[Initial Insight] Expensive Fees Blocking Bond Retail Investors

Higher Transaction Costs Compared to Stocks
Invisible Fees Such as Securities Firms' Middle Margins
Lower Trading Barriers Through Bond Trading Computerization

With the development of Home Trading Systems (HTS) and Mobile Trading Systems (MTS), stock trading commissions have fallen to around 1bp (1bp = 0.01 percentage points). The introduction of capital gains tax (investment income tax) has been postponed for two years, so except for securities transaction tax, the actual cost of stock trading has significantly decreased. Commissions that averaged over 30bp 20 to 30 years ago have dropped to less than one-thirtieth of that level thanks to technological advances. However, trading commissions for transactions conducted by calling securities firm counter staff have not become cheaper compared to the past.

Individuals have been able to employ various investment strategies thanks to the low commissions. Along with the decline in commissions, the previously asymmetric trading environment between institutions or foreign investors and individuals has also improved considerably. The low-cost and convenient trading systems have contributed to attracting individual investors to the domestic stock market. The surge in individual investors in the domestic stock market after the COVID-19 pandemic, known as the Donghak Ant Movement, is also partly attributable to the reduction in trading costs.

However, trading costs in the bond market remain high. On-exchange bond trading commissions vary by securities firm. Generally, the longer the remaining maturity of the bond and the smaller the transaction amount, the higher the commission. On average, bonds with less than one year remaining maturity are charged about 10bp, less than two years about 20bp, and over two years more than 30bp. Since longer maturities offer higher interest rates and potential gains from interest rate fluctuations, individual investors usually buy bonds with maturities of three years or more. As a result, most individual investors pay commissions exceeding 30bp each time.

Commissions for small transactions are much higher. In some cases, a single trade may incur commissions exceeding 1%. The structure encourages holding bonds until maturity or near maturity to minimize commissions. High trading costs make frequent trading difficult and hinder strategies involving frequent buying and selling.

The actual commissions related to bond trading do not end there. Bonds typically have relatively large bid-offer spreads?the price difference between buying and selling prices?due to lower liquidity compared to stocks.

Unlike the on-exchange bond market, the over-the-counter (OTC) bond market does not charge trading commissions. However, hidden fees exist. When securities firms offer retail bond inventory, they add margins to each bond. For example, bonds issued at a 5% interest rate may be purchased in the institutional market and offered to retail investors at 4.7?4.8%. Through such trades, securities firms can earn a risk-free margin of 20?30bp. This is the middle margin earned by buying bonds wholesale in the OTC market from investment institutions or financial companies and selling them retail to individuals.

When adding the 15.4% tax on bond interest income to trading commissions and middle margins, individuals pay non-negligible costs in bond trading. Although the tax on interest is calculated on interest income rather than the principal, making the base smaller, commissions are charged on the total transaction amount, making the base larger. While commissions may seem smaller than income tax numerically, the proportion of commissions in the total cost during trading is significant and burdensome.

Interest in bonds among individuals is growing so much that it is called the "bond era." However, many point out that commissions have not changed much since the days 30 years ago when bond trading orders were placed by phone at securities firm trading floors. Bonds can now be freely traded via HTS and MTS, whether on-exchange or OTC, and the service costs provided by securities firms during individual bond trading have also decreased significantly. With lower service costs, it is now time to reduce bond commissions to the level of stocks.