Do M&As or be left out

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During Asian financial crisis in 1997, the government planned and carried out structural reform in the financial sector. As one of the measures, the government actively encouraged the merger and acquisitions (M&A) between Korean and foreign financial institutions as well as among local financial institutions. The main purpose of encouraging M&A was to enlarge the size of individual financial institutions so that Korea could realize the economy of scale. Coming back to 2013, the FSC announced its ‘Plan to Stimulate M&As among Securities Companies’ on December 16 to revitalize capital markets as part of the so-called ’10-10 Value-up Plan’.

Korea’s securities industry has 62 securities firms which are small in size and their business scope is very limited to brokerage business in domestic market. Those companies face fierce competition in the saturated domestic market where they operate mainly on a commission basis thereby lowering commissions would seriously damage their profitability. Therefore, the FSC came up with measures to encourage M&A for securities firms to enjoy to overhaul the industry.

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The FSC prepared both carrot and stick to encourage M&A. As for the carrot, the FSC will ease the requirements eligible for investment banking licenses by lowering the minimum equity capital from the current KRW 3 trillion to KRW 2.5 trillion. For now, only top five brokerage houses meet the KRW 3 trillion requirements but after the change several companies with equity capital worth KRW 1 trillion and 2 trillion may be able to take advantage of the measure through consolidation. Along with lowering the barrier to establish Investment Banks(IB), the FSC will also allow firms to operate personal pension fund trusts which raise their equity capital by KRW 100 to 300 billion, and private equity funds to firms that raise their equity capital by KRW 50 to 150 billion.

As for the stick, the FSC will strengthen supervision for poorly-performing securities firms. Companies making quarterly net losses for two consecutive years and having more than a 900 percent leverage ratio, or those having over a 1,100 percent leverage ratio will be issued management improvement recommendation such as curtailment of expenditure, disposal of non-performing assets, establishment of special allowance for bad debts and so on. If companies make quarterly net losses for two consecutive years and have more than a 1,100 percent leverage ratio or have over a 1,300 leverage ratio they will be required to follow more drastic corrective measures: closure and consolidation of business offices, curtailment or organization, disposal of subsidiaries, demand for the replacement of corporate executives and so on.

Finally, the FSC will improve net capital ratio(NCR) rules, one of the barriers to M&As. NCR is a requirement that limits all brokers and dealers from having more than 15 folds of debt compared to their liquid assets. NCR is used when evaluating securities firms’ capability in case of liquidity risk, which should not fall below certain levels. Currently, NCRs of securities firms are calculated on an individual basis. Therefore, the acquirer firm’s NCR drops sharply with acquisition investment deducted from its equity capital. To address the problem, the FSC plans to introduce consolidated accounting standards in calculating NCRs.
The measures are expected to take effect in the latter half of 2014. In the saturated domestic financial market, encouraging M&A would reduce the number of market players and increase market dominance of those who survive.

Yeajin Shim (greatshimbabe@gmail.com)

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