Capital Market


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Capital Market

  1. 1. Capital Market Business Climate Korea’s significant effort and progress in reforming its capital markets and financial sector since the financial crisis in 1997/1998 has brought the country to a point where its aspirations to perform as a regional financial center for North Asia are being taken seriously by its neighbors. Importantly, national regulatory and policy decisions are increasingly being influenced by the still less than clearly defined objective of becoming an active participant on the global financial stage. The previous inward looking vision of financial regulators is openly shifting towards an interest in assuring that new domestic policy is consistent (and competitive) with that of its near neighbors. The interest in measurement against external standards reaches as far as London and New York. In this “opening up” to the world’s financial markets we are witnessing a very important change in the manner and speed with which we should expect the continuing evolution of the country’s capital markets. In recognition of this change, we consider it appropriate to begin presenting the situation of Korea’s capital markets, not only as they are today but also where they are perceived relative to other key financial centers in the region and globally. The recommendations for change will therefore be in the context of growing the local markets’ competitive stance against other country’s markets and, more importantly, allowing Korea’s markets to efficiently integrate into the global financial marketplace. As a backdrop for this year’s review, it is useful to understand that as of 1999 (the most recent year for which sufficient data is available) Korea’s financial sector revenues were already a measurable part of those in Asia (ex- Japan): Financial Sub-Sector Revenues ($ B) % of Asia (ex Japan) Banking $7,776 12.2% Securities Brokerage $2,934 33.8% Insurance $56,600 48.3% Asset Management $ 76 5.5% Investment Banking $ 171 15.4%
  2. 2. As an additional relative measure, Korea’s Debt and Equity capital markets reached a combined $ 574 Billion in 2001 which compares favorably with those of Hong Kong ($ 545 Billion). Development of a country’s capital and financial markets beyond a purely domestic focus and orientation will to some degree be influenced by the perceptions of international portfolio investors, financial professionals and institutions, and supporting professional disciplines such as law and accounting. The reality that “perceptions” are by definition subjective as a measurement tool can be equally frustrating and encouraging: frustrating in that the “facts” often do not match the subjective image and encouraging in that effective communication of the “facts” can easily change the subjective image. The following chart represents the results of a poll of financial professionals in which participants were asked to rank 6 global financial centers against each other in terms of perceived relative development. Importantly, for each measured financial sector, no financial center is considered “optimal”: each has room for improvement. Also of importance is that no financial center was seen as being equally developed across all key financial sectors. MARKET PARTICIPANTS Perceived Development Relative to Best Possible Commercial Banks Insurance Companies Asset Managers Securities Houses Investment Banks Service Providers LEGEND SHANGHAI KOREA LONDON OPTIMAL TOKYO SINGAPORE HONG KONG A similar ranking of perceived levels of market development has been developed for Debt Capital Markets:
  3. 3. DEBT CAPITAL MARKETS Perceived Development Relative to Best Possible Domestic Government Domestic Corporate International Government International Corporate LEGEND SHANGHAI KOREA LONDON OPTIMAL TOKYO SINGAPORE HONG KONG As well as for Equity Capital Markets: EQUITY CAPITAL MARKETS Perceived Development Relative to Best Possible Large Domestic Small Domestic Large International Small International LEGEND SHANGHAI KOREA LONDON OPTIMAL TOKYO SINGAPORE HONG KONG
  4. 4. Central to the healthy growth and development of any financial market center is a highly professional and sophisticated financial services sector. Korea has been noteworthy over the last ten years in promoting the active development of this critical foundation. A large part of Korea's recent success is attributable to two factors: legal reform and the infusion of technical knowledge provided by global service firms. The enactment of special laws based on precedents in other markets has transformed the financial landscape in Korea since the IMF crisis; for instance, the Act on Asset Backed Securitisation (the "Securitisation Act") which came into force in 1998, has undoubtedly been the chief driving force behind the success of securitisation as a financing tool. Foreign investment banks, consulting firms and law firms have brought to Korea the latest know-how and expertise in banking and finance that has ignited the rapid transformation of the country. The continued success of the Korean banking and finance sector will, however, require the liberalization of its service industry, most notably its legal sector. Korea's measures to protect its local legal industry come at a hefty price to its corporations and institutions, and as such remains to be a prime obstacle to the country's ambition to develop into a regional financial hub. Current Situation Currently, foreign law firms are not allowed to establish themselves in Korea, nor are foreign lawyers allowed to practice law in Korea. Further, although individual foreign lawyers have been widely employed as consultants by Korean law firms since the late 1970s, they are not permitted to operate independently and there exists no registration or enrolment system, which provides administration over them. Every other major financial center in the world, including Hong Kong, Singapore, Shanghai and Tokyo in Asia, has international lawyers and law firms operating on the ground and freely advising their clients on cross-border capital markets and corporate finance transactions, as well as the laws of international commerce, English and New York. In addition, Hong Kong, Singapore and Tokyo allow international law firms to provide local law advice as well under varying degrees of regulation. Korea treats foreign lawyers and law firms under the national treatment basis. Thus, under the relevant statute (i.e. the Attorneys-at-Law Act), for a foreigner to practice as a lawyer in Korea, he/she must pass the Korean bar examination just as a Korean national would. Similarly, in order to establish a law firm or office in Korea, only those lawyers qualified as Korean lawyers can set up such firms or offices. The Korean Bar Association has reported that no foreign lawyer has ever passed the Korean bar exam. Korea remains one of the last countries in Asia, which has not (even partially) liberalized its legal services market. Even though the Foreign Direct Investment Plan issued by the Ministry of Finance and Economy of Korea on 14 May 1996 indicated that the legal services sector would be open to foreign investment from 1 January 1997, such measure had no substantial effect in liberalizing the Korean legal market because no Korean law
  5. 5. firms would require any foreign investment and because it is virtually impossible for a foreigner to pass the Korean bar exam enabling such foreigner to open a law office or firm. As such, the Korean Government has not made any significant efforts to liberalize their legal services market to date. Problems Korea’s legal services market faces problems caused by the disproportionately small number of lawyers available and the lack of any foreign law firm presence. Some of the more significant problems are: • A clear need for international law firms in Korea to cater to the growing needs of international investors in Korea and Korean issuers accessing international capital markets; • The need for international law firms that are experts in international standards ("best practice") and know-how for both international and Korean entities; • The need for law practices with international networks of offices and significant expertise on complex international finance transactions; • The linguistic and cultural difficulties foreign investors may face in dealing with Korean law firms and the lack of sufficient international level training for Korean lawyers in these firms; • The market monopoly and the restrictive trade practice by the Korean Bar Association; • The lack of "one-stop shop," an integrated global legal service firm that handles cross-border transactions' domestic and international legal issues with efficiency; and • The lack of any external competition. These obstacles to the participation of foreign lawyers in the Korean legal market not only unfairly discriminate against foreign legal practitioners but they also represent a serious impediment to a more successful realization of the Korean Government’s efforts to make Korea a regional financial hub. Outlook Korea became a party to the General Agreement on Trade and Services (“GATS”) on 1 January 1995. Korea will be obliged to re-enter negotiations to further liberalize trade in services at the next round of GATS negotiations in this regard. The Deputy Director (WTO Division) of the Ministry of Foreign Affairs and Trade has stated that Korea would play an active part in liberalizing the legal services market so that the market may open up even before the conclusion of the WTO negotiations. We hope that the Korean Government will take this stance seriously and make further progress to liberalize the legal services sector well before the conclusion of the WTO round, which may be many years away. With international law firms allowed to practice in Korea, bringing with them expertise, clients, investment, taxable revenues and training, Korea will add another stepping stone in the foundation of a regional financial hub.
  6. 6. Korea has also been an early and aggressive adopter in opening of its domestic equities markets to foreign investment. Other Asian countries have clearly recognized this success and are moving (in some cases only tentatively) towards similarly allowing access to foreign portfolio investors. Korea therefore must face the near term prospect of foreign investors having more Asian equities markets in which to invest and thus diversify their Asian exposures. For Korea to maintain its leading position among foreign portfolio investors, it is worth considering the concerns of such investors, which go beyond the individual share issuing companies. Developed and successful asset management industries have usually ‘evolved’ rather than been ‘created’. This has meant an acceptance of market forces and free-market outcomes, with the institutional infrastructure and human capital (skills, experience) building up over time. Market structure – institutions • A healthy, competitive, flexible and innovative industry that is able to provide investment services to a broad range of customers, across a broad range of risk appetites, return expectations and time horizons. • The health of the industry is enhanced by a level competitive and regulatory playing field. Entry to, and exit from, the industry should be as frictionless as possible. Involvement of industrial capital and public (government) capital can skew the playing field. Government intervention should be limited to long term policy goals rather than using the industry as a short-term policy tool (for example supporting the stock market). • Asset managers will be attracted to a location that offers scalability: a large domestic savings pool, combined with the ability to leverage off existing resources offshore. Basic costs of doing business (capital, personnel, property and tax) should be attractive. Regulatory environment • The regulatory environment should be transparent and uniformly applied. Regulations should be drafted to achieve clarity and to avoid ‘grey areas’. This is often easier with a principles-based system rather than a rules-based system. All participants, whether large or small, old or new, domestic or foreign, should be treated equally. • The regulator should aim for co-operative supervision, deterring and punishing abuses, but also co-operating and interpreting to enhance innovation and flexibility within the industry. The role and extent of the powers of the regulator should be clearly defined. Industry associations with quasi- regulatory functions can cause confusion and conflicts of interest. • Regulations aimed at investor protection need to be balanced according to the sophistication of different types of customer. Where possible, market
  7. 7. outcomes should be accepted to avoid moral hazard, the bottom line being the principle of caveat emptor. Tax environment The tax regime should have a neutral impact on the structure of the industry, the investment decisions taken by the industry, and the investment choices made by the customer base. Personnel A professional, experienced and skilled workforce should be encouraged through regular training and the promotion of professional qualifications. Multi-language capability enhances the attractiveness of a location to multi-national asset managers. Products Different customers have a diverse range of requirements to be satisfied. Providing satisfactory products requires flexibility in the regulatory and tax environment and satisfactory (liquid and transparent) markets for the underlying assets. Support services A healthy industry requires easy and cost effective access to a broad range of support services (distribution, legal, custodial, actuarial etc). Access and cheapness can be enhanced through removing barriers to entry to these supporting functions, and using anti-trust legislation to avoid abuse of market power by any of these providers. What would be the benefits? Institutional investors are a vital source of investment capital for the development of the economy. A successful asset management industry can help to reduce the private and public costs of saving for future retirement, death benefits and healthcare provision. As an institutional participant in asset markets, the industry can bring greater professionalism, liquidity and stability to assist in the progress of those markets. Where are we now? The asset management industry in Korea is developing. • The playing field is not level. The industry is weakened by short-term policy measures: to protect certain players (for example the traditional ITCs) and certain service suppliers (for example, to protect the securities companies’ role as distributors, and local institutions as trustees and custodians), and potentially as a source of finance at times of economic crisis. The implicit asymmetry in capital requirements for different players hinders the profitability of certain sections of the industry. Meanwhile regulations prevent foreign institutions from utilizing their offshore resources thus reducing the scalability of the business. Heavy involvement of industrial capital creates conflicts of
  8. 8. interest and hinders the development of a robust corporate governance culture. • The regulatory environment requires more clarity, transparency and consistency of enforcement. ‘Grey areas’ persist in the rules. Regulations are imposed asymmetrically to protect certain sections of the industry. There is a tendency to ‘over-regulate’ and the regulator has failed to build an environment of co-operative supervision, regulatory interpretation and consultation. This is hindering innovation and rational development of the regulations. The quasi-regulatory role of the industry association creates conflicts of interest and at worst tilts the playing field against smaller players. Excessive and contradictory regulation hampers the development of a recognizable private equity industry. • Product development needs to make further progress to meet the diverse requirements of the customer base. Regulations prevent the use of over the counter derivatives and make pooling of assets and funds of funds unworkable. The tax regime makes offshore products offering exposure to overseas assets inefficient for most domestic investors. Obstacles to development are also created by problems in the underlying asset markets. The equity market, while broad and generally liquid, suffers credibility issues due to the lax enforcement of insider-dealing rules, short experience of active corporate governance, and IPO and takeover and merger regulations, which act against the interests of most investors. The bond market suffers from lack of flexibility (the minimum trading lot is w10bn), poor liquidity amongst corporate bonds and excessively short maturities. These problems reduce the choice available to the customer base and thus have wider negative implications for the development of a vibrant savings and investment industry. • Over time, these weaknesses will hinder the development of Seoul as a regional asset management center, and deter multinational asset management companies from locating in Seoul. How about the others? • Financial centers such as London, Hong Kong and Singapore have developed and sophisticated asset management industries with clear and transparent regulatory and tax regimes. All have competency across a broad range of products (local and foreign, onshore and offshore) and customer types, have an established local long-term savings business, and have become major centers for multinational asset management companies. Hong Kong and Singapore have prospered despite lacking a large domestic pool of savings. Both offer multi-language skills appropriate to a regional center. • The asset management industry in China is at a very early stage of development. Foreign participation is currently permitted through joint ventures only.
  9. 9. • Tokyo is a developed center with a large domestic pool of savings and an appropriate skills base. However, it has not become a major regional center because it suffers from being a high cost location and suffers similar regulatory hurdles to those being experienced by foreign asset managers in Korea. The Immediate Future: 2003 It is indeed encouraging that the newly elected administration of Roh Moo Hyun has firmly committed itself to establishing Korea as the business and financial hub for North East Asia. The following recommendations, in addition to those suggested earlier, are intended as a means of clearly signaling this commitment to the rest of Asia and the foreign community at large and accelerating the transition: 1. Concerns expressed in the local press and among some regulators in the part year regarding “excess profits” in some sectors of the financial industry ignore the self-correcting discipline of open markets: high levels of profitability attract competitors which in turn provides consumers with more choice and lower cost. 2. Truly multinational corporations, both foreign and domestic, require the ability to efficiently link their Korean based operations with operations throughout Asia and the rest of world. Requiring domestic data processing for financial corporations operating in Korea is inefficient and therefore, by increasing costs, reduces the potential attractiveness of Korea as a regional base for financial operations. It is worth noting that Shanghai, in an otherwise more restrictive regulatory environment, has allowed offshore transaction processing for 5 years. 3. Foreign commercial banks are discouraged in building larger presences in Korea by two particular regulatory requirements which seemingly conflict with each other: a. Compliance with the small and medium enterprise index (“SMI”) means that 25% of all loan assets created by the bank must be to small and medium enterprises…the vast majority of which are situated outside the Seoul metropolitan area where the foreign banks have their established offices, and; b. Approval of new foreign bank branch requests is seen as unnecessarily restrictive and subjective. Clear guidelines should be adopted for approval of such requests and could be in line with those used in other global financial centers, which tend to focus strictly on the financial strength of the requesting financial institution. With more branches allowed, foreign bank could expand their presences outside the Seoul metropolitan area and more easily extend loans to small and medium enterprises.
  10. 10. 4. Korean banks are allowed to issue financial debentures in the domestic market which is a prudent measure allowing those banks to diversify and strengthen their funding bases. Foreign banks operating in Korea are not accorded this allowance which forces them to assume otherwise unwanted liquidity and foreign exchange exposures in order to fund their local operations. Equal, “national” treatment of all banks operating in Korea would be consistent with the typical regulation of a regional financial center.