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
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%
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.
Perceived Development Relative to Best Possible
LEGEND SHANGHAI KOREA LONDON
TOKYO SINGAPORE HONG KONG
A similar ranking of perceived levels of market development has been developed
for Debt Capital Markets:
DEBT CAPITAL MARKETS
Perceived Development Relative to Best Possible
LEGEND SHANGHAI KOREA LONDON
TOKYO SINGAPORE HONG KONG
As well as for Equity Capital Markets:
EQUITY CAPITAL MARKETS
Perceived Development Relative to Best Possible
LEGEND SHANGHAI KOREA LONDON
TOKYO SINGAPORE HONG KONG
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
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.
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
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.
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
• 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
• 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.
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.
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
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.
• 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
outcomes should be accepted to avoid moral hazard, the bottom line being
the principle of caveat emptor.
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.
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
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
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
interest and hinders the development of a robust corporate governance
• 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
• 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
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
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.
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