Korea s Capital Markets and. Securities Industry. in a Period of Transition

Transcription

1 Seoul Financial Forum Friday, December 1, 2006 Korea s Capital Markets and Securities Industry in a Period of Transition Kun Ho Hwang Chairman Korea Securities Dealers Association

2 Distinguished guests, Ladies and gentlemen, It is my great pleasure to be here in front of many leaders of the Korean economy. Today, I would first like to talk about some of the key issues currently facing Korea s capital markets and securities industry, and then provide some background on the impending Capital Market Consolidation Act to give you an idea of what can be expected after its legislation. Lastly, I will outline the importance of sound relations between the banking sector and the capital markets, a subject of recent discussion. This year, the KOSPI index hit 1,464 points on May 12, which was a profound improvement from a mere two years ago--in August when it stood at just 719. During March and April of that year, foreign investors had sold off 3 trillion won worth of equity, which drastically lowered the KOSPI by 200 to 250 points, and led eventually to the August low of 719. At the time, foreign holdings amounted to 44 percent of market capitalization. This, I recall, worked to distort the markets, as foreigners trading behavior was shifting the entire market while domestic capital flocked to banks, which were considered to be safe havens. Though foreigners have already sold 11.5 trillion won worth of equity 1

3 in owing to what appears to be a market correction--the KOSPI index has unflinchingly remained above 1,000 point level since mid This shows that Korea s equity market is stable, and is in the midst of an upward cycle. Nurturing this upward cycle is the task we in the capital markets now have upon us. Let me examine major factors behind the market s recent positive momentum. The first factor is related to a saying in the stock market that the demand-supply level in a market precedes stocks actual fundamentals. This is a basic tenet of a market economy. It means demand is the key determinant of stock prices, above and beyond the intrinsic value of the individual stocks. Recognizing this, the government and the industry have made it a priority to bolster the markets demand base. Efforts have been made to wean the industry out of a market saturated with retail investors by fostering institutional investors, such as the National Pension Fund. Institutional investors help stabilize the market by reducing volatility and, in turn, strengthen the market s viability as a long-term investment channel. Permitting the National Pension Fund to invest in the equity market is one example of this. In addition, academia and industry have been conducting 2

4 extensive research on the feasibility of equity investment by other national pensions, such as the Private School Fund. With the introduction of the Corporate Pension Plan in late 2005, the demand base of the market expanded dramatically. I believe that, just as the 401(k) plans served as the engine driving the U.S. stock market in the 1980s, so too will the Corporate Pension Plans in Korea come to play a sizeable role. Second, we have been making efforts to create a sound investment culture, moving away from speculation and towards more long-term investment as, traditionally, our stock markets have been dominated by short-term individual investors. To address this issue, we undertook several years of public campaigns, such as the Saving through Stock Investment campaign, which proved that an advanced investment culture can indeed take root in Korea. Retail investors began to value the merits of long-term investing, which was given a further boost by the popularity of mutual fund products. Moreover, our aim of stimulating demand has also entailed working to facilitate a private equity fund (PEF) market. With the Korean legal system s strict separation of financial capital from industrial capital, PEFs are often the only mechanism to channel surplus capital from the manufacturing sector to the capital markets. 3

5 Investor confidence and market transparency have reached the level of advanced markets. Thanks to persistent restructuring efforts after the Asian financial crisis, corporate fundamentals have also solidified, with firms financial structures becoming much more efficient. For example, listed companies posted an average return on equity (ROE) of 13.3%, while sticking to a modest 83-86% debt ratio in Korean companies are also now in the top tier among Asian companies in terms of management transparency. We have also created a range of investor education programs to meet the needs of a consumer-oriented era. We have programs for teenagers and general investors designed to enhance their investment decision-making abilities and thereby promote the further protection of investor interests. To summarize, I can say to you with confidence that Korea s investment culture is definitely maturing, though more efforts are still needed. I can also say that Korea s capital markets have entered an upward cycle. If this momentum is allowed to continue, we can move away from situations of excess volatility or market distortions caused by small groups. Ladies and gentlemen, 4

6 Now, let me talk about the recent developments in Korea s securities industry. Following the Asian financial crisis, restructuring efforts were concentrated on the banking sector, while the securities industry lacked synergy due to the rigid separation among securities business areas. Securities firms also faced excessive competition and often played the numbers game, aiming merely to boost market share at the expense of profitability. The past two years, however, have seen record profits, as the industry has taken action to restructure its competitive dynamics. Though limited in scope due to a historical reliance on brokerage business, securities intermediaries are now searching for new sources of revenue. Against this backdrop, we at the KSDA put forth to the government in 2004 a bold set of proposals for regulatory reform, which has since been formed into the Capital Market Consolidation Act. The Act was drawn up with the intention of maximizing synergy in capital markets, thereby enhancing their competitiveness in the global market. The rigid separation of business areas has worked 5

7 against this goal--to compete with global players, we need to integrate these areas. This Act constitutes a major initiative in the government efforts to develop Korea into a Northeast Asian financial hub. To look beyond the Korean market and move forward towards other Asian markets, such synergy-promoting policy and system reforms are urgently called for. Announcement of the legislation was made this past June, and the bill is to be submitted to the National Assembly this December. Ladies and gentlemen, I would like to point out two reasons why the development of the capital markets is crucial to Korea s economic growth. First, we need to achieve balanced development in the financial sector. At present, the financial industry lags behind the manufacturing sector and, within the financial sector, the capital markets are less developed than the banks. In the past, banking was fostered to anchor rapid industrialization. However, when innovative companies in areas such as IT are emerging and thriving, banks risk-averse nature makes them ill-suited business partners. Alternative corporate financing channels are, therefore, called for in 6

8 order to adequately fund innovative businesses. Capital markets risk-bearing nature is properly fit to that end. When banking and capital markets develop in tandem, the financial sector, and in turn the overall national economy, will benefit. Reflecting this, IMF recommendations have also emphasized development of the capital markets. Second, with a rapidly aging population and low interest rates, the capital markets can play a major role in diversifying households asset portfolios. Capital markets need, therefore, to be further advanced if excess household funds are to be mobilized efficiently. Let me briefly review foreign examples along this line. Advanced economies are today focusing financial reform efforts not on the banking industry, but rather on the capital markets--the U.K. s Big Bang in 1986, and the U.S. s Financial Holding Company Act in 1999 being prominent among these. We often cite Australia as a benchmark case. With its Financial Services Reform Act in 2000, Australia s capital markets began to undergo full-fledged reform, cutting into the traditional dominance of its commercial banks. Singapore, Hong Kong, and Japan, which began to prepare reforms at nearly the same time as we in Korea 7

9 did, have passed similar market consolidation acts. Amidst excessive liquidity, many economies around the world have already begun taking action to nurture their capital markets. Empirical studies conducted by the Korea Securities Research Institute (KSRI) showed a positive correlation between the development of capital markets and economic growth. I want to reiterate that the growth of the financial sector is indispensable to Korea s entering the ranks of the most advanced economies. Ladies and gentlemen, Let me review the major features of the Capital Market Consolidation Act. The Act integrates seven related laws comprising a total of ten volumes and 420 provisions. The main goal is to enhance competitiveness and advance investor protection, thereby bringing about a big bang to the capital markets and securities industry. The first feature of the Act is the instillation of a comprehensive definition of financial products. Article 1 of the existing Securities and Exchange Act employs a positive system that defines the concept of securities and enumerates each permitted product, with the provisions for exceptions, mandating each new product to be 8

10 included on only a case-by-case basis. As such, every introduction of a new derivatives product requires the approval of regulators. A negative listing system is greatly needed to make the release of new products easier and promote innovation. Second, the Act will significantly expand securities companies business areas. Current regulations strictly prohibit firms from doing other securities business activities such as futures and asset management without earning relevant licenses, posing a major obstacle to the emergence of large investment banks in Korea. Under the Act, a single investment bank will be able to carry out all six functions of dealing, brokerage, collective investment schemes, investment advisory, discretionary investment, and trusts as inhouse businesses. Such a firm will be termed a financial investment company, to embody this increased scope. Third, the Act will introduce functional regulation. Currently, financial regulations in Korea are applied differently to different institutions. As a result, for an identical financial function, different regulations may be applied depending on the type of institution, which leads to regulatory arbitrage and cost overlaps. Implementing a shift from institutional to functional regulation will ensure the same regulation is applied to the same function. We expect that this change will advance and sophisticate financial 9

11 regulations. Lastly, the Act will reinforce the protection of investor interests. Existing laws prescribe certain protective measures for bona-fide third parties, but fail to account for subtle differentiations among investors. The level of protection must distinguish between professional investors and retail investors, the latter of which will be further protected by the Know-Your-Customer rule, the suitability principle, stronger measures on unsolicited calls, and so on. In addition, a tighter Chinese Wall will be implemented to prevent conflicts of interest that would otherwise arise from conducting cross-functional business. New rules on duty of due diligence and codes of conduct will also be adopted. One controversial feature of the Act concerns the allowing of securities firms to join in small-sum payment and settlement. Misunderstanding this as full settlement activities, some in other areas of the financial sector oppose this idea. However, this function is not meant to earn profits by connecting securities companies to the Retail Payment System of the Bank of Korea, but rather to prevent customers from being charged twice. This function should, therefore, be granted to securities firms. 10

12 I believe that the Act will accelerate the consolidation and specialization of securities companies and help engender a legion of qualified financial professionals. The capital markets will then be able to play its proper role in maintaining the fluid circulation of capital. I have earlier mentioned the need for balanced development between the banking sector and the capital markets. The gain of one does not necessarily translate into the gain of the financial system as a whole. I want to reemphasize that efficiency and competitiveness in the global market demands a healthy, complementary relationship between banking and the capital markets. The Capital Market Consolidation Act is not to allow the securities industry to enter into banking business. Rather, it is to lift restrictions and enable Korea s capital markets to become internationally competitive, thereby helping take the national economy to the next level. It is a fact that, since the Asian financial crisis, banks have dominated the financial sector heavily. Banks were able to enter into the stock market by selling mutual funds, and some banks adopted holding companies that included securities companies as 11

13 subsidiaries. Such movements are hardly benign, even for banks -- concentration of roles and homogeneity are destined to cause system risks. Let me lastly touch upon how we may reconcile the very commercial nature of the financial sector with the very public function that it is expected to fulfill. The basic grounds for financial services are, of course, the pursuit of profits. We know, however, that taking this to excess will bring about system risks and even the collapse of the entire financial sector, which in turn hurts the general public. That is why we must always keep the balance and harmony between the capital markets and other financial sectors firmly in mind. We are now witnessing that the capital markets are entering a virtuous cycle. I hope that we join together and seize this opportunity to expand the virtuous cycle to the national economy. Thank you. 12