By Eunkyung Seo and Frances Yoon June 13 (Bloomberg) — South Korea will tighten rules on holdings of currency derivatives at domestic and foreign banks to reduce volatility in capital flows and the won. Foreign bank branches will be required to trim holdings of foreign-exchange derivatives to 250 percent of equity capital and domestic banks to 50 percent under changes recommended to President Lee Myung Bak’s regulatory reform committee, the government and central bank said in a joint statement. South Korea joins developing nations including Taiwan, Brazil, Colombia and Russia that are tightening rules on capital flows to limit swings in their currencies. The won slumped 9.2 percent since April 1, more than double the decline in any of Asia’s other 10 most-used currencies. Banks will be immediately prohibited from increasing positions beyond the limit, will have three months to meet the ceiling and two years to cover existing positions. The ceiling on derivatives contracts to meet corporate settlements will drop to 100 percent from 125 percent. The new rules are to reduce systemic risks, which should serve as a safety net to avert a crisis, the government and central bank said in today’s statement. South Korea’s won slumped 3.6 percent to 1,246.10 to the dollar last week as government officials flagged the currency regulations. The government is concerned excessive investment in won forwards has caused volatility and increased short-term debt at the nation’s banks, said Frances Cheung , a senior strategist at Credit Agricole CIB in Hong Kong. ‘Avert Crisis’ The government aims to curtail won “volatility and avert a financial crisis,” Vice Finance Minister Yim Jong Yong said in an interview this week. The changes will respect the principles of an open economy and aren’t intended to deter foreign investment, he said. Forwards are agreements in which assets are bought and sold at current prices for future delivery. Banks often borrow foreign currencies to offset exposure to price swings on the contracts. South Korea is acting after it hosted the Group of 20 nations meeting in Busan on June 4, where countries said they will try to agree on new rules for capital flows by December 2012 to avoid a repeat of the global financial crisis. In January, Taiwan set a one-week deadline for money brought into the country to be invested or repatriated and in April it ordered a review of loans to flush out speculators. Herd Behavior Korean authorities stressed the policy isn’t aimed at setting a direction for the won, and they will take proper actions should the measures prompt herd behavior and shake the won. They pledged to supply foreign exchange should liquidity conditions suddenly worsen. Domestic banks will need to raise the ratio of mid- to long-term financing in foreign loan portfolios to 100 percent from 90 percent, while foreign banks will be asked to follow the rules on managing foreign-currency liquidity risk such as currency-specific management, an early warning system, crisis analysis and contingency funding plans. The won’s one-month implied volatility, a measure of exchange-rate swings used to price options, climbed 170 percent this quarter, the biggest jump among 47 global currencies. Nine of the 10 biggest increases are in Asia. The won also has the highest expected fluctuations at 25 percent, compared with 13 percent for the Indonesian rupiah and the Malaysian ringgit. Timing ‘Stinks’ “The timing stinks and could actually heighten volatility in the near-term,” Win Thin , senior currency strategist at Brown Brothers Harriman & Co., wrote in a June 10 report. Win, who says the government should have introduced the measures in April as the currency was declining, forecasts the won may drop to 1,292 by the first half of July. The regulations may ultimately lead to a shortage of dollars, he said. South Korea’s short-term external debt totaled $154.62 billion at the end of March, accounting for 57 percent of all overseas borrowings, Bank of Korea data show. At the end of 2008, short-term debt accounted for 75 percent of the total. “If the government is successful in tapering down volatility, it will probably be better for the wider economy,” said Joseph Lau , a Hong Kong-based Korea economist for Credit Suisse Group AG. Still, “anything offshore is out of the reach of authorities, and people can still take positions against the Korean won. There’s a limit to what they can do to reduce volatility.” Vulnerable South Korea is vulnerable to a surge in capital flows as a small, open economy, the finance ministry’s Yim said, noting that $65 billion was removed from the country in the four to five months after the 2008 collapse of Lehman Brothers Holdings Inc. Yim signaled continuing government intervention in the currency market, saying it will take “smoothing-operation” measures to stabilize the market and discourage herd behavior. Kim Yi Tae, director of the ministry’s foreign-exchange market division, said in an interview June 9 that the measures are not “capital controls as we’re not intending to levy transaction taxes.” JPMorgan Chase & Co. estimated total forward contracts at foreign-bank branches in South Korea would be limited to about $35 billion under the new rules, compared with a current level of about $40 billion to $60 billion, in a research report published June 10. “I don’t think the government is trying to roll back the market’s liberal or open measures from the last decade,” said Lau at Credit Suisse. Still, “if it is increasingly difficult for foreign banks to find profitable action in Korea they might move out.” Editors: Sandy Hendry, Jim McDonald To contact the reporters on this story: Frances Yoon in Seoul at fyoon2@bloomberg.net Eunkyung Seo in Seoul at eseo3@bloomberg.net
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Korea Will Curb Banks’ Currency Derivatives to Reduce Volatility of Won
