A new turning point for Korea’s capital markets

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Hello, our readers. Here is an important announcement that not only local residents but foreign investors should be also be aware of. The Legislation and Judiciary Committee of the National Assembly has finally approved the revision bill on the Financial Investment Services and Capital Market Act (FSCMA) on March 4, 2013, after a long dispute. The revision bill includes the creation of a central counterparty clearing house (CCP) and reflects related changes in the Commercial Act amended in April 2012.

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The original version of FSCMA was enforced in 2009 with a purpose of innovation and development of financial industry and capital market. Since 2011, Financial Services Commission (FSC) has pushed on planning the revision bill. FSC presented the first version of revision bill including four main issues in November 2011.

1. (Financial Industry) Propelling development of ‘Advanced Investment Banks

2. (Capital Market) Introducing Alternative Transaction System  (ATS) and Over-the-counter (OTC) CCP

3. (Corporate) Reflecting related changes in the Commercial Act, providing new tools for raising funds and making shareholders’ meeting substantial.

4. (Investors) Reinforcing punishment on illegal transaction such as price manipulation.

Among the four issues that were originally suggested, materials concerning CCP and the changes in the Commercial Act were submitted with understanding of the necessity to implement globally agreed agenda and mitigate reverse discrimination of listed companies.

What are the specific contents of the revision bill? Let’s look through in depth. First, CCP for OTC transactions will be introduced. A new business sector will be created to deal with clearing of financial investment contracts. The business will be related with offset disposal deducting multiple claim-obligation relationship by covering liabilities occurring from multilateral OTC derivatives transaction. Also, OTC derivatives whose default could deliver significant impact to the market will be mandatorily cleared through a CCP. In addition, Interest rate swaps (IRS) will be designated as products which should be cleared through a CCP.

Secondly, related changes in the Commercial Act which already went into force last year will be reflected. With the amendment to the Commercial Act, some provisions in the original FSCMA are abolished under which listed companies might be further restricted in clearing off their profits than non-listed companies. In this sense, listed companies will be exempted from disclosure obligations under the Commercial Act as they are supposed to disclose important facts on-line when they allocate new shares.

Now that we looked through the contents, what can we expect from the revision? What can creation of CCP provide? First, the creation of a CCP for OTC derivatives is expected to significantly reduce counterparty risk and establish effective risk management system for OTC transactions. Although Korea’s OTC derivatives market as of end-2011 amount to KRW 690.4 trillion, 98 times that of face-to-face market, proper risk management system is not yet established.

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With CCP, transaction amount of face-to-face derivatives market is estimated to be about 70~80% of the present value. In addition, real-time data of transaction amount and risks for OTC market will be accurately measured so that market risks can be systemically managed. In particular, if IRS, which takes up the largest portion of OTC derivative market, were mandatorily cleared through the CCP, the settlement safety of OTC derivatives will be significantly improved.

Secondly, CCP will prevent flight of clearing demands to overseas competitors. Most of G20 countries are already running CCP and Asian countries such as Hong Kong and Singapore are also eagerly preparing to establish CCP. Creating a CCP in Korea as soon as possible will help survive growing competition among global CCPs. Korea will be able to implement G20 agreements and bring OTC derivative regulations in line with global standards.

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As we have looked through, the introduction of CCP will bring more effective risk management system and enhanced competitiveness among advanced countries. What are FSC’s following plans for the revised bill? The FSC will proceed with revision of the FSCMA enforcement decree in order to ensure the CCP immediately begins its clearing business in three months after the announcement of the revised FSCMA. In addition, the public-private T/F, composed of KRX, interest parties, and market experts, was already created and now in operation for the introduction of CCP. Let’s look carefully how revised FSCMA change Korean capital markets!

By Soon Young (Andy) Chung (syjpeter@nate.com)

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