Long road ahead for Korean financial sector
By Bruce Klingner
The Capital Market Consolidation Act (CMCA) proposed by the administration of
President Roh Moo-hyun will revolutionize South Korea's financial sector by
removing barriers and allowing the consolidation of single-sector companies
into multifunctional financial-services providers.
The bill, likely to be enacted by late this year and coming into effect in
2008, will make Korean financial firms more competitive, but it is not enough
to enable the country to become the financial hub of Northeast Asia. The bill
will cause short-term domestic turmoil in the financial sector as the resulting
mergers and acquisitions eventually lead to the emergence of a few strong
financial conglomerates able to compete against foreign companies. These larger
Korean firms, however, will likely remain at a disadvantage to established
foreign firms.
The CMCA will liberalize the non-banking financial sector by eliminating the
regulations that have restricted Korean financial institutions to a narrowly
defined range of services. Existing legislation prevents South Korean firms
from providing a variety of products, such as equities and derivatives trading,
asset management and investment banking. The CMCA would replace six separate
laws governing the financial-services sector as well as remove one-third of 300
existing regulations. The resulting integration of the capital markets will
allow local brokers to eventually function as full-service investment banks.
South Korea's financial sector would then be divided into three main categories
- banks, insurance companies, and all other financial firms, including
investment banks.
Seoul's advocacy of the CMCA is driven by four principal objectives: improving
the international competitiveness of South Korean financial institutions;
liberalizing the financial-services sector to make it a growth engine for the
economy; improving the viability of the overall services sector to reduce the
country's over-reliance on exports for its economic strength; and fulfilling
Roh's vision of making South Korea the financial hub of Northeast Asia.
The CMCA is one component of a multi-faceted government strategy to modernize
and enhance South Korea's financial sector. Seoul will also strengthen the bond
market by issuing more long-term Treasury bonds and diversifying investment
options; accelerating the removal of foreign-exchange regulations; and
submitting the Financial Hub Act and banking and insurance liberalization
legislation to the National Assembly.
The CMCA will indeed enhance Korean financial firms' competitiveness. Moreover,
the local populace will be receptive to the new mixed-asset funds that the
enhanced Korean investment banks will be allowed to offer.
Private South Korean investors have traditionally favored two kinds of
investments, real estate and the stock market. But many Koreans perceived that
the Roh administration's anti-speculation measures implemented in August
eliminated real estate as a viable investment option, which in turn led to a
massive injection of cash into the stock market. The resultant record-setting
market increases created a potentially over-exuberant perception of the
nation's economic recovery. The new mixed asset funds of securities, real
estate and derivatives allowed under the CMCA will tap into this trend and
attract significant investment.
For all its promise, the CMCA will likely not attain its more strategic
objectives for several years. While Korean financial markets will become more
dynamic, domestic firms will remain at a disadvantage to the foreign firms that
have greater experience in providing a broader spectrum of products. Korean
companies will need to develop greater expertise in the full range of their new
capabilities and how to integrate them. As such, Minister of Finance Han
Duck-soo's February 19 call for Korean financial firms to focus increasingly on
expanding their share in foreign markets to enable South Korea to become the
regional financial power is unrealistic.
Korea unlikely to achieve macro-objectives
It is also unlikely that the financial-services sector will significantly
reduce South Korea's over-reliance on exports for its economic vitality.
Exports currently account for 40% of the country's gross domestic product (GDP)
but are expected to decline this year as a result of the strengthening won. The
government's projected 5% growth rate is predicated on an increase in domestic
spending, stronger foreign direct investment and an expanded role for the
services sector. Moreover, South Korea's quest to become a financial hub must
first overcome a number of significant challenges unrelated to the vitality of
its financial-services sector, such as lingering concerns over Roh's economic
policies and strong competition from established financial centers such as
Singapore and Hong Kong.
While the CMCA will both open South Korea's financial sector to international
firms and liberalize it locally, domestic concerns over the perceived dangers
of foreign investment may trigger calls for legislative or regulatory
protectionist measures.
US corporate raider Carl Icahn's hostile takeover attempt of Korea Tobacco
& Ginseng has unnerved Korean firms and invigorated calls for government
defensive actions. Business advocates, such as the Federation of Korean
Industries, assert that foreign takeover threats could jeopardize South Korea's
economic recovery and long-term national competitiveness. Although attention
has been focused to date on Korean manufacturers and banks, the opening of the
financial sector could generate similar concerns about potential dangers to
local financial institutions.
The Roh administration will remain divided over the extent to which the
government should intervene against foreign ownership or takeovers.
Pro-business advocates, led by Han, will continue to play up the benefits of
opening South Korea to foreign businesses while regulatory agencies remain
protectionist.
After some nationalist comments by senior regulatory officials caused
international unease, Han emphasized on March 9 that the government will not
implement any new defensive measures for domestic firms. He also expressed
grave concern over escalating negative sentiment against foreign investment,
lamenting that the legislature, public and media were too nationalistic in
their attitude toward foreign capital.
Fair Trade Commission chairman Kang Chul-kyu and Financial Supervisory
Commission chairman Yoon Jeung-hyun have both advocated augmenting the ability
of Korean companies to fend off takeovers or extensive foreign ownership.
International business advocates have also complained that the Korean
bureaucracy deliberately interprets vaguely written legislation and regulations
to give the advantage to South Korean companies.
Despite the Roh administration's disinclination to intervene, South Korean
legislators and business advocates will continue to press for new legislation
to keep foreign firms at a disadvantage in response to public outrage over
perceived excessive and often tax-free foreign profits. Kang Bong-kyun,
chairman of the ruling Uri Party's policy committee and a former finance
minister, stated on March 9 that he will seek to abolish limits on chaebol
(conglomerate) holdings of shares in their subsidiaries, which he deemed
disadvantageous to Korean firms.
South Korean firms will also seek to augment their own defensive measures.
Companies will consider changing their corporate rules, including adding
"golden parachute" clauses, to make themselves less vulnerable. The financial
sector will be particularly important since it may not only be a future
battleground between domestic and foreign firms, but also a base for "white
knights" to buttress the defenses of mainstream Korean companies against
foreign competitors by increasing domestic investment in vulnerable local
firms.
There will be a higher level of uncertainty and volatility in the financial
market in the near to medium term until the effects of the CMCA become more
evident. Many smaller or medium-sized South Korean firms will either fail or be
acquired by indigenous or foreign companies, leading to the creation of fewer
but larger and more integrated Korean financial institutions. Merger and
acquisition activity could occur even before formal implementation of the
legislation. This trend would mirror similar activity that has already occurred
in the banking sector.
Deputy Finance Minister Kim Seok-dong commented on February 21 that Seoul's
goal was to establish "globally competitive investment banks of world-class
size and competence". Large securities firms, such as Samsung, Hyundai, Woori,
Dongbu and Daewoo, would be expected to benefit from the legislation, while
small and medium enterprises (SMEs) would likely find themselves forces to
specialize in niche markets.
Although the CMCA will not apply to the banking and insurance sectors, banks
and insurance companies have protested the proposed legislation, seeing the
emergent full-service financial institutions as threatening their interests.
Competition between Korean banks and financial companies will increase as
boundaries are eliminated, not only those within the financial sector but also
among the banking, insurance and financial sectors. Banks might respond by
acquiring non-bank entities such as brokerages.
The insurance industry has vowed to counter the CMCA, claiming that allowing
financial companies to sell insurance derivatives will erode the profits of
insurance providers.
Bruce Klingner is the Korea analyst for Eurasia Group, the world's
largest political risk consultancy. The views expressed herein are his own. His
areas of expertise are national security, political, military and economic
affairs in Korea, China and Japan. He can be reached at klingner@eurasiagroup.net.
