1. FreeBond
a. Background
Similar to developed nations, the bond market in Republic of Korea has traditionally used telephone voice trading as a negotiated sale method. With the advances in information technology after the Asian financial crisis, instant messenger became
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an important trading method, particularly among young brokers, as the advantages of speed and storage function became widely known. This new method sped up the way trading is executed and enabled market participants to overcome limitations, contributing to the development of the Korean bond market.
However, private messenger undermined price discovery function, and when it crashed or slowed down, the bond market as a whole was paralyzed. In addition, there were structural problems since it was difficult to adapt to the needs of market participants. Against this backdrop, the government created a taskforce in March 2009 and announced the Reformation of Bond Trading Market that October, which aims to establish a specialized bond trading system. Based upon the measure, KOFIA established the online bond trading system, FreeBond and launched it in April 2010.
Since the late 1990s, major developed nations have successfully introduced electronic bond trading systems using advances in information technology. However, in the case of Republic of Korea, legal restrictions have hindered the introduction of alternative trading system(ATS).
b. Main Contents
i. Definition and Composition of FreeBond
FreeBond, operated by KOFIA, enables financial investment firms and market participants to discover quotes and supports trade negotiations. Participants refer to bond trading brokers, dealers, managers, and traders who apply to use the system and are approved by KOFIA pursuant to regulations on registration of financial investment companies. In addition, KOFIA’s operation enables continuous communication with market participants, better reflecting the needs of participants.
As for the bond information system (BIS) and information vendors, FreeBond comprise of two main components: instant messenger and T-Board (Figure 3.5).
Unlike private messenger, chat rooms are included in the system. T-Board offers trading functions such as bid/ask prices discovery, orders, negotiation and confirmation, and analyses and reference. Instant messenger, a replacement of the current private messenger, provides functions specialized for bond trading including 1: N chatting and automatic storage of chatting records, on top of the general functions of private messenger.
Figure 3.5 Operation of FreeBond
Source: Korea Financial Investment Association. Chapter 9 in 2010 Capital Market in Korea.
Market Participants
Transmit quote information Bond Quotation System
Online Trading System (Instant Messenger,
Trading Board)
Market Participants
Discover quotes and order Report quote information Disclose and distribute the information
1) Market participants discover bid/ask price on FreeBond and execute orders.
2) Quote information is transmitted to BQS.
3) The concentrated information is disclosed to the market through KOFIA’s Bond.
ii. Characteristics of FreeBond
The major strengths of FreeBond are its specialization, security, and stability. In terms of specialization, the system can only be used by bond trading professionals in line with the Regulation on Business and Operation of Financial Investment Companies.
When a financial investment company applies to use the system and receive approval from KOFIA, bond traders from that company are able to access FreeBond. Under this system, FreeBond can develop into a specialized system, unlike private messenger which anyone can access.
In addition, T-Board enables market participants to find quotes in real time, issues of interest, information on bond issuance, and it offers a bulletin board for trading.
Unlike private messenger, chat histories and quotes are encrypted, preventing hacking from occurring. Furthermore, its use is managed by KOFIA’s registration process, enhancing credibility in the system.
To boost the stability of FreeBond, the system is backed up with double servers to prevent system failures from trade concentration, and it is managed around the clock.
iii. Expected Effects
The success of FreeBond in the market with its wider use by market participants is expected to become a turning point in the advancement of the OTC bond market in Republic of Korea for the following reasons:
1) It will significantly improve the bond trading infrastructure.
2) The formalized and safer FreeBond will not only boost the security of bond trading but it will also integrate the market which had been divided by different messenger groups.
3) Users can enjoy the ease and convenience of bond trading on FreeBond.
Information asymmetry will be reduced, and price discovery and the search of trading counterparts will be easier.
FreeBond was designed by and for bond traders, which makes it especially “market friendly” and thus convenient for users. The system reflects all the requirements needed for trading, such as a variety of trading methods and analyses.
When FreeBond adds the settlement function and builds a global network with advanced bond trading system in the future, foreign investors will find it more convenient to participate in the Korean bond market and domestic financial institutions will be able to expand into overseas markets. This will eventually lead to the globalization of the Korean bond market. In addition, the use of bond market information concentrated in the system will make it possible to calculate real-time bond indices and facilitate the development of new products, such as bond ETFs and interest derivatives.
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While the bond and equity markets are the two major pillars supporting the Korea capital market, the bond market is still underdeveloped compared to the equity market. However, the launch of FreeBond will spur the advancement of the bond market, allowing it to serve its main role in the capital market.21
Table 3.14 Questions and Answers on FreeBond and Over-the-Counter Trade Matching
Questions Answersa
KSD mentioned OTC trade matching is done at KOFIA, but outside FreeBond;
details?
• KOFIA does not perform the role of matching over-the-counter bond transactions.
• Participants in the over-the-counter bond market including securities firms and investors conduct the discovery of ask/bid prices, negotiations, transactions through FreeBond (KOFIA) and private messenger services such as Yahoo.
- After transaction occurs, matching is confirmed by each trading party, and settlement is made in T+1 - T+30 through the KSD’s SAFE system and the Bank of Korea’s BOK-wire, using delivery versus payment.
• Based on the needs of the market and the relevant laws, KOFIA plans to transform FreeBond into an ATS equipped with a settlement function.
KOFIA requires trade reporting within 15 minutes; everybody agrees this is good for transparency, etc.; however, requirement is to report trades at IRC level – this is a big issue for CPs because allocation of trades across individual (IRC) accounts may not happen within 15 minutes; possible chance to help ease market issue
• KOFIA’s Regulations on Business Conduct and Services of Financial Investment Companies and the Enforcement Bylaws (hereinafter be referred to as the “Regulations, etc.”) require financial investment companies to report the trading of bonds to KOFIA within 15 minutes of the trade. However, the 15-minute rule does not apply to commercial papers.
※ Types of bonds subject to the 15-minute rule: government bonds, municipal bonds, monetary stabilization bonds, bank debentures, other financial bonds, corporate bonds, and asset-backed securities
- Under separate provisions* of the Regulations, etc., the trading of commercial papers must be reported to KOFIA by 5:30 p.m. on the day of trade. Therefore, the issue described in the question above is not likely to occur.
* Art. 7–14 of the “Regulations on Business Conduct and Services” of Financial Investment Companies and Article 52 of the Enforcement Bylaws
※ In accordance with the Act on Issuance and Distribution of Electronic Short-Term Bonds, which is expected to take effect in January 2013, most CPs are likely to be replaced by short-term bonds. In this scenario, the trading of short-term bonds will not be subject to the 15-minute rule.
a Provided by KOFIA
ATS = Alternative Trading System; IRC = investment registration certificate; KOFIA = Korea Financial Investment Association; KSD = Korea Securities Depository; SAFE = Speedy, Accurate, Faithful, and Efficient
Source: Korea Exchange. www.krx.co.kr