Celebrating 15th Anniversary

The Korea Securities Dealers Auto-mated Quotations (KOSDAQ), which began an over-the-counter market in April 1987 and turned into one of competitive bidding in 1998, celebrated its 15th anniversary on July 1, 2011.

The combined gross sales of the companies listed on the KOSDAQ amounted to 101 trillion won last year, accounting for 8.6% of Korea’s GDP. The figure stood at 6.8% back in 2001. Since its inception, the KOSDAQ market has been a great boon to local venture firms and small and mid-sized enterprises (SMEs) in need of financing channels. A total of 39 trillion won has been raised by initial public offering (IPO) on it until now. It means that the tech-heavy market has successfully fulfilled its role as a place where corporations can share the fruits of economic growth with investors and shareholders.

At present, the bourse is ranked second among new markets worldwide in terms of trade volume and fourth in terms of the number of listed companies and market cap. Though it is undeniable that the market is enjoying high international standing, it is also revealing some downsides stemming from condensed growth. Further-more, the bourse has seen a series of financial crimes, including embezzlement, breach of trust and price manipulation, leading some experts to claim it should go through an overhaul in order to address speculative practices across the board.

According to the Korea Exchange, the market capitalization of the KOSDAQ stood at 96.9 trillion won as of the end of June, increasing more than 12-fold from 7.6 trillion in its first year. During this period, the number of listed corporations has surged from 331 to 1,025. In 1996, 100,000 shares were traded daily on average, with turnover standing at approximately two billion won. These figures skyrocketed to 555 million shares and 1,845 billion won, respectively in just a decade and a half.

The KOSDAQ has also functioned well as an incubator for fledgling industries. As of 2010, 86% of those listed were SMEs. More than half of them were in the high-tech and so-called new growth driver industries such as IT, biotechnology and culture technology. The KOSDAQ is assisting them with financing so that they can nurture themselves into those of medium standing. The bourse has also created a lot of jobs. The Korea Exchange once surveyed 231 of the firms on it and found that the number of employees at these companies after they went public grew 40.9% on annual average between 2005 and 2009.

Meanwhile, more than half of those companies that recorded the biggest market cap on the bourse have left it. According to data released by the Korea Exchange on June 29, eight of these companies have set the record for the biggest cap, including Hyundai Heavy Industries, which posted the largest market cap in the KOSDAQ’s first year, with five of these now in the Korea Composite Stock Price Index (KOSPI) market.

The eight companies to have set the records are Hyundai Heavy, Industrial Bank of Korea, KT Freetel, KTF (what is now KT), Hanaro Telecom (what is now SK Broadband), NHN, Seoul Semicon-ductor and Celltrion. Of these, only three – SK Broadband, Seoul Semiconductor and Celltrion – still remain there.

The growth of the KOSDAQ began in earnest with the venture boom that followed the Asian financial crisis between 1997 and 1998. In fact, the KOSDAQ had been close to being a fringe market until 1998, when its daily turnover stood at around six billion won. However, the boom boosted this figure to 429 billion won and 2.4 trillion won in 1999 and 2000, respectively, with the index setting an all-time high of 2834.40, on March 10, 2000. Soon afterwards, the bubble burst and the index was cut in half. Since then, the figure has never surpassed the 1,000 mark. Nowadays, it is moving sluggishly below 500, unlike the KOSPI index which has been on the upturn.

Despite fast growth, the vulnerabilities of the KOSDAQ can be easily observed. These include it still needing more foreign and institutional investors’ participation, it having to deal with a lack of large-caps and blue-chip stocks, the fact that not a few investors have doubts about the reliability of quoted companies and the fact that it is still immature in regards to derivatives.

Since most participants are individual investors, stock prices are prone to fluctuation and easily swayed by external circumstances. Currently, the total investment by funds in the KOSDAQ market stands at no more than 3.8 trillion won. The investment share and percentage vis-à-vis the market caps are both less than 4%.

The market is led mostly by individual stocks and investors making short-term decisions centering around mid- and small-caps. For example, Celltrion is currently No.1 in the KOSDAQ in terms of market cap, yet slides to around No.50 once in the securities market. In addition, some KOSDAQ companies are luring investors by exaggerating their performances through the use of news and rumors, such as the emergence of a green industry. Such reasons are why institutional and foreign investors with considerable financial firepower are hesitant to step into the bourse, with the shares in the market currently at just 3.6% each. This means that individual investors currently account for 91.8% of the KOSDAQ, turning it into a speculative market for myopic investment.

A further problem with the KOSDAQ is that it has failed on many occasions to earn the trust of investors due to the not-infrequent cases of misappropriation, professional negligence, and unfaithful disclosure, etc. Although efforts have been made to correct such malpractices, such as the introduction of a substantial pre-delisting investigation, many investors are still skeptical as to the soundness and transparency of the KOSDAQ. Supervision over the KOSDAQ has been relatively laxer than over the KOSPI, with these breeding irregularities, which in turn has driven out an increasing number of firms and created a climate of mistrust. 43 out of 162 companies delisted between 2008 and 2010 were involved in fraud, embezzlement, and malfeasance, and so on. In addition, a total of 45 companies received no auditor’s opinion regarding their inappropriate accounting treatment. In the first half of 2011 alone, no fewer than 30 firms were delisted from the KOSDAQ.

Not a few brokerage firms are providing any comments on investing in KOSDAQ companies. According to FnGuide, a local financial information service provider, Korean securities companies released a total of 1,036 reports regarding KOSDAQ corporations. The investment opinions of 421 of those were NR, or Not Rated. This is in sharp contract to the KOSPI, which saw only 7.7% receive the same grade.

Finally, it needs to be pointed out that derivative transactions involving KOSDAQ stocks are very inactive, with experts claiming that arbitrage and hedge transactions are virtually impossible there at the moment.

“The majority of the KOSDAQ firms in question have undergone audits, but the problem is that such inspections have failed to function as desired,” said Jeong Geun-hye, who is at the helm of the Small-cap Team at Woori Investment & Securities. He added, “Having a hard time doing business on their own, these companies have resorted to an unfair money game.”

Industry insiders are claiming that the listing examination should become stricter in order to block controversial companies from the get-go and make the bourse sounder. Until recently, securities companies have been scrambling to attract more IPO firms, making light of the significance of prior verification to some extent. “The fatal weakness of the KOSDAQ at present is that it is high-risk yet low-return,” commented researcher Lee In-hyeong from the Korea Capital Market Institute, adding, “More effort needs to be made by creating a new index by gathering healthier, sounder companies and developing relevant investment products.”

Commemorating the 15th anniversary, the KOSDAQ Market Division of the Korea Exchange is aspiring to renew the tech-heavy bourse into one of the finest new stock markets of the world, announcing that it would more aggressively protect investors and provide assistance to promising corporate entities.

As such, the division is preparing various measures designed to improve the soundness of the market. These measures include enhancing the effectiveness of pre-delisting investigations, conducting more thorough screenings of backdoor listing and third-party allocation, and tightening supervision of those companies accused of harming the market’s integrity.

In addition, the division is to provide exemplary firms with investor relations (IR) services and useful business information in tandem with the government as well as strive to bring in corporations not listed yet. By doing so, the division is intending to create a virtuous cycle in the KOSDAQ; inducing the participation of SMEs, institutional and foreign investors and thus galvanizing the market which in turn will attract the participation of even more such companies.