Investing in Korea - Gwang-woo Jun (Chairman of Deloitte Korea)
「Institutional Investor」, September 2007
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Billed in Seoul as a "Big Bang," the impact of new legislation passed by South Korea's National Assembly in July will fall chiefly on the country's financial industry. Like previous big bangs around the world in London and Tokyo (which have, in practice, been rather varied in extent and degree), these measures involve widespread deregulation and financial reform.
The ambition: to make Seoul a financial center. Why? It's not as if Asia is short of financial centers. Hong Kong, Singapore, Tokyo and Sydney already vie for the title, shile Shanghai and perhaps Mumbai have growing claims, too. "Korea's aspiration to become a regional hub is good for its economy as a whole," says Kwang-woo Jun, chairman of Deloitte Korea and the Ambassador for International Finance for the Republic of Korea, the second person to hold the title, which was first bestowed after the Asian financial crisis a decade ago.
"Broadly speaking, creating a financial hub would increase the global competitiveness and efficiency of the Korean financial industry. It would help attract world-class institutions and deepen our globalization efforts. Our capital markets would become more liquid and resilient to future economic shocks. And, speaking as a diplomat, it would engance Korea's diplomatic position internationally as well as regionally."
Seoul City, whose government will be a driver of this push to be a regional hub, says that "the financial sector tops the list of the high value-added industries," according to a spokesperson. "In order to achieve the goal of $30,000 per capita income, Korea needs to nurture its service industry."
If that explains Korea's aspiration, there is still the question of the country's ability to achieve what it hopes. "I personally think it's a realistic goal," says Jun. "Korea is a large economy, the 11th largest in the world, located at the center of northeast Asia. It has a highly educated work force and excellent infrastructure, including the world's most advanced IT system and transportation network. And Korea is aimed at establishing a regional financial center specializing in asset management: It's relatively narrowly defined." In asset management, the country is assisted by demographics, with an ever-increasing pool of funds available for active portfolio management.
Moreover, the Seoul City spokesperson argues that Korea stands out for its fair working evnironment and intellectual property protection, as well as selected tax exemptions, cash grants and state-owned property rental fee reductions.
Freedom to Innovate
The shifts themselves cover a range of areas, but the biggest overall change in approach is that instead of market participants being told what they can do, they're being told what they can's. This is a subtle but significant difference. If you have a list of things you can do, the assumption is that you can's do anything else, which is no recipe for innovation. If you have a list of things you can't do, then the assumption is that anything else is OK - and that does encourage innovation.
"The general trend in recent years has been to move to a system where there are fewer restrictions in terms of creating innovative financial preducts and developing new businesses," says Duncan Wooldridge, senior economist for North Asia at UBS. "That is quite important for financial development. They are many years off from being in a position to compete with someone like Hong Kong, but Rome wasn's built in a day, and they are doing some of the right things."
Wooldridge considers the measures "a good start. It clearly shows the government understands that, in terms of growth drivers for the future, it's going to be less manufacturing and more service industries. This is a good effort to produce a dynamic financial industry, which will hopefully over time compete in international financial markets. You've got to start somewhere."
Many of the early impacts of the Capital Markets Integration Act, the key legislation approved in July, will be felt most keenly in the domestic financial markets industry. A key part of the new legislation is that it combines a lot of regulations into one for the industry, which should create a platform for competition and efficiency. Securities firms will be allowed to offer financial settlement services (at the moment, they are offered only by banks), so that individual brokerage account holders can pay their bills change how brokerages look. "The sector should be able to lower its dependence on brokerage commissions and transform into more legitimake investment banks over the medium term," says Macquarie's Mark Barclay in a June report. He expects brokerages with strong relationships with chaebol (conglomerates) such as Samsung or Daewoo, or financial institutions, such as Woori, to benefit most, alongside brokerages with strong asset management operations such as Mirae Asset Securities and Korea Investment Holdings.
Says Jun: "For a long period of time, Korea's financial industry has been dominated by banks, leaving very little room for growth of nonbank institutions. One of the impediments to the development of the non-banking industry has been the complex and segmented regulation governing the financial sector. This more consolidated legislation should help overcome the problem."
If brokerages start aggressively taking deposits, that will increase competition for banks, although Barclay argues that "banks should be long-term winners given their superior franchise and capital strength." Banks do gain from some other measures, notably the deregulation of conglomerates' ownership limits on banks, which used to stand at 4 percent, and the pending opening of bancassurance in 2008. Deregulation might also prompt consolidation in Korea's banking sector, Barclay suggests, and he envisions three scenarios" Kookmin acquiring KEB; Woori Finance Holdings and Industrial Bank of Korea being privatized; and consolidation among regional banks. Banks may also try to acquire nonbank financial services, particularly asset management, brokerage and insurance companies.
Influx of Foreighers
These domestic issues are likely to be the first development in Korea's planned transformation, rather that an influx of foreign banks as occurred in Hong Kong. For that to happen, many more things need to be done. "They probably need to be a bit more aggressive in opening up service sectors that are complementary to the finance sector, like accounting and legal services," says Wooldridge. "And when you talk about being a financial center, you are talking about dramatically increasing the percentage of foreign-born residents. The infrastructure needs to support that, whit schools and hospitals."
Still, senior Koreans say that they do need foreigners to make this work. "Foreign investor participation will be very important," says Jun. "When we want to develop a competitive nonbanking industry, a competitive investment bank, it would be very important to have active networking and affiliations with globally competitive investment banks, securities companies and asset management firms. I expect a more active role from international investors.
"If we want Seoul to be an international center we have to be able to attract globally competitive asset management firms to locate at least their regional headquarters in Seoul."
In doing this, Seoul will have to counter the perception that Koreans are, if not antiforeign, then suspicious of the engagement of foreign companies with their Korean counterparts. Koreans say these views are the exception rather than the norm. "There have been some cases that could be viewed as negative against foreign investment here," says Jun, "but they're very isolated cases." He brings up the backlash Lone Star has faced in its attempts to sell Korea Exchange Bank to Kookmin, and Carl Icahn's attempts to take over KT&G, but he argues they need to be viewed in context. KT&G "became an issue because it was a hostile takeover case. It was not very familiar to Korean investors. But overall policymakers and market participants are very much in favor of active foreign investment."
The Seoul City spokesperson takes similar line. "It is repeatedly reported that anti-sentiment against foreigners and foreign-invested companies is growing among Koreans," particularly because of the Lone Star situation. "However, this sentiment in considered to come from only a few Koreans." It is important to note that Korea is now implementing a free-trade agreement with the US. "Under these circumstances, many Koreans are fully ready to accept the trend that foreigners are actively making inroads and investing in Korea," says the spokesperson. "Moreover, they consider the trend as necessary for national growth."
How Korea's Banks Have Revived
The banking system is dramatically stronger than it was a decade ago, when South Korea reeled under the impact of the Asial financial crisis. In the intervening 10 years, total assets in Korean banks have more than doubled, while nonperforming loans have fallen below 1 percent - low by any measure, and a huge improvement from more than 10 percent after the crisis.
In terms of capital adequacy, the BIS ratio for the industry as a whole has climbed to 13 percent, compared with 7 percent in 1997, with tier one now accounting for more than 9 percent of adjusted assets. A decade ago, return on equity was negative; now it's more than 20 percent for the sector. "Compared with the leading international banks, I think the figures stand up pretty well," says Kwang-woo Jun, chairman of Deloitte Korea.