ONLINE TRADING IN TAIWAN

ONLINE TRADING IN TAIWAN Online trading is still not the mainstream. In December 2001, only 8.7% of the total market turnover value was conducted online and 16% of total investor accounts were online accounts. Online trading is offered, mainly to retail investors, as an alternative channel to the traditional trading method. Initially, online trading experienced rapid growth along with the rapid development of the Internet and e-commence but more or less flattened out in the second half of 2001. Manual re-input is still required for some brokers, while others systems enable straight-through routing of online orders. Consolidation in the online brokerage industry began in late 1999 when a number of mergers and acquisitions took place. As of November 2001, 76 out of 158 brokers were online brokers. They are domestic brokerage firms and maintain strong offline businesses. The major obstacles to the development of online trading include: insufficient acceptance by investors; low cost-saving incentive for investors to move to online trading; reluctance of brokers to switch from traditional business practices; and network security concerns. CONTENTS 1. Introduction...2 2. Development history of online trading...2 3. Statistics on online trading...3 4. Market structure for online trading...6 5. Regulation of online trading...8 6. Obstacles to and prospects for online trading...9 [OTT.doc] - 1 - CSU-Research & Policy, HKEx

1. INTRODUCTION Online securities trading in Taiwan began in 1997. As of November 2001, there were 76 online brokers, all of them having strong offline business. The traditional trading method is still preferred by investors. Only 16% of total investor accounts are online accounts. The turnover value of online trading accounted for only 8.7% of the total market turnover in December 2001 1. The retail participation rate in Taiwan is very high. In December 2001, retail investors contributed 87% of market turnover value. Brokers online trading services mainly cater to retail investors. Brokers usually have a professional sales team to serve institutional investors and offer preferential treatment to them, such as rebates. The incentive for institutional investors to switch to online trading is, therefore, very low. It is believed that online trading is mainly a retail investor phenomenon. This report will therefore focus on the retail online trading market. In this report, online trading refers to trading where investors directly place orders by electronic communication channels, such as the Internet. It includes trading for which orders are routed directly to the Exchange s trading system and for which orders need to be manually re-input by the brokers into the Exchange s trading system. 2. DEVELOPMENT HISTORY OF ONLINE TRADING In 1997, Fortune Securities 2 started offering online trading services to retail investors and four other brokers entered the market in the same year. In October 1997, the Taiwan Securities and Futures Commission (SFC) approved the revision of the Taiwan Stock Exchange (TSE) Operation Rules to allow investors to place orders through electronic channels. In 1999, the TSE issued a number of guidelines to accommodate the development of online trading. To monitor the development, beginning on 20 August 1998, the TSE requires online brokers to report related information and the quantity of online orders to them on a monthly basis. As Taiwan experienced rapid development of the Internet and e-commence after 1997, the number of online brokers increased rapidly to 66 by 1999. Thereafter, the online brokerage industry began to consolidate 3. Some online brokers merged and some discontinued their online business, while some firms started to offer online trading services. As of November 2001, there were 76 online brokers out of a total of 158 brokers in Taiwan. Among them, 8 online brokers are bank-related. (Figure 1) 1 2 3 證 券 商 電 子 式 每 月 成 交 彙 總 資 料 查 詢 表, Taiwan Stock Exchange. Originally named Da Shin Securities. Consolidation began in late 1999, when the nation s largest broker Yuanta Securities merged with the third largest Core Pacific Securities. Since then, a number of mergers and acquisitions have taken place. The number of online brokers stabilised and the number of brokers decreased. [OTT.doc] - 2 - CSU-Research & Policy, HKEx

80 70 Figure 1. Number of online brokers 66 75 76 60 50 40 30 27 20 10 0 5 1997 1998 1999 2000 Nov 2001 Source: "On-line Trading - Are there any Limits?", Taiwan Stock Exchange 3. STATISTICS ON ONLINE TRADING Online trading value increased substantially by 490 times from NT$739 million in July 1997 to NT$363 billion in January 2000. It then fluctuated sharply in 2000 and 2001, influenced by the change in the overall market sentiment. The market share of online trading, however, increased quite steadily from its launch in 1997 until November 2000. Since the second quarter of 2001, the market share has declined slightly. One possible reason may be the arousal of security concerns among investors, especially after a report on securities firms systems being hacked 4. In December 2001, the online turnover value was NT$521 billion, accounting for 8.7% of market turnover (Figure 2). The number of online transactions and percentage share of market total number of transactions have similar pattern. In December 2001, the number of online transactions was 2.9 million, accounting for 7.2% of the market total (Figure 3). The number of online investor accounts rose rapidly in 1999 and 2000 and then at a diminishing rate in 2001. As of December 2001, there were two million online investor accounts, or 16% of the total 13 million investor accounts in Taiwan. (Figure 4) 4 On 3 July 2001, Taiwan newspaper 聯 合 晚 報 reported that a hacker entered at least two securities firms systems and stole information on 2000 clients. The information was then used by the hackers to trade stocks involving a transaction value of about HK$2 million. This was the first reported case of securities firms systems being hacked. [OTT.doc] - 3 - CSU-Research & Policy, HKEx

Figure 2. Online trading value and market share 600 500 Online trading value Online trading as percentage of market turnover value 8.7% 8% (Billion NT Dollar) 400 300 521 6% 4% 200 100 2% 0 0% Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Source: " 證 券 商 電 子 式 每 月 成 交 總 資 料 查 詢 表 ", TSE. (in thousand) 4,000 3,500 3,000 2,500 2,000 1,500 Figure 3. Number of online transactions and percentage share Number of online transactions Online transactions as percenatage of the total number of transactions 7.2% 2,927 8% 6% 4% 1,000 500 2% 0 0% Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Source: " 證 券 商 電 子 式 每 月 成 交 總 資 料 查 詢 表 ", TSE. [OTT.doc] - 4 - CSU-Research & Policy, HKEx

Figure 4. Number of online investor account 2,500 2,000 (Thousand) 1,500 1,000 2,008.4 500 0 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Source: " 證 券 商 電 子 式 每 月 成 交 總 資 料 查 詢 表 ", TSE. At the beginning stage after online trading was introduced in July 1997, the average online deal size was significantly lower than the overall average deal size. After one year of development, online investors had more knowledge about the new trading method. Since September 1998, the average online deal size became more or less in line with the overall average deal size. Beginning from September 2000, the average online deal size stayed consistently above the overall average deal size (Figure 5). However, the online deal size may be capped by online brokers risk management procedures: brokers impose daily limit restrictions on the dollar amount of online trading orders from each client. Figure 5. Average deal size of transactions made online in comparison with overall average deal size 350 300 Average deal size of online transactions Overall average deal size (Thousand NT Dollar) 250 200 150 100 50 178 148 0 Jul-97 Sep-97 Nov-97 Jan-98 Mar-98 May-98 Jul-98 Sep-98 Nov-98 Jan-99 Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01 Source: " 證 券 商 電 子 式 每 月 成 交 總 資 料 查 詢 表 ", TSE. [OTT.doc] - 5 - CSU-Research & Policy, HKEx

4. MARKET STRUCTURE FOR ONLINE TRADING The online trading process in Taiwan is not a wholly straight-through process: some online brokers still require manual re-input for their online orders received. The trading mechanism is described below, followed by a description of the business practice of online brokers. 4.1 Trading mechanism An online order input by a client is routed to the broker s online system for primary checking on login identity and then to the broker s workstation terminal for approval. Currently, most online brokers enable auto-approval for online orders that are below the preset credit limit on the client. For orders exceeding the limit, the broker may reject the order or may approve the order manually on a case by case basis. Online brokers that require manual re-input of online orders normally do not have the facility for auto-approval in their system. After approval, orders will be transmitted through a closed network ( 分 封 網 路 ) to the TSE s trading system Fully Automated Securities Trading (FAST) system for auto-matching. The FAST system also sends out order confirmations and trade reports to brokers. The broker will then notify the client of the transaction after receiving the trade report. (Figure 6) Figure 6. Mechanism for online trading in Taiwan Order input online by investor Broker s online system for primary checking on login identity Broker with auto-approval function (straight-through) The system check whether within preset No credit limit on the investor Yes Broker without auto-approval function (manual re-input) Manually check whether within preset No credit limit on the investor Yes Reject order* Automatically transmitted to exchange Manually input order at workstation Reject order* FAST system in the TSE * On the broker s discretionary decision, they may have follow up action on the investor to approve the order. [OTT.doc] - 6 - CSU-Research & Policy, HKEx

4.2 Online brokers The Taiwan brokerage industry is dominated by domestic brokerage firms. There are only 15 brokers of overseas origin and they mainly target institutional investors. Many local firms maintain extensive branch networks throughout Taiwan. As of December 2001, there were 158 brokers with 978 branch offices throughout Taiwan. The number of branch offices is almost double the 592 at the launch time of online trading in 1997. However, the total number of brokers reduced from 205 in 1997 to 158, as a result of industry consolidation. It appears that the brokers in Taiwan are not shifting their business online, but are expanding both their online and offline business network in order to better serve customers under the fierce competition. The business practices of online brokers in Taiwan are discussed below. 4.2.1 Business practices Online brokers generally offer multiple order capturing channels, including the Internet, interactive voice recognition system (IVRS) ( 語 音 下 單 ) and other electronic channels. The main channel for online trading is through the Internet. Online brokers are offering low fees at about half the price for offline trading in order to capture market share in a short period of time. Many online brokers are still not making money in their online business. Online brokers also compete by offering quality customer services. They usually set up a customer service hotline to serve online investors. They also offer a personalised online interface, and more functionalities with investment and analysis tools. Online brokers usually promote online business aggressively to attract new customers and build up reputation, even though the profitability of online trading is currently compressed by the low price and low user acceptance. This is to prepare for the future when online trading is expected to become the mainstream. However, online brokers generally tend not to promote online trading actively to existing offline customers. One reason is the internal resistance from account executives whose salaries are based on commission on offline trades from existing customers. The other reason is that the profit on offline customers is more attractive. Online brokers usually don t promote online trading services to their large customers. Instead, they usually assign a designated account executive to handle accounts of large investors in order to build a stronger bond with them. [OTT.doc] - 7 - CSU-Research & Policy, HKEx

4.2.2 Percentage share of online investor accounts among brokers The percentage share of online investor accounts is concentrated in a few online brokers. The top five online brokers already share half of the market total, leaving 71 online brokers to fight for the remaining market share (Table 1). These top-five brokers are all major domestic securities firms. They have a long history and well-established brand name in Taiwan. In addition, they maintain extensive branch networks as their main service distribution channels. Table 1. Top five online brokers in terms of number of securities accounts, as of August, 2001 Rank Broker Number of online accounts Percentage share of market total 1 Polaris ( 寶 來 證 券 ) 353,433 18.7% 2 Yuanta Core Pacific ( 元 大 京 華 證 券 ) 216,150 11.4% 3 Sino-Pac ( 金 華 信 銀 ) 159,097 8.4% 4 Capital ( 群 益 證 券 ) 106,745 5.6% 5 Master Link ( 元 富 證 券 ) 103,882 5.5% Subtotal 939,307 49.6% Others 950,281 50.4% Total 1,889,598 100.0% Source: On-line Trading - Are there any Limits?, TSE. 5. REGULATION OF ONLINE TRADING To accommodate the development of online trading, the relevant rules and regulations have been amended since 1997. In 1999, the TSE issued three sets of guidelines for securities firms who offer online trading services. The key provisions in the regulations and guidelines on online trading are summarised below. (1) Investors, whose maximum trading amount for a given day would be NT$1 million or less, are exempted from opening an account in person at a securities firm s place of business. These investors can open accounts online or by mailing. However, the account opening process should be completed with the investor s signature and approval from the broker, which may involve face-to-face contact. (2) A securities firm that accepts securities trading orders solely by means of telephone or electronic means may be exempt from the requirement of establishing a business floor and counter for taking client orders. (3) An online order received may be validated automatically by the broker s computer system provided that the investor s IP address and the order file are recorded and saved for at least 5 years. [OTT.doc] - 8 - CSU-Research & Policy, HKEx

(4) Starting from May 2001, both brokers and online investors should use digital signatures issued by Certificate Authorities 5 for the transmission of orders and order report. (5) In relation to the use of e-mail, electronic bulletin boards and websites, securities firms must install firewalls and certificate authentication systems and at the same time properly supervise the business practices of the operational staff. (6) Online brokers are required to report on a monthly basis to the TSE their online trading statistics, including number of online investor accounts and number and value of online transactions. (7) Brokers who plan to launch online trading services are required to report to the TSE the order flow mechanism in their online systems and related information. 6. OBSTACLES TO AND PROSPECTS FOR ONLINE TRADING In Taiwan, the share of online trading in total market turnover and the proportion of investors who are online investors remains low. This section summarises the major obstacles to the development of online trading and then discusses the prospects for online trading in Taiwan. 6.1 Major obstacles Insufficient acceptance by investors. As many brokerage firms maintain extensive branch networks, investors can easily find a branch near them. Investors can also place orders conveniently by offline methods. As a result, investors have low incentive to switch to the new trading method. In addition, similar to other regions like Hong Kong, Taiwan s Internet population consists mainly of young people, while the majority of existing investors are middle-aged. These existing investors may not be very receptive to new methods and do not have enough computer knowledge to use the Internet to make trades. Low cost-saving incentive to investors for online trading. Under the keen market competition, the order handling fees for traditional trading are already very low. The room for attracting investors to trade online by price-cutting is quite limited. The current price differential offered by online brokers is not very effective. 5 There are a number of Certificate Authorities in Taiwan. One of them is the Government Certification Authority (GCA). People can apply for digital signatures from GCA in person or online for people having an account in the HiNet, the main Internet Services Provider owned by Chung Hwa Telecom ( 中 華 電 信 ). [OTT.doc] - 9 - CSU-Research & Policy, HKEx

Conservatism of brokers. Although online brokers usually make big efforts to promote their online trading business, they still prefer to maintain a strong presence in traditional business. These online brokers do not encourage existing customers to switch to online trading and still run a large number of branches throughout Taiwan. They would not take the risk to move the profit-making offline business to the profit-uncertain online business. Another reason may be the internal resistance from account executives whose income is based on commission. Customers switching from account executive-based traditional trading methods to online trading would seriously affect account executives income. Security concerns. Although securities firms are required to comply with the TSE s standards about network security, there are still reports of people being defrauded through online trading. Such reports adversely affect the confidence of investors and make investors reluctant to engage in online trading. 6.2 Prospects A number of potential developments in Taiwan and its brokerage industry may directly or indirectly support the growth of online trading. The growing Internet penetration in Taiwan is also expected to have positive effect on online trading. This section attempts to discuss the prospects for online trading in Taiwan in the light of such changes. Opportunities to expand domestic the online customer base. Internet penetration in Taiwan is deepening. As of 2001, 34% of the total Taiwan population have access to the Internet 6 and 15% of the Internet users are broadband Internet users 7, up from 27% and 14.3% respectively in 2000. Although the penetration rate for Taiwan is relatively low when compared with some other Asian countries 8, given the sizable population in Taiwan, the increasing number of Internet users should provide opportunities for Taiwan online brokers to expand their business. In addition, one major online broker believes the usage of online trading will be higher when more young people, who are heavy Internet users, hit the investment age. Enhancements in brokers online systems to attract new customers. After its accession to World Trade Organisation (WTO) in December 2001, Taiwan will start to open the domestic retail securities industry to overseas firms. That means foreign securities firms will enter the domestic retail market which is currently dominated by domestic firms. To face the challenge, Taiwan local brokerage firms would have to increase their competitiveness. One way is internal technological advancement to increase operational efficiency. Online brokers tend to introduce continuously new investment management systems and enhance their existing 6 7 8 Taiwan Internet User Survey ( 我 國 網 際 網 路 用 戶 數 調 查 統 計 ), September 2001, Institute for Information Industry. Statistics from the Directorate General of Telecommunications, 2001, Ministry of Transportation and Communications. The Internet penetration rate for Hong Kong and Korea are 43% (Source: Statistics Department, HKSAR Government, 2001) and 45.9% (Source: NetValue Korea, July 2001) respectively. [OTT.doc] - 10 - CSU-Research & Policy, HKEx

in-house trading systems. Such systems move towards a straight-through trading process, with a more user-friendly interface, and more functionalities for online trading. Such enhancements are expected to stimulate more investors to trade online. Globalisation for online brokers. Taiwan brokers are eager to expand their businesses overseas. Given the similarities in culture and language, the two major overseas markets are Hong Kong and China. In fact, Taiwan brokers have already been in the Hong Kong market for a few years and are now expanding their online brokerage business here. Examples are KGI and Core Pacific-Yamaichi, a subsidiary of Yuanta Core Pacific. Such expansion is expected to benefit the domestic online trading industry as Taiwan investors can invest in Hong Kong stocks online and vice versa. The China stock market, however, is still relatively closed to overseas brokers. Similar to Hong Kong s online brokers, Taiwan online brokers monitor closely the opening of the China market that is expected to provide a huge potential investor base for online trading. References 1. 網 際 網 路 證 券 交 易 專 題 研 究, Nov 1999, Taiwan Stock Exchange. 2. Monthly statistics, Taiwan Stock Exchange. 3. Big is better for brokers, 28 Feb 2000, Taipei Times. 4. Online trading booming, 24 Mar 2000, Taipei Times. 5. On-line Trading - Are there any Limits?, November 2001, Mr. Ted Peng, Taiwan Stock Exchange, presented at Asian Securities Analysts Federation 2001 Conference. 6. 證 券 商 開 辦 網 際 網 路 委 託 及 語 音 下 單 配 合 事 項, 13 November 2001, Taiwan Stock Exchange. 7. Yuanta sees Taiwan brokerage shakeout, 18 July 2000, Reuters. [OTT.doc] - 11 - CSU-Research & Policy, HKEx