ONLINE TRADING IN KOREA

Online trading has become the dominant mode of trading in Korea. It currently contributes over 50% of total market trading value. Online subscription of shares is also available online. In 2000, 690 companies raised funds by public offers via the Internet. As in other overseas markets, online trading in Korea is mainly a retail investor phenomenon. The success of online trading in Korea is attributed to the following factors: the high penetration of personal computers and the widespread use of Internet and broadband; the large retail investor base; securities firmsinitiatives to developing online trading; appropriate regulatory changes; and the economic pick-up in 1999. The Korean online trading market should continue to grow but at a slower pace. Competition among securities firms would remain vigorous, stimulating continuous efforts in system upgrade and service enhancements. However, the potential risks resulting from the increased trading activities and the electronic trading mode would require further regulatory changes to strengthen investor protection.

CONTENTS 1. Introduction......................................................................................................................2 2. Development of online trading.......................................................................................2 3. Popularity of online trading in Korea.............................................................................3 4. Online order placement...................................................................................................5 5. Drivers for the development of online trading ..............................................................6 5.1 5.2 Regulatory measures............................................................................................7 Popular use of Internet and large retail investor base in Korea ........................8

5.3 Initiatives of securities firms .............................................................................10 6. Outlook for Koreas online trading ..............................................................................12 6.1 6.2 6.3 Steady but slower growth of online trading .....................................................12 Continued competition among securities firms................................................12 Investor protection and regulatory changes......................................................13

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1.

INTRODUCTION Online trading in the Republic of Korea or South Korea (hereinafter referred to as Korea) refers to trading whereby orders placed by investors via electronic media to the in-house system of the broker firms are routed to the trading system of the exchanges automatically on a straight-through basis. In Korea, there are four markets for securities and derivatives trading, namely, the Korea Stock Exchange (KSE), the KOSDAQ, Korea's Third Market (OTC Bulletin Board Market) and the Korea Futures Exchange. The markets are regulated by the Financial Supervisory Commission (FSC) (responsible for policy formulation) and the Financial Supervisory Services (FSS) (responsible for policy enforcement) of the Ministry of Finance and Economy (MOFE). Online trading is available for all these markets. Since the statistics available are mostly based on the Korean Stock Exchange (KSE) and KOSDAQ, the report will present mainly the trading activities of these two markets. However, reference will be made to the picture of online trading in Korea as a whole.

2.

DEVELOPMENT OF ONLINE TRADING Online securities trading in South Korea was legally permitted in 1997 when the revised Securities and Exchange Act (SEA) authorised securities companies to receive client orders by electronic communications such as computer communication devices, Personal Digital Assistant (PDA), Automatic Response System (ARS) and mobile phone. In other words, investors in Korea can place orders online when trading stock, futures or options without the direct assistance of any securities firm staff. The first online order-placement channel introduced was the Home Trading System (HTS) 1 developed by securities firms. Through the HTS, investors could trade online on their PCs using the securities firms self-developed software. Despite the fact that many securities firms provided such online trading service, online trading was not well-received in 1997. This was because the concept of e-commerce and online trading was new to the Koreans. Secondly, many investors were driven out of the Korean securities markets as a result of the severe economic depression caused by the Asian financial crisis. After April 1999, alongside the implementation of major financial reforms and corporate restructuring, the Korean economy began to pick up and the stock market sentiment improved. Meanwhile, many securities firms decided to seek new business potential and to reduce their operating costs by introducing online trading services. As a result, online trading in Korea started to flourish. By end-1999,

Home Trading System (HTS) is a software system developed by brokers through which individual investors can place orders, receive trading data, and confirm transactions. To trade via HTS, the investor has to install this broker-developed program at his personal computer. Then he can log in and start trading. Placing online orders via this channel offer investors a higher degree of security and reliability. -2CSU - Research & Policy, HKEx 11 March 2002

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online trading contributed 19% of total securities trading value in Korea, up from just 2% in 1998. Thereafter, the market share of online trading continued to climb and exceeded 50% of the market total in 2001. In November 2001, the market share of online trading in KSE and KOSDAQ was 59% and 77% respectively. 2 In addition to the secondary market, online subscription of shares is also available in the primary stock market. Gold Bank Communications Co., Ltd. was the first firm in Korea to make a public offering of their shares through the Internet when it was listed on KOSDAQ in April 1998. In 1999, there were 180 companies raising funds via the Internet and the number of companies raising funds by public offers via the Internet grew to 690 in 2000.

3.

POPULARITY OF ONLINE TRADING IN KOREA Since 1998, online trading has become popular among Korean investors and has experienced significant development in several dimensions. The statistics presented below encompass online trading in the KSE and KOSDAQ. During January to August 2001, online trading value amounted to 1,398 trillion won, registering a substantial rise from 22 trillion won in 1998. In addition to the growth in its absolute value, online trading experienced a continuous increase in its percentage share of total trading value between 1998 and 2001 (Figure 1).
Figure 1. Online trading value and market share in Korea
(KRW trillion) 2,500 Online trading value to total trading value 55%

54%
Total online trading value 2,000 Market share of online trading value

47%
45%

1,940
1,500

35%

25%

19%
1,000

1,398
15%

500

684 2% 22

5%

0 1998 1999 2000 2001 (Jan - Aug)

-5%

Note: Online trading includes online trading of stock, futures and options in the KSE and KOSDAQ. Source: Online Securities Trading in Korea, Korea Securities Dealers Association (KSDA).

Securities available for trading online in Korea include stocks, futures and options. Over the past four years, stocks have had the largest online trading share, but other products have not been far behind. (Table 1)

Online Securities Trading in Korea by the Korea Securities Dealers Association (KSDA). -3CSU - Research & Policy, HKEx 11 March 2002

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Table 1. Market share of online trading by product type Year 1998 1999 2000 2001 (Jan - Aug) Stocks 3% 25% 56% 66% Futures 1% 11% 34% 43% Options 2% 18% 35% 52% All products 2% 19% 47% 54%

Source: Online Securities Trading in Korea, KSDA.

In value terms, online trading is dominated by stock trading which contributed 58% of total online trading value during Jan - Aug 2001. Nevertheless, the percentage share of online futures trading grew from 27% in 1999 to 41% during January to August 2001, reflecting the increasing popularity of online trading in futures. (Figure 2)
Figure 2. Online trading value and percentage share by type of securities
(KRW trillion)

2,500
Options (O) <1% (O)

2,000

Futures (F) Stocks (S) 30% (F) 1% (O)

1,500

41% (F)

1,000
70% (S) 1% (O) 27% (F) 58% (S) 49% (F) 51% (S) 72% (S)

500

0 Options (O) Futures (F) Stocks (S)

1998 0 11 11

1999 3 186 495

2000 12 580 1,348

2001 (Jan - Aug) 20 567 811

Source: Online Securities Trading in Korea, KSDA.

The number of online trading accounts increased significantly from 1.6 million in 1998 to 38.1 million in 2000 but decreased to 33 million in August 2001. Nevertheless, the share of online trading accounts as a percentage of total investor accounts increased continuously from 4% in 1998 to 49% in August 2001 (Figure 3).

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Figure 3. Online trading acounts and their percentage share of total number of investor accounts

(Million a/c) 120

100

Online trading a/c Non-online trading a/c 37%

80

60 4% 40

17% 49%

20

0 Online trading a/c Non-online trading a/c

1998 1.61 43.02

1999 11.47 57.02

2000 38.12 65.87

2001 (Aug) 33.14 34.74

Source: Online Securities Trading in Korea , KSDA.

Concerning online trading by investor type in October 2001, retail investors captured 98% of the total online stock trading value and institutional investors 2%. Investors online trading activities have been increasing in terms of number of orders and trading amount. In 2000, an investor account had an average of 13 online trades per month, more than double that in 1998; and the trading amount per account in a month was 50 million won, more than 3 times that in 1998. (Table 2)
Table 2. Trading statistics obtained from online investor accounts

Year 1998 1999 2000 Aug 2001

No. of orders per month per account 6 13 13 9

Trading amount per order (million won) 3 5 4 4

Trading amount per month per account (million won) 16 64 50 36

Source: Annual Report (Year 2001), KSDA; Online Securities Trading in Korea , KSDA.

4.

ONLINE ORDER PLACEMENT No matter whether trading online or offline, securities trading on the Korean exchanges can only be done by securities firms authorised by the exchange, i.e. exchange members.3 An investor wishing to trade securities has to open an account with a securities firm. When placing an order with the securities firm, whether

Members of KSE can trade the securities on KSE including stocks, bonds, stock futures and options while members of KSDA can trade stocks on KOSDAQ. -5CSU - Research & Policy, HKEx 11 March 2002

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online or offline, the investor is required to pay a good faith deposit4 in cash. When an order is input to the system of the securities firm, the system would first check if the requirement of the good faith deposit has been met. Then the orders are transmitted directly to the stock exchange via the computerised order-routing system offered by the exchange or developed by the securities firm. In Korea, securities firms can receive client orders (1) by written document; (2) by phone, telegram, fax; or (3) via computer or similar electronic communication methods (i.e. orders received online). In offering online trading services, the securities firm needs to enter into a prior agreement with the investor on this type of order placement and is obliged to fulfill certain requirements imposed by the exchange.5 These requirements apply to online services provided to pure online investors as well as to investors trading online using existing offline trading accounts. Investors can trade online via HTS, PDA, mobile phone or ARS (Automatic Response System). According to KSDA, HTS remained the most popular channel, contributing 86% of the total online trading value as of August 2001. The online trading process is fully automated. Online orders received by securities firms are routed automatically and directly to the trading system of the Korean exchanges without manual re-input. In Korea, the large securities firms usually develop their own online trading platforms while smaller ones can make use of the system offered by KOSCOM, a subsidiary of KSE. 6

5.

DRIVERS FOR THE DEVELOPMENT OF ONLINE TRADING Several factors contribute to the success of online trading in Korea. Apart from the economic pick-up in 1999, appropriate regulatory measures, rapid advancements in information technology and the high penetration of personal computers as well as the initiatives of securities firms in developing online business are all contributing factors. They are described below.

The deposit rate is set by the securities firm and the amount of deposit is determined by multiplying the deposit rate by the cash consideration of the order. Such deposit is needed for investors buying or short-selling the stocks. Selling of stocks already owned does not require the placement of deposits in the account. For the KSE, the requirements are based on the Enforcement Rules of the Business Regulation of KSE (KSE Rules). Other markets including the KOSDAQ and the Korea Futures Exchange have a similar set of rules governing such service in their markets. According to the KSE Rules, the requirements include: (1) the securities firm must be able to confirm the authenticity of the user, maintain records of the online orders and notify its online investor of the details of orders executed; (2) the investor should be able to confirm the details of an online order; (3) the securities firm s system should have records of rejected orders and prevent unauthorised users from submitting orders, withdrawing cash or securities etc. Online securities trading in Korea, Management Brief, Issue No. 7 (by Planning & Research, HKEx). -6CSU - Research & Policy, HKEx 11 March 2002

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5.1

Regulatory measures

5.1.1 Measures relating to online trading Article 109 of the Securities and Exchange Act (the 12th revision) (SEA) states that a securities company may be entrusted with securities transactions by means of electronic communication and other manners. As a result, online trading was legally permitted with effect from January 1997. Since then, with online trading, the securities trading process was simplified without the need for manual assistance by a broker staff as in the case of orders received via written documents, telephone and facsimile in the past. Further to this, changes in rules and regulations7 have occurred from time to time to accommodate the rapid development of online trading. Later in February 1999, the SEA was further revised to allow securities firms to establish Cyber Branches. This means that securities firms are free to open branches with speedy Internet connections like Cyber/Internet caf where investors can trade securities online. As a result, resources for business operations can be reduced.8 5.1.2 Measures relating to securities trading To encourage securities trading, brokerage commission was fully liberalised from September 1997. The brokerage commission rates, based on the transaction value, are freely determined by individual securities firms. The securities firms are free to compete for online traders by offering attractive commission rates. Previously, the Exchange had the authority to set the good faith deposit rate. In April 1998, the requirement for the good faith deposit was liberalised. Since then the securities firms can determine the amount or ratio of good faith deposit for a customer and the collection method.9 This has greatly stimulated short-term investment through day trading. As a matter of fact, liberalisation of both brokerage commissions and good-faith deposit are considered the most important measures in boosting online trading in Korea. To encourage more trading, the government relaxed the daily price fluctuation limit for stocks and stock index futures. From December 1998, the trading hours were extended. In May 2000, lunchtime breaks were abolished to promote continuous trading during the day.

At present, the regulation of online securities trading in Korea is based on Article 109 of the SEA. FSC and FSS regulate the securities markets in Korea in accordance with the provisions of the Act. In addition, each exchange has its own set of rules to regulate online trading in its market. Before this rule became effective, securities firms had to meet certain facility and personnel requirements for opening new branches. Yet the securities firms are required to inform the Exchange whenever they change the rates. -7CSU - Research & Policy, HKEx 11 March 2002

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After March 2000, real-time disclosure of quotation information by the Exchange has been widened to include the best 5 price queues and their aggregate order amount. From January 2002, this disclosure was further broadened to include the best 10 price queues and their aggregate order amount. 5.1.3 Measures protecting investor To protect investors, securities firms offering online trading services are required to enter into a special agreement with their online customers and install appropriate systems to ensure a secure and stable process for online trading. Apart from this, the Basic Act on E-commerce a privacy protection e-commerce act and an electronic signature act were enacted. 5.1.4 Measures for the primary market For the primary securities market, the revised SEA in May 2000 allows companies wishing to make an Internet public offering of under 1 billion won to do so without having a securities firm as a lead manager, and exempts these companies from filing a registration statement with the FSC. As a result, many small to medium venture companies were attracted to list on the KSE and Internet public offerings became popular. Meanwhile, more stringent issuer disclosure requirements were introduced to regulate the companies wishing to have Internet public offerings. 5.2 Popular use of Internet and large retail investor base in Korea In the last decade, Korea has witnessed rapid growth of Internet usage penetration. As of September 2001, the number of Internet users exceeded 24 million and reached a penetration rate of 50% of the population in Korea 10 (Figure 4). Further to this, 95% of the households with access to the Internet use broadband networks which provide higher efficiency in connectivity and data transmission.11 To date, Korea is among the countries with highest PC penetration rate in the world.12 In addition, the government has been keen in building up a knowledge-based society in Korea. 13 All these have created a favourable environment for online business to develop.

10 11

Korea Network Information Centre (http://stat.nic.or.kr/). Online trading are there any limits? by Chu Jin-hyung in Asian Securities Analysts Federation 2001 Conference. 12 Online securities trading in Korea, Management Brief, Issue No. 7 (by Planning & Research, HKEx). 13 This is reflected in some of its policies: (1) to promote PC usage, computers are distributed to students and teachers free during the Comprehensive School Informatisation Project (19972002); (2) Internet training for housewives, military personnel, farmers and fishermen is organised by the government department; and (3) low tariff for Internet access is permitted. -8CSU - Research & Policy, HKEx 11 March 2002

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Figure 4. Number of Internet users in Korea (1994 - Sep 2001)

(Unit: 1,000) 25,000 24,120

20,000

19,040

15,000 10,860 10,000

5,000 3,103 1,634 138 0 1994 1995 1996 1997 1998 1999 2000 9/2001 336 731

Source: Korea Network Information Centre (website).

The high retail participation in the Korean securities markets is another fundamental factor for the success of online trading in Korea. For the Korea Stock Exchange, retail investors contributed up to 70-80% of total stock trading value (Figure 5). The large and active retail investor base has attracted many securities firms to embark on online trading business.

Figure 5. Percentage share of retail investors in total stock trading value of the Korea Stock Exchange
80% 78% 76% 74% 72% 70% 68% 66% 64% 62% 60% 1995 1996 1997 1998 1999 2000 67% 71% 73% 72% 77% 76%

Source: Stock, Korean Stock Exchange, 2001.

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5.3

Initiatives of securities firms Securities firms have been playing a vital role in the development of online trading in Korea. As of September 2001, 38 out of 63 securities firms in Korea (or 60%) provide online trading services (Table 3). In contrast with pure online securities firms in the United States, most of the online securities firms in Korea are the online trading arm of traditional full-service firms. Given that, it is not surprising that all the 38 online securities firms are domestic firms.
Table 3. Securities firms providing online trading as of September 2001 Securities firms Domestic Foreign Total Available 38 0 38 Unavailable 6 19 25 Total 44 19 63

Source: Development of online securities trading in Korea , Securities Times, 14 November 2001.

Competition among the securities firms is vigorous. Yet the top 5 firms already take a substantial proportion of total stock trading (Figure 6). To compete, many firms have invested a huge amount of capital in developing their online systems and offering quality customer service. Further to this, a one-stop service is promoted by most of the securities firms.14 Some securities companies have established alliances with banks to facilitate funds transfer in order to become full-service online financial institutions.

Figure 6. Percentage contribution to stock trading by the top 5 securities firms in Korea
60% 49% 50% 37% 47% 46% 41% 40% 36%

30%

20%

10%

0% 1996 1997 1998 1999 2000 9/2001

Note: The top 5 firms are Samsung, Hyundai, Daishin, Daewoo and LG Investment. Yet, for 1996 & 1997, Dongsuh instead of Samsung were among the top five while the other four remained the same. Source: Securities Statistics Yearbook (1997-2000) , KSE; Stock (October 2001) , KSE.

14

According to Management Brief No. 7, the services offered by these firms include real-time information and data (i.e. corporate news, index and price information, research paper), online order placement, alarm for specific stock through e-mail alerts, chat-room facility for clients and online investment consultancy. - 10 CSU - Research & Policy, HKEx 11 March 2002

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Despite the majority of securities firms entering the online business, the online trading market remains highly concentrated in a small number of large companies. The market share of the top five brokers in online trading (which were more or less the same top five for overall stock trading), though declining in the past four years, was still high at around 50% as of September 2001 (Figure 7). To some extent, the dominance of the top five securities firms in Korea may be conducive to the development of the online trading market as the huge initial development cost for new service could only be afforded by major players with large client base.
Figure 7. Percentage contribution to online stock trading by the top 5 securities firms in Korea
80% 70% 60% 50% 40% 30% 20% 10% 0% 1998 1999 2000 9/2001
Note: The top 5 firms are Samsung, Hyundai, Daishin, Daewoo and LG Investment. Source: KSDA; reprint from Online trading are there any limits? by Chu Jin-hyung in Asian Securities Analysts Federation 2001 Conference.

Brokerage commission was fully liberalised in September 1997. When online securities trading first started in 1997, securities companies set the commission fee for transactions at around 0.5%, the same as for traditional transactions. Since investor demand for online trading has a high degree of price elasticity, securities firms began to reduce their fees and a price war started in August 1998. Since then, securities firms have been competing vigorously against each other in fee schemes, such as exempting inactivity fees and providing various fee packages for trading.15 As of March 2001, commissions for online trading dropped to around 0.1% to 0.025% of trading amount, compared to around 0.5% for traditional securities trading. 16 Commission fee reduction is beneficial to investors but it also means that the profit margin for online securities firms is getting smaller.

15

Online trading are there any limits? by Chu Jin-hyung in Asian Securities Analysts Federation 2001 Conference. Also, commission schemes vary among firms. Some firms adopt a fixed rate system while others adopt variable rates, i.e. higher transaction values are rewarded with lower commission rates. 16 Annual Report (Year 2001), KSDA.
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6. 6.1

OUTLOOK FOR KOREAS ONLINE TRADING Steady but slower growth of online trading Alongside the advance in information technology, the usage of computers and other electronic communication devices among individual investors will continue to grow. With the securities firms concerted promotional efforts, online securities trading will have the potential to become even more popular. However, it appears that online trading in Korea has passed its high-growth stage, as reflected from Figure 1 and Figure 3. Its market share is expected to grow at a slower pace from now on as the market may be approaching saturation. Based on the fast-growth experience in 1998, the growth of online trading in value terms will likely depend on growth in retail participation in the stock and derivatives markets as well as on market sentiment.

6.2

Continued competition among securities firms Given the popularity of online trading in Korea, it is inevitable for the securities firms to compete in online trading business. This is especially important for those serving domestic retail investors. The keen competition has already eaten up the market shares of the largest online players. From Figure 7, the contribution to online stock trading by the top 5 securities firms has been on a downtrend over the past four years. At present, strategies adopted by the securities firms in capturing market share centre around price reduction and service offering. Since the liberalisation of brokerage commission in 1997, commission rates have been lowered significantly. Rather than engaging in cut-throat competition in commission rates, securities firms have steered their business strategy to providing customers with better services. In doing so, the firms hope that higher commission fees can be derived in the longer run. In addition to enhancing service quality, securities firms also adopt other initiatives to expand their customer base and retain the loyalty of online investors. Some of the measures include offering multiple online trading media, one-to-one online talks with analysts, and providing call centres to support online traders. Meanwhile, the securities firms are expected to work towards system upgrades to improve speed and stability and to enhance system security. Following the global trend of removing cross-industry barriers in the banking, insurance and securities industries, companies in these disciplines in Korea are allowed to enter each others businesses as non-core business from January 2000. Accordingly, competition in the securities business will be intensified. An increase is expected in joint-ventures or mergers with foreign securities firms specialising in online trading, cooperative strategic alliances, small-/medium-sized securities firm specialising in online trading only, or mergers between securities firms. Meanwhile, the weaker firms will be closed or acquired.

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6.3

Investor protection and regulatory changes The convenience in order placing offered by online trading and the relaxed regulatory measures for trading have not only boosted securities trading volume and price volatility17, but also stimulated more day-trading and speculative trading activities. Daily stock trading volume on the KSE increased from 12 billion shares in 1997 to 74 billion shares in 2000. As of 2000, day trading was responsible for around 40% of total stock trading in KSE. Further to this, in view of the increasingly sophisticated technology employed for providing enhanced online trading services, this will provide a breeding ground for online crimes. Currently, there are no rules and regulations tackling these potential risks. It is expected that regulators will consider the above in their policy formulation.

17

According to KSDA Annual Report (Year 2001), the average daily volatility of stock prices was between 11 to 14 (index) points in the period 1996 to 1998 whereas the volatility in 2000 was around 16 (index) points. - 13 CSU - Research & Policy, HKEx 11 March 2002

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References 1. 2. 3. 4. 5. Annual Report (Year 2001), the Korea Securities Dealers Association (KSDA). Development of online securities trading in Korea, Securities Times, 14 November 2001. Online securities trading in Korea , Management Brief, Issue No. 7 (by Planning & Research, HKEx). Online securities trading in Korea (Monthly Statistics), KSDA. Online trading are there any limits? by Chu Jin-hyung in Asian Securities Analysts Federation 2001 Conference. Securities Statistics Yearbooks (1997-2000), Korean Stock Exchange (KSE). Stock (Monthly Statistics), KSE. Website of Korea Stock Exchange (http://www.kse.or.kr/). Website of Korea Network Information Centre (http://stat.nic.or.kr/).

6. 7. 8. 9.

10. Website of KOSCOM (http://www.koscom.co.kr/).

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