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Newsletter | February 2016, Issue 1
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SECURITIES
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Korea′s Top Financial Watchdog Announces Plans for Regulatory Reform
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Background:
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Since the March 2015 ad hoc Financial Reform Advisory Panel, there have been active discussions on the need for financial regulatory reform.
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On October 14, 2015, Korea’s top financial watchdog, the Financial Services Commission (the “FSC”), and its enforcement arm, the Financial Supervisory Service (the “FSS”), announced an omnibus guidepost plan on financial regulatory reform measures to boost competitiveness of the Korean financial industry (the “Reform Plan”).
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Experts expect various reform measures that are being contemplated by the Reform Plan to be gradually implemented through the end of 2016.
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Key Reform Measures Being Contemplated:
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1. Cross-border business guideline
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Unless it is conducted on a strict reverse-inquiry basis, in their business interactions with Korean clients, foreign financial institutions must go through a licensed onshore broker-dealer as an intermediary. However, what has not been made clear is the scope of activities that foreign financial institutions can engage in when utilizing this “intermediary method.”
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On December 8, 2015, the FSS distributed a cross-border business guideline on the scope of activities that foreign financial institutions can engage in vis-à-vis Korean clients and licensed onshore broker-dealers.
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Offshore foreign financial institutions are allowed to: (1) Visit an onshore licensed dealer upon request from the onshore licensed dealer; (2) visit clients in Korea solely for relationship maintenance purposes (i.e., without mentioning specific products or services); and (3) visit clients in Korea by accompanying an onshore licensed broker to perform a supporting role, without engaging in any direct investment solicitation or marketing activities, when the onshore licensed broker explains a product to the clients .
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2. Rehypothecation of collateral
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In Korea, “pledge” is the common way to provide securities as collateral in financial transactions.
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However, in a “pledge,” the ownership of the pledged securities does not transfer to the secured party, and rehypothecation of the collateral securities is usually not an available option to the secured party.
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To give secured parties more flexibility in utilizing the collateral securities, the Reform Plan contemplates allowing securities lending for collateral purposes.
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Currently, securities firms must procure separate collateral from the borrower when entering into a securities lending transaction. Also, in principle, a securities lending transaction without returning the securities lent is not permitted.
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The Reform Plan addresses these two points so that transaction parties can pursue rehypothecation of collateral as an option:
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Securities companies will not be required to take collateral in certain securities lending transactions.
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Termination of securities lending transactions without physically returning the securities lent will be allowed, but the risk of naked short selling must not be high.
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The Reform Plan also contemplates the following:
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The Korea Securities Depository will institute a new separate system for intermediating and monitoring securities lending transactions for collateral purposes;
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In the early stage, only Korean Treasury Bonds and Monetary Stabilization Bonds may be lent for collateral purposes under the new intermediation system; and
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At the beginning, the purpose of the rehypothecation will be limited to collateralization and repo transactions. Down the road, there will be the possibility of further expansion, depending on the level of its usage in the market.
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3. Lending capacity of “comprehensive investment banks”
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Currently, the aggregate credit amount (including corporate lending and all other types of credit, e.g., payment guarantees) that a securities firm designated as a comprehensive financial investment business company (i.e., “comprehensive investment bank”) can provide is limited to 100 percent of its equity capital.
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To promote corporate lending by a “comprehensive investment bank,” the Reform Plan gives more flexibility to a “comprehensive investment bank” in managing its credit exposure. This is done by allowing corporate lending up to an amount equal to 100 percent of its equity capital (without considering all other types of credit).
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Also, the current limit on payment guarantees of a “comprehensive investment bank” will be abolished, aiming to place a “comprehensive investment bank” on a level playing field with other securities firms.
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4. Stock trading of “comprehensive investment banks”
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The Reform Plan contemplates “comprehensive investment banks” trading unlisted shares without having to go through a broker by allowing:
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Direct transactions with customers; and
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Brokering the trading of unlisted shares through ″internalization″ (i.e., execution of internal orders).
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Also, on a limited basis, “comprehensive investment banks” will be allowed to operate a trading facility for listed shares.
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5. “QIBs” private placement market
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Due to regulatory constraints, the private placement market for qualified institutional buyers (“QIBs”) is rarely used.
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The Reform Plan contemplates allowing any domestic company to issue securities in the QIBs private placement market so long as its total assets are less than KRW 2 trillion.
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Also, foreign companies, regardless of their asset size, will be allowed to issue securities in the QIBs private placement market. The goal is to allow foreign companies to use the QIBs private placement market in issuing foreign currency-denominated bonds, such as Chinese Yuan denominated bonds.
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If bonds issued and traded in the QIBs private placement market satisfy certain requirements, the bonds will be treated as securities, not as loan receivables. Privately placed bonds can then be used in securities lending transactions or repo transactions between institutions.
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6. Securities firms’ hedge funds operations
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Subject to having an appropriate conflict of interest policy in place, all securities firms will be allowed to set up and manage hedge funds.
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7. The scope of professional investors
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The Reform Plan contemplates expanding the scope of individuals who qualify as a ″professional investor”:
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A balance of at least KRW 500 million in financial investment products; and
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An annual income of at least KRW 100 million or total assets of at least KRW 1 billion.
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Also, the Reform Plan contemplates expanding the scope of corporations that qualify as a ″professional investor″ by including corporations with a balance of at least KRW 5 billion in financial investment products, and total assets of at least KRW 12 billion.
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We also expect the Reform Plan to exclude professional investors from counting the number of investors in determining whether or not securities are offered in a public offering.
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8. Affiliate information sharing
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To give more flexibility to financial institutions when sharing information with their affiliates (i.e., ″wall crossing″), the Reform Plan contemplates the following :
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Stage 1: Regulators will first collect opinions from the market to expand the list of exceptions to the prohibition on information sharing.
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Stage 2: In the long term, regulators will consider amending the relevant provisions in the Financial Investment Services and Capital Markets Act to shift the regulatory focus from the current prohibition-based scheme to a regulatory system that focuses on post facto punishment where a violation occurs.
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9. Underwriting
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Currently, a securities firm, which owns 5% or more equity in a company, or together with its affiliates, 10% or more, cannot act as a manager for the company’s initial public offering (the “IPO”) or underwrite the largest portion of the shares offered in the IPO.
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Under the Reform Plan:
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If the shares owned by the securities firm are subject to a sale restriction from the execution date of the relevant underwriting agreement until six months after the IPO, such shares will be excluded for the purpose of determining whether the securities firm is an interested party of the issuer.
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This will ease the qualification requirements for underwriters. However, if the securities firm is the largest shareholder or an affiliate of the issuer, regardless of the sales restriction, the securities firm cannot act as a manager in the IPO.
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The relevant underwriters′ proprietary trading desks will be allowed to participate in the IPO book building process.
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