A great return on investment for the financial industry

The Taiwan Stock Exchange hit 18,000 points as financial industry profits hit a new high in 2021. Ted Ho, Director General of the Taiwan Securities Association (TSA), has made important contributions to the Taiex’s success since he took office, including a new transaction-by-transaction system, intraday fractional trading, and halving and extending the tax reduction. Looking forward to 2022, Ho will continue to promote risk avoidance and tax reduction on warrants, refine the re-entrustment business, and expand the scope of private equity business for securities firms, as well as participate in the International Finance Institute to cultivate more international financial talent for Taiwan.

Low rates, relaxed policies, and good economic fundamentals

The great return on investment has driven the pre-tax profit of the three main segments of the financial services industry (banking, securities, and insurance) in 2021 to NT$ 936 billion, a record high with an annual growth rate of 38.7%. The profit breakdown is as follows: the banking industry earned NT$ 385 billion, an annual increase of 4%, and the insurance industry earned NT$ 411 billion, with an annual growth rate of 88.5%, a record high. Security and investment trust companies earned a total of NT $139 billion, an annual growth rate of 72%.

Ho said that during the pandemic, the global capital market was in a low-interest environment, and the fundamentals of Taiwan's economy were good. More importantly, the Taiwan securities market has also launched three key measures: relaxed restrictions on opening negotiable securities accounts, the launch of one-by-one transactions to drive transaction volume and leverage ratio, and intraday odd lot trading for inclusive finance.  

Ho believes that Taiwan’s financial markets have experienced three major awakenings. First, Taiwanese savers now hold NT$ 1 trillion in overseas high-yield bond funds. The impending interest rate hike by the US Fed, as well as soaring inflation and decreasing returns and increased volatility in the US stock market has caused Taiwanese funds from overseas investment to flow back to Taiwan. Second, Taiwanese people now understand the difference between insurance, investment, and wealth management – including that salary income is not enough to support retirement. In order to retire comfortably, they need to invest in stocks and place importance on financial management. Third, the annualized return of investing in Taiwan stocks in the past 10 years has exceeded 12%, while this year alone is expected to surpass 5%. With the return overseas capital, capital reallocation, high yields, and low interest rates, Taiwan’s stock market will continue to achieve good results this year, and even have the opportunity to hit 20,000.

Transforming securities firms into investment banks

To promote the long-term development of the financial market, Taiwan's securities industry should strengthen its infrastructure. Ho pointed out that last year, brokerage business accounted for 74% profits of securities industry profits. Even though the core business of the securities industry is marketable securities, it only accounted for 5% of its underwriting profits. In order to build a one-stop investment bank, Taiwan should open the early, middle, and late stages of various businesses derived from securities. This includes private placement and venture capital in the front stage, initial public offering (IPO) trading and marketing in the middle stage, and financing and lending in the end stage to build investment banks with integrated services.

Taking a securities firm's customer settlement account as an example, the negotiable securities industry must further develop its investment banking business. Therefore, the TSA recommends that funds in separate accounts be allowed to be transferred to any bank in a decentralized manner, so that funds in separate accounts may be used for high-security financial products such as government bonds and treasury bills, avoiding excessive risk concentration. At the end of last year, the door opened for investors to apply for unrestricted loans (T+0) as well as creditor's rights of delivered receivables with guarantors. The TSA also recommends that when listed OTC companies handle capital injection, securities companies can provide original shareholders and employees with stock subscription financing, which will strengthen their service functions and accelerate their development into investment banks.

As the three key segments of the financial industry become more intertwined, they will face cross-industry, cross-border and cross-generational issues. “The banking and securities industries will inevitably have overlapping business in the future.” Ho asserted that negotiable securities firms should branch out into bank lending and deposit business, suggesting that banks and securities industries should work together to complement each other.

Improving re-entrustment service

In this long-term low-interest rate domestic environment, the demand of the Taiwanese public to invest in the international securities market is becoming ever stronger. Securities firms have been in the re-entrustment business for 30 years, but Taiwanese customers cannot use re-entrustment finance or borrow investments in foreign securities, and the scope of investment in foreign bonds is even more limited: general investors are limited to investing in foreign bonds with grade A- or above.

Recently, the market has become concerned about the exposure of Taiwan's financial industry in Ukraine and Russia. According to the Financial Supervisory Commission (FSC), as of the end of 2021 the exposure of Taiwan's financial industry in Ukraine and Russia reached NT$ 229 billion, including NT$ 209 billion in Russia, and only NT$ 20 billion in Ukraine. The exposure of the insurance industry in Russia was NT$147 billion, while individual exposure through investment trust funds was NT$ 21 billion, and through overseas funds was NT$ 35 billion, accounting for 0.43% and 0.91% of their fund’s net value, respectively, totaling to NT$ 56 billion. The exposure of the banking industry was NT$ 5 billion. The negotiable securities and future contract industries have no exposure in Russia, and ordinary investors cannot invest in the Russian stock market or purchase related products through re-entrustment.

Ho said that securities companies have made great efforts to cultivate new investment in foreign securities. But even with their competitive IT technology, handling fees, and interest rates, foreign countries also allowing financing and lending, and also have the advantage of complete product lines. As a result, many investors open accounts and trade directly overseas.

Ho emphasized that domestic securities firms are not afraid of international competition but also attach great importance to risk control. He suggested that the government should open up re-entrustment and lending business for negotiable securities firms, and also allow general investors to invest in foreign bonds with investment grades above BBB- in order to prevent merchants from finding new customers, then handing these customers over to overseas firms.

Expanding the scope of securities firms' private-equity business

According to the FSC, the number of corporate fundraising cases last year was 422, with total fundraising of NT$ 1.5 trillion, both growing from previous years; the main reason was the increase of small fundraising cases. The vast majority of Taiwanese companies are small and medium-sized enterprises, which face capital and transformation constraints. In addition to financing from banks, they are also capable of financing through private equity.

Negotiable securities firms have enough capital, expertise, talent, access, brand, trustworthiness, and firewall experience, are highly supervised, with abundant knowledge of the finance industry. Therefore, TSA recommends that securities firms be allowed to operate and manage private equity funds, and foreign operating practices. Private equity funds should set up a special-purpose vehicles (SPV) before making investments abroad to help isolate risk.

Currently, the insurance industry can invest in foreign hedge funds, private funds (including private equity funds, private debt funds, and real estate private equity funds), and infrastructure funds. Ho expects to open up the scope of securities firms to invest in private equity funds, just as the insurance industry guides its abundant funds into various types of private domestic funds, keeping the capital in Taiwan.

Listing of Taiwanese products on the stock market

Due to regulatory restrictions and tax regulations in Taiwan's capital market, the financial industry has relied on imported products for many years, and has been able to only produce down- and mid-stream financial products. The lack of innovative financial products has caused domestic capital and talent to migrate overseas. Ho said that the government should encourage securities companies to make their own products and list them for trading, so that they place importance on the cultivation and retention of international financial talent.

Ho explained that negotiable securities firms issuing warrant securities bear the responsibility of creating markets and must be dynamically hedged. These firms must pay 1‰ securities tax on issuance, and 3‰ on replacement of the underlying stocks. In the past three years, warrant issuers have paid TWD 5.1 billion in tax, which is much higher than the TWD 2.6 billion profit from the warrant business. Due to the heavy tax burden, securities companies cannot provide investors with more favorable buying and selling prices, reducing the growth potential of warrants trading volume compared to the overall market. Warrant products are the core technology of Taiwan's new financial products, opening the cradle for schools to cultivate financial engineering, risk control, and financial talent. TSA calls for the reduction of the warrant hedging tax rate for Taiwan stocks as soon as possible to solve the tax burden problem and enlarge the commodities business and its contribution to Taiwan’s financial innovation.

In practice, warrants, electronically traded funds (ETF), exchange-traded notes (ETN), and other listed financial products are all broad exchange-traded products (ETP). Promoting the listing of ETPs is a specific measure of the capital market blueprint to “promote securities firms to develop diverse financial

products and activate a new system of securities listing.” TSA suggests that the stock exchange or OTC center refer to the Swiss Stock Exchange for its product structure, first select the types and priorities of listed products that meet the needs of investors, and discuss follow-up system specifications so that securities firms can issue structured commodities for listing, providing investors with more diverse financial services.

English skills and practical experience

The FSC has allowed negotiable securities companies to handle wealth management services for high-asset clients. In addition to their basic securities, futures, trust, wealth management, life insurance, and other statutory licenses banking and life insurance practitioners hold, wealth management personnel in the securities industry should also strive to obtain more advanced senior international Certified Financial Planner (CFP) licenses to improve their professionalism and service quality.

The financial sector has been listed as one of Taiwan’s foundational industries. In order to cultivate talent, the FSC and the National Development Council have discussed and promoted the International Finance Institute, comparable to Taiwan’s School of Semiconductors. The banking, insurance, and securities industries view the Institute with a positive attitude and are willing to invest resources to assist skills development in Taiwan's financial industry.

Ho stressed that the Institute must adopt an all-English format to form a long-term advantage and competitiveness as well as reinforce practical experience. Attention should also be paid to product design and taxes. The debt-to-equity ratio of the securities industry is relatively low, and it has sufficient capability to design better products. In addition, it is also necessary to improve the investable re-entrusted commodities and functions so that Taiwanese can manage Taiwanese funds, leading to import substitution, job creation, and tax revenue increases.