A Capital Market Partner Adding to Customer Value

Comprehensive Management Plan for Algorithmic Trading in the KRX Derivatives Market

7.12.2013

Korea Exchange
1

A Capital Market Partner Adding to Customer Value

I. In progress

Korea Exchange (Derivatives Development & Regulations of the Derivatives Market Division) is opening a briefing today in order to provide its members with the latest updates in regard to the management of algorithmic trading. It is also to avoid negative market impacts generated by algorithmic trading errors and secure both effectiveness and safety of the derivatives market with the comprehensive management plan designed to prevent such abnormalities.

A Capital Market Partner Adding to Customer Value

II. Summary of the comprehensive management plan

Assortment Risk management of algorithmic trading Register Detail algorithmic trading Minimize negative by market abnormal Anticipated Outcome

accounts to KRX

- Set the cumulative order quantity impacts limit - Take advantage of Kill Switch Set up the automated order

caused

transactions due to algorithmic trading errors

cancellation system Excessive order management Risk management of the ex-post customer margin account - Restrict receiving excessive orders - Secure stability of the exchange

- Impose a surcharge for excessive derivatives system orders - Increase the management level of risk exposure amount - Reduce the risk that institutional

- Abolish the obligation that requires investors fail to fulfill their maintenance customer margin in ex- settlement obligation to maintain post customer margin accounts the ex-post customer margin

This booklet is prepared only to assist the understanding of members on matters related to order receipt and submission. It should be kept in mind that the contents herein are subject to changes when the Business Regulations of KRX Markets are amended.
3

A. Risk management of algorithmic trading

1. Obligation to register algorithmic trading accounts to KRX

a. Current problem: It is nearly impossible for KRX to perform real-time monitoring

on every single automated transaction or to detect a trace of abnormal transactions in absence of information, the account information of its members in algorithmic trading.

Currently, it is mandatory to register only market making accounts of members and expost customer margin accounts to KRX.

b. Improvement: KRX becomes capable of protecting the market against negative

market impacts, such as technical glitch generated by abnormal orders due to the algorithmic trading errors, by making use of member-submitted account information in algorithmic trading.

Definition of algorithmic trade: algorithmic trade is the use of electronic platforms for entering trading orders with an algorithm which executes pre-programmed trading instructions whose variables may include timing, price, or quantity of the order, or in many cases initiating the order without human intervention.

Members are obliged to register algorithmic trading accounts of their own and their customers to KRX ahead of placing an order. * In regard to investors who trade on algorithms and manually at the same time, they are also on the obligation to register their algorithmic trading accounts in advance.

* Members are asked to fill in extra information such as process ID and contact information for emergency use in the registration process.

Within the range of registered algorithmic trading accounts, KRX supervises all transaction records to detect signs of abnormal orders through the monitoring system under development.

In regard to members with unregistered algorithmic trading accounts with over 20,000 daily orders, they are required to submit a statement to prove their non-algorithmic trading intention by the market closing time of the following day.

<Guideline for registering the algorithmic trading accounts>

Assortment Applicant - Members - All derivatives accounts in use for algorithmic trading (Both members and their customers) Object to register * According to the definition of algorithmic trade- algorithmic trade is the use of electronic platforms for entering trading orders with an algorithm which executes pre-programmed trading instructions whose variables may include timing, price, or quantity of the order, or in many cases initiating the order without human intervention.
5

Details

- It is an obligation to report to KRX in no delay whenever any change arises regarding the status of algorithmic trading accounts as long as those When to report
* Members should report to KRX especially when they permanently close their algorithmic trading accounts. By doing so the exchange derivatives system can be relieved from burden of unnecessary workload.

accounts are registered and valid for use.

How to register

- It is required to type in the information into the exchange derivatives system via the member derivatives system (API method) Item to register Account No. of algorithmic trade accounts Order process ID in use for algorithmic -To provide Details members with Kill

Switch* -To provide a function called Cancel on Disconnect** - Provided only if it is identified as an exclusive process To make contact with a

Registration in details

trading accounts Contact Information of

a representative in charge of representative without delay in case of algorithmic trading emergency

* Kill Switch: allocated to the account No. of the registered account ** Cancel on Disconnect: allocated to a registered order process ID (Introduction of this function is subject to the test result from the Exture+ system under development)

- An additional account code for algorithmic trading will be added to the existing account code types.
6

Account code

* Current account code types Customer: 31, Member: 41, Market Making: 42, Arbitrage& Hedge: 51

- When the algorithmic trading account code appears from unregistered accounts while receiving orders, it is mandated to make confirmation with How to manage the code from unregistered accounts - When the non-algorithmic trading account code appears from registered accounts while receiving orders, it is mandated to make confirmation with corresponding members. Registered accounts continue to remain as algorithmic to KRX until they are reported as permanently closed to KRX. - KRX gives a notification to members who hold unregistered accounts Statement submission to verify non-algorithmic trading intention - Members are required to submit a statement to verify their nonalgorithmic trading intention until the market closing time of the following day. Members should check with their customers from the very start to see if those customers intention of opening an account accords with requirements of algorithmic trading accounts with over 20,000 daily orders (except for trade on CME Globex and negotiated trade) after the closing of trade. corresponding members. It is not to be processed until members confirm.

2. Introduction of the cumulative order quantity limit

a. Current Problem: There exists the order quantity limit now, but not enough to put
a limit on heavily accumulated orders caused by irregular duplication of individual orders which comply with the current quantity limit per contract. (January 7th, 2013).
* Ex) the order quantity limit for KOSPI 200 futures: 1,000 contracts

b. Improvement: Members should estimate and set the cumulative order quantity
limit for their own and their customers ex-post margin accounts to curb orders beyond the limit.

* Upfront initial customer margin accounts, quantities of which are already ceiled due to adoption of the upfront initial customer margin, are exempted from adopting the cumulative order quantity limit.

* An additional step for verifying the cumulative order quantity limit is newly added to the existing steps for the verification by members (Regulation 65) and it applies equally for both members and their customers.

* Members are strongly advised to set their own cumulative order quantity limit within the scope of fixed figures** to the bid/offer* as KRX stipulates.
* It is not easy to detect irregular repetition of the bid/offer orders solely under the net cumulative limit (Ex: 10,000 contracts of short futures + 10,000 contracts of long futures= 0) ** The cumulative order quantity limit is 7,500 Delta to the bid/offer for ex-post customer margin accounts of algorithmic trading accounts, whereas it is 15,000 Delta to the bid/offer for ex-post

customer margin accounts which are not in the category of algorithmic trading accounts.

* Investors, including members, are temporarily allowed to place mass orders beyond the cumulative order quantity limit if they acquire authorization from their department of risk management to raise the limit for a limited time. * All records relevant to the case above should be kept in a secured storage.

<Guideline for the cumulative order quantity limit>

Assortment - Members Applicant
* It is way beyond capability of the exchange derivatives system to estimate every cumulative order quantity limit for all derivatives accounts individual member systems can share the burden

Details

Applicable product

- KOSPI 200 Futures (incl. spread), KOSPI 200 Options

* Expected to gradually expand to all products.

- Members own accounts and ex-post customer margin accounts

* Upfront initial customer margin accounts, quantities of which are already ceiled due to adoption of upfront initial customer margin, are exempted from adopting

Object to verify

the cumulative order quantity limit.

- It is intended to check order quantities submitted to the exchange during the order receiving hours of the regular session
* Trade on CME Globex and negotiated trade are not counted

- It is newly added to the existing verification by members

- Excessive orders over the cumulative order quantity limit will be automatically dropped off

- Members are strongly advised to set their own cumulative order quantity limit within the scope of fixed figures to the bid/offer as KRX stipulates How to verify - The cumulative order quantity limit is 7,500 Delta to the bid/offer for ex-post customer margin accounts of algorithmic trading accounts

- The cumulative order quantity limit is 15,000 Delta to the bid/offer for expost customer margin accounts which are not in the category of algorithmic trading accounts.

- Investors, including members, are temporarily allowed to place mass orders beyond the cumulative order quantity limit if they acquire authorization from their department of risk management to raise the limit for a limited time.

10

<Formula to calculate cumulative order quantities> Assortment Remarks (Order quantities from buying futures contracts + Quantities of unmatched orders from buying futures contracts)+ (Order quantities from futures SP + Quantities of unmatched orders from futures SP)+ Bid |(Order quantities of orders from buying call option + Quantities of unmatched orders from buying call option)* delta * the multiplier ratio|+ |(Order quantities from selling put option + Quantities of unmatched orders from selling put option)* delta * the multiplier ratio| (Order quantities from selling futures contracts + Quantities of unmatched orders from selling futures contracts)+ (Order quantities from futures SP + Quantities of unmatched orders from futures SP)+ Offer |(Order quantities from selling call option + Quantities of unmatched orders from selling call option)* delta * the multiplier ratio|+ |(Order quantities from buying put option + Quantities of unmatched orders from buying put option)* delta * the multiplier ratio|
* KRX provides Delta from the previous day for the use of managing the open interest limit * The multiplier ratio= option trade multiplier/ futures trade multiplier 1 for KOSPI 200 Products

11

3. Introduction of Kill Switch

a. Current problem: The existing Exchange derivatives system does not allow
members to cancel a batch of unmatched orders or to shut down receiving orders for each account by one click. As a consequence, the system is potentially exposed to a huge risk of the failure to fulfill settlement because there is no safety bar to stay away from algorithmic and systematic errors.
Assortment Current situation - Inconvenience to cancel* each Order cancellation order in a separate way, not - The existing cancellation method allowing to cancel a batch of orders takes at once too long to cancel entire Problem

unmatched orders if algorithmic traders

* The individual order No. is hold a multiple number of them. required to cancel each order. - The exchange is not capable of Order shut down Unless abnormal orders are

shutting down receiving orders immediately detected and properly from a particular account taken care of, it may seem unlikely to

* Yet, there is a way to block manage the increasing size of the loss receiving orders from a particular due to algorithmic trading errors. member

b. Improvement: Kill Switch is set up for use to enable members to cancel a batch
of orders by one-click and to shut down additional orders afterwards.
* Taking advantage of Kill Switch, members can make a quick response to an unintentional, abnormal order by algorithmic trading errors and prepare not to repeat the unfortunate accident
12

that recently happened in January 7th, 2013.

<Guideline for Kill Switch>

Assortment Details - Members should pass through the user-authentication process to access to the Applicant application section for Kill Switch - KRX cannot initiate Kill Switch without a request from its members
* It is very unlikely to discover irregular orders only with the partial information on orders/ transactions

- Algorithmic trading accounts in which an irregular activity, such as technical glitch or error, arises. - It cannot be initiated to unregistered algorithmic trading accounts* Applicable object
* Considering the way the Kill Switch operates in the exchange system, it is strongly advised to register to KRX in advance.

- If Kill Switch runs for every account, there arises risk to burden the exchange system, in forms of system overload or system lag. That being said, only registered algorithmic trading accounts to KRX are covered for operation of Kill Switch.
* Total No. of algorithmic trading accounts: approx. 50 to 100 Total No. of entire trade accounts: approx. 30,000 to 40,000

Operating hour How to apply

During the order receiving hours of the regular session(08:00-15:15)

- Apply via the Member Derivatives System (API method) or the member derivatives terminal
13

- When members type in the account no. of their algorithmic trading accounts on Application process details the system, the registration process for Kill Switch is completed. - It is irrevocable once the application process has been completed.
* Members are responsible for initiating kill switch, therefore should be careful enough not to freeze the well-functioning accounts by mistakes

- One stop process(+) Cancel a batch of unmatched orders from the account by one click Operation process of Kill Switch Automatically shut down receiving orders from the account
* It saves unnecessary inconvenience to cancel each unmatched order separately.

- It might look quite identical with the existing process to cancel an order when it comes down to the entity who decides and proceeds the operation, but the newly devised Kill Switch distinguishes itself from the existing as it cancels a batch of orders at one time, not each order in a separate way. - It is possible to stop* Kill Switch operation in 10 minutes from initiation.
* Stop means to release an action of blocking receiving orders from the

Release of Kill Switch Operation

corresponding account, reinstating the account back to the normal state.

- Initiating Kill Switch should not be abused for investment strategies. To prevent such kind of abusive usage, it goes on to stay active at least 10 minutes for each time.

- Kill Switch operation continues to stay effecive unless there is an official request from members.(It goes on the following day and after if not)

14

4. Obligation to set up the automated order cancellation system

a. Current Problem: According to the regulations of Korea Exchange, it states no

clause mandating to set up the automated order cancellation system* in requirements** for the member derivatives system.
* The system serves to cancel each unmatched order automatically. It is not yet mandatory to serve for the purpose above although there are some members, systems of whom are set to operate for that purpose above. ** Requirements of the member derivatives system (Enforcement rule 117-3, Regulation 65, in the guidelines related to connection to member derivatives system) : It should serve to process the user authentication, protect customers information from abuse, and confirm order details without delay, review order/transaction details, record order history, reject to receive orders if necessary, verify suitability of an order, use a separate and exclusive security device, and manage the member system directly, and so on.

It gets to the first priority to come up with a contingency plan to cope with abnormal orders for the time until the next generation system Exture+ debuts.

* It is on schedule to introduce Exture+ in 1st half, 2014

b. Improvement: KRX mandates each member to set up the automated order

cancellation system*.
* It will be added to the requirements for the member derivatives system (Enforcement Rules 117-3)

15

It is anticipated that it gets possible to take care of abnormal orders from members accounts promptly by activating Kill Switch* in cooperation with the automated order cancellation system
* It will be provided around the time when the next generation system Exture+ comes out in 1st half, 2014

Comparison between the two systems

Assortment From member to KRX Out of the exchange - Type in the order No. for cancellation - Process each cancellation separately (current method to cancel an order) The automated order cancellation system - Automate the existing process Kill Switch - Initiate Kill Switch on a particular account - Type in the account No. - Process order cancellation a batch by one click in

16

B. Excessive Order Management

1. Restriction on receiving excessive orders

a. Current problem: There exists no safety bar to restrict on receiving excessive

orders, thus undermining the potential risk that the exchange derivatives system goes through critical technical glitch by accidentally submitted excessive orders due to algorithmic trading errors.
* It is currently applied to the night session of the KOSPI 200 futures Regulation 156-2, enforcement rules 164-2: In case where the exchange derivatives system has failed or is expected to fail due to influx of excessive orders or it is necessary for the market management, the Exchange may not accept a part or all orders placed by the concerned member

AVG No. of orders for the previous 3 seconds > 750 orders - Refuse to receive orders except those for cancellation AVG No. of orders for the previous 3 seconds > 1,000 orders - Refuse to receive all orders without exception * It raises a concern about the system break-down due to influx of excessive orders under the asynchronous Exture+ system which processes higher volume of orders than the current system does.

b. Improvement: It gets to refuse acceptance of excessive orders in case of system

break-down or errors due to influx of excessive orders.

17

< Guideline for refusal to receive excessive orders>

Step Details In case where it comes to go beyond the excessive order quantity limit 1 Members are obliged to control the interval of order submission immediately after the exchanges notification 2 In case where it exceeds the excessive order quantity limit The exchange refuse to receive orders from the corresponding account In case where it comes to exceed the maximum order receipt limit of the entire exchange 3 derivatives system The exchange immediately shuts down the whole trade operation of a particular product for which excessive orders are submitted. (Ex: Index option)
Operation designed for the trading safety of members is scheduled to be in enforcement by the time the development of the Exture+ system is completed.

18

2. Impose a surcharge for excessive orders

a. Current Problem: A large number of orders by algorithmic trading continuously

burden the exchange derivatives system, generating an increasing number of unmatched orders as a consequence. Therefore, It is essential to avoid such ineffectiveness and to impose* a surcharge on excessive orders.
* It seems more reasonable that a member, who trades more on a frequent basis within the exchange derivatives system, pays more for maintenance of the system.

b. Improvement: KRX imposes a surcharge on accounts where appear to put out

excessive orders for KOSPI 200 futures/ option products depending on a degree of contribution to the exchange derivatives system.

<Brief guideline for imposing a surcharge for excessive orders>

Assortment Details KOSPI 200 futures (incl. futures spread)/ option product
* except for trade on CME Globex and negotiated trade

Object

The market making accounts are exempted if they belong to market making products
* It is not applicable for KOSPI 200 futures/ option products since they are not in the category of market making products.

All accounts meeting the standards in both quantity and quality Quantity Standard: Total No. of orders per day 20,000 Quality Standard: The ratio, No. of orders to Trading Volume of orders, is higher than 20:1 or 10:1 depending on the No. of orders

19

 Accounts with No. of orders < 20,000 Not Applied Imposing standard Accounts with No. of orders 20,000 < 100,000 The ratio of the accounts 20:1 Account with orders 100,000 The ratio of the accounts 10:1 Applied No. of orders Assortment Trading Volume of orders (Quality) <10:1 <20,000 No. of 20,000Orders 100,000 (Quantity) 100,000 FEE Amount N/A Applied Applied Applied N/A N/A Applied Applied N/A 10:1-20:1 N/A 20:1 N/A N/A Applied

Flat Fee, KRW 1,000,000 per day* for each product * Fee waivers up to two times a month may be applicable unless the ratio (No. of orders to Trading Volume of orders) doesnt exceed five times the applicable standard ratio (thus, less than either 100:1 or 50:1)

Purpose

Only for the purpose of contribution to improve of the exchange derivatives system

Payment

A member, who receives a bill from the exchange on the transaction date (Tday), should make payment within 2days (T+2) from the day.

20

C. Risk Management of the ex-post customer margin account

1. Increase the management level for risk exposure amount

a. Current problem: It is urgent to fortify management level for risk exposure

amount of ex-post customer margin accounts, not to repeat committing the very same accident caused by algorithmic trading errors in January 7th, 2013
* Originally, management for risk exposure amount of the ex-post customer margin account was first introduced in March 28th, 2011 to protect a member from a risk of the failure to fulfill the settlement obligation after the option shock (November 11th, 2010) arose.

Assortment

Status

Problem - The current level of the limit is too

Limit on risk exposure amount

- Members are required to set the high and broad to prevent a risk of risk exposure limit lower than 10 the failure to fulfill the settlement times of the total depository. obligation when the algorithmic

trading errors arise. - Within an hour members should - It is currently given a certain request their customers to lower duration of time to resolve a problem risk exposure amount voluntarily. Measurement Over the limit - If it is not resolved yet, members should balance the exceeding - However, it turns out ineffective in with emergency quickly on their own for the convenience of qualified institutional investors.

amount by either applying upfront dealing

21

initial margin or performing an because of the risks of delay and opposite transaction. abusive usage by some institutional investors

b. Improvement: It gets to increase the management level of risk exposure amount in

ex-post customer margin accounts by lowering and narrowing its risk exposure limit and stopping receiving orders without delay.

Lower the risk exposure limit below 5 times of the total depository. In case of the excess over the limit, it immediately blocks receiving orders from customers without offering a time to resolve a problem on their own - But, exception may be applicable to receive orders in case of lowering risk exposure amount.

22

2. Abolish the obligation that requires maintenance customer margin in expost customer margin accounts

a. Current Problem: It is necessary to trim the method to yield customer margin of

the ex-post customer margin account so as not to provoke investors misunderstanding because of its high level of complication.

<Current method to find customer margin of ex-post customer margin accounts> Domestic Object Customer margin Deposit Deadline qualified institutional investors Until 10 AM*** From 10 AM The account with new trade on the day* Calculate apply customer margin and ex-post Open for trade Closed Foreign qualified institutional investors Open for trade Closed unless it is the public of banks

holiday overseas or

submitted

with a copy of the payment

instruction

23

The account without trade or only with offsetting trade**

Calculate

and Until 12 PM From 12 PM Closed until additional customer margin is paid or the position is closed out by reverse dealing

apply additional customer margin

* Enforcement rules 146(Deposit of Ex-post Customer Margin), 148(-post Cash Deposit Requirement) ** Enforcement rules 150(in Total Deposit), 151(Shortfall in Cash Deposit) *** Anytime as members select prior to 10AM of the day or the following day

Status Assortment by characteristics of trade

problem - It is much beneficial to take advantage of the benefit by dividing into ex-post/maintenance customer margin depending on types of orders - It doesnt seem rational to adapt ex-post customer margin to a new trade from investors holding a multiple number of open interests. - There arises a frequent dispute between members and institutional

Level of understanding about the obligation

investors because an order is not processed when maintenance customer margin is low. Most institutional investors often misunderstand that only ex-post customer margin is applied to ex-post customer margin accounts. But in fact, maintenance customer margin is applied too.

24

b. Improvement: For ex-post customer margin accounts, only ex-post customer

margin is applied, which means keeping maintenance customer margin is not required anymore.

Qualified institutional investors are only asked to pay ex-post customer margin until 10AM of the following day, minimizing confusion among members and investors.

It should not be burdensome since most qualified institutional investors retain enough amounts of substitute securities more than required margin.

< Modified way to find the customer margin of the ex-post customer margin accounts> Customer Object margin Deadline Domestic qualified institutional investors Until All ex-post Calculate and 10AM* Closed Closed unless it is the public holiday of overseas banks or submitted with a copy of the payment instruction Open for trade Foreign qualified institutional investors Open for trade

customer margin accounts

apply From ex-post 10AM* customer margin

* Anytime as members select prior to 10AM of the day or the following day

25

A Capital Market Partner Adding to Customer Value

III. Future Plans

<Scheduled enforcement dates of the management plan for algorithmic trading> Assortment Detail - Register algorithmic trading accounts to KRX - Set the cumulative order quantity limit Risk management of algorithmic trading Exture+) - Set up the automated order cancellation system Sep.30th, 2013 1st half, 2014 Excessive order management Exture+) - Impose a surcharge for excessive orders Risk management of the expost customer margin account customer margin in ex-post customer margin accounts amount - Abolish the obligation that requires maintenance Sep.30th, 2013 - Increase management level of the risk exposure Sep.30th, 2013 Sep.30th, 2013 - Restrict receiving excessive orders (Estimated operational date of - Take advantage of Kill Switch (Estimated operational date of Scheduled date Sep. 30th, 2013 Sep. 30th, 2013 1st half, 2014

26