty Purchase Amount Q’ty Purchase Amount2016 4,322 5,996 179 23
2017 4,683 9,623 1,524 28
2018 5,225 9,818 2,223 26
2019 6,012 14,441 1,072 29
144 Source: The Statistics of KSD. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
As of December 2019, Korean investors’ foreign currency securities by continent are as shown in the figure below.
[Figure 2-14] Korean Investors’ Foreign Currency Securities by Continent
Asian Market (10,282M Shares) EU Market (249M Shares)
US Market (2,203M Shares)
Source: The Statistics of KSD. 3.3. Cross-border Securities Transactions in Korea: Focus on Infrastructure Supporting Post-Trade Securities Processes
3.3.1. Inbound
This chapter is based on the assumption that nonresidents in Korea (hereinafter “foreign investors”) invest in stocks listed in the Korea Securities Market. In most cases, foreign investors enter into a custodian contract with a global custodian for post-trade processing, and the global custodian delegates the tasks to the local custodian under the contract.
3.3.1.1. Main Regulations Related to Foreign Investment
A. Definition of a Foreigner
A foreigner is an individual or a foreign corporation with foreign nationality who does not have an address or residence in Korea for more than six months, according to the Regulations on Financial Investment Business managed by the Korean Financial Services Commission (FSC). 145 CHAPTER
B. Limits to Foreigners’ Acquisition of Listed Stocks 02 Establishment of Infrastructure for Cross-border Securities Trading The Korean Capital Market Act requires a public corporation’s articles of incorporation to include the limit on foreigners’ total acquisition of equity securities. For example, Korea Electric Power Corporation (KEPCO) prevents anyone from holding more than 3% of the total number of issued shares, regardless of the name. On the other hand, when a securities company receives a purchase order from a foreigner, it must verify that executing the order does not exceed the limit on foreign share ownership. If the order exceeds the limit, it should be rejected.
C. Foreign Investment Registration System
A foreigner who intends to acquire securities listed in the Korea Stock Exchange market must apply for registration (hereinafter “investment registration”) in advance and register personal details in the name of the foreigner according to the method specified by the FSS.
D. Opening Trading Accounts
When a foreigner intends to open a trading account at a securities company for investment in securities, he/she must open a separate trading account for each securities type. E. Opening Foreign Currency Accounts for Investment and Nonresidents’ Korean Won Account
Foreign investors can open accounts exclusive for investment or nonresidents’ Korean won accounts exclusive for investment in their own name in foreign currency banks (hereinafter “investment-only accounts”), and deposit and dispose of related funds to invest in Korean won securities (including foreign remittance of the price of securities sold) or to pay funds related to authorized securities lending and borrowing and RP. This is for preventing foreigners’ domestic securities investment funds from being used for other purposes; otherwise, the domestic financial market may be disturbed by frequent inflows and outflows of foreign investors’ funds.
On the other hand, since March 1995, Korean securities companies have also been able to handle currency exchange. Therefore, foreigners can deposit, remit, receive, and exchange investment funds for Korean securities using foreign currency and Korean won accounts in the name of the securities company in foreign exchange banks. In this case, the foreigner’s deposit and withdrawal of foreign currency funds are individually managed through the 146 client’s account by the securities company. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
F. Appointment of a Standing Proxy
When a foreigner intends to conduct securities transactions in Korea, he/she needs to appoint a standing proxy to conduct securities transactions and a custodian to keep the acquired securities. For the foreigners, the standing proxy (as delegated by the global custodian) performs the following activities:16
i. Receive a letter of attorney from a foreigner and obtain an Investor Registration Certificate from the FSS;
ii. Open investment-only accounts or nonresidents’ Korean won accounts in the local custodian for depositing foreign currency and converting to Korean won;
iii. Open a trading account in a financial investment company;
iv. Make orders on behalf of foreign investors and report trading results;
v. Instruct a settlement and deposit settlement funds;
16 Korea Financial Investment Association ”Financial Investment Company Compliance Manual.” vi. Notify the completion of settlement;
vii. Handle matters related to other trading accounts and financial investment instruments.
G. PFMI Compliance Status for Attracting Foreign Investors
The principles for financial market infrastructures (PFMI), are the global standards for financial market infrastructures (i.e., payment systems, central securities depositories, securities settlement systems, central counterparties, and trade repositories). Issued by the CPMI and the International Organization of Securities Commissions (IOSCO), the PFMI is part of a set of 24 key standards that the international community considers essential to strengthening and preserving financial stability.
PFMI is a combination of three key principles and recommendations published in the early 2000s. In the case of Korea, the Bank of Korea, the Korea Exchange, and the KSD act as infrastructure in the Korean capital market and regularly publish self-assessments of PFMI. 147 CHAPTER [Figure 2-15] Changes in Key Principles Related to Post-trade Infrastructure
Core Principles for Systemically Important Payment Systems 02
(CPSIPS, '01.1) Establishment of Infrastructure for Cross-border Securities Trading “the Principles for Financial Market Recommendations for Securities Settlement Systems (RSSS, '01.11) Infrastructures” ('12.4) Recommendations for Central Counterparties (RCCP, '04.11)
Source: Author’s own. [Figure 2-16] Status of Financial Market Infrastructures (FMIs) in Korea
Settlement of Fund Settlement of Securities and Derivative Settlement Instruction Trade Matching Deriva- Securities Government Financial tive Market Bond Market OTC Spot & Derivative Institution market Market General Bond (Future, RP Market Market Option)
Korea Central Counterparty
Clearing Financial Clearing Telecommu- KRX nications and KRX (CCP of Spot and, Derivative) KRX (TR) Clearings KSD (OTC Institute (OTC Spot) Derivative) Settlement Settlement Bank of KSD Korea KSD (CSD & DVP) (Settlement)
Source: Author’s own. 148 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market The status of PFMIs observed by KSD is as follows.
Self-assessment of Principles for Financial Market Infrastructures (PFMIs) by KSD No Name of Principle Applicable Self-assessment
1 Legal basis Observed ● 2 Governance Broadly observed ● 3 Framework for the comprehensive management of risks Observed ●
4 Credit risk Observed ● 5 Collateral Observed ● 6 Evidence Observed ● 7 Liquidity risk Observed ●
8 Settlement finality Observed ● 9 Money settlement Observed ● 10 Physical deliveries Observed ● ContinuedNo Name of Principle Applicable Self-assessment
11 Central securities depositories Observed ● 12 Exchange-of-value settlement systems Observed ●
13 Participant-default rules and procedures Observed ● 14 Segregation and portability Observed ●
15 General business risk Observed ● 16 Custody and investment risks Observed ● 17 Operational risk Broadly observed ●
18 Access and participation requirements Observed ● 19 Tiered participation arrangements Observed ● 20 FMI links Broadly observed 149 ● CHAPTER
21 Efficiency and effectiveness Observed 02 ● Establishment of Infrastructure for Cross-border Securities Trading 22 Communication procedures and standards Observed ●
23 Disclosure of regulations, key procedures, and market data Observed ● 24 Disclosure of market data by trade repositories Observed ● Total 24
Source: Author’s own.
The contents related to the “Broadly observed” of the above table are as follows.
“Broadly Observed”-related Contents Assessment Category Principle SumObserved Principle 1, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 18, 19, 21, 22, 23, 24 21
Broadly Observed Principle 2, 17, 20 3
Partly Observed - 0
Not Observed - 0
Not Applicable - 0
ContinuedCategory Main Reason for Assessment Result of Broadly Observed
KSD's ownership structure is extremely centralized on KRX (74.1%). 2. Governance Thus, It is limited to appropriately reflect interests of all relevant stakeholders, including those of its direct and indirect participants.
In case an emergency situation occurs, it is recommended that the business should 17. Operational Risk be restarted within 2 hours pursuant to PFMIs, however, KSD's BCP specifies that the main business should be restarted within 3 hours
Currently, there are no direct risk analysis and management system related to FMI links. Within the next few years, KSD will make a plan for co-risk management system 20. FMI Links in cooperation with domestic FMIs, and then establish framework for comprehensive risk management system related to overseas FMI links.
Source: KSD (2019), PFMIs observance self-assessment.
3.3.1.2. Foreign Securities Investment Procedure (Overview)
A. Opening Accounts and Submitting Orders
For foreigners to trade in the KRX stock market, they must open a trading account in 150 a securities company as described above. Subsequently, the foreigner submits an order Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market through a securities company in which the trading account is opened, and the securities company submits an order (quotes) to the KRX.
B. Notifying Trade Executions and Trading Results
The exchange that receives the quote from a securities company concludes the transaction in accordance with the principle of the transaction conclusion and immediately notifies the securities company of the result. The securities company will notify the foreign investor of the result received from the exchange.
C. Settlement
Settlement in the Korean securities market is made on T+2. The foreigner makes a payment for the purchase price or delivers securities to the securities company through the local custodian on the settlement date according to the result of the trade execution, and the securities company pays the selling price to the foreigner’s Local Custodian or deposit purchased securities into the account. Separately, settlements are performed daily between clearing members (securities companies) of the stock exchange. 3.3.1.3. Inbound Infrastructure Operation Status for Securities Transaction Settlement
Inbound infrastructure can be divided as shown in the figure below.
[Figure 2-17] Inbound Infrastructure
(Infra 1) Regulated Market (RM) Clearing (CCP) Settlement Settlement (DVP ) Ⅲ Institutional Institutional Trade Trade Settlement Settlement Seller Buyer Regulated - Member of RM Sell Buy - Member of RM ② Market ② - Broker & Dealer - Broker & Dealer
(Infra 2) (OTC) Sell Buy ① Matching DVP ① Ⅱ • Investment Managers • Investment Managers • Custodian Banks (Infra 3) • Custodian Banks (Foreign Investors) A Solid Legal (Foreign Investors) Basis for • Banks, Insurance Co. • Banks, Insurance Co. 151 Beneficial CHAPTER Shareholder, • Individuals • Individuals CA
Broker & Dealer’s Customer Broker & Dealer’s Customer 02 (Non Member of RM) (Non Member of RM) Establishment of Infrastructure for Cross-border Securities Trading
Source: Author’s own.
A. Trade-matching System
Trade comparison (or matching) consists of two steps. First, it is made between the brokers (i.e., clearing members) to check the results of the order commissioned by the investor. Second, it is made by the broker and the investor who has commissioned the order. Matching is important because the creditor/debtor relationship (settlement position) among investors, brokers, and counterparties of the brokers are confirmed when this process is completed. In this regard, the US and advanced countries in Europe are exerting great efforts for the straight-through processing (STP)17 of matching, recognizing matching on the trading day as a key task for streamlining securities trading.
According to the “Recommendations for securities settlement systems” announced in January 2001 by CPSS-IOSCO’s Joint Task Force, it is recommended that the trading comparison between the direct participants (= clearing members) of the stock market be
17 STP refers to “processing the entire process from trading order to settlement in a seamless manner by hand, by linking the stan- dardized message format and system in securities transactions.” completed on the day of the transaction (T) and that of the direct participants (the securities company) and indirect participants (especially institutional investors) be done by no later than T+1.
Recommendation
Trade confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1 (“Recommendations for securities settlement systems”)
In particular, when a securities trading order by foreign investors or institutions is executed in a regular market such as a stock exchange, trading comparison is made in two steps. As mentioned earlier, one is the matching between clearing members,18 and the other is between clearing members (i.e., securities companies), and foreign investors or local custodians.19
152 The latter matching is divided into trading matching and settlement matching. As shown Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market in the figure below, trade matching refers to the procedure to check the abnormality of the order details between the foreign investor (or institutional investor) who entrusted the order and the securities company that was given the order. On the other hand, settlement matching refers to the procedure to confirm the way to settle the trading between the local custodian20 designated by the foreign investor and the securities company. Settlement matching includes payment accounts, fees, and transaction-related taxes, which are not found in the trading matching.
[Figure 2-18] explains trading matching and settlement matching focusing on the basic process, and in major countries such as the United States, Japan, and Korea, which process the settlement matching using an STP-based matching system provided by the CSD.
18 In the market, this transaction confirmation is called locked-in. 19 In the market it is called confirmation & affirmation. 20 In practice, a global custodian, which has a contractual relationship with foreign investors, appoints a local custodian, and foreign investors and the local custodian do not know each other in many cases. [Figure 2-18] Foreign Investors’ Securities Trading and Matching Process
Trading Order (T) ① Notify Execution (T) ② Securities Foreign Investor Split Execution (T) ③ Company Trading Report (T) ④
⑤ ④ ⑥ Trading Checking ⑦ Settlement Settlement Report Settlement Instruction ~ Settlement (S) ② ④ (T~T+1) Condition (S) (T~T+1) Trading Matching Matching ( , ') ④ ⑤
Local Global Custodian Custodian 'Settlement Instruction (T~T+1) ⑤
Source: Author’s own.
1) Trading Matching in Korea 153 CHAPTER In Korea, a trading comparison between direct market participants is completed on the
transaction date through locked-in comparison. However, because of the incompleteness of 02 the STP business base of some entities, a trading comparison for foreign investors involves Establishment of Infrastructure for Cross-border Securities Trading some manual processes such as the use of telephone and fax, and manual input.
As shown in [Figure 2-19], the securities company delivers the details of trade execution (notification of execution to investors) to the foreign investor by phone, email, or Bloomberg at the time of execution. After the securities market is closed, the foreign investor will give a split instruction to each local custodian through fax or email, and the securities company will manually enter the split instruction details into the ledger of the foreign investor. Subsequently, the securities company notifies the foreign investor of the result of split trading through fax or email.
On the other hand, domestic large securities companies and foreign securities companies are expanding the use of “Oasys Global,” the Omgeo’s21 trading matching system.
Trading matching for Cross-border securities transactions is provided by Oasys Global, through which Korean securities companies handle 20–50%22 of the trading matching of
21 Omgeo was an American company that provides solutions for post-trade and pre-settlement processes to securities companies and institutional investors (including foreign investors). In May 2001, DTCC and Thomson Financial jointly established (50% investment), and in September 2013 it became a wholly owned subsidiary of DTCC. 22 This ratio is the data that KSD employees visited and surveyed about 10 Korean securities companies. transactions by foreigners. The major processes handled by Oasys Global are shown in the following figure.
[Figure 2-19] Status of Oasys Global Usage
Order (Phone, E-mail, Fax, Bloomberg) ①
(Block) Notify Execution (Phone, E-mail, Fax, Bloomberg) ② In-house System
’ (Block) Notify (Block) Notify ② ② Execution Execution ’ Block Matching Foreign ③ ( vs ) Split Execution ② ③ ’ Split Execution Investor ③ ③ Global Koscom ’ Partial Matching System System ’ Trading Report ④ Trading Report ④ ( vs ) ④ ③ ④ ( reflect the ledger) ⑤ Trade Approval ’ Trade Approval ⑤ ⑤ Oasys Global (Domestic) Omgeo Securities Company
* For notification execution, some means other than Oasys Global are used.
Source: Author’s own. 154 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 2) Settlement Matching
STP-based settlement matching is partially made through the Institutional Investor Settlement System operated by KSD, SWIFT, etc. First, a securities company notifies the trade execution of a foreign investor to KSD through the computer-to-computer (CCF) method on day T after the market is closed.
KSD delivers the transaction details of each foreigner received from the securities company to the local custodian designated by the foreigner. Most local custodians use the method of downloading through the web.
On the other hand, local custodians mainly use SWIFT to receive settlement instructions from global custodians, and local custodians notify their intention to settle through the KSD’s Institutional Investor Settlement after affirming between the settlement instruction from global custodians and the details of the execution provided by the KSD.
The KSD registers the relevant data, which has been completed for settlement matching, and conducts DVP between the securities company and the local custodian in connection with the Bank of Korea. [Figure 2-20] Institutional Investor Settlement Processes for Foreign Investor Securities Transactions
Trade Report Trade Report ① ① ② (Web) (Web, Batch) Settlement Instruction Approval for ④ (SWIFT) Local Settlement (Web) KSD Custodian Global Settlement (Institutional Settlement Securities ⑤ Invenstor ⑤ Custodian ③ Details (Web) Details (Web) Company Affirmation Settlement (Match vs ) Notify System) Notify ① ② ⑦ ⑦ the Completion the completion of Settlement of Settlement (Web) (Web)
DVP (CCF, On-Line) ⑥
Bank of Korea
Source: Author’s own.
Cases in the US and Japan 155
1. United States CHAPTER
• DTCC and Thomson established Omgeo, a 50:50 joint venture with the goal of establishing a 02 matching system to realize T+1, in May 2001. Establishment of Infrastructure for Cross-border Securities Trading
- Then, in September 2013, DTCC acquired all 50% of Thomson’s stake, and Omgeo became a 100% subsidiary of DTCC.
• Omgeo provides various matching systems by inheriting the existing settlement matching system TradeSuite and the trade matching system OASYS.
• The use of Omgeo’s Central Trade Manager (CTM) is increasing for foreign investors’ securities transactions.
- CTM features real-time central matching, settlement instruction notification, and ISO 15022 message adoption. Continued
Omgeo System
- OASYS: Supports the trade matching of securities transactions (split instruction, trading report, etc.) in the US
- OASYS Global: Supports the trade matching of Cross-border securities transactions (split instruction, trading report, etc.)
- CTM: Supports trade matching and settlement matching (settlement instruction, etc.) for domestic and Cross-border securities transactions
[Figure 2-21] Omgeo’s CTM Process Flow
Omgeo ① (Block) Notify Execution Split Trade Matching ② Execution ’ Split ② Securities Institutional Central Matching Execution Trade Report ’ Block Matching (①VS②) Company ③ ② Investor ’ Split Matching (②VS③) Trade Report Trade Approval ③ ③ ④ Trade Approval Settlement Notification ④ 156
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market ⑤ Global / Settlement ⑤ Instruction ⑤ Settlement Local Settlement Settlement Instruction Instruction Agent Custodian DTC (DVP)
Source: Author’s own.
2. Japan
• In September 2001, Japan Securities Depository Center, Inc. (JASDEC) established a Pre- Settlement Matching System (PSMS) with the recognition that a trade comparison system is required for STP and T+1 settlement.
- PSMS supports trade* and settlement matching for domestic securities transactions.
* In Japan, as the fund splitting process is complicated, PSMS does not accept block matching (between execution notification and split instruction), and only supports split matching (between split instruction and trading report).
• Unlike domestic securities trading in Japan, PSMS only supports settlement matching for securities trading by foreign investors.
- PSMS’s settlement matching service features central matching, CCF (online) connection, and ISO 15022 message adoption. Continued
[Figure 2-22] JASDEC’s PSMS Process Flow
Settlement Settlement ① JASDEC ① Instruction data Instruction data (MT 540-543) (MT 540-543) PSMS
Matching Result Matching Result ③ ③ (MT 548, 578) Matching 1 (MT 548, 578) ② ( vs ) ① ① Local Settlement Settlement Securities ④ ④ Custodian Instruction Data Instruction Data Company Update (MT 599) Matching 2 Update (MT 599) ⑤ ( vs ) ④ ④ Completion of Completion of ⑥ ⑥ Settlement Settlement Instruction Data Instruction Data Update Update (MT 548, 578) (MT 548, 578) Settlement ⑦ Instruction
Book-entry system
157
Source: Author’s own. CHAPTER 02
B. DVP Support Establishment of Infrastructure for Cross-border Securities Trading
Delivery Versus Payment (DVP) is the most powerful system to eliminate principal risk. DVP is divided into the following three categories, and DVP Ⅱ is mainly used for settlement of foreign trades.
DVP Types and ComparisonSection DVP I DVP II DVP III
(Securities Leg) Gross, (Securities Leg) Gross, (Securities Leg) Net, Definition (Fund Leg) Gross (Fund Leg) Net (Fund Leg) Net
• Small number of transactions Trading • Many transactions among the limited (clearing) member • Big quantity per one Specification • Small quantity per one transaction transaction
Regular Market Adopting OTC OTC Equity Market (Equity and Small Bond Market (Bond Market) (Mainly) Market)
ContinuedSection DVP I DVP II DVP III
• Since securities leg is settled trade by trade base, market • CCP function is not required. • The securities market can get can easily solve the grid-rock. Advantages • Responsibility of Credit Risk the largest netting effect and • Because fund leg is settled by is clear and limited. lowest settlement cost. Netting base, market can get netting effect.
• The participants should pay the highest settlement cost. • The securities market needs • If one or plural party fail • In case of Back-to-Back to complicated and effective one's settlement obligation, Disadvantage Trades, the Participants are risk management system the occurring possibility of easily exposed to grid-lock to control credit risk due to system risk is the largest. due to one party's lacking of securities delivery first. balance.
Source: Korea Securities Depository.
Meanwhile, KSD includes foreign transactions in OTC institutional settlement systems. OTC Stock institutional settlement refers to the settlement between a securities company and its institutional investors (including foreigners) following transactions such as stocks in 158 regular markets and other markets, and it handles Exchange Traded Fund (ETF), certificate Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market of preemptive right to new stocks, company warrants, Equity Linked Warrant (ELW), beneficiary certificates and depositary receipts (KDRs), as well as stocks.
In OTC stock institutional settlements, the KSD, as a central counterparty (CCP), is responsible for trading comparison, debt takeover, netting, confirming settling securities and payment, and settlement guarantee, and as the central securities depository(CSD), is in charge of delivering securities and making payment. The features are briefly introduced below.
1) Settlement Cycle and Method
The settlement cycle is T+2, and the simultaneous settlement method is DVP Ⅱ defined by BIS. Securities settlement is a two-step process: a book entry between the selling member’s account and the KSD’s account (securities book-entry delivery), and a book entry between the KSD’s account and the buying member’s account (completion of securities book-entry delivery). Settlement amount is calculated by netting.
i. Local custodian’s affirmation
A local custodian is notified of the transactions of their clients, the foreign investors, through the KSD’s FundNet on the trade day (T date), and of a settlement instruction from the global custodian until T+1 day. It matches the two details (transaction details and settlement instruction) and notifies the KSD of the approval for settlement if the two are not different. The KSD confirms the received settlements as DVPⅡ settlements.
If the two details are different, or the arrival of the settlement instruction is delayed, it is designated as an exception for settlement and treated as an exception to a case-by-case settlement date.
ii. Conditions and execution of book entries
The characteristic of DVP Ⅱ is that the delivery of securities precedes each settlement. Therefore, the KSD sets three conditions for executing a book entry from the time when the selling member’s securities are delivered through book-entry transfer to ensure the buying member’s payment to the selling member.
Conditions for the selling member’s securities balance ① 159 The selling member must meet the condition of the securities balance. In other words, CHAPTER the total shares of securities deposited, the securities to be received,23 and the transferrable collateral designated securities in the selling member’s account must be greater than the 02 Establishment of Infrastructure for Cross-border Securities Trading quantity of the settlement securities.
[Figure 2-23] Conditions for the Securities Balance of the Selling Member
Seller's Settlement Account
KSD's Settlement Account Nontransferable Securities
Transferable Securities
Securities Transferable to Be Received Transferable Securities Securities Designated as a Collateral
Source: Author’s own.
23 “Securities to be received” refers to securities deposited in the KSD’s settlement account as securities executed by another member as a buyer. Securities to be received can be disposed of by the KSD if the relevant member fails to settle the payment, thus perform- ing the same function as collateral. ② Conditions for the buying member’s net debt cap
The buying member must meet the conditions of the net debt cap. In other words, the deductible amount, including the settlement amount for the book-entry transfer, must not exceed the net debt cap. The net debt cap for each member is KRW 100 billion, but it will be raised to KRW 200 billion in the future.
[Figure 2-24] Conditions for the Net Debt Cap of the Buying Member
Net Debit Cap Total Amount to Be Total Paid The Amount Amount to Be after Received Netting
160
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Source: Author’s own.
③ Conditions for the buying member’s margin
The buying member must meet the conditions of the margin. Including the settlement amount for the book-entry transfer, the calculated margin must be zero or more. The margin refers to the balance after deducting the deductible amount from the secured assets, and the secured assets are composed of securities to be received, collateral designated securities, and settlement funds.
[Figure 2-25] Conditions for Margin
Securities Margin to Be Received
Securities Secured The Desingated as Assets Amount Collateral after Netting Clearing Fund
Source: Author’s own. KSD confirms settlements that satisfy the book-entry transfer conditions in an online batch method from 9:00 a.m. to 4:10 p.m. (the book-entry transfer deadline) and delivers the securities deposited in the selling member’s account to the KSD’s account through book- entry transfer.
iii. Completion of book-entry transfer (= Completion of securities settlement)
KSD executes book-entry transfers of securities from the KSD’s account to the buying member’s account from 9:00 a.m. to 4:10 p.m. when the following requirements are met.
This applies to the case where all securities have been delivered by the securities company, and the case where the securities company has settled all the payments. That is, the securities are first delivered (book-entry transfer) to the securities company with no debt related to the settlement.
iv. Payment
161 KSD prepares and manages the fund record book to calculate the payment for DVP Ⅱ, CHAPTER which is prepared in the following way from 9:00 a.m. to 4:10 p.m., the book-entry transfer time limit. 02 Establishment of Infrastructure for Cross-border Securities Trading
An increase is recorded in the buying member’s fund record and a decrease in the ① selling member’s fund record when the book-entry transfer is executed.
An increase is recorded in the member’s fund record when a member deposits a ② payment promotion amount and a decrease in the member’s fund record when the amount is returned. The payment promotion amount is the money that a member deposits to the KSD to facilitate securities settlement.
After completing the securities settlement, the KSD confirms the payment amount ③ for each member based on the fund records and notifies the members. The paying member settles the amount to KSD’s account established in the BOK until 4:50 p.m., the deadline for payment. KSD completes the settlement by transferring the amount to the receiving member’s account. [Figure 2-26] KSD DVP II Process Flow (I)
Financial Institute Trade Report (T) Trade Report (T) (Fund Manager, Trade Matching Foreign Instruction (T) Investor, Etc.) Instruction by Manager (T) Settlement Matching Settlement Settlement Approval (T+1) Fund-Net Approval (T+1)
Settlement Report Member Settlement Confirmation Settlement (Broker/ Statement Statement Dealer) (T+1) (T+1) Securities Local Settlement Securities Securities Custodian Settlement [KSD] Settlement (Completion, T+2) (Completion, T+2)
Cash Memorandum A/C
KSD’s Account Fund Fund Payment (T+2) [BOK] Payment (T+2)
162 Source: Korea Securities Depository. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
[Figure 2-27] KSD DVP II Process Flow (II)
The Bank The Bank KSD of Korea of Korea Non-BOK Settlement Member Agent bank Cash Transfer Payment Result → Settlement Transfer Agent Amount List KSD’s A/C Transfer Bank’s A/C per paying Cash Agent Result Agent Bank → KSD’s A/C member Transfer Bank’s A/C Transfer Result → BOK Cash Transfer Paying KSD’s A/C BOK Member’s A/C Settlement Receiving Member →KSD’s A/C Conditions Cash Member’s A/C Transfer Member Transfer Result
Net Settlement Fund Net Settlement Fund (Debit Balance) (Credit Balance)
Source: Korea Securities Depository.
2) Settlement Risk Management
KSD has been introducing and operating the following system to manage the risks of the stock institutional settlement system, the settlement system for foreign trading. i. Settlement liquidity supply and settlement delay fine: This refers to a system that supplies liquidity and imposes penalties for delayed payment to prevent the delay of settlement.
ii. KSD’s CCP role: Securities settlements and money settlements are performed separately because of the nature of DVP Ⅱ. Therefore, the KSD, as a CCP, guarantees trade settlements by acquiring debts.
iii. Net debt cap: This refers to a device to limit the risk that can be caused by the member’s default settlement. The KSD sets a certain amount of net debt cap for each member and manages a member’s deductible amount not to exceed the net debt cap whenever a securities book-entry transfer is executed.
iv. Clearing fund accumulation: It has been prepared to compensate for damages caused by a member’s inability to pay the settlement amount because of the lack of liquidity. The KSD has accumulated KRW 50 billion, and assesses the appropriateness of the accumulated amount through risk analysis quarterly. 163 CHAPTER 3.3.2. Outbound (Focused on Post-trade Infrastructure) 02 Establishment of Infrastructure for Cross-border Securities Trading As mentioned above, institutional investors in Korea were allowed to invest in foreign currency securities in June 1988, and individual investors were allowed to do so in 1994.
Koreans can invest in foreign securities through indirect investment such as fund joining and direct investment by directly buying stocks listed in the foreign stock markets. This report intends to explain methods focusing on the foreign currency securities settlement system, the infrastructure operated by the KSD.
3.3.2.1. Korean Investors’ Order to Trade Foreign Currency Securities
If investors want to trade foreign currency securities in a foreign stock market in Korea, they must entrust a securities company to trade foreign currency securities. For this, they must enter into an agreement for trading foreign currency securities with an investment broker and open an account for foreign currency securities transactions.
In such a case, the securities company entrusted with foreign currency securities trading needs to send, receive, and exchange foreign currency following the trading or rights exercise of foreign currency securities through a “foreign currency account exclusive for foreign currency securities investment” established in a foreign exchange bank in the name of the investor or the securities company.
The investment broker who has been entrusted with the trading of foreign currency securities from an investor opens an account in a foreign securities company or a foreign financial institution and classifies the investor’s trading orders and make orders through this account. In this case, the investment broker should notify the foreign investment broker of the item, quantity, price, and item number used in the foreign stock market and inform them of the fact that settlement is processed through the KSD.
3.3.2.2. Korean Investors’ Settlement for Foreign Currency Securities Trading
When an institutional investor in Korea acquires foreign currency securities from a foreign stock market, it can perform the settlement or custody of foreign currency securities using a global custodian or an international central securities depository, such as Euroclear.
However, the investors (corporate or individual investor, etc.) other than institutional 164 24
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market investors must be entrusted to a securities company, and the securities company should perform settlement, and deposit and manage foreign currency securities through global custodians designated by the KSD under the Capital Market Act.25
The obligatory deposit of foreign currency securities to the KSD is a measure considering for small investors who have difficulties in designating a custodian in foreign countries. In addition, other important purposes of the measure include protecting investors’ property and rights, and reducing transaction costs through economies of scale by centrally managing the acquired securities through the internally and externally reliable domestic CDS.
A. Establishment and Management of Foreign Currency Securities Accounts
Institutional investors have no obligation to use the KSD’s foreign currency securities settlement system, but if needed, they can become a foreign securities depositor by applying for opening an account for the deposit and settlement of foreign currency securities. General investors open an account for foreign currency securities investment in a securities company, and the securities company becomes the depositor of foreign currency securities and manages the foreign currency securities through KSD.
24 Foreign Exchange Transaction Regulations Article 7-33. 25 Article 75 of the Capital Markets Act. [Figure 2-28] Opening an Account for Foreign Currency Securities
Open Open Open foreign currency foreign currency foreign currency securities securities securities trading a/c deposit a/c custody a/c
General Investor Securities Company (Client) (Depositor) KSD Global Custodian
(manage client’s a/c) (manage depositor’s a/c) (manage client’s a/c)
Source: Author’s own.
B. KSD’s Appointment of Global Custodians
To centrally deposit foreign currency securities, the KSD has appointed custodians with global reputation and expertise as global custodians. The KSD shall notify the securities companies when such a qualified foreign custodian is appointed.
As of the end of December 2019, the KSD is in charge of appointment, custody, and 165 CHAPTER settlement as follows. 02
[Figure 2-29] KSD Cross-border Outbound Settlement Establishment of Infrastructure for Cross-border Securities Trading
Global Market Sub-custodian Local CSD Custodian Available
U.S CITI NY DTCC
Hong Kong CITI HK CCASS Direct Clients CITI Japan CITI Tokyo JASDEC
China CITI Shanghai SD&C Securities Settlement Instruction /Confirmation Company (SWIFT) Europe HSBC Local NCSDs HSBC Middle East HSBC Local NCSDs Settlement Instruction /Confirmation KSD (SAFE+) Africa HSBC Local NCSDs Euro clear Institutional Eurobond Local Investor NCSDs Market Custodian Clear stream 36 Markets
Source: Author’s own.
Status of Global Custodians (As of December 2018) (Unit: USD 100 M)Headquarters Custodian Name Area Remarks Location
Euroclear Brussel Europe (euro bonds), Russia
Clearstream Luxemburg Europe (euro bonds), Russia
8 countries including North America, Citibank New York Hong Kong, Japan, Vietnam, and India Total: 436.2 27 countries including Europe, China, HSBC London Indonesia, and Thailand
Mirae Asset Securities Brazil Sao Paulo Brazil
ICBC Beijing China
Source: Author’s own.
[Figure 2-30] Legal Basis for KSD Cross-border Outbound Settlement
Regulation on Regulation on 166 Foreign Exchange Foreign Securities Capital Market Act Investment
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Act Deposit & Services Settlement
Capital Market Act of Korea
Contents Articles
Eligible - Foreign Securities are legally regarded Foreign - Article 2 & 4 of Act as “Securities.” Securities
- Foreign Securities invested by Individual - Article 75 of Act Investors through brokers and dealers Centralized Deposit - Foreign Securities invested by Financial Investment Service Provider (Except Banks - Article 61 of Act and Insurance Companies)
Source: Author’s own.
C. Custody and Management of Foreign Currency Securities and Investment Funds
Foreign currency securities invested by Korean investors are kept in accounts in the name of the KSD in a global custodian.
Instead of being remitted to the domestic market, funds and the exercise of rights can continue to be deposited in the foreign currency accounts. In this way, an investor can settle with the deposited funds without paying the transfer/exchange fee of foreign currency funds when purchasing foreign currency securities.
D. Settlement of Foreign Currency Securities Transactions
i. Prepare for settlement: When a general investor trades the foreign currency securities, he/she should request a trading order to a domestic securities company. When buying, he/she must deposit the purchase money and commission before ordering. When selling, he/she must deposit the total securities to be sold at KSD through the securities company before ordering. This is the same when institutional investors use KSD.
ii. Settlement instructions: As described above, as the trade order is delivered to a foreign securities company through a domestic securities company, and the securities that have been traded are stored in a global custodian in the name of KSD, the settlement of the traded securities is made in two steps: a foreign 167 settlement between the global custodian and the foreign securities company, CHAPTER and a domestic settlement between domestic securities companies and domestic
investors. 02 Establishment of Infrastructure for Cross-border Securities Trading
The foreign settlement is made according to the settlement date set by the foreign stock market. However, considering the time difference between the trade and receiving a settlement report confirmation from the global custodian, the domestic settlement applies the settlement cycle of the foreign country by setting the trading date as the contract date based on Korean time.
For example, in the US, where the settlement date is T+2 business days, securities traded on April 1 are settled on April 3. However, April 1, the trading date in the United States, corresponds to April 2 in Korea. Therefore, the domestic settlement is made on April 4, two business days after the contact date, April 2.
iii. Settlement and recording in the account book: The effective date of settlement is the actual settlement date, not the contractual settlement date agreed with the settlement partner at the time of the trading. KSD records in the depositor’s account book of the foreign currency securities on the day when receiving a settlement report confirmation from the global custodian (based on Korean time), as well as the effective date of settlement (actual settlement date in the foreign country) specified by each global custodian for each settlement case. KSD notifies the depositor of the foreign currency securities if settlement is not made in the foreign country, and it manages the securities as unsettled securities in the depositor’s account until instructed by the depositor.
iv. Flow of foreign currency funds following the trading settlement: When foreign currency securities are purchased, the transfer is made from the foreign currency account in the name of the client to the foreign currency account in the name of KSD established in the global custodian. In addition, it is possible to pay for the purchase with the money deposited in the foreign currency account in the name of KSD in the global custodian.
The selling money is transferred to the foreign currency account in the name of KSD in the global custodian when an investor sells foreign currency securities ⇒ (foreign currency account in the domestic securities company) ⇒ investor’s foreign currency account. In addition, if the investor wants, he/she can deposit the selling money in the foreign currency account in the name of KSD.
168
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market v. Exercise of the rights of deposited foreign currency securities: For all foreign currency securities deposited by KSD in global custodians, the rights are secured in the name of global custodians and ultimately distributed to KSD, depositors, and the clients of depositors. At this time, the effective date of rights in the foreign country is recorded in the depositor’s account book and the investor’s account book, and the number of deposits for each investor will be readjusted according to the record date for the rights in the foreign country.
vi. Tax processing on foreign currency securities income: Income such as dividends and interests from foreign currency securities is generally received after (foreign) tax deduction in each foreign country according to the tax agreement between Korea and the issuing country, and if it is necessary to collect additional tax in accordance with the domestic tax law, the balance after deducting the tax is paid to the foreign currency securities investor. For example, under the situation where the Korean interest income tax rate is 14%, Korea and Japan have signed a tax agreement. When an investor who invests in Japanese bonds receives interest, he/ she will be paid after 10% of interest income tax in Japan, and 4% of the remaining amount is paid in Korea.
Strength of KSD Global Custody Service Investor Protection Low Cost• Cross border investments charge high costs compared to • Segregate deposit of ordinary investor's assets from the local investments. investment brokers. • Economy of scale by centralized deposit enables KSD to • Safe and efficient custody service through world leading have high bargaining power against global custodians so global custodians. that reduces investment cost of investors.
Single Gateway to Multi Markets Identical IT Platform to Local Securities
• Investment brokers use the same IT platfrom of KSD • KSD is the single gateway to the multi markets for ("SAFE+") for foreign currency securities business as korean investors. Korean local securities so that no additional system implementation is not necessary.
Source: Author’s own.
[Figure 2-31] Flow of Foreign Currency Securities Settlement
Domestic Market Global Market 169 CHAPTER 02 Trading Trading General Order Domestic Order Foreign Execution Global Establishment of Infrastructure for Cross-border Securities Trading Investor Securities Securities Exchange Company Execution Company Report
Settlement Settlement Instruction Confirmation
Settlement Instruction Settlement Global Global Settlement Custodian CSD Confirmation
Source: Korea Securities Depository.
3.3.3. Legal Basis for the Exercise of Rights
The custodian of a foreign investor should ensure that the securities in custody are deposited at KSD. In this case, the custodian becomes the depositor who opened the account at KSD, and the foreign investor becomes the client of the custodian. Accordingly, the depositor account book for recording and managing the custodian’s deposited securities details is prepared and stored at KSD, and the investor account book for foreigners’ holding securities at the custodian.
The basis for the Capital Market Act in this regard is as follows.
Artcle 315
Artcle 315 (Exercise of Rights by Beneficial Shareholders)
(1) Co-owners of stocks of deposited securities (hereinafter referred to as "beneficial shareholder") shall be deemed to hold stocks equivalent to a co-ownership share under Article 312(1) in exercising rights as a shareholder.
(2) Drop
(3) Where as issuer of stock certificates of deposited securities specifies a certain period or a certain date pursuant to Article 354 of the Commercial Act, the issuer shall immediately notify the Securities Depository of such fact, and the Securities Depository shall immediately notify the issuer concerned or the transfer agent of the matters referred to in the following subparagraphs with respect to benefical shareholders on the fist day of the period or on the specified date (hereafter in this Article referred to as "specified date for the closing of the roster of shareholder"): 1. Names and addresses; and 2. Type 170
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market and number of stocks under paragraph (1).
Artcle 316
Artcle 316 (Preparation of Register of Beneficial Shareholders)
(2) The statement in the roster of beneficial shareholders with respect to stocks certificates of which are deposited in the Securities Depository shall have the same effect as the statement in the roster of shareholders.
On the other hand, it is also possible for foreign investors to designate KSD as a custodian and open a direct account to keep acquired securities. In either case, the exercise of the rights by foreigner is carried out in the same way as that of Koreans.
In the following, the basic functions of infrastructure supporting the exercise of rights of the securities held by foreigners and deposited at KSD through local custodians will be explained.
First, the order of making a beneficial shareholder list is as follows. [Figure 2-32] Order of Making a Beneficial Shareholder List
Notification ② of Record Date & Request for Beneficial Share Notification Notification Participant ① ① Holder List of Record Date Issuing of Record Date of KSD Beneficial (Custodian, KSD Company Share (Transfer Securities Notification Notification Individual ③ ④ Agent) ⑥ -holder Company) Beneficial Share Beneficial Share Notification Holder List Holder List for Beneficial Making ⑤ Shareholder Shareholder List
Source: Author’s own.
After a beneficial shareholder list is prepared, the shareholders’ register is made by merging shares of each shareholder, and the exercise of rights can be applied according to the schedule announced by the issuing company.
If a beneficial shareholder applies for the exercise of rights through his/her local custodian, KSD applies for and receives the rights against the issuing company.
171 [Figure 2-33] Structure of Foreigners’ Rights Exercise CHAPTER
② Apply CA ③ Apply CA ④ Apply CA 02
Beneficial Issuing Establishment of Infrastructure for Cross-border Securities Trading Local Share KSD Company ⑦ Custodian ⑥ ① Announce (Transfer -holder Distribute Distribute CA Schedule Agent) CA Fruit CA Fruit ⑤ Receive CA Fruit
① Announce CA Schedule
Source: Author’s own.
On the other hand, the rights exercise services provided by KSD are divided into services for foreigners and services for all shareholders (including foreigners).
Overview of KDS’s Rights Exercise ServicesEntitlement Event Provided Services
Foreign Proxy voting on behalf of foreign shareholder (beneficial owners) Exercise of Investor Voting Rights Issuer Proxy voting on behalf of SPAC (Special Purpose Acquistion Company) shareholder
Distribution of Stock Support for subscription, receipt and payment of dividends for shareholder (beneficial Dividends, Paid-in Capital owners) Increases and Bonus Issues
ContinuedEntitlement Event Provided Services
Securing Rights in Merger or Securing and allocating shareholder (beneficial owner)'s rights in merger or reduction Reduction of Capital of capital
Support of the exercise of request for purchase from shareholders (beneficial owners) Exercise of Appraisal Rights who notify opposite intention
Untransferred Shares and Receipt and management of dividend payments and bonus stock accrued by investors Dividends of Unclaimed who held share certificates in physical from after withdrawing from deposit and did Shares not transfer the title by the record date.
Source: Korea Securities Depository.
3.4. Implications from KSD’s Case
3.4.1. Inbound
Investors who invest in Korea often use global custodians for stocks and ICSDs for bonds, so the KSD, one of the representative Finance Market Infrastructures (FMI) in Korea, has 172 developed and operates an STP-based matching system and a DVP II-based simultaneous Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market settlement system to efficiently handle related tasks under the PFMI. The right exercise support system for exercising rights of foreign beneficial holders is also operated in the same way as that of Korea. Moreover, the above infrastructures are not systems exclusively for foreigners. The matching system and DVP Ⅱ system were first developed and operated for the trade matching and settlement of Korean institutional investors, and then modified and applied to foreign investors.
The rights exercise system is operated in the same way as that of Korean (individual and corporate) investors.
In other words, by modifying and operating the domestic infrastructure (systems and practices) in the Korean market to meet global practices, instead of establishing a separate infrastructure for foreign investor transactions, the same infrastructure is provided to investors locally and abroad. Moreover, the goals of infrastructure, such as improving efficiency, reducing transaction costs, and strengthening global competitiveness, have been achieved through the efforts.
3.4.2. Outbound
The greatest characteristic is that the KSD, as the CSD, operates a foreign currency securities settlement system for individual investors of Korea. This is meaningful, as this enables investors such as individuals and institutional investors who cannot open a settlement account26 at global custodians or ICSD because of relatively small funds. By gathering them into a KSD account, the KSD has increased efficiencies such as providing Cross-border trade opportunities, improving the accuracy of post-trade processes, and saving related costs. However, the burden of the CDS increases as the size and type of risks vary and increase depending on the partner countries and trading quantities. Accordingly, the KSD needs to enhance task performance and risk management abilities.
4. Recommendations for Establishing Cross-border Securities Transaction Infrastructure in the Mongolian Stock Market
4.1. Principles for Establishing Recommendations
4.1.1. Minimize Negative Impacts 173 CHAPTER
The negative impact of the opening of the capital market is that it may distort the stock 02 market structure. In other words, foreign investors can influence the market with enormous Establishment of Infrastructure for Cross-border Securities Trading capital power if the stock market is relatively small. In this case, the stock market may be confused by short-term capital movements driven by international speculative capital, or by unreasonable prices because of the manipulation of specific capital or funds in pursuit of short-term profits. Therefore, to minimize these negative impacts, a policy related to opening the stock market and establishing the infrastructure should be designed.
4.1.2. Phased Development Based on the Capabilities of the Mongolian Stock Market
The presence of institutional investors in the Mongolian stock market is negligible. At the same time, there are few foreign investors investing with long-term portfolio strategies. In this situation, it is premature to establish a matching system and a DVP system for foreign investors. Hence, it is reasonable to perform the functions manually, or by utilizing the existing systems until a certain level of participants and transactions are secured.
26 In this case, since settlements cannot be made, Cross-border trade is essentially impossible. 4.1.3. Mongolian Stock Market Infrastructure Meeting Global Standards
Foreign cases show that the adoption of global standards to the domestic securities market infrastructure is a way to increase efficiency and global competitiveness. Creating and operating Mongolia’s own standards will be another barrier to investment for foreign investors who are accustomed to global practices, and will lead to increased transaction costs.
In addition, as described above, there are few exclusive infrastructures for foreign investors, and they are often integrated with the infrastructure for institutional investors. To this end, the Mongolian stock market will need to foster experts on global standardization or seek ways to refer to foreign institutions’ cases through active cooperation.
4.1.4. Inbound is Required, Outbound is Optional
The inflow of foreign investors is essential for the quantitative and qualitative development of the Mongolian stock market. In particular, Mongolia needs foreign investors 174
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market who can invest scientifically with long-term strategies. There is also a need for foreign shareholders who can recommend that the corporate governance structure of Mongolia is aligned with those of developed countries. Hence, it is necessary to develop infrastructure that will attract inbound investment in advance.
On the other hand, as seen in the case of Korea, building an outbound infrastructure is rare for a CSD. Whether or not to build it depends on the MCSD’s choice and capabilities, but it seems premature to implement an outbound infrastructure at this time.
Accordingly, the recommendation model, implementation strategy, and tasks to be described below will focus on inbound related issues, excluding those of outbound.
4.2. Recommended Model for Establishing Cross-border Securities Trading Infrastructure
Through the interviews with MCSD and local custodians operating in Mongolia, the infrastructure elements (or system improvements) required to facilitate Cross-border securities trading in Mongolia have been investigated. All were related to inbound, and not a single issue belonged to outbound. In addition, Korea’s cases were investigated and described. In particular, ① Matching (especially Affirmation) system for foreign investors’ transactions, ② Simultaneous settlement system between foreign investors’ local custodian and securities companies (DVP Ⅱ), and ③ Corporate action system for the exercise of rights by foreign investors as shareholders are the key areas requiring attention. It is identified that laws are needed to recognize the legal ownership of foreign investors’ holdings recorded in local custodians’ register, which corresponds to the particular registration,27 one of the registration systems managing ownership in the Mongolian capital market through meetings with local custodians. To accomplish this, it is recommended to look at related cases of the KSD, which operates a beneficial shareholder system.
There are some additional requirements to establish the above system. First, it is required to adopt global standards. Second, it is recommended to develop and operate general-purpose systems that can be applied to the trades of (institutional) investors in Mongolia, as mentioned in Section 3.4.
5. Implementation Strategy (Inbound Only)
5.1. Deriving Tasks for Building a Recommendation Model 175
5.1.1. Matching System and DVP II System CHAPTER
The KSD originally named this part as an institutional investor settlement system, and 02 Establishment of Infrastructure for Cross-border Securities Trading recently changed it to an OTC settlement system. As shown in the name change, it was first introduced to improve efficiency and eliminate the risks of transactions by institutional investors in Korea, and grew into an integrated settlement system to settle all transactions including foreign investors’ settlement as well as settlement between clearing members in the regular market. To adopt this system, the Mongolian stock market is required to review the following tasks in advance.
First, the clearing membership system of MSCC, the MSE clearing body, should be changed. Currently, the MSE adopts the locked-in (trade matching at the time of execution) system, and as a clearing member, it grants clearing membership to local custodians as well as securities companies. As mentioned above, the local custodian cannot handle clearing under the same conditions with a securities company (Clearing Member), because it can settle (i.e., delivers the securities and receives the fund, or in reverse) according to the settlement instruction after completing the affirmation between the global custodian’s settlement instruction and the transaction details notified by the securities company (or matching system). Therefore, the current clearing membership system that recognizes a local custodian as a participant in the clearing body of a regular market should be changed.
27 Mongolia Securities Act 42.2. In addition, under the current situation—that is, before implementing the affirmation function as a system like the United States, Japan, and Korea—, the Mongolian stock market is required to establish processes for local custodians to perform affirmation.
It is possible that the global custodian’s settlement instruction is delivered on or after the settlement date. In other words, it is the case where settlement between the clearing member and its client, the local custodian, fails. To redress this, the Mongolian capital market authorities should consider the introduction and implementation of the continuous netting settlement (CNS)28 and the Buy-In29 system. This was also recommended through a separate report (Introduction of T+2 settlement cycle, etc.).
Second, the level of institutional investors should be expanded quantitatively and qualitatively, and foreign investors’ transactions should be revitalized. Attracting foreign investors depends on not only the level of infrastructure but also the quality, liquidity, and high return of stocks listed on the Mongolian stock market. However, far from the subject of this report, the issue will not be further covered, but it must be clear that this task should be
176 preceded by the third task below. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
Third and last, like the US, Japan, and Korea, the Mongolian stock market should separately install and operate a trade matching system for the OTC market to which foreign investors belong.
The trading matching between direct market participants (securities companies) and their clients (institutional investors, foreign investors, etc.) falls to a particular area, called post-trade∙pre-settlement, which requires the intervention (matching, confirmation, adding settlement information) from various stakeholders (investors, securities companies, (global or local) custodians, (depending on the type of investor) business management companies, ratings agencies, settlement banks, etc.). Accordingly, this area requires STP-based (global) standardization and automation processes to comply with the standardized settlement cycle (T+2).
The Mongolian stock market also needs a separate STP-based trading matching system to reduce transaction costs caused by the influx of foreign (institutional) investors. For benchmarking, KSD’s Fund-Net in Korea and JASDEC’s PSMS (Pre-Settlement Matching System) in Japan are recommended.
28 One of Settlement methods by netting the failed details with the next business settlement day. 29 How to close the fail situation by CCP directly buying the failed settlement quantity in the stock market and delivering it to the settle- ment counterparty. 5.1.2. Establishment of the Exercise of Rights
The Mongolian stock market established a clearing settlement system with T+2 settlement cycle (CCP, DVPIII, etc.), which complies with the PFMI. As a result, investors have gained confidence that settlements will be completed (i.e., securing the status of shareholders) without the principal risk, even in the event of the settlement fail or default of the counterparty.
Now is the time to establish a legal basis for rights to be exercised by foreign investors as shareholders and to ensure transparency and standardization of procedures. The related tasks are as follows.
First, a legal concept regarding the status of shareholders of foreign investors should be prepared. As described in Section 2.4, “Inbound, Outbound Investment Difficulties”, foreign investors who keep their shares in a local custodian that conducts “securities’ particular registration” under the Mongolia Securities Act are the beneficial shareholders. However, there is no clear basis for foreign investors to exercise their rights as shareholders in the 177
Securities Act. Accordingly, legal supplements are needed. CHAPTER
Second, along with the first task, the account structure and its best practices should be 02 Establishment of Infrastructure for Cross-border Securities Trading reestablished. The Mongolian stock market uses a direct registration method. Based on this, MCSD operates an integrated deposit and registration system. If the first task, the concept of beneficial shareholders, is introduced, the system and best practices related to the Omnibus Account (or nominee account) should be introduced as well. Currently, it is known that an Omnibus Account can be opened only by local custodians, but various disagreements are occurring because of unclear related laws, lack of mutual understanding between MCSD and local custodians, and undefined business system.
5.2. Proposed Road Map
The tasks suggested in 5.1 can be summarized as the solutions in the figure below. [Figure 2-34] Roadmap for Each Task
Launching New Clearing & Settlement Implementing the System Based on PFMI securities market ① However, the Clearing Membership matureity policy seems to be revised. ① Revising current CM ③ Creating a matching & Preparing Matching System(STP) and DVP Ⅱ (Affirmation) system (financial between the securities (manual base) institutional ② The concept of Beneficial company and foreign investors & Sharesholders should be included Investors (local custodian) foreign investors in the Securities Act. investment ② Including the legal vitalization etc) base of The concept of (Refer the topic3) Beneficial Sharesholder ③ It is necessary to create a matching system snd DVP II between the securities company and foreign ④ Making the clear role investors (Local Custodian). assignment & practice standardization between MCSD and Local Custodian
④ Clear role assignment and practice standardization between CSD and Local Custodian is necessary. 178
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Short Term Mid Term Long Term
Source: Author’s own.
The above solutions ①, ②, and ④ are considered to be performed in the short term in light of the capability and urgency of the current Mongolian capital market.
However, for solution ③, the maturity of the Mongolian stock market is a precondition. In the current situation where the transaction volume is low and the influence of institutional or foreign investors is negligible, a manual method (task ①) seems more economical and efficient. It is recommended to build automated systems in the future according to how the stock market develops. References
Bank for International Settlements, Cross-border Securities Settlements, 1995.
European Central Bank, The Securities Custody Industry, Occasional Paper Series No. 68, 2007.
Financial Supervisory Service, Guide to Investing in Korea, 2012.
------, Foreign Investment Trends (Each volume).
Korea Institute for International Economic Policy (KIEP), Foreign Capital’s Impact on Foreign Currency and Stock Market: Policy Implications for Stabilizing the Financial Market and Current Balance, Research Report, 2009, 09-17.
Korea Securities Depository, Market Statistics (Each volume). 179
Maya, David and Hugues Bessiere, Securities Services: The Good Times Are Over; It Is Time CHAPTER to Act, Oliver Wyman, 2015. 02
SWIFT, Cross-border Securities Market Infrastructure Links – Lessons and Perspectives for Establishment of Infrastructure for Cross-border Securities Trading Asia Pacific, 2017.
Trepanier, Thomas, Expanding Market Infrastructure through Service Providers, Omgeo, 2012. 03 CHAPTER
Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
Ho Yeol Lim (Tantan Global Network) Undraa Nursed (Ministry of Finance)
1. Overview 2. Current Status of Capital Market and Analysis of the Obstacles to Foreign Investment in Mongolia 3. Best Practices for Korea and Reference Countries Attracting Foreign Portfolio Investment 4. Policy Recommendation to Successfully Expedite Foreign Portfolio Investment 5. Implementation Plan
Keywords Mongolia, Capital Market, Foreign Portfolio Investment, Legal Basis, Market Infrastructure Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
Ho Yeol Lim (Tantan Global Network) Undraa Nursed (Ministry of Finance)
Summary
The purpose of this chapter is to make policy recommendations to the Mongolian government on measures to attract foreign investment in the Mongolian capital market.
The GDP growth rate of Mongolia is closely correlated with foreign portfolio investment 181
(FPI), and this phenomenon shows that maintaining good economic fundamentals is an CHAPTER important incentive for promoting foreign investment. The Mongolian economy has been 03 losing its growth momentum due to a sharp drop in foreign investment inflows since Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market 2013, and an analysis of the factors behind the contraction in investment has found some implications. First, foreigners’ interest and the boom and bust cycle of foreign investment are closely related to the structural limitations of the Mongolian economy, which is focused on the mining industry, and the country risk caused by inconsistency in foreign investment policies. Second, the regulatory framework is insufficient, and the development of products with high investment attractiveness is delayed. Third, the proportion of institutional investors is too low, at around 10%. Fourth, the transaction costs of the stock market (1.43– 3.18% of the trading amount) are too high, which constrains market liquidity around 5%. Fifth, transaction costs are mainly incurred at the post-transaction stage, and the efficiency of the capital market is considered low due to differences in IT systems between related institutions. Sixth, taxes on dividend earnings of stocks and capital gains of corporate bonds (CBs) are unequal between domestic investors and foreign investors.
To come up with measures to expedite foreign investment in Mongolia, we analyzed Korea’s experience in developing capital market and policy cases in other developing countries, including China, Nigeria, and Vietnam, which have undergone an economic development processes similar to Mongolia. Results of the analysis showed that, first, South Korea and China have long sustained inflows of FPI due to foreign investors’ high confidence on their growth potentials and economic fundamentals. Second, South Korea increased the predictability of its future through a five-year economic development plans, eliminated uncertainties about foreign investment, and maintained consistency in its investment policies. Third, high transaction costs, lack of attractive investment instruments, and excessive regulations may limit foreign investors’ opportunities to generate profits. Fourth, it is necessary to expand the base of institutional investors to strengthen the stock market’s safety plates and strengthen market liquidity. Finally, in terms of demand side in the stock market, it is necessary to refer to the People’s stock system and the Korea Stock Market Stabilization Fund. Korea’s Public Corporation Inducement Law and the Special Purpose Acquisition Company introduced to promote listing in terms of expanding supply base also deserve reference.
Based on the experience from Korea and other reference countries, we present several criteria to create an optimal investment environment in Mongolia. The first criterion is to establish the principle of capital market operation. Political and macroeconomic stability, sustainable economic growth, and expansion of growth potential of the stock 182 market are key investment incentives. In Mongolia, inconsistency of ownership rights and
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market procurement bidding, determining a license for political reasons, or revoking a license should not be repeated. Following the government switching to a market economy in 1992, the foreign investment policies have also continued to change as the ruling party has been replaced every four years. It will also have to improve external imbalances with active macroeconomic stabilization policies. The improvement of external imbalances and the expansion of foreign exchange (FX) reserves should proceed by reducing excessive foreign debts exceeding 200% of GDP.
Second, it should create an optimal environment for promoting Cross-border securities transactions. However, foreign investors’ assessment of Mongolian companies is low in terms of money laundering concerns, governance, transparency, and rule of law. In addition, enhancing the transparency of information disclosure by Mongolian state-owned enterprises (SOEs) will also contribute to creating a better investment environment. The third criterion is to strengthen the legal system on investment infrastructure. The fourth criterion is to remove institutional constraints that hinder FPI and to strengthen market infrastructure. For example, the IT system for transaction of MSE is not fully utilized and has a high cost of maintenance and service fee. In the securities industry, there are too many securities companies compared to the size of Mongolia’s capital market, and the profit structure of securities companies depends only on brokerage fees. Tax inconveniences for foreign investors and discrimination between Mongolian domestic investors and foreign investors should be eliminated. Fifth, measures to strengthen the capital market in terms of demand and supply should be devised. Meanwhile, the development of credit rating agencies is crucial to promote the development of the bond market. In the case of the Mongolian bond market, it may be advantageous in terms of cost to borrow at low interest rates through concessional financing provided by international organizations or bilateral cooperation with reference countries, rather than making up for the fiscal deficits through the issuance of domestic bonds.
Regarding policy recommendations to promote FPI in Mongolia, it is essential to create long-term investment environments through the establishment of capital market operating principles. First of all, a new legal clause protecting foreign investors regardless of government regime change should be established in the Foreign Investment Reinforcement Council or National Development Agency. In conjunction with this, the Mongolian Investment Law and Securities Market Law should also include clauses that strengthen the protection of foreign investors. It is also necessary to diversify the industrial structure and to create conditions for deepening capital markets. Along with the rapid development of the systemic investor response mechanism, the introduction of an investor ombudsman system to solve foreign investment disputes and grievances is also necessary. 183 CHAPTER
Second, general regulations on the OTC platform should be established to strengthen the 03 legal basis for foreign securities investment, and the primary market should be revitalized Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market by the readjustment of regulations between private placement and public offering. The introduction of new SPC-type mutual funds in addition to the LLC-type in the Company Law will contribute to the revitalization of the indirect investment market. The toxic clauses such as regulations on one fund–one operator and a mismatch between the standard date for exercising voting rights and paying dividends should be removed. In addition, tax inequality among domestic and foreign investors should be corrected immediately.
Third, it is necessary to improve market infrastructure, including reducing transaction costs and information disclosure. For example, it would be better to integrate IT systems among securities-related institutions and to computerize manual tasks that are being duplicated at the post-transaction stage. In particular, a plan to request support from the Korea International Cooperation Agency (KOICA) could be considered to integrate the IT system. Meanwhile, it would better to enlarge the size of securities companies through M&A. In addition, instead of lowering transaction fees, the government should also allow securities companies to operate business models other than brokerage business. It should also more improve the credit rating system to strengthen information disclosure, and allow foreign credit rating agencies to enter Mongolia. Fourth, in order to develop investment products in the capital market, innovative products such as the form of stock of working investment in the mining industry should be released. The government bonds (GBs) market needs to be revitalized rather than CBs issued at high interest rates. Therefore, if the IMF program is terminated, it is necessary to activate the secondary market with real-time reporting of GBs’ intraday transactions and the introduction of Repo service. It will have to introduce new products related to CBs and financial derivatives that attract foreigners in the OTC market.
Finally, in order to expand the capital market base, it would be better to make it mandatory to invest in the capital market more than a certain percentage of the assets operated by the Social Insurance Fund and the Pension Fund (e.g., 30% in stocks and 40% in bonds) in terms of demand. It would better to activate the People’s stock system, which was test-run in 2016, and to introduce the stock market stabilization fund during the period of instability in the stock market. In terms of supply, we propose policy ideas such as invigorating the IPOs of private blue-chip companies through the enactment of the Corporate Listing Promotion Act, and developing markets exclusively for small and medium- 184 sized enterprises and venture companies that benchmark Korea’s KOSDAQ and KONEX
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market markets.
To establish a desirable investment system that can drive the development of the Mongolian stock market, 26 tasks in five areas are divided into short-, medium-, and long- term tasks and a roadmap is presented. Short-term task to be improved within 1–2 years will be mainly internal development of the capital market such as advancing infrastructure. These include fostering the stock issuance and secondary markets and strengthening the demand and supply base in the securities market. Medium-term tasks to be improved within 3–5 years will include establishing principles for capital market operation, creating an environment suitable for Cross-border securities trading, providing various incentives, including tax benefits for foreign investors, and protecting investors. Long-term tasks, which will take more than 5 years, will include securing macro-prudential and financial stability by reducing the rapid inflow and outflow of foreign capital.
Fostering the FX market and financial literacy education are evaluated as important infrastructure in the capital market. However, due to the limitations of research period and coverage, this study was not fully covered. The high volatility of Mongolia’s Tugrik exchange rate and the depreciation trend are preventing inflow of foreign investment. The lack of a proper FX market and a non-deliverable forward (NDF) market reduces the attractiveness of foreign investment due to a lack of liquidity. Therefore, it is necessary to establish transparent legal procedures for FX transactions and develop instruments for FX hedge purposes, so that foreign investors can efficiently manage currency risks. Finally, financial literacy education is needed to expand investment bases. For example, most Mongolian should deeply realize the need for the People’s stock system to increase their income and form property. Finally, education and training are important to enhance the competence of officials in charge of implementing policy proposals at the Ministry of Finance, FRC, and Bank of Mongolia.
1. Overview
1.1. Challenges Facing the Mongolian Capital Market
After Mongolia changed from a planned economy to a market economy in the early 1990s, solid economic growth between 1993 and 2017 was achieved based on the rise in mineral prices and the expansion of overseas capital inflows into mining development. In response, the World Bank re-classified Mongolia from a low-income country to a middle- income country in 2007. Since the mid-2010s, however, the economy has contracted sharply 185 due to a fall in international mineral prices and a sharp drop in foreign direct investment CHAPTER (FDI), stemming from concerns that resource-dependent growth could fall into the middle 03
income trap due to external deficits. Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
The IMF program called Extended Fund Facility was introduced in May 2017, but GDP growth rate remained at 5.1% in 2019. Meanwhile, as of 2019, the banking sector accounted for 85% of Mongolia’s financial market. The capital market, on the other hand, was largely backtracked due to the high transaction costs and delayed development of the stock market and corporate bond (CB) market. The reasons for the lagging capital market are the lack of information disclosure by state-owned enterprises (SOEs), which account for more than 90% of listed companies due to the remnants of the planned economy, and the delayed listing of private blue-chip companies. In addition, the proportion of institutional investors, and the legal system and financial supervision, are also inadequate. Foreign investors are also turning a blind eye to the Mongolian capital market due to its financial system insufficient to international standards, opaque governance structures of SOEs and unstable exchange rates. The Financial Regulatory Commission (FRC), a non-bank institution oversight body, was established in 2006 and revised the Law of Mongolia on the Securities Market in 2013, but it is still in the process of overhauling detailed regulations, and lacks professional manpower and experience in managing policy.
Meanwhile, in 2019, the Mongolian stock market fell to the 17% of 2017 level, when the average daily trading volume hit a record high, while trading by foreign investor shrank 75% from 2012. In the secondary market, only about 20% of 198 listed companies are trading smoothly. The IPO market is dominated by privatization of SOEs, while Mongolian blue-chip companies are mainly directly listed in overseas securities markets, making it difficult for the domestic stock market to grow.
1.2. Literature Survey and Lessons
The Nomura Report (2017) evaluates the current situation of Mongolia’s capital market and presents the direction of development of the financial market. The report contends that Mongolia’s capital market is suffering from issues related to investor base, products, infrastructure, and the legal framework. It was pointed out that lack of shared direction for the capital market and limited capacity of the government. On the supply side, it assessed that there was a lack of opportunities to activate the market with low quality of stocks, non-utilizing of new listings, and inadequate regulations impeding the CB issuance. On the demand side, a lack of effort to promote the secondary market, limited efforts to attract
186 foreign investors related to tax incentives, and legal obstacles were assessed as hindering
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market the growth of institutional investors. In terms of infrastructure, problems pointed out included a lack of long-term planning for the overall IT systems, a post-trading environment that does not meet international best practice, and an underdeveloped intermediary preventing the development of efficient capital market for investors. Kihoon Ro (2019) analyzed four challenges and solutions for the Mongolian securities market. He pointed out that Mongolia’s capital market is facing challenges to expand the proportion of institutional investors, Cross-border investment, and reforming of post-trade practices with high cost and low efficiency. The study focuses mainly on cost reduction in post-trading stage rather than on inducement of FPI in the capital market. Japan International Corporation Agency (JICA, 2018) recommended that credibility of the Mongolian capital market be enhanced through improvement of supervision and regulation in Mongolia. Taguchi (2018) contended that the cumulative public debt and too high policy rate have stagnated the stock prices, through identifying the negative impulse responses of stock prices to the shocks of policy rate and GB under a vector-autoregressive model estimation.
These are studies on strengthening the foundation of the Mongolian capital market. However, they are not directly related to foreign investors’ inflow of investment into the Mongolian capital market. In this respect, this research sets itself apart from existing studies. 1.3. Research Purpose, Scope, and Structure
Mongolia’s economic development has been delayed due to its mining-oriented economic structure, a banking-oriented one-sided financial market, and high policy rates. Thus, for the economy to take a leap forward, the task is to diversify the industrial structure by expanding investment in non-mineral sectors and to raise long-term economic development funds by revitalizing the capital market. In this chapter, we want to present policy measures to promote the attraction of foreign investment in the Mongolian stock market, as diversification of financial instruments and inflow of foreign investment are essential to support the stable growth of the Mongolian economy.
The scope and structure of the analysis cover the investment status of Mongolia’s capital market and the inflow of FPI and identifying the impediments of FPI in Mongolia’s capital market system. This study will also analyze the successful policies that promoted foreign investment in reference countries, including Korea. Based on this, policy alternatives will be presented to facilitate the inflow of foreign investment into the Mongolian capital market.
187 CHAPTER 2. Current Status of Capital Market and Analysis of 03
the Obstacles to Foreign Investment in Mongolia Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
2.1. Analysis on Investment Situation of Mongolian Capital Market
2.1.1. Recent Development of Mongolian Capital Market
The capital market has been developing in Mongolia for 28 years, but it has yet to fulfill its role of raising long-term funding sources in the financial sector. This is partly due to the fact that 90% of the investors who invest in the Mongolian stock market are domestic individuals and entities such as small financial institutions. In addition, investors are more likely to seek profit from short-term stock price differences rather than making long-term investments. On the Mongolian Stock Exchange (MSE), stock trading began in 1995, while the CB market has started in 2001. Thus, foreign investment inflows into the Mongolian stock market started in 1997 and increasing from 2005 to 2012, accounting for up to 90% of total trade and in 2013 it suddenly dropped to 13% of total trade. With Mongolia’s economy recovering in 2017, the number of IPOs increased, and foreign investment also recovered to a level close to 40% of the stock market’s trading volume. However, stock market trading volume and foreign investment both fell sharply in 2019. [Figure 3-1] Trend of Stock Price Index in Mongolian Capital Market (1995–2020)
25,000
20,000
15,000
10,000
5,000
0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020.08.25
Source: Mongolian Stock Exchange (2020.8).
[Figure 3-2] Number of Listed Stocks (1992–2020)
500
400
188 300 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 200
100
0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 1992
Listed companies Newly listed companies Delisted companies
Source: Mongolian Stock Exchange (2020.8).
Current Status of Foreign Portfolio Investment in Mongolian Capital Market: All TransactionTotal Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
1995 811.5 0 0.0 0.0% 0 0.0 0.0%
2000 14,101.6 0 0.0 0.0% 324 71.6 0.5%
2005 11,979.2 4 454.7 3.8% 496 348.2 2.9%
2010 92,889.5 1,462 48,961,3 52.7% 3,474 7,610.9 8.2%
2011 351,130.8 3,110 91,400,0 26.0% 8,731 11,154.9 3.2%
2012 145,056.7 5,664 131,647.1 90.8% 3,065 2,738.1 1.9%
2013 98,609.2 3,476 10,968.7 11.1% 2,256 2,095.5 2.1%
ContinuedTotal Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
2014 60,358.5 2,328 3,815.2 6.3% 1,899 3,140.1 5.2%
2015 546,401.7 2,519 3,329.8 0.6% 802 5,906.7 1.1%
2016 348,684.8 1,992 1,797.4 0.5% 844 6,521.3 1.9%
2017 860,234.9 2,972 10,595.7 1.2% 1,902 24,318.6 2.8%
2018 245,212.9 1,955 89,176.7 36.4% 3,565 6,961.0 2.8%
2019 143,648.7 689 19,393.6 13.5% 1,957 14,518.1 10.1%
Total 3,276,199.0 30,976 466,026.5 14.2% 43,031 96,552.2 2.9%
Source: Mongolian Securities Central Clearing (2020.2).
[Figure 3-3] Investment Status of Mongolian Capital Market
100%
80% 189 CHAPTER 60%
40% 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market 20%
0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Total
Foreign entity Foreign individual Local entity Local individual
Source: Mongolian Securities Central Clearing (2020.2).
Considering the trading volume of Mongolia’s capital market by type of securities, the proportion of (CBs was less than 1% of the total capital market turnover. On the other hand, GBs accounted for 64.3% and stock 34.7% in terms of total trading volume since the opening of the capital market. The high proportion of GBs is attributed to the guarantee of a firm- rate return, which is higher than return of equity with more volatile prices, and the risk-free bond compared to CBs.
Current Status of Foreign Investment: Corporate Bond Market Transaction through MSE Total Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
2001 1,204.3 0 0.0 0.0% 0 0.0 0.0%
2005 2,663.7 0 0.0 0.0% 9 20.4 0.8%
2008 502.0 0 0.0 0.0% 1 2.0 0.4%
2011 4,394.5 5 164.6 3.8% 23 435.9 9.9%
2012 309.7 5 265.2 85.6% 7 44.6 14.4%
2015 459.6 0 0.0 0.0% 2 2.6 0.6%
2017 10,295.6 0 0.0 0.0% 13 299.9 2.9%
2018 723.7 0 0.0 0.0% 1 2.9 0.4%
2019 0.0 0 0.0 0.0% 0 0.0 0.0%
Total 30,299.0 10 429.8 1.4% 67 874.9 2.9%
190 Source: Mongolian Securities Central Clearing (2020.2). Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
Current Status of Foreign Investment in Mongolian Capital Market: Government Bond Market Transaction through MSE Total Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
1996 144.3 0 0.0 0.0% 0 0.0 0.0%
2000 11,132.1 0 0.0 0.0% 0 0.0 0.0%
2005 6,767.7 0 0.0 0.0% 0 0.0 0.0%
2010 30,000.0 2 10,500.0 35.0% 0 0.0 0.0%
2011 237,483.1 17 25,918.5 10.9% 7 42.0 0.0%
2012 0.5 1 0.5 100.0% 0 0.0 0.0%
2013 1,010.4 0 0.0 0.0% 0 0 0.0%
2014 36,116.9 2 58.8 0.2% 26 866.4 2.4%
2015 515,464.7 1 1.0 0.0% 95 5,244.1 1.0%
2016 299,638.0 1 6.0 0.0% 102 5,466.0 1.8%
2017 773,490.3 13 8,708.5 1.1% 319 22,073.2 2.9%
2018 34,486.9 11 829.9 2.4% 43 1,652.8 4.8%
2019 10,136.8 0 0.0 0.0% 5 172.9 1.7%
ContinuedTotal Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
Total 2,108,054.5 48 46,023.3 2.2% 598 35,519.4 1.7%
Source: Mongolian Securities Central Clearing (2020.2).
Current Status of Foreign Investment in Mongolian Capital Market: Stock Market Transaction through MSE Total Foreign Entity Foreign Individual Year Transaction Number of Amount / Number of Amount / % % /Million MNT Participation Million MNT Participation Million MNT
1995 811.5 0 0.0 0.0% 0 0.0 0.0%
2000 2,969.5 0 0.0 0.0% 324 71.6 2.4%
2005 2,547.8 4 454.7 17.9% 487 327.8 12.9%
2010 62,889.5 1,460 38,461.3 61.2% 3,474 7,610.9 12.1%
2011 109,253.2 3,088 65,316.8 59.8% 8,701 10,676.9 9.8% 191 2012 144,746.5 5,658 131,381.4 90.8% 3,058 2,693.5 1.9% CHAPTER
2013 97,598.8 3,476 10,968.7 11.2% 2,256 2,095.5 2.2% 03 2014 24,241.6 2,326 3,756.3 15.5% 1,873 2,273.7 9.4% Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
2015 30,477.4 2,518 3,328.9 10.9% 705 660.0 2.2%
2016 49,046.8 1,991 1,791.5 3.7% 742 1,055.2 2.2%
2017 76,449.0 2,959 1,887.1 2.5% 1,570 1,945.5 2.5%
2018 210,002.2 1,944 88,346.8 42.1% 3,521 5,305.3 2.5%
2019 133,511.9 689 19,393.6 14.5% 1,952 14,345.2 10.7%
Total 1,137,845.5 30,918 419,573.5 36.9% 42,366 60,157.9 5.3%
Source: Mongolian Securities Central Clearing (2020.2).
The Mongolian government issued its GBs in two channels. The first channel is being traded through the Bank of Mongolia’s interbank system, which accounts for 85–90% of all market sales. The second channel is being traded at the MSE, which accounts for around 10– 15% of all sales. In addition, there is no restriction for foreigner trading of GBs in the capital market or GB market. GBs are risk-free assets and Mongolian GBs are estimated to have a high interest rate of around 12–18% per annum. [Figure 3-4] Trading Structure by Product in Mongolian Capital Market
0.2%
Shares
Corporate bond 92.1% 7.7% Government securities
Source: Mongolian Securities Central Clearing (2020.2).
Issuance of GBs in Mongolian currency was temporarily halted by the IMF program on Oct. 2017. By the way, from 2013 to 2019, foreign investors’ investment in GB was only 1 to 7% of the total.
In the third quarter of 2019, which excludes the seasonality of trading volume, the 192
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market stock market traded in the amount of MNT 112.0 billion. Of the total trading volume, stocks account for 92.1%, and government securities account for 7.7% in the secondary market trading, while corporate debt instruments account for only 0.2%. A total of 1.8 3million people have accounts in the capital market. In other words, about 56% of Mongolia’s population of 3.28 million have accounts in the capital market.
When looking at foreign portfolio investors in Mongolia by nationality, there are 86 institutions in 18 countries, including Hong Kong (27 investors), the United States (10), the United Kingdom (8), and Luxembourg (7). A total of 103 individual investors are investing in 22 countries, including Korea (39 investors), Japan (19), and Germany (6), the U.S. (5), and the United Kingdom (4) which have relatively large investments, are investing in 10 to 20 stocks, while other countries with small investments are investing concentrically in 1 to 5 stocks.
Status of Foreign Investors in the Mongolian Capital Market Number of Stocks Items Number of Foreign Number of Foreign Countries Invested Individual Investors Institutional InvestorsHong Kong 23 0 27
Japan 14 19 2
Korea 14 39 3
UK 11 4 8
United States 10 5 10
ContinuedNumber of Stocks Items Number of Foreign Number of Foreign Countries Invested Individual Investors Institutional Investors
Turkey 8 0 8
Germany 7 6 1
Singapore 5 2 3
Switzerland 5 4 1
UAE 4 0 4
China 4 4 0
Cayman Islands 4 0 4
Luxembourg 3 0 7
Poland 3 3 0
Malaysia 2 3 1
Russia 2 1 1
Australia 2 1 3 193
Ireland 2 1 1 CHAPTER
Lebanon 2 2 0 03
Vanuatu 1 1 0 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
France 1 2 1
Hungary 1 0 1
Swaziland 1 1 0
Canada 1 1 0
Netherlands 1 1 0
Belgium 1 1 0
Tajikistan 1 1 0
Panama 1 1 0
Total 134 103 86
Source: Mongolian Central Securities Depository (2020.4).
Meanwhile, Mongolia’s GDP growth rate shows deep correlation with foreign portfolio investment (FPI). For example, Mongolia’s GDP grew by an average of 12.0% annually between 2000 and 2012, when FPI accounted for more than 60% of the total investment in Mongolia’s stock market. However, Mongolia’s GDP growth rate stood at an annual average of 3.8% between 2014 and 2016, when FPI accounted for only 5% of the total investment. The analysis shows that the two variables of FPI and GDP growth are moving together.
[Figure 3-5] Mongolia’s GDP Growth Trend (Unit: %)
20.0 17.3
15.0 12.3 10.6 10.2 11.6 10.0 8.6 8.9 7.3 7.9 7.2 6.4 7.0 6.4 5.0 3.9 4.7 5.3 5.1 2.1 3.3 3.1 3.0 2.4 -1.3 1.2 0.0 -3.2 2.2 1.1 -5.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 -8.7 -10.0 -9.3 -15.0
Note: Period with reduced FPI Source: International Monetary Fund (2020.2).
194 2.1.2. The Progress of Capital Market Development Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
From 2000 to 2011, large-scale investment inflows were accelerated due to the rapid growth of the mining industry and the development of Oyu Tolgoi’s huge copper and gold mine. In 2011, Mongolia’s largest direct foreign investment was $ 4.5 billion. This, on the other hand, added to the volatility of the balance of payments, which in 2012 reached 27% of GDP. Since 2013, however, because of the falling commodity prices in the world and weakening investor sentiment, there has been a sharp decline in foreign investment.
Although the majority of foreign investment is in Mongolia’s mining sector, instability of the domestic legal environment hinders investment in the mining sector. There are also difficulties such as inconsistency of ownership rights, procurement bids, and the decision to license or revoke a license unexpectedly due to political instability. While the government is taking measures to increase foreign investment in the mining sector, such a policy could hinder diversifying and improving the economic structure by inducing foreign investment into Mongolia’s other industrial sectors. In the past, investment policies deviated from the direction of favoring foreign investment, and there had been cases where the opening policy that favors FDI and some amendments to the Investment Law were at odds.
Particularly, the Foreign Investment Law passed in 1993 provided that a foreign legal entity underwent a series of steps through its investment in a foreign country, giving investors a false, ambiguous negative signal. The rigid and discriminatory approach to investing was in conflict with the formal liberal view that FDI in production and services, with the exception of a few sectors or activities, such as weapons, drugs and gambling, was open. Although no request was made to invest within the scope of the above requirement, it was uncertain that legal restrictions were possible.
In May 2012, the Strategic Entities Foreign Investment Law (SEFIL 2012) was hastily drafted and enacted by Mongolian parliament, without public consultation, purportedly to block a very large foreign investment that was about to be concluded in the mining sector. This law essentially required all foreign investments, by private or state-owned entities (SOEs), in strategic sectors (i.e., mining, banking, telecom and media) to be approved by the government, and those investments that exceed a 49% equity stake to be approved by the parliament. It is also said that the sharp decline in foreign investment at that time was affected by the slowdown in China’s economy and commodity price decline, as well as the consequences of above law. Hence, the law led to uncertainty among investors and weakened trust in Mongolia.
In 2013 Mongolia passed a new Investment Law to replace the Foreign Investment Law 195
(1993) and Law of Foreign Investment in Business Entities in Strategic Sectors (2012). The CHAPTER new law was developed and adopted with the support of the World Bank, which was good 03 news for investors. One of the key features of the new law was to replace the screening Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market of all private and SOEs investment (when the investment exceeded certain thresholds) by a system whereby screening is limited to investment by foreign SOEs in strategic sectors (mining, banking, telecommunications and media). This law sets out the rights and responsibilities of investors, issue a tax stabilization certificate, and also the powers and functions of a government agency that is responsible for promoting and regulating investment. However, since the new Investment Law was enacted in 2013, sub-regulations have not been sufficiently legislated. This has been due to a lack of human resources and the worsening economic condition, which prevented the capital market from being significantly revitalized. Moreover, there was lack of the financial literacy of the securities issuers which are Mongolian entities. They had no knowledge about IPO or issuing CBs, which are fundamental topics in the Mongolian capital market.
In late 2016, the Mongolian government closed the Invest Mongolia Agency (IMA), which had promoted investment opportunities for Mongolia and assisted foreign investors with obtaining tax stabilization, corporate registrations. In addition, the National Development Agency (NDA) was established. Meanwhile, the establishment of Foreign Investment Reinforcement Council (FIRC) was set up under prime minister’s office in 2016. The FIRC aims to create a favorable environment for the foreign investors and to respond to the grievances systematically; to protect the rights and needs of the foreign investors, to provide them stable legal policies, to aid in its implementation process of the international contracts, domestic laws and regulation. This council is headed by Minister of Mongolia and Chief of Cabinet Secretary and consists of high-level officials of ministries and representatives of private business and NGOs. It has solved around 150 requests and grievances in the past. As this council has created positive expectations among foreign investors, newly established NDA had decided to convert the grievance solving process into an online system. Therefore, NDA is developing Systemic Investor Response Mechanism (SIRM) by cooperation with the IFC.
The Parliament of Mongolia approved the Sustainable Development Vision 2030 (SDV 2030) with the Resolution No.19 in 2016. Under this long-term vision, several national programs have been implemented, including the National Program to Develop Financial Market until 2025. The SDV 2030 aims to increase capital market’s share in the financial sector to 10% by 2020 and 16% by 2030 and decrease dominance of the banking sector to 90% by 2020 and 82% by 2030. 196
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market In order to attract foreign investors’ investment in the capital market, Mongolian Ministry of Finance has approved the ‘National Program for Developing Financial Market Until 2025’ as a Master Plan in 2017. As part of the program, the government is pushing to adopt the DvP/T+2 settlement cycle,1 revise the Securities Market Laws, and ease regulations that hinder foreign investment. It is also preparing to develop a new in-house system on the market’s infrastructure to solve their systemic problem and to reduce the transaction costs.
The new Securities Market Law, which is being revised in 2020, focuses on improving the regulatory framework for the stock market, establishing more supportive arrangements for private investment funds, eliminating overlapping functions between the state and the self- regulatory companies, and creating an open space for the emerging technologies. This law also includes strengthening the rights of regulatory authorities. Based on the amendment to the Securities Market Law, with the purpose of introducing new products and services to the market, the Mongolian government will expand the scope of regulation of the securities market, differentiate between exchange and non-exchange markets, and further adjust the related regulation. As the new products and services are introduced, it will make the transactions easier and cheaper for foreign and domestic investors. Additionally, Mongolia has adopted Delivery versus Payment (DvP) system on 31 March 2020. This adoption of an international standard started to net the securities leg and cash leg in T+2 settlement cycle,
1 The DvP (Delivery versus Payment) guarantees that transfer of securities only happen after payment has been made, while T+2 set- tlement cycle refers to the settlement dates of security transactions that occur on a transaction date plus two days. The introduction of this system means that the DvP in the Mongolian stock market reaches a global standard level. which will help to reduce transaction fees on the Mongolian capital market.
Amending of securities market related laws, including new Private pension fund act to develop the capital market and ease the regulation, is also being pursued in 2020. Meanwhile, the privatization of MSE and major SOEs through the capital market, and dual- listing of one of the biggest mining company also has been pursued. Under the IMF Extended Fund Facility (EFF) Program, the government of Mongolia has improved overall fiscal discipline and economic situation. Also, credit rating has improved over few years.
The Improvement of Capital Market and Foreign Investment-related Systems Introduction Name of Law or Systems Purpose and Outline Year1993 Foreign Investment Law Rigid and discriminatory approach to foreign investment
Strategic Entities Foreign Strategic sectors to be approved by the government and 49% 2012 Investment Law equity stake, to be approved by the parliament
All private and SOE investment by a system whereby 2013 Investment Law screening is limited to investment by foreign SOEs in strategic sectors 197
2016 NDA, FIRC Protects the rights and needs of the foreign investors CHAPTER
2016 SDV 2030 National Program to Develop Financial Market Until 2025 03
Adopt the ‘DvP/T+2’ settlement cycle Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market National Program for Developing 2017 Revise the Securities Market Laws and ease regulations that Financial Market Until 2025 hinder foreign investment
Improving the regulatory framework, establishing more supportive arrangements for private investment funds, 2020 Securities Market Law eliminating overlapping functions between the state and the self-regulatory companies, creating an open space for the emerging technologies
New Private Pension Fund Act to develop the capital market 2020 Securities Market-related Laws and ease the regulation
Source: Created by Author.
2.1.3. The Evaluation of Capital Market Infrastructure
Despite these efforts, if you analyze the investment situation of Mongolia’s capital market, market capitalization remained low as of the end of 2019, and its liquidity ratio stood at only 5%. [Figure 3-6] Market Capitalization and Liquidity Ratio in Mongolia (Unit: Bin ₮)
3,000 10% 2,511.75
2,440.23 2,500 8.4% 2,693.05 8.0% 8% 2,168.57 1,670.53 2,000 1,799.90 1,373.95 5.8% 6% 1,442.66 1,474.17 1,500 5.0% 5.0% 4.6% 1,262.50 4% 1,000 3.3% 3.2% 2.4% 2% 500 1.7%
0 0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Market capitalization /Bin ₮/ Liquidity ratio
Source: Minister of Finance of Mongolia (2020.3).
198 In terms of asset quality and investor base, inadequate supply of quality securities Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market at the market, poor governance, information disclosure, and transparency of the listed company are highlighted. In terms of market efficiency, low ratios on financial and capacity, improper financial literacy among private companies, over regulation of FRC and inefficient supervision, high cost of trading fee for the investors are also problems. In terms of poor market infrastructure, lack of adaptability in technology development, underdeveloped infrastructure, and regulations for opening foreign investors’ account are indicated as issues.
Meanwhile, in Mongolian capital market, only stock trading is active, and its transaction costs are relatively high compared to the other countries.
Transaction Costs of Securities Transactions Transaction Brokerage MSCC MSE FRC Investor 3) Securities Amount 1) Company MSE 2) Type /Million MNT Buy/Sell Buy Sell Buy Sell Buy Sell Buy Sell≤100.0 1.4~2.5 0.24 0.24 0.40 0.40 0.04 0.04 0 2.08~3.18 2.08~3.18
100~ Stock 1.4~2.5 0.24 0.24 0.38 0.38 0.04 0.04 0 2.06~3.16 2.06~3.16 1,000 Equity 1,000~ 1.4~2.5 0.24 0.24 0.30 0.30 0.04 0.04 0 1.98~3.08 1.98~3.08 10,000
ContinuedTransaction Brokerage MSCC MSE FRC Investor 3) Securities Amount 1) Company MSE 2) Type /Million MNT Buy/Sell Buy Sell Buy Sell Buy Sell Buy Sell
10,000~ 1~2.5 0.24 0.24 0.20 0.20 0.04 0.04 0 1.48~2.98 1.48~2.98 Stock 30,000 Equity ≥30,000.0 1~2.5 0.24 0.24 0.15 0.15 0.04 0.04 0 1.43~2.93 1.43~2.93
GB 0.048~ 0.0605~ 0.16975~ - 0.00375 0.00175 0.00875 0.12 10% 10% 0 Primary 0.05 0.0625 0.17175
GB 0.048~ 0.0605~ 0.048~ - 0.00375 0.00 0.00875 0.00 10% 0 0 Secondly 0.05 0.0625 0.05
CB - 0.1 0.0075 0.0075 0.01750 0.1575 10% 10% 0.1 0.125 0.265 Primary
CB - 0.1 0.0075 0.00 0.01750 0.00 10% 0 0 0.125 0.1 Secondly
Notes: 1) per trade amount is one order that matched in MSE trading platform 2) It is registration fee 3) Total amount of fee that investor must pay 4) FRC 10% fee is taken from broker fees that client and broker agreed. 5)In order to participate MSE trading client must open account and make agreement with one of the brokers. Brokers usually 199
charge service fee as 0.68% to 5% percent of each trade. MCSD does not charge any fee related to stock exchange except CHAPTER opening account. Source: Mongolian Central Securities Depository (2020.1). 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market In the case of stock trading on the Mongolian stock market, brokerage companies charge 1.4 to 2.5% of the trading amount of the buying and selling, respectively. In addition, MSE will charge 0.15 to 0.40%, Mongolian Securities Central Clearing (MSCC) 0.24% and FRC 0.04%, depending on the transaction amount. Ultimately, investors pay between 1.43% and 3.18% depending on the size of the transaction amount, which is quite high. Note that the FRC receives 10% of their revenue from the Mongolian Central Securities Depository (MCSD), MSE and MSCC in the name of service fees.
2.2. Factors Hindering Foreign Portfolio Investment under the Current Law and System
Factors hindering FPI include lack of political stability, policy instability due to frequent government change, weak governance and lack of transparency, inadequate legal environment protecting foreign investor’s right, and lack of economic diversification. Moreover, Mongolia’s economic development is heavily reliant on the mining sector, and FDI is concentrated and comes mainly from China and Canada in the mining sector. These have also been factors hindering FPI in Mongolia. Recognizing this, the government’s recent action program specifies a consistent policy to attract foreign investment in all areas of infrastructure, mining, energy, agriculture, tourism, and more. In order to attract foreign investors in capital market, the Ministry of Finance is taking the following measures. In 2017, the Mongolian government approved the ‘National Program for developing Financial market until 2025’ as a Master Plan. This plan included adopting the DvP/T+2 settlement cycle in the infrastructure system of capital market according to principals for financial market infrastructures (PFMI) and amending securities market-related laws to develop the capital market and ease regulations. In addition, researching to develop a new in-house system on the market’s infrastructure organization to solve their systemic problem and to reduce the transaction fees is included.
2.2.1. Legal and Regulatory Environment
Current capital market’s legal and regulatory environment is largely regulating only exchange board market. Due to the insufficient regulation and uncertain regulatory framework of the over-the-counter (OTC) market2, there are big restrictions on the 3 200 development of CBs , financial derivatives and other products of the OTC market. In
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market the Securities Market Law, difference between private placement and public offering’s regulation is unclear, which makes uncertainty in the market.
In case of indirect investment, funds are established as a special purpose company with legal entity rights. However, special purpose company regulations are not yet clear under company law and other laws. Also, the Investment Management License and Operations Regulations approved by FRC Resolution 08 of August 2014 regulate investment management companies to have at least one manager from the managed investment fund, but the SCC is still working to make changes to this regulation.
Meanwhile, foreign investors should receive legal guarantees from compliance that they are legally acquiring securities before investing overseas. However, it is unclear whether Mongolia is following the rules proposed by the Bank for International Settlements (BIS) or International Organization of Securities Commissions (IOSCO). This is why Mongolia’s MSE was eliminated from FTSE’s Frontier Market List in 2017.
2 Mongolia do not have OTC platform. However, the Mongolian Securities Association (MSA) hopes to establish the OTC platform and related infrastructure. 3 The requirement and regulation on the public issuance of corporate bonds are too high. During the last 5 years, only two corporate bonds have been issued, and there were comments that cost and process are so tough. 2.2.2. IPOs and Information Disclosure
The Mongolian government approved the main directive for the privatization of state- owned companies through the MSE in 2015. In this direction, more than 20 SOEs will be privatized, so the products at the stock exchange will increase. On the other hand, it would simplify the multi-step process of issuing shares by amending the Securities Market Law, making the registration requirements for securities more flexible and creating the legal framework for companies to attract funding from the stock market. More active IPOs could lead to an increase in long-term investors in the capital market. However, it is imperative for private blue-chip companies to vitalize their IPOs rather than SOEs, which remain as remnants of the planned economy.
Another issue is information disclosure. The public trust in information disclosed for the public in Mongolia is low: 30% of listed companies are said to be not complying with the disclosure requirements. In fact, only 19 of the 198 companies listed on the MSE regularly disclose their financial statements, while only 36 companies listed after 2006 are subject to disclosure restrictions. The threshold for public offering (i.e., 50 investors) should be reduced 201 for CBs when institutional investors grow and a professional investor market is established. CHAPTER
Foreign shareholders also express dissatisfaction with the disclosure of information in 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market exercising their shareholder rights. For example, most countries determine the exercise of voting rights and the standard date for dividend payments at the end of the year. In Mongolia, however, the standard date for voting rights exercise and dividend payout are different,4 which makes foreign long-term investors reluctant to invest.5
One set of disclosure requirements for both liabilities and equity is considered good. But FRC could give thoughts to disclosure for debt such as solvency and liquidity, for equity such as profitability. Meanwhile, credit rating is needed to enable nonsecured CBs.
2.2.3. Institutional Investors
In 2018, the government has launched a project to provide a legal framework for the establishment of supplementary pension system in Mongolia with the technical assistance of the Asian Development Bank. Within the project’s scope, the project team has drafted the new private pension scheme law and is preparing for the public consultation. Under
4 The Mongolian Ministry of Finance (MOF) is currently studying the current Securities Market Law along with the Company Law and Investment Law to value corporate behavior patterns and help them exercise shareholder rights smoothly. As a shareholder of MCSD, MOF guides MCSD that listed companies should utilize its system and make it easy to use their system. 5 The author surveyed Korean investors (2020.1). the new law, the following three entities are able to set up private pension funds. Those are employees, life insurance companies, and legal entities whose purpose is to pursue the civil retirement program and the employer retirement program, to be established under the Company Law.
Although the legal framework has not yet been established, the following companies are currently operating in Mongolia with the nature of private pension funds. These companies will officially run pension fund once the law has passed. Which are National Life Insurance LLC, Mongolian Railway SOE, and Mongolian First Pension Fund. As of the first quarter of 2020, there are 25 asset management companies and 20 private funds registered at the FRC under Investment Fund Law.
2.2.4. Transaction Cost
The high transaction costs charged by infrastructure companies are mainly due to the following reasons.
202
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market First, it is due to the overall challenges of the capital market infrastructure institutions: 1) Lack of integration between financial institutions, 2) Use of different IT systems by different institutions, 3) It is difficult for international investors to participate in the market, 4) No international custodian banking offered (recently JP Morgan’s global custodian is cooperating with Golomt bank custodian), 5) High service fees for intermediary companies in the capital market, 6) Market liquidity is weak, 7) Capacity of infrastructure organizations is weak, and 8) There are too many prerequisite steps for the participation of investors.
Second, the following tasks for the MSE have yet to be resolved: 1) Listed out from FTSE Frontier market watch list in 2017, 2) MSE’s stock exchange computing system MIT system is not fully utilized, high cost of maintenance and service fee and there is no linkage with the market participants, 3) Market activity is weak, with only 10% of listed companies traded actively in the secondary market, 4) There are a very few professional investors, 5) The liquidity of the exchange market is weak, 6) Limited product types, and 7) Lack of human resource capacity.
Third, Mongolian Central Securities Depository (MCSD)’s challenges include: 1) The opening of a depositary deposit account is done manually by hand, it is time-consuming, 2) Online account is not available, foreign investors have difficulty opening accounts in the MCSD, and 3) System upgrade required Fourth, Mongolian Securities Central Clearing (MSCC)’s challenges include: 1) It only performs trading settlements on the MSE and 2) Lack of human resource capacity.
2.2.5. Investment Instruments to Attract Investors
In Mongolia’s capital market, there are not enough investment products foreign investors want to buy.
The bond market in Mongolia was started in 2001, but over the last 18 years, only 15 companies have issued CBs on the MSE, while one company made an issuance on the Securities Exchange (privately owned). A total of 16 companies have raised a total of 26 billion MNT by issuing CBs. The CBs issued by these companies have a maturity period of 6 to 24 months, and 90% of funding is spent on working capital. Over the last 2–3 years, however, companies have dramatically increased to raise a fund through private placement under the Civil Code. According to unofficial estimates, in 2018, 20–40 billion MNT bonds were closed, with an average coupon rate of 16–20%. The domestic bond market development accelerated in 2015–2017, as the GBs were issued to the public regularly through the MSE. The GBs are 203 tax exempt, making it attractive for domestic retail investors. Local companies could use CHAPTER the exchange traded GBs as collateral for government tenders, which made it attractive for corporates as well. In addition, the government started collecting 10% tax on interest income 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market earned from bank deposits starting April 2017, which tax rate were previously 0%. As a result, these efforts drove increased interest in the bond market, GB trading accounted for 90% of MSE primary market and secondary market trading volume in 2015–2017.
As public interest in the local bond market increased, corporate issuers started issuing corporate debt instruments in the local market as well. In 2015, after a 3-year absence, the first publicly offered corporate debt securities were issued on the MSE, and in 2017, the largest public offering of corporate debt security in the history of Mongolian capital market was completed in the shortest period of time on MSE. As a result, in 2017 the MSE had its best year in its history, in terms of total primary market and secondary market trading volume, GB trading volume, as well as corporate debt securities trading volume.
However, local currency GB issuance was temporarily halted by the MOF on October 2017. As part of a $5.5 billion multi-donor financing package to support the Mongolian government’s Economic Recovery Plan, the International Monetary Fund (IMF) approved a three-year arrangement for Mongolia under the EFF on 24 May 2017. The local currency government securities issuance was halted temporarily, in order to curb government budget expenditures under the program, as these government securities had yields in the range of 12–18% per annum. That is why investors do not have GBs to buy.
In the absence of local-currency GB issuance, local investors started investing actively in the domestic CB market, including privately placed corporate debt instruments. However, due to the fact that current regulatory requirements are the same for publicly offered debt securities and IPOs under the current Securities Market Law and the FRC regulations, public offers of corporate debt instruments are required to go through a time-consuming and costly process for the issuers, compared to private placements, which are unregulated. The gap between demand and supply for high-yield bonds is being filled by privately placed corporate debt instruments, as there has been no new public offering of corporate debt security since June 2017, and no fresh issuance of GBs since October 2017.
2.3. Implications from Current Status Analysis
Based on the analysis of the current state of Mongolia’s capital market and factors that hinder foreign investment under the current law and system, several challenges are considered key factors constraining the development of the capital market. 204 Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market First is the issue of how to address the low interest among foreign investors with high country risk due to structural limitations of the Mongolian economy focused on the mining industry and inconsistency of foreign investment policies.
Second, as previously analyzed, the regulatory framework on the OTC market and other areas is insufficient. In addition, indirect investment for individual investors is quite important to the growth of the capital market. Note that, in Mongolia’s indirect investment market, mutual funds take the form of limited liability (LLC) by company law of Mongolia. This hinders the growth of the indirect investment market because closed-type mutual funds need to be listed to be redeemed. Before the introduction of the IMF program in 2017, the issuance of CBs was low, but GBs issuance was relatively active. However, it is necessary to revitalize the GBs secondary market due to its backwardness. The expansion of the indirect investment market could also contribute to the revitalization of the secondly market both CBs and GBs.
Third, the proportion of institutional investors is too low at around 10%. The institutionalization of the securities market means that the securities market transactions are centered on institutional investors. In most of the developed countries’ securities markets, institutional investor volume accounts for more than 50% of total trading volume. In developed countries, in order to become an institutional investor-focused securities market, a number of support measures have been introduced and operated so that individual investors can indirect invest joining funds. The Mongolian capital market needs to attract institutional investors through the establishment of related infrastructure in advance. As previously explained, it is desirable for the Mongolian government take various measures to expand institutional investors since 2017.
Fourth, transaction costs on the capital market are too high: investors should pay between 1.43% and 3.18%, depending on the size of the transaction amount. Market liquidity is being severely constrained by high transaction costs, which currently stands at around 5%. In the capital markets of advanced countries, considerable investments in IT equipment have improved business efficiency while lowering transaction costs. Twenty years ago, in Korea, investors paid 1% of the transaction amount for buying, and 0.45% of the transaction amount for selling. With the establishment of online brokerage firms6 in Korea, nowadays transaction fees have dropped significantly, and more recently, new customers are free for life.7 As a result, transaction costs currently stand at just 0.3 to 0.4%. Mongolia’s transaction costs are considered to be four to eight times higher than Korea’s.8 Meanwhile, MCSD also do not provide with online accounts. It is considered difficult for foreign portfolio investors to 205 open accounts at the MCSD.9 CHAPTER 03 Fifth, most costs in the capital market are incurred in the post-trade stage. Post- Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market trading costs are high because policy makers and market participants are lagging behind in investment priority as they are relatively less interested than stock exchange market participants. However, in case of the United States, new standard in the Post-Trade stage were adopted to shorten the settlement cycle and trying to significantly reduce transaction costs in the securities market. Therefore, the Mongolian government is deemed to need investment to improve efficiency in the post-trade stage.
Sixth, foreign investors are experiencing inconveniences due to tax problems. Moreover, taxes on foreign investors’ stock dividends and capital gains of securities differ from
6 Some of Mongolian securities companies have their applications made by the IT companies. Around five companies have their on- line securities application website. However, online transactions are not active. 7 Instead, after attracting a large number of new customers, funds are lent to customers to invest in stocks, and interest income on those loans is becoming an important income source of brokerage firms. In other words, it intends to earn money by replacing the role of stockbroker with that of a fund provider. 8 In Korea, stock transaction costs consist of brokerage fees (mostly online trading, 2 to 6 bp of transaction amount), KRX fees (14 to 23 bp depending on transaction amount), settlement fees (0.04 bp of stock trading amount, 0.002 bp of government bonds), and stock exchange taxes (0.1% of KOSPI, 0.25% of KOSDAQ and 0.1% of KONEX) will be added to them. Accordingly, all transaction costs are between 0.3 and 0.4 percent depending on the transaction amount. 9 Cross-border issuance is much more detailed, and its role and sole business purposes are totally different than in Mongolia. For ex- ample, it seems Mongolian local custodians and Canadian transfer agents are the main key features in order to achieve basic share- holders’ rights and protect their interests and use proxies as safeguarding securities and to attend any stock company’s meetings. However, at this moment there are no rules about this Cross-border issuance in Mongolia. those imposed on domestic investors. For example, securities companies and related institutions do not immediately issue tax payment certificate for foreign investors. That is why even if foreign investors pay taxes in Mongolia, they have to pay taxes again in their own countries.10 Another tax issue relating to the capital market infrastructure is the tax disadvantage of foreign investors. In stock investment, Mongolian investors pay a 10% tax on dividend earnings and 20% on capital gains. Foreign investors, however, are required to pay 20% tax on dividend earnings and 20% as withholding tax, making a total of 40% in tax. When it comes to CB investments, domestic investors pay a 5% tax on interest income and a 10% tax on capital gains. Foreign investors, however, have to pay a total of 25% in taxes on CB investments, as the 5% tax on interest income is the same as Mongolian investors’, but there is a 20% as withholding tax.11 Meanwhile, the Mongolian government is exempt from taxation on the profits from investment in GBs.12
Double taxation agreements (DTAs) are treaties signed by the Mongolian Government with other countries that specify tax exemption on income derived from investments, whereby investors are only liable to pay income tax in one country as a means of inducing 206 foreign investment. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
Comparison of Taxation by Type of Securities between Mongolian and Foreign Investors Mongolian Investor Foreign Investor Type of Securities Income Capital Gains Income Withholding TaxStock 10 20 20 20
CBs 5 10 5 20
GBs Tax Free Tax Free
Source: Mongolia’s Ministry of Finance (2020.6).
10 The author surveyed Korean investors (2020.1). 11 According to the General Taxation Law (amended 22 Mar 2019), dividends, interest, and rental income are subject to Mongolian personal income tax at the flat rate of 10% for residents and 20% withholding tax for Mongolian sourced income of non-residents, unless the term is reduced pursuant to an applicable tax treaty. 12 Government bonds and debt instruments issued by the Development Bank of Mongolia are exempt from income tax, under the current tax legislations. In addition, under the revised Corporate Income Tax Law and Personal Income Tax Law (effective 1 January 2020), interest income earned from publicly issued corporate debt securities is subject to 5% income tax, instead of 10%. Capital gains from trading of publicly issued corporate debt securities are subject to the standard tax rate of 10% in principle. 3. Best Practices for Korea and Reference Countries Attracting Foreign Portfolio Investment
3.1. Korea’s Institutional Incentives to Revitalize Foreign Portfolio Investment
3.1.1. Capital Market Development Process and Lessons in Korea
The Korean stock market began to develop in 1956, when the Korea Stock Exchange (KSE) was launched to smoothly raise long-term economic development funds. The KSE developed into a Korea Exchange (KRX) that merged all stock markets such as KOSDAQ market for venture companies, KONEX market for early small- and medium-size companies in 2005.
The KRX also has a market for financial futures and options that offer various investment opportunities. It is also focusing its efforts on exploring new strategic markets and new business areas. As a result, the KRX gold market, Petro market, the emission market, and OTC clearing service are being developed. 207 CHAPTER
Before the enactment of the Capital Market and Financial Investment Services Act, 03 the domestic securities industry was heavily dependent on profits from the brokerage Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market transaction sector, while the investment banking sector in charge of corporate financing was vulnerable. In addition, the business between securities companies was no differentiation each other and the size of their equity capital was small. Since the law went into effect in February 2009, the equity capital of the Korean top five securities companies has grown 2.3-fold over the decade. However, it did not expand to a meaningful level compared to the equity capital of domestic commercial banks. The portion of the brokerage transaction sector in the profits of securities companies has fallen from 70% to 40%, and the diversification of the profit structure has progressed as the proportion of investment banks and trading sectors has increased. In particular, the portion of profits in the investment banking sector increased more by small- and medium-sized companies than by large securities companies. At the same-time, the business of securities companies has gradually become specialized.13 In addition, with online securities companies allowed, the transaction fees were seen to have dropped significantly as competition between offline securities companies and online securities companies was spurred.
As of 2020, the stock market has grown to seventh in the world in terms of liquidity,
13 Sunghoon CHO, Changes in the Korean securities industry for 10 years after the implementation of the Capital Market and Financial Investment Services Act, KCMI (2019) while the bond market has expanded to fifth in the world in terms of daily trading volume. The KRX currently has the world’s highest level of IT infrastructure and can handle 20,000 TPS per second, and 200 million cases daily with a processing speed of 70 us per second.
[Figure 3-7] Trend of Korea Composite Stock Price Index (KOSPI, 1992–2020)
1980.01.04=100 2.50K
2.25K
2.00K
1.75K
1.50K
1.25K
1.00K
750
500
250 208
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: ECOS, The Bank of Korea (2020.8).
[Figure 3-8] Trend of KOSPI’s Transaction Volume and Transaction Amount (1992–2020)
(1000 Korean Won) (Number of shares) 2.25T 225B
2.00T 200B
1.75T 175B
1.50T 150B
1.25T 125B
1.00T 100B
0.75T 75B
0.50T 50B
0.25T 25B
0 0
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 KOSPI Transaction amount (left) KOSPI Transaction volume (right)
Source: ECOS, The Bank of Korea (2020.8).
Trends in the Transaction Volume and Amount by Foreign Investors Transaction Volume and 2004 2006 2008 2010 2012 2014 2016 2018 2019 AmountSelling Volume 4,156 5,597 9,286 6,084 5,879 6,226 8,064 12,606 12,780
Selling Amount 119,708 224,730 343,898 273,757 265,938 289,096 315,435 435,570 347,731
Buying Volume 4,836 5,280 7,917 6,282 6,211 6,306 8,300 12,736 12,686
Buying Amount 130,192 213,976 310,294 295,330 283,400 293,931 326,770 429,848 348,682
Net Buying Volume 680 -317 -1,369 198 333 80 236 130 -94
Net Buying Amount 10,484 10,753 33,603 21,573 17,462 4,835 11,336 -5,723 950
Source: ECOS, The Bank of Korea (2020.8).
[Figure 3-9] Stock Exchange Structure in Korea
Korea Exchange (KRX)
209 Market Securities KOSDAQ KONEX Derivatives CHAPTER Oversight Market Market Market Market Commission
Stocks Stocks Stocks Futures Market 03
(Big Company) (Venture Company) (SME) Surveillance Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market Options Bonds Member Mgt KSM Market & General Securities Dispute M&A Brokerage Overseas Settlement Platform Connection
Market for SME & Venture Company
Source: Illustration by the author using KRX materials (2020.2).
Analyzing the process of opening up the Korean capital market showed that more policies were implemented to curb the excessive inflow of speculative short-term funds than policies that promoted the inflow of foreign investment. In Korea, the inflow of foreign investment continued continues steadily except during the 1997 Asian financial crisis thanks to robust economic fundamentals and high economic growth. In 1992, when the capital market was opened, the proportion of foreign investors was less than 5%, but it rose to 38% in 2020. Since the complete opening of FPI in 1998, structural problems such as political instability, increased inconsistency and uncertainty in economic policies, and concerns over corporate and financial insolvency have caused weakening or outflow of FPI. Meanwhile, foreign investors improved capital efficiency and conditions for corporate financing for the domestic stock market. It also contributed to increasing interconnection of financial markets, foreign exchange (FX) markets, and stock markets through integration with the international capital market. Second, foreign investors are assessed to have contributed to stabilizing the stock market and to improving liquidity through the spread of rational investment patterns, reflecting the intrinsic value of the company and the propensity for long-term investment. This can be seen by comparing the trading turnovers between Koreans and foreign investors. In terms of the investment propensity of each stock, it is assessed that the investment items were chosen by scientific analysis of growth stocks and blue-chip stocks with low PER. Third, the impact of foreign investment on the Korean securities system has contributed to boosting foreign investors’ stock investment by expanding the scope of foreign investors. In addition, foreign investment contributed to promoting overseas investment by Koreans in order to relieve excess currency in the country and to promote the issuance of overseas securities to reduce corporate funding costs. Fourth, the impact of foreign investment on the Korean securities industry is credited with helping strengthen the international competitiveness of the securities industry and 210 enhance the external image of the domestic securities market. Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market
The negative effects of foreign investment added instability to the market in the case of financial crisis, making it difficult to forecast the capital market and causing unfair OTC trading and biased buying demand.14
The Korean capital market had 57 securities firms and 49,000 employees as of the end of 2019.15 The profit structure of securities companies is diversified to 48% commission from brokerage and trading, 10% underwriting fees, 8% commission from consulting M&A, 6% commission for fund sales, 2% commission for asset management, and 26% other income such as CMA operation and loan interest.16
3.1.2. Measures to Expand the Stock Market’s Demand Base
Major measures to expand the demand base of the stock market include the Employee Stock Ownership Plan (ESOP), People’s stock, and the Stock Market Stabilization Fund (SMSF).
The ESOP is a system in which employees own shares of their companies for special purposes and in a way that contributed to the expansion of the stock market’s demand
14 KRX, Korea Exchange 60 year history (2016). 15 Korea Financial Investment Association (2020.2). 16 Financial Magazine, An Analysis on the Profit Structure of Financial Investment Companies (2018.6). base. ESOP was used as a labor management measures to enhance employees’ awareness of attribution to companies, or as defense instruments for corporate management rights to secure stable shareholders. In recent years, major countries have mainly encouraged workers as one of the measures to promote their wealth. In Korea, the Act for Promotion of Capital Markets in 1968, the Act on the Promotion of Corporate Disclosure in 1972, and the measures to implement the expansion of the employee stock ownership system in 1974 were introduced as a series of government-led policies for fostering capital markets and promoting corporate disclosure. In particular, the ESOP in 1974 expanded the implementation of only some listing companies to private corporations, and strengthened tax and financial support. Usually, ESOPs have various tax benefits. For example, contributions of stock are tax-deductible. This means that firms can get a current cash flow advantage by issuing new stocks to the ESOP. In addition, cash contributions are also deductible. A Korean company can contribute cash and take a tax deduction for it, whether or not the contribution is used to buy shares from current owners in the ESOP. Contributions used to repay a loan the ESOP takes out to buy its firm shares are tax-deductible. In this case, the ESOP can borrow money to buy existing and new shares. Regardless of the use, the contributions are deductible, meaning ESOP financing is done in pretax money.17 211 CHAPTER
[Figure 3-10] Structure of Employee Stock Ownership Plan in Korea 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market BANK SHAREHOLDER
Loan Cash Stock STEP 1 STEP 2 Loan Repayment STEP 4 ESOP TRUST
Cash at Termination Cash Contribution STEP 5 of Employment STEP 3
EMPLOYEE COMPANY
Source: BTA, Employee Stock Ownership Plan (2020.2).
In Korea, People’s stock was widely distributed by selling shares of blue-chip companies held by government-invested institutions to the public for the purpose of improving income and promoting the development of the national economy. The People’s stock policy was implemented with the aim of encouraging the public to improve their income through the distribution of corporate income and contributing to the development of the national economy by allowing the majority of the public to participate in corporate capital-raising.
17 National Center for Employee Ownership, How an ESOP works (2018). The system was aimed at stocks of profitable companies that could be owned as a means of property growth as the general public deposits in banks. In addition, the entity that is subject to People’s stock should be a large, government-funded company that can earn adequate profits and distribute profits. In addition, the People’s stock trust, or the People’s stock subscription deposit system, was implemented to facilitate the acquisition of People’s stock, and the operating income of the subscribers was tax-free. In Korea, POSCO, the steel giant, supplied the first People’s stock in 1988, and Korea Electric Power Corp (KEPCO) supplied their first People’s stock in 1989. At that time, 78% had been allocated to workers with a monthly salary of 600,000 won or less, which included farmers and fishermen and self-employed people. In Korea, the People’s stock policy is considered to have contributed to the people’s wealth.
The Korean SMSF is a public fund created to stabilize investor sentiment by launching stock purchases in case of a sharp fall in the stock market. In the case of Korea, the first SMSF was created in 1990 during the stock market slump and operated for six years. The SMSF was created with 2 trillion won from securities companies, 500 billion won from 212 banks, 500 billion won from insurance companies, and 1 trillion won from listed companies.
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market The SMSF mainly purchased stocks of large manufacturing and financial companies, which had a large market impact. The SMSF is credited with contributing to the stabilization of stock prices. On the other hand, there were side effects as well. For example, buying stocks of large companies to boost stock prices has pushed up the stock prices of those companies, while stock prices of companies with smaller market capitalization continued to fall. To prevent stock prices from falling in a short period of time, the fund was required to sell 20% of its shares every year over five years after banning their sale for two years.
The second Joint SMSF was created in 2003 with the appearance of securities-related institutions when the stock market was depressed due to the credit card crisis. The amount was 400 billion won and was operated for four and a half years. The SMSF contributed to the stabilization of the stock market, and its return on profit was also good, recording an annual average of 13.5%. The third SMSF raised 515 billion won in 2008 in response to the global financial crisis. The contribution was made up of 250 billion won from the Korea Stock Exchange, 210 billion won from the Korea Deposit Insurance Corp., 50 billion won from the Korea securities dealers association, and 5 billion won from the Asset Management Association. The fund was invested at a ratio of 80% of listed stocks and 20% in GBs.
3.1.3. Measures to Expand the Stock Market’s Supply Base
In Korea, the Act on Promoting Public Corporations Listing was enacted and operated to expand the supply base of the stock market. Since 1967, the financial structure began to deteriorate due to a surge in corporate capital demand. As a result, companies needed to raise capital through the stock market. In response, the Federation of Korean Industries (FKI) undertook a “stock popularization project” aimed at improving the image of large capital and promoting pro-business sentiment within the people. The government also gave privileges to listed companies in terms of taxes and finance and took measures to protect their management rights. The biggest incentive was various tax benefits. As a result of these efforts, the Act on Promoting Public Corporations Listing was enacted in 1968, increasing the number of companies going through initial public offerings and listing on the stock market. The IPO was also made to improve management strategies or consolidate “common profits” by distributing shares to employees or customers. The capital raised through the stock market jumped from $8.2 billion in 1969 to $55.5 billion in 1973. The government’s initial call for public offerings has been stepped up since 1972. The government enacted the Public Corporation Inducement Law in 1972 to facilitate the listing of companies and improve their fund-raising and financial structure, and to contribute to the sound development of the national economy by inducing people to participate in businesses. On the other hand, the giant capital has reformed corporate governance to protect management rights and 213 launching institutional investment firms such as securities companies. CHAPTER 03
Meanwhile, the global financial crisis triggered by the collapse of U.S. investment bank Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market Lehman Brothers has dampened corporate funding through the capital market. In 2009, the Korean government introduced the Special Purpose Acquisition Company (SPAC), which is widely regarded as an alternative investment tool in developed countries, in order to boost the IPO market and promote listing of blue-chip companies. The SPAC has contributed to expanding funding opportunities for promising SMEs and boosting investment through M&As.
The Korean government opened the KOSDAQ market in 1996 to support the smooth financing of high-tech venture firms. For venture firms, five of the 12 registered conditions (such as the debt ratio) of the KRX were excluded. Those were establishment history, capital, stock distribution, assets return value, and management performance. In addition, the criteria for special cases of stock distribution were newly established and the debt-to-equity ratio was eased to 200% or less, thus improving the registration of venture companies. The scope of venture companies has been steadily expanded, and in 2004, exceptions to the requirement for limiting changes in equity interests were set when foreign investors acquired shares to support the overseas capital of KOSDAQ market-registered corporations.
Meanwhile, in 2007, an entity designated by the Freeboard (K-OTC market) accepted both recruitment performance and sales performance by expanding the special requirements for stock distribution. In 2011, the scope of previous growth-driven venture firms was expanded to create a listing special case for SMEs with technological capabilities, such as exempting them from the requirements of management performance and size of profits (ROE or net profit) when they receive a certain technology assessment grade. In 2013, the Act excluded the application of capital condition and management performance requirements to companies with equity capital of 100 billion won or a base value of 200 billion won or more in order to support the activation of large technology companies. It also exempted them from reducing the period of sale and the minimum investment obligation of listed shareholders.
In June 2014, the previous requirements were mitigated and the qualitative review was simplified for the KONEX market blue-chip corporations that met certain requirements, including market capitalization, continuous net income, and ROE (10% or more) to support the rapid transfer of the KONEX market blue-chip company to the KOSDAQ market. The KRX also introduced a ‘special listing system’ in 2015, under which start-up companies with 214 certain requirements, such as technical skills, can be listed on the KONEX market without
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market a designated advisor. If an institutional investor designated by the exchange received a technology rating of ‘BB’ or higher from a Technical Credit Rating Agency (TCB) of the entity that holds more than 20% of its shares and the designated institutional investor agrees to a special listing, it could be listed on the KONEX market through a technical evaluation without a designated advisor.
The revitalization of the KOSDAQ and KONEX markets is believed to have greatly expanded the stock market supply base through listing of fledgling technology companies, venture firms, and promising SMEs.
3.1.4. Measures to Expedite Foreign Portfolio Investment
As of the end of 2019, 48,058 foreign investors were registered on the Korean stock market, of which individual investors (11,657person) accounted for 24% and institutional investors (36,401) accounted for 76%. Of the total institutional investors, the collective investment scheme account for 48% and pension funds 5%: the U.S. (33%), Japan (9%), the Cayman Islands (7%), Luxembourg (5%), and Ireland (3%). Foreign investors hold 716.8 trillion won in listed securities, of which 593.2 trillion won in stocks account for 83%, with the remainder being bonds worth 123.7 trillion won. The amount of listed stocks held by foreigners in the securities market accounts for 38% of the total listed stocks. By investment method, portfolio investments account for 97% of the total, excluding direct investments (19.2 trillion won). Foreign investors sold a net 450 billion won worth of stocks in 2019, while bonds received 8.8 trillion won net investment.
It has been 28 years since Korea opened its domestic stock market to foreigners in 1992. After the opening of the stock market, speculative short-term funds, which had been poured into Korea in large quantities, were leaked in the aftermath of the 1997 Asian financial crisis, causing a foreign exchange crisis.
Status of Foreign Investors in Korean Capital Market (Unit: Number of People)By Investors 2016 2017 2018 2019 (Change)
Individual Investors 10,763 11,088 11,440 11,657 (10)
Institutional Investors 32,534 33,843 35,260 36,401 (74)
(Collective Investment Scheme) 20,094 21,054 22,156 23,064 (55)
(Pension Fund) 2,181 2,235 2,280 2,305 (1)
(Investment Trading Broker) 962 975 986 997 (-) 215 (Commercial Bank) 713 718 728 739 (2) CHAPTER
(Insurance Company) 493 498 506 512 (1) 03 (Other Investor) 8,091 8,363 8,604 8,784 (15) Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
Total 43,297 44,931 46,700 48,058 (84)
Source: KRX (2020.1).
In order to strengthen the international competitiveness of the stock market, Korea was allowed to list foreign corporations in 1996 in the form of Depositary Receipt (DR). In addition, in 2000, it allowed original stocks to be listed on the domestic stock market, and eased the listing requirements of foreign companies to match domestic ones. In the beginning, only secondary listing of companies listed on foreign stock exchanges was allowed, but primary listing of foreign entities that were not listed on foreign stock exchanges was also allowed after the consolidation of the stock exchanges in 2005. Under such efforts, China’s Hwapung Textile was first listed on the stock market in 2007. In 2013, the investment obligation level of listed foreign subsidiaries was mitigated to the acquisition commission rate level. In addition, foreign corporations listed on the eligible market were required to recognize the standard of governance in their home country, and for secondary listing of global blue-chip corporations, only the requirements were reviewed and exempted from qualitative examination and review by the public listing committee.
Looking back, in the case of Korea, the inflow of FPI was high because economic fundamentals were good and the economic growth outlook was positive. Therefore, it was important to curb hot money at a reasonable level rather than to expedite FPI. In other words, policies to attract FPI were scarce. This is different from Mongolia’s policy conditions.
Meanwhile, various policies were implemented to create a favorable investment environment by foreign investors through raising confidence in the Korean economy and removing uncertainties in investment. Since the mid-1980s, Korea has been focusing on reforms to attract FDI, as the balance of payments has largely maintained a surplus stance. To attract foreign investment, the Korean government had improved the predictability of the future, maintained policy consistency, and emphasized persuasion of the public. The government regarded that reform was not as a one-time occurrence but a continuous process.18 It established a medium-term agenda for foreign investment reform through Five-year Liberalization Plans from the early 1990s. In addition, the actual implementation of the measures announced years in advance has been remarkably consistent, without any significant delays or reversals.19 Especially, despite the Asian financial crisis in the late 1990s, the government’s response was consistent, and reform policies to promote foreign 20 216 investment were maintained even if the government in power changed. This policy
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market stance is considered to be a key factor in facilitating the inflow of foreign investment, as foreign investors do not invest when uncertainties are high. The government also has made continuous efforts to promote public awareness on financial reform. There were many institutional changes, such as through the Committee on Foreign Investment and the Investment Ombudsman, to improve not only the investment condition itself but also the atmosphere for investment policy making. For example, the tripartite Commission of labor, management and government was created in Korea in 1998 in order to involve all key stakeholders in the discussion of financial reform as a way of escaping from the Asian currency crisis. The Commission was renamed the Economic and Social Development Commission in 2007. Furthermore, through the Home Doctor system, foreign investors’ grievances were resolved, and the Investor Ombudsman also represented the views of foreign investors within government. At the same-time, financial literacy education to the public through the Bank of Korea, the Financial Supervisory Service, and KDI (a think tank) has also been strengthened.
18 OECD (2013). 19 WTO (1996). 20 The OECD (2013) evaluated this as the most interesting lesson learned from the Korean experience. 3.2. Measures for Promoting Foreign Portfolio Investment of Reference Countries
3.2.1. Expansion of Stock Market Base and Foreign Investment Policy in China
In China, like Korea, various policies were used to curb excessive inflow of hot money rather than attracting FPI. For example, B-Stock market for foreigners-only was opened on the stock exchange to allow for a gradual inflow of foreign investment. The qualified foreign institutional investor (QFII) system also managed the qualifications and limits of FPI. The QFII system, however, was completely abolished in 2019 following China’s trend of financial opening.
With the first phase of the U.S.–China trade dispute, foreigners’ entry into the Chinese capital market will be liberalized from 2020, with more foreigners expected to expand portfolio investment in the Chinese capital market in the future.
Meanwhile, in January 2020, the Chinese government announced measures to boost the 217
stock market by luring household deposits (70 trillion yuan, about $10 trillion, and about CHAPTER 70% of China’s GDP) into the stock market.21 The Chinese stock market is highly volatile, because individual investors account for 80% of the total and institutional investors have 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market little participation. Therefore, if household deposits deposited in banks flow into the stock market, it will serve as a long-term investment fund and is expected to serve as a positive factor for the stock market. The content of the measure has three key points. First, the policy is to divert bank savings amounting to 198 trillion yuan to the stock market. Specifically, this allows banks to set up a wealth management company and invest directly in the stock market through it. As of the end of December 2019, 32 wealth management companies were established, of which the six largest commercial banks and another six banks such as China Ever-bright Bank and China Merchants Bank began operations. Over the next 10 years, the stock-inclusion ratio of wealth management products is expected to rise from 2% to 10%, and the amount is expected to reach 5.5 trillion yuan.
Second, there is a huge inflow of bank loans into the strategic emerging industry. The plan calls for strengthening strategic funding for the new growth industry at a time when China’s technological independence has become a national issue due to the aftermath of the technical war between the U.S. and China. The Chinese government is expected to foster technology stock markets such as Star market and ChiNext, and change the IPO to a registration system. Thereby, the government will greatly expand funding for these
21 CBIRC, (2020.1.4). 关于推动银行业和保险业高质量发展的指导意见 companies. Third, it actively blocks funds flowing into real estate. The Chinese government intends to fundamentally prevent funds from banks and others from flowing into real estate through abnormal shadow banking in a bid to curb excessive property price hikes. Instead, they are encouraging floating funds to flow into the stock market.
3.2.2. Foreign Portfolio Investment Policy in Nigeria
Developing countries that have experienced similar economic development processes with Mongolia, such as Nigeria and Vietnam, are developing their economies by attracting foreign investment. In particular, attracting foreign investment is focused on FDI rather than FPI. Policies aimed at promoting FPI are generally aimed at stable long-term portfolio investments, not at the inflow of hot money.
Nigeria is similar to Mongolia, which relies on mineral exports in terms of mainly exporting crude oil and petroleum gases. Nigeria’s net FPI, real GDP, CPI, market capitalization, and trade openness are closely related. Especially, FPI has a positive significant impact on economic growth. Many studies recommend that governments 218
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market should initiate policies that will promote the long-term growth of the capital market and the economy and that they must create a conducive business environment by maintaining policy consistency. The capital market should be further deepened. In a prominent study,22 FPI and market capitalization have positive effect on real GDP while exchange rates have an inverse relationship with real GDP. Therefore, economic performance is critical to attracting FPI into any country. The Nigerian government has been creating an environment that can stimulate the economy and strengthen its fundamentals. It also seeks to stabilize capital and money markets by implementing appropriate investor-friendly policies to sustain their internationalization and appeal to investor.
The federal government of Nigeria should strengthen the Security and Exchange Commission (SEC) to promote constant inflows of FPI into Nigeria. The government should develop capital markets so that domestic trading volume should increase more than FPI because of the existence of huge risk premium in Nigeria and that Central Bank of Nigeria (CBN) should be proactive in regulating FX transactions in Nigeria since the country is import-dependent country.23 It is also pointed out that it is necessary to accurately assess the level of risk through the activation of the functions of credit rating agencies in order to promote FPI.
22 Acha, Ikechukwu A., Essien, Joseph M. (2018). 23 Onyeisi Samuel et al (2016). Meanwhile, through a study of 128 financial and manufacturing companies’ chief finance officers and investment officers in Nigerian, the factors that attract FPI in the Nigerian bond market were analyzed. The results showed that the FPI’s contribution to long term funds in the bond market between 2003 and 2011 was mainly due to interest rate (85%), gross domestic product (90%), bond market capitalization (91%), inflation rate (89%) and external reserve (95%).24 Other studies that analyzed the long-term determinants of FPIs in Nigeria during the 1986–2006 period also showed that FPIs positively correlate with return on investments in the capital market, real interest rates, and investment, but they also showed negative correlations with real exchange rates and trade degree of openness.25
A research on the relationship between exchange rate volatility and foreign portfolio inflow in Nigeria between 1980 and 2011 assessed that exchange rate volatility had a slightly negative effect on foreign investment inflows.26 In sum, it shows that while domestic economic performance is a crucial factor for the inflow of FDI into Nigeria, there are more external factors in the long run to determine the inflow of FPIs. Indeed, emerging markets need above-average compensation to offset higher-than-average risks, and sound exchange rate management is imperative. To attract FPI, Nigeria must compete with other larger and 219 deeper markets, and to attract international investors’ attention, it needs to reduce barriers CHAPTER to access including other disincentives. 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market 3.2.3. Vietnam’s Policy to Expedite Foreign Portfolio Investment
Vietnam has been quite successful in attracting FDI since the inception of economic reform in 1986. The inflow of FDI has contributed significantly to the economic development of Vietnam.27 In Vietnam’s capital market, bond markets began to develop first with the issuance of GBs right after the Doi Moi reform. The stock market was opened after a certain period of time had elapsed after the issuance of GBs, as it took time for a listed company to emerge. The bond market began in 1992 when it issued less than three years of Vietnam domestic currency and foreign currency-denominated GBs and CBs covering power lines. The short-term treasury bills market was opened in June 1995, and in July 2000, the Vietnamese central bank launched open market operations and began bond purchases from the state-run commercial bank.28 Vietnam’s case suggests that developing the bond market first will contribute to attracting FPI when the stock market is not sufficiently active.
24 Moses, Ekperiware et al (2015). 25 Patterson Ekeocha, Chukwuemeka (2008). 26 Omorokunwa et al (2014). 27 Ngoc Anh, Thang Nguyen (2007). 28 Ho Yeol LIM et al (2015). Meanwhile, in Vietnam, like Mongolia, the weight of the banking sector is excessively high. The loan ratio to SOEs in the bank portfolio is also considered high, while that of loans to various industrial sectors and SMEs is relatively low. In addition, the financial market is focused on the credit of the banking sector, and the proportion of financing through bonds and stocks accounts for only 40% of the total. The Vietnamese government is pushing for reforms aimed at promoting infrastructure investment by raising long-term financing through capital markets, and innovative growth through links between capital market finance and technology development. Experts say that modernizing the legal and regulatory foundation of the capital markets, improving governance, and information dissemination are needed to develop the Vietnam capital market. For example, information disclosure to the CB market remains extremely limited, due to the current lack of transparency and information available to prospective investors, as well as inadequacy of high-quality analysis. It is also important to broaden the investor base to non-bank investors such as Vietnam Social Security Fund (VSSF), insurance companies, and private pension funds, and to develop innovative products such as infrastructure bonds and asset-backed securities.29
220 The following measures are particularly highlighted as policies to attract FPI in Vietnam.
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market The development of a liquid market for risk hedging instruments may help deepen and sustain the development of the market, as foreign investors are more interested in buying Vietnamese securities. An upgrade of Vietnamese market status in global stock and bond indexes will also promote foreign investment and support sustainable growth of the capital markets and diversified participation in the markets.
3.3. Lessons from Korean and Reference Countries’ Experience
Several implications can be found when analyzing Korea’s case and countries that had undergone economic development processes similar to Mongolia’s, such as China, Nigeria, and Vietnam.
First, Korea and China had foreign confidence on the high growth potential and economic fundamentals of the domestic economy, which put pressure on inflow of FDI and FPI. Therefore, the main policy was to control the excessive inflow of short-term floating money, so-called hot money, by foreigners in a short period of time rather than to promote foreign investment.
Second, foreign investors consider the uncertainties of the economies of countries to be invested in. It should be noted that Korea increased the predictability of the future through
29 World Bank (2019). its five-year plans. Maintaining the policy’s time consistency is also critical in that it removes uncertainties about economic development and attracting foreign investment. It will also be important to raise people’s financial literacy of the capital market and to gain stakeholder cooperation.
Third, in terms of demand side in the stock market, considering the reality of Mongolia, which has low loyalty to companies, the People’s stock system targeting blue-chip companies is more worthy of reference than the ESOP. Something similar to the Korean SMSF will also be a good policy idea. In terms of stock market supply, attention should be paid to Korea’s Public corporation inducement law of 1972 and the SPAC introduced in 2009. In addition, listing on the KOSDAQ for start-up technology companies or venture firms, and listing of KONEX for un-listed and promising small and medium-sized enterprises with excellent technology but short history contributed to expanding the supply base of the stock market.
Fourth, foreign investors expect investment profits and ample market liquidity. The high maintenance cost of the IT system for the settlement of Mongolia’s stock exchange is also cited as a factor in increasing transaction costs. Therefore, a strategy will be needed to lower 221 transaction costs. Lack of attractive financial instruments or overregulation can also reduce CHAPTER investment profits. 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market Fifth, in the case of Mongolia, the high proportion (around 85% of the total financial asset) of bank deposits that guarantee high profits could hinder the development of the stock market. Even in Korea’s experience, the stock price index rises when market interest rates stabilize, and falls when market interest rates rise. On the other hand, we can see the higher the real interest rate of the bonds, the stronger the economic growth and external assets, and the larger the size of the bond market, the richer the liquidity, which facilitated the inflow of the FPI into the Nigerian bond market. [Figure 3-11] Correlation between Korea’s KOSPI and Market Interest Rate
2,280 -
2,240 -
2,200 - - 1.5
2,160 - - 1.4 2,120 -
2,080 - - 1.3 2,040 -
2,000 - - 1.2 1,960 -
1,920 - - 1.1 2019/08/29 2019/09/18 2019/10/08 2019/10/28 2019/11/15 2019/12/05 2019/12/25 2020/01/14 2020/02/03 2020/02/21
KOSPI (left) GB (3 years, right)
Source: http://freesis.kofia.or.kr (2020.2.29).
Sixth, Individual investors mainly focus on short-term investments because they do not 222 have the scientific evaluation capability on stock value. On the other hand, institutional Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market investors not only serve as a basis for enhancing the stability of the stock market, but also a driving force that balances power with foreign investors. South Korea has also kept foreign investors in check to control the stock market as institutional investors grow. In case of China also had a high share of private investors, the stock market was highly volatile. However, as a result of creating a foreign-only B-share market and pushing for the expansion of institutional investors, the share of foreign and institutional investors in the B-share market reached 50% at the end of 2019.
Seventh, it is assessed that infrastructure improvements are needed in a variety of areas related to the capital market. There are too many Mongolian securities companies (54 companies) compared to in Korea (57 companies), which ranks around 7th in the world in terms of capital market size. Thus, for less profitable securities firms, switching to online securities firms will be one of the ways to survive.
Eighth, if we consider the order of development in the stock market and bond market, it would be good if the development of the bond market precedes that. In the case of China or Vietnam, long-term funds of companies were effectively raised through the bond market based on the advantages of relative high interest rates in the early stages of capital market development. In Mongolia’s case, the GB market is tied to the IMF program, and the CB market is lagging, so it is deemed necessary to promote systematic development of the bond market. 4. Policy Recommendation to Successfully Expedite Foreign Portfolio Investment
4.1. Setup Criteria of To-be Investment Environment
This project is aimed at strengthening the infrastructure of Cross-border securities investment by analyzing the reasons for the lack of FPI and factors that hinder investment in Mongolia, which falls short of global standards. Therefore, it is necessary to present principles of capital market operation to promote FPI, and to create conditions suitable for Cross-border securities transactions. It also aims to strengthen the legal framework on investment infrastructure, remove institutional constraints on FPI and present policies to strengthen demand and supply bases in Mongolia’s capital market.
Based on the experience of attracting FPI from Korea and other reference countries, this study seeks to present several criteria to create an optimal investment environment suited to Mongolia’s national characteristics and unique conditions in the capital market. 223
The first criterion is to establish the principle of capital market operation. The experience CHAPTER of attracting FPI from developing countries such as Nigeria and Vietnam suggests that 03
political and macroeconomic stability, sustainable economic growth, and expansion of Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market growth potential of the stock market are key investment incentives. Therefore, the most important thing in the principle of capital market operation is the consistency of foreign investment policy. In Mongolia, a lack of consistency in investment policy is hampering FPI. Cases of inconsistency of ownership right and procurement’s bid, determining a license for political reasons, or revoking a license for no apparent reason should not be repeated. This contrasts with Nigeria (a mineral exporter like Mongolia), which has maintained consistency in foreign investment policies and continued to pursue investor-friendly policies.
Predictability for the future is also important. Since the government switched to a market economy in 1992, the ruling party has changed every four years in the general elections. Accordingly, foreign investment policies are changing in a similar pattern. Therefore, increasing the predictability of the future should be the basic framework for capital market operations.
Finally, it is necessary to improve external imbalances with active macroeconomic stabilization policies. Looking at Mongolia’s economic structure, it is vulnerable to overseas shocks, with 90% of exports being mineral resources and 90% of export being to China. In addition, stable management of foreign investment is one of the important economic policy objectives, as Mongolia’s foreign debt exceeds 200% of GDP as of 2020. Thus, the improvement of external imbalances through the reduction of foreign debt and the expansion of FX reserves should proceed. Under the current basic economic conditions, attracting foreign investment through capital market development may have aspects of boosting growth and strengthening the internal balance of lowering inflation, but it should also be noted that there is a possibility of worsening the external balance.
[Figure 3-12] Issue, Challenges, and Expected Outcomes in Mongolian Capital Market
ISSUE CHALLENGES EXPECTED OUTCOMES
Why is FPI Lack of infrastructure for Proposing principles for capital market operation not active in Cross-border securities to expedite FPI Mongolia? transaction in line with global Optimal environment for Cross-border securities standard. transactions
Reinforcement of the Act on investment infrastructure
Measures to remove institutional constraints on FPI
224 Measures to strengthen the capital market in
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market terms of demand and supply
Source: Created by Author.
The second criterion is to create an optimal environment for promoting Cross-border securities transactions. The only solution that can accelerate the development of the competitive mining sector in the face of a lack of domestic capital is foreign investment. From this perspective, attracting FPI will be a very important economic development tool. However, foreign investors’ assessment of Mongolian companies is low. For example, money laundering concerns, which are terrorism financing for financial transactions with North Korea and Iran, have not been completely resolved. In October 2019, the Financial Services Commission on Money Laundering (FATF) classified Mongolia as a Gray-list country. Thus, commercial banks’ banking relations with the correspondent banks have been cut off. The government has been trying to IPO the state-owned coal company (ETT) in the Hong Kong market over the past few years, but its listing has been delayed as it has failed to dispel doubts among foreign investors about the structural problems. Therefore, it is imperative for the Mongolian government to create an optimal investment environment in terms of government and corporate governance, transparency, and rule of law.30 In addition, foreign investors do not invest in areas with high uncertainties. Therefore, enhancing the transparency of information disclosure by Mongolian SOEs will also contribute to creating
30 World Bank, Doing business 2020 – Mongolia placed 81 out of 190 countries, 2019.10.25. a better investment environment. Only then will environment for Cross-border securities transaction mature.
The third criterion is to strengthen the legal system on investment infrastructure. For example, as noted earlier in terms of specific legislation, it is necessary for the Mongolian government to refine the regulatory framework for the OTC market to facilitate the development of OTC market’s financial instruments such as CB and derivatives. It should also take the lead in removing obstacles to the primary market by clarifying the difference between private placement and public offering regulations in the Securities Market Law.
The fourth criterion is to remove institutional constraints that hinder FPI, and strengthen market infrastructure. As noted earlier, it is necessary to expand the base of institutional investors to strengthen the safety plate of the stock market and increase liquidity. The high transaction costs of Mongolia’s stock market must be improved. For example, the IT system for transactions of MSE, the so-called MIT system, is not fully utilized, and there are high costs of maintenance and service fees and there is no linkage with the market participants.
This means that the use of different IT systems by different institutions. In terms of the 225 securities industry, there are too many securities companies compared to the size of CHAPTER Mongolia’s capital market, and there are problems with the profit structure of securities 03 firms. In other words, the profit structure of securities companies depends solely on Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market brokerage fees. Tax problems regarding foreign investors must also be improved. The issue is also linked to the government’s tax revenues. To facilitate foreign investment, however, the Mongolian government must remove tax inconveniences for foreign investors and eliminate discrimination between Mongolian domestic investors and foreign investors.
The fifth criterion is to devise measures to strengthen the capital market in terms of demand and supply. This will be helped by the experience of policy management in Korea and major reference countries. Note, on the supply side of the Mongolian stock market, the number of companies that can be listed is very limited. For example, none of the 13 commercial banks have been listed on the Mongolian stock market. Most of the mining sectors that are attractive to be listed on the stock market are state-owned companies, or are in the form of joint investment by the government and foreigners. However, for political reasons, the government does not consider converting the company into a national enterprise through a stock market listing.31 Only when these obstacles on the demand and supply side are resolved will the measures to attract FPI gain momentum.
Next, the relationship between stock price index and market interest rate tends to be
31 In fact, there are only 12 IPO companies in the last three years. inversely correlated. In light of Mongolia’s recent average GDP growth rate and inflation over the past 20 years and expected depreciation of exchange rate, there is room to lower deposit rates, which are currently around 12–14% per annum. The average bank’s lending rate is around 18–20% per annum, due to small bank size, lack of credit information, and poor credit screening. The loan-to-deposit margin is very high, but due to the inefficiency of the financial system, there are many non-performing assets and banks’ profitability is also weak. Therefore, the government should lower expectations of inflation and raise the efficiency of the financial system to lower the corporate funding costs. On the other hand, it is a very difficult environment to do business with 20% annual financial costs. Therefore, it is necessary to foster a capital market where promising companies that cannot afford high financial costs can raise funds. In other words, if both the lowering of deposit rates and the development of the capital market are pursued at the same time, there will be synergy effects.
Meanwhile, the development of credit rating agencies is crucial to promote the development of the bond market. In particular, it is impossible without the support of a 226 credit rating system to boost the issuance of unsecured bonds such as CBs. In the case of
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Mongolian bond market, it is considered advantageous in terms of cost to borrow at low interest rates through Concessional financing provided by international organization or bilateral cooperation with China, Japan, and South Korea, rather than making up for the fiscal deficits through the issuance of domestic bonds. This is different from other developing countries such as Vietnam, where bond markets have become more advanced than stock markets.
4.2. Strategy to Build To-be Investment System
4.2.1. Reinforcing Long-term Investment Environment by Establishing Capital Market Operation Principles
First of all, in order to attract FPI in Mongolia, it is urgent to establish principles for capital market operation and create optimal environment to promote Cross-border securities transactions. The Mongolian government had been trying to attract more investors and stabilize the legal environment and create more beneficial conditions for investment procedures and regulations through the establishment of the NDA.
However, the NDA has not implemented procedures to do so, despite being required to issue tax stabilization certificates. It also promised to set up an Investor Dispute Resolution Council with the International Finance Corporation (IFC) and the World Bank, but this also has not been established as of August 2020. The Prime Minister’s Office maintains only an Investors Advisory Council, which representatives from the foreign investment circles. In addition, the protection of foreign investors’ rights is still considered fragile despite the establishment of the Council of Foreign Investment Reinforcement under the Prime Minister’s Office in 2016.
[Figure 3-13] What Are the Principles of Capital Market Operation to Promote FPI?
ISSUE REASON STRATEGY
What factors hinder Political instability and Strengthening the authority of the Foreign FPI in Mongolia? economic uncertainty in Investment Reinforcement Council and the Mongolia are hindering function of the Investor Ombudsman attracting FPI. Establishment of a sustainable foreign investment protection system regardless of government regime change
Improving Cross-border securities investment environments by diversifying industrial structures and deepening capital markets
Source: Created by Author. 227 CHAPTER
Therefore, it is imperative to stipulate a clause in the authority of the NDA or the FIRC that firmly protects FDI and FPI regardless of government regime change. In addition, the 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market Mongolian government should continue make policy efforts to effectively carry out its policy commitment to attract long-term investment by foreigners. Mongolia’s Investment Law and Securities Law should also naturally reflect clauses that strengthen the protection of foreign investors regardless of government regime change.
Along with the rapid development of the SIRM, the introduction of an investor ombudsman system to solve foreign investment disputes and grievances will also be necessary.
Second, the industrial structure should be improved. As the industrial structure of Mongolia is composed mainly of mining industries, there is no diversity and FDI is concentrated on mining sector investment from China and Canada. For the future of the Mongolian economy, it is imperative to improve Cross-border securities investment environments by diversifying industrial structures and deepening capital markets. The government of Mongolia has developed its action program to be implemented for the period of 2016–2020, reflecting Mongolia’s Sustainable Development Vision 2030. Through this program, Mongolia have passed policies to diversify the economic industry. It is aimed at supporting domestic businesses and investors and small companies and individuals through tax discount, to repay their loans and improve their credit history. Furthermore, in 2019 The World Bank’s Board of Directors approved 100 million US dollars in financing to help Mongolia further stabilize its economy and move it towards a more sustainable development path. This program is directed to strengthening public administration and improving economic governance and transparency; enhancing the competitiveness of Mongolia and diversifying its economy; and empowering the country’s professionals.
In addition, the Mongolian government has applied for the emergency financing (Rapid financing instrument) to the IMF as the balance of payments worsened due to the border blockade with China caused by the Coronavirus Pandemic. However, the amount of funding is known to be small and one-time. By the way, the amount of public foreign debt due next year exceeds 20% of GDP, and FX reserves are still insufficient to absorb external shocks. If Mongolian government do not diversify its mining-focused economy, it will still be difficult to break the boom and bust cycle.
To more upgrade and diversify its economy, Mongolia will need to attract efficiency-
228 seeking investment, which is not coming to the country at the moment. This would
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market require an effort to expand the export basket. In addition, the new policies focused on the foreign investment should create a favorable environment for the investors. Furthermore, whenever an important policy or regulatory decision is being considered concerning either new or existing FDI and FPI, a key driving force and criterion should be whether the decision under consideration will support the diversification agenda of Mongolia. If there is a conflict between economic players when Mongolia introduces such policies, Mongolia should refer to Korea’s past creation of a tripartite committee including labor, management, and government to persuade workers and labor unions, while strengthening financial literacy education in various forms.
4.2.2. Strengthening the Legal Basis for Foreign Portfolio Investment
The lack of legislation in the OTC market is due to the sluggish capital market and the lack of human resource since the economic situation worsened in 2013. Moreover, Mongolian securities issuers’ financial literacy was insufficient. In particular, they were not well aware of the IPO or issue of CBs which are fundamental issues in the Mongolian capital market. In addition, there is no OTC platform in Mongolia. However, the Mongolian securities association hopes to establish the platform. Another reason is that the requirement and regulation on the public issuance of CBs are too high. And only two CBs have been issued over the last 5 years, with CB issuers pointing out that cost and process are too tough. The revised Securities Market Law in 2020 distinguishes between the stock exchange and OTC platform. In addition, there is further focus on OTC market regulation, which has led to constraints in further expanding the market and increasing investment flows.
Therefore, in order to strengthen the legal basis for promoting FPI, firstly, the FRC will have to generate general regulations on the OTC platform. At the same time, the Ministry of Finance as a policy maker, should encourage the development of OTC platform by policy on the general bond market itself. In addition, the securities primary market should be activated by classifying private placement and public offering regulations.
Second, due to the Mongolian Law on the Company and Investment Fund, the regulation is not detailed to identify the restriction of mutual funds. The introduction of new SPC-type mutual funds in addition to LLC-type will lead to the revitalization of the indirect investment market, which will serve as an opportunity to promote FPI.
Third, there had not been any change in the regulation of one fund should be managed by each fund manager. Most countries determine the exercise of voting rights and the standard date for dividend payments at the end of the year. In Mongolia, however, the 229 standard date for voting rights exercise and dividend payout are different. As such, toxic CHAPTER clauses that reduce the efficiency of the capital market should be removed as soon as possible. 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
Fourth, for now, there is no provision in the Securities Market Law that a certain percentage of private pension funds should be invested in securities. However, the Mongolian government acknowledges the underdevelopment of the private pension fund’s system and its necessity to develop. This is also linked to the legal foundation needed to expand the demand base of the capital market. [Figure 3-14] How Will the Act on Investment Infrastructure Be Reinforced?
ISSUE REASON STRATEGY
What is needed to Regulatory frameworks are FRC would better generate general regulation on strengthen the legal needed for the OTC market. the OTC platform. foundation on FPI? The difference between The securities primary market should be private placement and public activated by classifying private placement and offering regulations should public offering regulations. be clarified. The introduction of new SPC-type mutual funds LLC-type mutual fund and 1 will lead to the revitalization of the indirect fund - 1 manager regulations investment market. are blocking the growth The toxic clauses such as 1 fund - 1 manager of the indirect investment regulation, a mismatch between the standard market date for exercising voting rights and paying dividends.
Tax inequality between domestic investors and foreign investors which reduces the efficiency and attractiveness of Mongolian capital market, should be improved.
Source: Created by Author. 230
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Fifth, tax inequality among domestic and foreign investors on dividend earnings of stocks and capital gains of CBs should be corrected immediately. For example, the General Taxation Law (amended 22 Mar 2019) should be amended to address inequality in personal income tax on earnings from stock dividends between residents (10%) and non-residents (20%). In addition, the Corporate Income Tax Law and Personal Income Tax Law (effectively 1 January 2020) should be amended to address the tax inequalities between residents (10%) and non-residents (20%) on the capital gains of publicly issued corporate debt securities.
4.2.3. Improving of Transaction Costs, Information Disclosure, and Dissemination, and Market Infrastructure
Meanwhile, mitigation of uncertainties about the market could be a major factor in the inflow of FPI. The credit rating system is considered basic capital market infrastructure to minimize the market uncertainty. In the unsecured bond market, in particular, the credit rating agency’s accurate credit assessment will contribute to reducing uncertainty. A project, “Capacity Building for Capital Market in Mongolia” is being implemented in the framework of the partnership.32 In this regard, the plans to establish a credit rating agency in partnership with the Insurance Association of Mongolia and commercial banks is being discussed. In addition, the Ministry of Finance and other stakeholders are now working on
32 The project was introduced at a discussion organized by FRC under the theme, ‘Development of Corporate Bond Market, and its Regulatory Environment’. At the discussion, Chairman of the Mongolian Association of Securities Dealers B. Ulziibayar informed about the plans to establish a credit rating agency in partnership with the Insurance Association of Mongolia and commercial banks. establishing a new capital market in-house system.
A comprehensive analysis of these developments still leaves considerable room for improvement in terms of transaction costs, information disclosure and dissemination, and market infrastructure. First, it is imperative to integrate IT system among securities- related agencies such as MSE, MCSD, MSCC, etc. The integration of IT systems among those institutions will improve the efficiency of whole capital market and lower transaction costs. It could ask for assistance from the Korea International Cooperation Agency (KOICA) to integrate the IT system. It can also think about financing securities-related institutions’ integration of IT systems through international financial institutions. For example, the Asian Bond Market Initiative, led by the ADB, may use funds to support the relevant countries to expand its presence. In addition, the new capital market in-house system should focus on ease the manual process and lower the transaction cost. In particular, the redundant manual process in the post-transaction stage should be dramatically improved.
Concerning transaction cost cuts, it is also necessary to lower brokerage fee and to give a new profit model for securities companies. The brokerage fee consists of an investment 231 consultation service fee and a commission for consignment sales, which in the case of CHAPTER an online securities company, there is no face-to-face consultation and, therefore, only 03 commission for consignment has to be paid.33 Thus, as the online of securities transactions Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market progresses, commission fees will be lowered. In addition, intensifying competition between online securities companies and branch-network securities companies will accelerate the decline in commission fees. Meanwhile, it is necessary to enlarge the size of securities companies through M&A for the securities industry. In addition, instead of lowering transaction fees for securities companies, the government should also allow securities companies to operate business models other than brokerage business, and securities companies themselves must find new sources of profit.
33 Twenty years ago, Korea had to pay about 1 percent commission to buy and sell shares with a 0.45 percent commission. However, transaction fees were drastically lowered as competition intensified with the emergence of online securities companies. [Figure 3-15] How to Build Infrastructure for Cross-border Securities Trading?
ISSUE REASON STRATEGY
How to build Transaction costs are too IT system integration and manual process in the infrastructure high. post-trade stage should be improved. for Cross-border Poor information disclosure It is necessary to enlarge the size of securities securities trading? magnifies uncertainty. companies through M&A and to allow securities What policy companies other business models besides Market infrastructure is will remove the brokerage. weak, including low liquidity institutional and difficulties in opening It is necessary to further improve the credit constraints that hinder accounts. rating system and introduce foreign credit rating the inflow of foreign companies. investment? It is important to improve access to investment such as opening A/C and issuing tax payment certificate, as well as developing FX market.
Source: Created by Author.
Second, the credit rating system has been in the process of improving in recent years. However, the possibility of foreign credit rating company entering the Mongolian market 232 is currently uncertain. In any case, it is clear that establishing a transparent credit rating Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market system is one of the key mid- to long-term tasks for the Mongolian capital market.
Third, unstable FX rate and lack of liquidity and exchange-hedge function in the FX market could undermine the attractiveness of foreign investment. In addition, institutional investors may have different access to Mongolia’s capital market depending on whether local custodian is able to provide quality services, including FX payments, and whether liquidation settlements are smooth. Mongolia may lack the liquidity of commercial banks if it immediately repays it due to short-term borrowing by foreign institutions. Mongolia’s FX market is dominated by the Bank of Mongolia and commercial banks, so it should create policies to manage the FX market and strengthen the policies surrounding the bank management, damage control and risk analysis. Also, since Mongolia is creating a favorable environment to attract foreign investment, liquidity through the FX market can be improved if these policies work. In addition, even if FDI increases, demand for currency from recipient countries will increase and its exchange rate will rise.
Meanwhile, in order to open an online account, citizens of Mongolia and foreign investors need to have an account in the central securities depository.34 However, continuous improvement is essential because opening an account at MCSD is considered inconvenient.
34 To protect their information, they are required to come personally to open the account or to send the request together with the relevant documents by registered mail. Then, they are required to make the payment for opening the account and will receive the registration code. Despite the double taxation agreements, securities companies and related institutions have not issued tax payment certificate to foreign investors quickly who paid taxes in Mongolia pay taxes again in their own countries. These inconveniences should also be addressed immediately.
4.2.4. Promoting Innovative Products to Respond to Market Demands
The supply of quality securities to Mongolia’s stock market is inadequate, making it insufficient for foreign investors to buy. As innovative financial instruments, products made in the form of stocks of working interest35 in the Mongolian mining industry, and Genghis Khan bonds using Mongolia’s high interest rate are promising ideas.
Meanwhile, the Mongolian government is exempt from taxation on profits from investing in GBs. Foreign investors can open their accounts and participate in the GB market. In the case of Nigeria and Vietnam, bond market development is more important than stock market in the early stages of capital market opening. But the Mongolian GB issuing market is now controlled by the IMF program. Following the IMF’s recommendation, the Mongolian 233 government has cut public debt by 20 percentage points over the past three years through CHAPTER fiscal tightening. However, in 2020, the government is considering raising funds through the issuance of GBs to cope with a decrease in tax revenues and increased fiscal spending due to 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market the impact of Corona virus crisis. The IMF will also evaluate that a temporary expansionary budget is inevitable to cope with the slowing economy. This is because border control is necessary to prevent the spread of Covid-19, and it is advantageous to raise funds through the issuance of GBs in a small open economy such as Mongolia.
35 In the case of the mining industry, it is a risky business that is as risky as oil mining, but if mining is successful, huge profits will follow. For example, in oil developing, the probability of successful oil discovery is 20 to 40%, and commercial oilfield development accounts for only 5 to 10%. Once the mining is successful, however, it is followed by huge rewards, ranging from tens of millions to billions of dollars. Thus, methods of securitizing the working interest of mines can be used (Sung-hoon KIM, Oil Development Proj- ect, KNOC, 2007, Jin Kim, International Petroleum Transaction – Upstream, Korea National Oil Corporation, 2007). [Figure 3-16] Why Are There Not Enough Innovative Products That Foreigners Want to Invest in?
ISSUE REASON STRATEGY
Why are there not The infrastructure for the The form of stocks of working interest in the enough capital emergence of innovative mining industry will be innovative products. market products that products is insufficient. If the issue of GBs is resumed, it will be a good foreigners want to GBs issuing market is now product for foreign investors. If frequent intraday invest in? controlled by the IMF transactions are reported in real-time, it also will program. contribute to revitalizing the GB market. The introduction of the bond Repo service system will There are no related products also contribute to revitalizing the GB secondary due to the absence of the OTC market. market. If the OTC market develops, CB-related products and financial derivatives can develop.
Source: Created by Author.
In addition, Mongolian GB investors are mostly commercial banks that hold bonds until maturity, so secondary market transactions of GBs do not occur frequently. Therefore, it is
234 difficult for foreign investors to buy GBs due to a lack of supply of them in the secondary
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market market. If Mongolia’s GB issuance resumes, they will be a good investment product for foreign investors. Moreover, if the secondary market for GBs is activated due to frequent intraday transactions, real-time reporting that dealerships should report transactions within about 30 minutes is considered a better option. The introduction of GB’s Repo service could contribute to revitalizing the secondary market.
Meanwhile, in the OTC market, if the restrictions on the development of financial instruments are lifted, new financial instruments such as CBs and financial derivatives and other products could be developed to meet market demand. In addition, the inflow of FPI will be greatly facilitated if derivatives are available to prepare for currency risks in the FX market.
4.2.5. Widening the Demand and Supply Base for Capital Markets
In terms of demand side in the stock market, it is necessary to refer to People’s stock36 and the SMSF in Korea. In order for the People’s stock system to contribute to expanding the demand base of the stock market, stock prices will have to stabilize and investors’ asset growth will have to be made. In case of Mongolia, 1,072 shares of the ‘Erdenes Tavan Tolgoi’, which is equivalent to 1 million MNT per person, were distributed as People’s stock
36 However, unlike Korea, it is considered that the initial policy results have not been achieved as prices have plunged after going through overseas listing on the Hong Kong stock market. according to the election pledge in 2016. At that time, the government set the value of the issuance, and 1.8 million people, including nomadic people, opened accounts at MCSD to pay for People’s stock. In 2020, Mongolian government decided to allocate the Erdenes Tavan Tolgoi SOE’s dividends to its shareholders from May 1st.37 However, the decline in stock prices has led to the prevailing assessment that the government failed to achieve its original policy goal of dual listing of this company. In Korea, the People’s stock system had contributed to the expansion of the demand base for the stock market, while Mongolia still has a weak demand base for individual investors as it has failed to establish a People’s stock system. The establishment of a People’s stock system should be based on efforts to enhance the people’s understanding of the stock market and financial literacy. Meanwhile, stock market stabilization funds can contribute to minimizing stock price falls caused by shocks from outside the stock market, such as the Coronavirus crisis.
As previously analyzed, institutional investors are insufficient in the Mongolian capital market and the investment base is not strong. In addition, foreign investors are not attracted to listed companies (SOEs and blue-chip companies) that do not meet international 38 standards. In addition, corporate governance is also unclear. 235 CHAPTER
As a way to expand the demand base of stock market, it will also be necessary to 03 encourage institutional investors such as the Social Insurance Fund and pension funds Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market to invest a certain percentage of their operating assets in the stock market, and to induce insurance companies to invest in the stocks. These policies will contribute to strengthening the demand base in the stock market. For example, the Social Insurance Fund or pension funds could be designed to induce more than 30% of its operating assets to invest in stocks and 40% in bonds.39
37 With this news, many shareowner citizens are starting to show interest in the market and asking inquiries from the MCSD, MSE, and brokerage companies. 38 The IFRS for SMEs Standard is under consideration by the Ministry of Finance. In addition, companies hire international auditing companies, such as KPMG, Deloitte, EY, etc. to meet the international standards. 39 According to the asset composition of the country’s major institutional investors, 18 percent for domestic stocks, 20 percent for for- eign stocks, 45 percent for domestic bonds, 4 percent for foreign bonds and 13 percent for alternative investments. [Figure 3-17] What Are the Measures to Strengthen the Capital Market in Terms of Demand and Supply Side?
ISSUE REASON STRATEGY
In terms of demand The demand base of the stock It would be better to activate People’s stock and supply side, what market is weak. system, which was test-run in 2016, and to launch are the measures the SMSF when stock market is unstable. Institutional investors’ to boost the capital investment ratio is too low. A certain percentage (30% in stocks and 40% market? in bonds) of the operating assets of the Social IPOs are not active, and Insurance Fund and the pension fund may be markets exclusively for SMEs encouraged to invest in the stock market. and venture companies are insufficient. Promote the IPO of private blue-chip companies through the enactment of the Corporate Listing Promotion Act, and actively develop markets exclusively for SMEs and venture companies.
Source: Created by Author.
On the supply side of the stock market, the introduction of the Corporate Listing Promotion Act appears to be a priority. In addition, MSE should more faithfully consider
236 fostering the stock market, which only targets promising SMEs and venture companies
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market with technological power. This is also linked to policies that diversify the mining-oriented economic structure. In the case of Mongolia, promising SMEs in the dairy and tourism sectors, and venture companies in the IT soft-ware sector based on high education enthusiasm should be actively attracted to the stock market. For this, Korea’s SPAC, the KOSDAQ market and the KONEX market could be great help. We hope to develop the second and third parts of the Mongolian stock market into a customized market for SMEs and venture companies. In order to expand the supply base of the stock market, it would be better to push for the listing of major SOEs or private blue-chip companies in Mongolia and consider double-listing of key mining companies. To promote the IPO of private blue-chip companies, it will be necessary to present various incentives, including tax favors.
5. Implementation Plan
5.1. Policy Roadmap to Expedite Foreign Portfolio Investment
To establish a desirable Cross-border securities investment system that can drive the development of the Mongolian stock market, it is important to present a roadmap with policy priorities and timetable. In this study, 26 tasks in five areas are divided into short, medium-, and long-term tasks and a roadmap is presented. Short-term tasks, to be improved within 1–2 years, will mainly be internal development of the capital market, such as advancing infrastructure. These include fostering the stock issuance and secondary markets, and strengthening the demand and supply base in the securities market. More specifically, toxic clauses, such as the provision that each fund manager should manage only one fund and the clause that differs from exercise date of voting rights and the standard date for dividend payments, should be removed as soon as possible. In the aspect of capital market infrastructure, the redundant manual process in the post-transaction stage should be improved within 1–2 years. Meanwhile, the inconvenience of foreign investors opening online accounts at MCSD and the inconvenience of paying double taxes due to delays in handling securities firms and related agencies should be eliminated in the short term.
Medium-term tasks to be improved within 3–5 years will include establishing principles for capital market operation, creating an environment suitable for Cross-border securities trading, providing various incentives, including tax benefits for foreign investors, and protecting investors. More specifically, these are strengthening the Foreign Investment Reinforcement Council, amending Investment Laws and Securities Market Laws, establishing 237 function of Investor Ombudsman, strengthening investment protection system. In terms of CHAPTER strengthening the legal foundation for FPI, there are enactment of general regulation on the 03
OTC platform, classifying private placement and public offering regulations, the introduction Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market of SPC-type mutual funds, and tax rate equalization for foreigners. Other measures will include licensing other business models for securities companies, structural reform in the securities industry, promoting innovative products such as stock form of working interest, development of the OTC market instruments, and the legislation of the Corporate Listing Promotion Act.
The current Mongolian economy will need the IMF’s emergency financing and Extended Fund Facility for the time being, as it is hit hard by the Covid-19 Pandemic. However, once this situation is resolved, the Mongolian government will have to resume issuing GBs within a few years to foster the GB market and boost the GB secondary market through intraday transactions. [Figure 3-18] Policy Roadmap
Policy Category and Item 2020~22 2023~25 2026~ Remarks
1. Establishing Capital Market Operation Principles
1) Strengthening the Council of Foreign Investment Reinforcement
2) Amendment of Investment Laws and Securities Market Laws
3) Establishing Function of Investor Ombudsman
4) Strengthening Investment Protection System
5) Diversifying Industrial Stuctures and Deepening Capital Markets
2. Strengthening the Legal Foundation for FPI
238 6) Enactment of General Regulation on the OTC
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Platform
7) Classifying Private Placement and Public Offering Regulations
8) The Form of LLC Turning into SPC
9) Amendment of 1 Fund-1 Manager Regulation
10) Matching Standard Date for Voting Rights and Paying Dividends
11) Tax Rate Qualization for Foreigners
3. Improving of TC, Information Disclosure and Market Infrastructure
Request to 12) IT System Integration KOICA
13) Computerization of Manual Process in the Post- Trade Stage
14) Structural Reform of Securities Companies & Other Business Models [Figure 3-18] Continued
Policy Category and Item 2020~22 2023~25 2026~ Remarks
15) Establish a Credit Rating System
16) Improvement of FX Market and Financial Literacy Education
17) Improvement for Foreigners' Access Such as Opening A/C
18) Tax Payment Certificate
4. Promoting Innovative Products
19) Stock Form of Working Interest
20) GB Issue, Intraday Transactions
239 21) OTC Market Instruments CHAPTER
5. Widening the Demand and Supply Base 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
22) People's Stock System
23) Stock Market Stabilization Fund
24) CB Investment of Social Insurance Fund and the Pension Fund
25) Corporate Listing Promotion Act
26) Exclusive Market for SMEs and Venture Companies
Source: Created by Author.
Long-term tasks, which will take more than 5 years, will include securing macro- prudential and financial stability by reducing the rapid inflow and outflow of foreign capital. Long-term tasks include diversifying industrial structures and deepening capital markets, integration of IT system between securities-related agencies, advancing a credit rating system, improvement of FX market and financial literacy education, and development of exclusive stock market for SMEs and venture companies. 5.2. Future Challenges – FX Market & Financial Literacy Education
As analyzed so far, the structural limitations of the Mongolian economy, which relies heavily on mining sectors, and its relatively large amplitude of the economic cycle compared to other countries, are the fundamental factors that undermine Mongolia’s national credibility and attractiveness of foreign investment. However, it is not easy to find alternatives or achieve results in a short period of time. Therefore, the structural transformation of the Mongolian economy is left as another task in the future in this report, which focuses on the infrastructure of the capital market.
Fostering the FX market, financial literacy education is evaluated as an important infrastructure in the capital market. However, due to the limitations of research period and coverage, this study was not fully covered.
Regard to the FX market, the volatility of the exchange rate of Mongolia’s Tugrik is high and the trend of the exchange rate’s trending depreciation is hindering foreign investment. 240
Suggestions on the Establishment of Cross-border Securities Issuance and Investment Infrastructure for the Advancement of Mongolian Capital Market Mongolia does not have a proper FX market, nor does it have an offshore FX market (NDF: Non-Deliverable Forward). Unstable FX rates and insufficient liquidity due to the lack of FX markets may also lower foreigners’ investment attractiveness.40 A fintech company listed on the Mongolian stock market attempted to issue a KDR on Korea’s KOSDAQ market, but Korea’s main management agency rejected it, citing a lack of liquidity in Mongolian securities. This is an example of the lack of liquidity in Mongolia’s stock market discouraging foreign investors from investing in Mongolia.41
Therefore, it will be necessary to establish transparent legal procedures for FX transactions, develop FX transaction products for FX hedge purposes, and establish a reporting obligation system for regulators in exchange hedge transactions so that foreign investors can efficiently manage currency risks in the future.
Finally, to advance Mongolia’s capital market, financial literacy education is needed to expand the investment base. For example, through financial and economic education, most Mongolians, including nomadic people, should recognize the need for savings and realize that a People’s stock system is needed to increase their income and to form property. In addition, education and training to enhance the working capacity of officials who are in charge of implementing policy proposals in Mongolia’s Ministry of Finance, Financial
40 However, there is no foreign exchange regulation when foreign investors enter the Mongolian stock market. 41 The author surveyed Korean investors (2020.1). Supervisory Commission, and Bank of Mongolia are also considered important.
Since 2016, the Mongolian government has been pushing for the National Strategy for the Financial Knowledge of the Public, with the Bank of Mongolia, the Mongolian Bank Association, and the FRC at the center, to improve the people’s financial literacy rate.42 However, the role of securities companies is important to improve people’s financial literacy in the capital market. For example, Mongolia should continue to increase public interest and trust in the capital market by expanding and developing the Investor Week event, which has been held since 2016. In addition, it is important to educate financial experts to improve their abilities. In Korea, the Korea Banking Institute (KBI) and Korea Institute of Financial Investment have been established to improve the capabilities of experts working in financial institutions. They have been steadily training experts on the capital market by installing specialized certificate courses such as financial planner and fund manager. It is also in charge of developing related textbooks and educating students in connection with universities. In Mongolia, it is considered essential to strengthen the base of the capital market in parallel with such policy efforts. 241 CHAPTER 03 Suggestion of Measures to Expedite Foreign Investors’ Investments in Mongolian Capital Market
42 With the support of the World Bank, comic books for students and websites for improving financial literacy and developing adult learning materials have been developed. In particular, it has provided advice on the actual contents of its website, including market information and basic knowledge of the capital market. References
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