Korean financial sector awaits 2nd ‘big bang’

With President Lee Myung-bak’s appointment of a new government financial regulator earlier this year, reform is once again a serious topic in Korea’s one-step-forward, two-steps-back financial services industry.

“The most revolutionary area (of reform) will be the introduction of hedge funds,” said Ernst J. Lee, spokesperson for the Financial Services Commission, echoing recent pronouncements by his new boss, Kim Seok-dong.

The reforms will be “as broad as possible,” Lee declared, stressing that the market itself now is preparing for another leap forward.

Among other projects, the FSC is currently preparing a major update to the financial service industry’s legal framework, revising the existing scope of the regulations governing private equity funds in Korea to include hedge funds.

According to the FSC, the goal is to expand the boundaries to allow more market actors, with the timeframe for the reform reset to be quick. The FSC hopes to have legislation under consideration at the National Assembly in six months.

It’s an ambitious schedule. It has now been just over two years since Korea ignited its own version of a “financial big bang,” following, most notably, England under Margaret Thatcher in the 1980s and Japan under Ryutaro Hashimoto in the 1990s, with the 2009 introduction in Seoul of the much-anticipated Financial Investment Services and Capital Markets Act.

The new law was meant to reshape the landscape of the industry by breaking down regulatory barriers separating stock brokerages, futures trading and asset management, thus encouraging market consolidation to form large, internationally competitive players capable of nurturing Korea’s dream of becoming a financial hub.

But Korea’s bang was more of a dull thud, no thanks to the inauspicious timing of its occurrence during a worldwide credit market meltdown. It’s a fact that the regulator is keen to embrace.

“It was mainly due to the global financial crisis that we haven’t seen much effect from the capital market consolidation act,” explains Lee. “At that time, the government put the priority on stabilizing the market rather than fostering growth.”

Their goal is something akin to what happened in England, where the big bang is credited with sparking an economic boom that revitalized London’s role as a financial capital and generating tremendous wealth for the country. England’s financial sector contributes about 30 percent to the country’s GDP. In Korea, it is 7 percent at best.

Part of the problem is that the sector is still grappling with consolidation, a fact that the FSC is saying it wants to change, pointing to the need to nurture global investment banking champions.

“Local financial institutions still don’t have enough reserve capital to develop investment banks that can compete globally,”

says Lee. “Remember, we were facing a liquidity crisis just two years ago.”

This is the nub of the problem facing the Korean government as it seeks to unload its 57 percent stake in Woori Financial, 10 years after cobbling it together in the wake of the 1997-98 Asian financial crisis.

Industry players say that the deal, valued at some $6 billion, is holding up all others, as there is no local player with the capital to take on such a big bite except for the other major banks.

The regulator is now saying that it will do what it takes to sell Woori, including breaking it into parts, diluting the so-called management premium, and reducing the overall value of the return to taxpayers. It had previously resisted such a move.

Privatization of state-run Korea Development Bank (KDB), a major policy goal of the Lee administration, would come next, with the goal of spinning it into a major global player.

In fact, that was the goal two years ago, when Korea put into effect the Financial Investment Services and Capital Markets Act. It then envisioned the birth of the local versions of investment banking giants like Goldman Sachs and Morgan Stanley.

But such a thing has never happened, and this has been the cause of much consternation and hand wringing in government circles.

When Korea won a multi-billion dollar nuclear reactor project in the United Arab Emirates in December 2009, for example, President Lee reportedly lamented the lack of domestic financial companies big enough to finance the deal, estimated at over $10 billion.

Kim Seok-dong’s appointment as the new head of the all-powerful FSC was seen as a clear signal that the Lee administration wants to switch up the status quo. And, after tremendous industry and media speculation, Lee’s influential economic confidant, Kang Man-soo, was recently appointed to head KDB, setting off even more speculation about whether KDB will be privatized or whether it will swallow Woori to create the envisioned giant.

But even with these moves, and the new envisioned legislation to remake the industry, it’s still unclear whether Korea will be able to have big, internationally competitive domestic financial firms, according to experts.

“One key to privatization is the globalization of KDB and there can’t be a bias towards foreign capital in the industry,” said a senior manager in a local financial firm. “That would be a major red flag for an industry that is trying to be a regional financial hub.”

Korea has other problems, too, such as the need to clean up its ailing savings bank industry, which is saddled with mounds of non-performing project financing loans left over from the real estate sector bust of the last few years.

The FSC has already demonstrated that it is not going to stand on ceremony, shuttering eight of the country’s 105 banks and orchestrating the buyout process for at least one.

It’s also taking a no-nonsense approach to industry shenanigans. Recently, when news broke that Shinhan Financial Group’s disgraced former chairman and current sitting director Ra Eung-chan would receive stock options despite having been clipped for violating the country’s real-name financial transaction law, the head of the Financial Supervisory Service was quoted as saying that bank’s board had failed “to come to its senses.”

The new FSC chief went further, saying that “Shinhan needs to change its organization and its executives or else there is no future for the company.”

Some players are not overly concerned about the state of Korea’s industry and there is cautious optimism for the upcoming reforms.

“We believe the FSC has a clear vision of what it wants to achieve and is pragmatic at the same time in its rollout,” said Giselle Lee, head of sales in Hong Kong and Korea for Man Investments.

But Man’s status in Korea speaks volumes of the state of the industry. A British hedge fund with some $68 billion under management, it has offices in every major financial center in the world, including four major Asian centers.

And yet, despite doing business with Korean institutional investors since the 1990s, it manages Korean business from Hong Kong, and through local Korean partners like Samsung Securities, still unable to legally operate under Korea’s existing regulatory framework.

At a recent investor outreach event in Seoul, she spoke about the company’s desire to set up shop in the country, saying that they’ve been considering it for some time, if and when the laws allow for it.

“Man is very optimistic on the future development of the Korean market,” she said. “It is a very important economy in Asia with huge potential to grow and develop into a regional financial hub.”

“From a hedge fund standpoint, we need to see regulatory development that allows establishment hedge funds and allows distribution of offshore hedge funds into Korea. Both are equally important aspects in a developed market.” 

(Yonhap News)