Asiamoney.com: Asian private bankers keep it in the family
1 February, 2011Euromoney: Dangdang dishes the dirt
2 February, 2011Euromoney, February 2011
An investigation into a market plunge on the Korea Exchange in November has put Deutsche Securities under the spotlight and triggered a raft of changes to Korean derivatives market practice. Deutsche will probably find out by March what, if anything, it’s been found guilty of and what the outcome will be.
On November 11, the Seoul market fell steeply in the last half hour of trade on the back of heavy foreign selling, much of it in program trading, and specifically an arbitrage trade on an expiry date for options. Deutsche’s local securities unit made W1.6 trillion won of sales, bringing the Kospi index down 2.7%.
A market fall of less than 3% is not the end of the world, but it caused a great deal more scrutiny than might otherwise have been the case, for two reasons. One, the market movement was bad enough to bring one Korean asset manager, Wise Asset Management, unstuck; it has since folded. And two, it happened just as Seoul was hosting the G20 meeting, where world leaders – and financial top brass including Deutsche’s own CEO, Josef Ackermann – were gathering to discuss, among other things, greater financial stability.
Embarrassed and puzzled, Korea’s regulators, the Financial Supervisory Service and Financial Services Commission, set about an investigation on two fronts. They dispatched a team to Hong Kong, since the trading involved Deutsche’s Hong Kong office; and they set about revising market rules.
The Deutsche investigation is interesting. While Deutsche clearly moved the market by unwinding the trade, there’s nothing illegal in that. So what’s the regulator looking for? Those close to the investigation say Deutsche may have been late – by about a minute – in its disclosure of its intention to do the trade, but that’s something to be told off for, not banned. Instead, the focus appears to have been on whether any related trades took place at the same time. The regulators themselves say the Hong Kong investigation is “working to determine if an act of violating the Capital Market and Financial Investment Business Act, including market manipulation, was involved.” Soomi Kim, a spokesperson at the FSS, says the investigation has “made considerable progress and is under legal review.”
Regulators are also looking into what happened to Wise Asset Management, since there is clearly a deep underlying problem if a fund manager can go under on the back of such a modest fall. There was obviously a major leverage issue here, but regulators so far think the problem is isolated rather than endemic. “We found that with arbitrage trading, some asset management companies were exceeding their clients’ daily investment limits, which led to some exposures and losses,” says Yoonkon Choi, head of the securities market team in the Financial Investment Department of the FSS in Seoul. “But we believe it is not an industry-wide issue. We have found only a couple of AMCs and some securities companies are vulnerable in these areas,” and he believes Wise was the only one with a serious problem.
On the market side, revisions were announced in December and clarified in January, with some due to be in place by the end of the month. They include changes to margin rules, requiring pre-trade margin deposits for many institutional investors rather than post-trade as is the case today; the imposition of daily order limits; revisions to so-called random end rules, which allow for an extension to the deadline for submitting quotations when there is a big movement in the market in the last five minutes of the day; and a prohibition of new program trading after 2.45pm on option expiry dates. There are also caps on unsettled positions and new reporting requirements on futures and options positions.
“We did not realize a large volume of trading could impact the stability of the market, so that was an issue we focused on,” says Choi. “We believe once these measures are implemented it will be difficult for market to see such large-scale trading and may lessen the impact on the market itself.”
On the ground in Seoul, opinion seems to be somewhat fragmented. Much of the frustration voiced is about the nature of arbitrage and program trading rather than specifically about Deutsche.
But there’s also one other key piece of information that needs to come out of the Deutsche investigation that may shift opinion. Several reports, apparently all stemming from the same briefing, have quoted Ackermann as saying that the trade took place for a client. Some in Korea see this as somewhat diluting Deutsche’s responsibility, in that banks have to do what their clients want them to.
But there’s a problem with this. Euromoney believes the trade was not for a client, but proprietary. An arbitrage trade on this scale, with its numerous moving parts, is unlikely to have been for a third party client, and many in the market believe it looks like a bank trade and that Ackermann’s comment was either erroneously understood or wrong.
If this is true, it will be interesting what impact it has on the regulator’s conclusions and Deutsche’s standing in Korea. If nothing else, making a market-moving proprietary trade, at the precise moment one’s own chief executive is in town with world leaders talking about how to make the markets more stable, is unfortunate timing on a truly epic scale.
