Today marks Korea's "Big Bang", as the Capital Market Consolidation Act*, which is meant to revolutionise the country's financial markets, is finally implemented. But don't expect too many fireworks.
The decline then death of the US investment banking model, which had inspired the Act's many drafters, will mean a search for a new prototype. While the demonization of derivatives and structured products, widely blamed for the global financial meltdown, must make regulators and legislators wonder why they bothered at all.
The intention, first set out in the Indirect Investment Act in 2004, was admirable, fixed firmly in a recognition that Korea was ready to move from a predominantly low-cost manufacturing-based economy to one shaped more by financial and other services. A per capita income on a par with or higher than Western industrialised countries confirmed that.
Most importantly, small- and medium-sized enterprises, wholly-dependent on restrictive bank finance, needed access to alternative sources of funding, according to a foreign press spokesman at Korea's Financial Services Commission (FSC).
There had been a lack of financial intermediation, and corporate funding through capital markets has actually shrunk between 2002 and 2006. Furthermore, capital markets had failed to grow proportionately with GDP.
Since the Asian financial crisis in 1997-8, Korea's banking sector has undergone significant restructuring and consolidation, but the capital markets haven't followed, in terms of profitability and scale. In fact, the number of securities firms in the country has grown in number. In 1999 there were 32 securities firms and 31 asset management companies; in September 2008 there were 48 securities firms and in January this year, 63 asset management companies. And they are not very profitable. As the FSC spokesman points out, securities firms rely of brokerage fees for 70% of their revenues, while asset management companies pass on most of their profits in distribution costs to banks and other intermediaries.
The main objectives of the Act, which was passed by the National Assembly on July 3, 2007, were fivefold: First, to develop a "comprehensive approach" to financial products; then introduce a function-based regulatory system; third, to expand the business scope of financial institutions; fourth, to enhance investor protection; and finally, set off a "big bang" through mergers and acquisitions within the financial sector to entrench and ensure global competitiveness.
From a product perspective, a key element was to shift from a positive list to a negative list – in other words, from prescribing benign financial instruments to proscribing especially malign ones. The previous regulatory system listed and limited the types of financial products allowed to be sold, whereas the new one sets no general limits, which should broaden the product range available to both corporate and retail customers. And of course, and perhaps more clearly now, it might threaten to widen and deepen their exposure to risk.
The FSC still expects a rapid expansion - eventually - of the derivatives markets, both in volume and in terms of new product development; and much of it will take place in over-the-counter trading rather than on tightly regulated exchanges.
The idea is that investor protection will be solidified by strict "know-your-client" guidelines, buffered by financial investment companies being held liable for any losses incurred by a failure to observe their "explanatory duties".
Meanwhile, the introduction of function-based regulation means that the same rules will be applied for each financial activity regardless of the category of financial institution. Previously, firms were segmented into securities firms, asset management companies, investment trusts and futures trading businesses - and there could be no cross-over of activities. And so, the Korean universal financial company is born.
The brave new world simplifies a diffuse financial sector into one dominated by a triumvirate of dominant banks, insurance companies and financial investment companies (FICs). The FICs will be an amalgamation of securities firms, asset management companies and futures firms.
Now securities firms and asset management companies will be able to engage in multiple tasking. They will need to apply for separate licences for trading, brokerage, collective investment, advisory services, trust businesses and asset management.
But, the FSC is keen to point out that this will not mean the creation of "universal" banks, combining deposit-taking and lending functions with securities underwriting and distribution. After all, the Act does not apply to banks. Nevertheless, Korea's largest banks - Kookmin, Shinhan and Woori for instance - have restructured into holding companies which contain securities firms. Although they will be separate, the banks' distribution networks might be useful.
The authors of the Act envisaged that mergers and acquisitions among financial institutions would accelerate in two stages. First, between securities firms and asset management companies in order to gain economies of scope; and second, the newly formed FICs would look for economies of scale.
The FSC identifies five initial candidates for qualifying as FICs, due to their size: Daewoo Securities, Hyundai Securities, Korea Investment Trust Securities, Samsung Securities, and Woori Investment Securities. But first, as the FSC foreign press spokesman suggests, the expectation is that foreign capital will move into Korea's new liberated landscape.
Yet, perhaps the best part of Korea's "Big Bang", at least for the health of the overall financial system and the country's economy, is that the domestic securities firms are simply not ready. They are too many and too small.
*The CMCA is officially the Financial Investment Services and Capital Market Act, but the old name is still commonly used by officials, regulators and market participants.
