Korea's Finance Ministry Floats a Mini-"Big Bang"

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SUBJECT: Korea's Finance Ministry Floats a Mini-"Big Bang"


SUMMARY
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1. Korea's Ministry of Finance and Economy (MOFE) has
launched an impressive new raft of regulatory reform
measures in the early months of 2006. According to ministry
plans, regulations governing financial services will be cut
drastically, with barriers separating traditional business
domains eliminated or significantly reduced. Foreign
financial service providers have welcomed the new measures
as evidence of the Korean government's intention to try to
make good on the promise inherent in the "financial hub"
vision originally outlined by President Roh Moo-hyun when he
took office three years ago. End Summary.

MOFE PROPOSES SIGNIFICANT FINANCIAL REGULATORY REFORMS
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2. The Ministry of Finance and Economy formally announced a
series of new financial regulatory reform measures on
February 19, after having foreshadowed the action through a
number of previous public statements starting in early 2006.
Announcing the initiative, Korea's Deputy Prime Minister in
charge of finance and the economy, Han Duck-soo, proclaimed
that "The twin pillars of the Act are opening and
competition, with the purpose of giving financial firms a
freer hand in the development and marketing of products."


3. According to MOFE's plans, the current six major laws
individually governing each sub-sector of the financial
system will be merged into one, while breaking down barriers
between business lines. Meanwhile, the number of
regulations applied to financial services will be reduced in
both number and impact, with the number of rules to be cut
from the current 300 regulations to only 190 relevant rules.
The ministry explains that the new deregulation steps are a
result of its "Zero-base Financial Regulatory Reform
Review," which took place in 2005.


4. Financial shares rose sharply on the news of the
ministry's reform plans, with listed securities companies
seeing increases in share prices in the 10-12 percent range
on February 20, the next trading day, even as the market
overall grew just one percent that day.


5. The key piece of legislation to bring to life MOFE's
dream will be a new "Capital Market Consolidation Act,"
which MOFE will submit to the National Assembly in the
second half of 2006, aiming for entry into force in 2008.
According to MOFE, the Consolidation Act will aim to
fundamentally reformulate the legal framework that has
governed Korea's capital markets for the last 43 years, ever
since the enactment of the Securities and Exchange Act in

1962. MOFE promises that the legislation will revamp
Korea's existing regulatory system by (to the extent
possible) switching from positive-list to negative-list
regulation of financial services. In addition, the new
rules should go a long way toward eliminating sector-by-
sector division to allow more "universal" financial services
business models.


6. For example, under the Consolidation Act, non-bank
financial institutions will be empowered to manage and
market more versatile products, freely deciding what sort of
assets to include in each investment portfolio. Investment
banks will also be allowed to engage in a variety of
financial services ranging from investment banking to wealth
management, securities services and futures. MOFE also
pledges that, with its new rules, investors will enjoy
improved investor protection, "on a par with that of the

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advanced economies," while being furnished with improved
investment opportunities into new and diverse financial
products. Corporations raising funds should also be able to
utilize a wider range of financial sourcing methods tuned to
their specific needs.


7. MOFE notes that its legislation will be at least loosely
modeled on Australia's Financial Services Reform Act of

2001. The legislation also draws inspiration from the
United Kingdom's "big bang" reforms of the 1980's, which
helped make London into the key financial services center of
Europe.

ANATOMY OF A MINI-"BIG BANG"
--------------


8. In May 2005, MOFE established 13 public-private task
forces to study the benefits of a "zero-base" financial
regulatory reform initiative, and to conduct a comprehensive
review of Korea's regulatory situation. Altogether, the
task forces reviewed 40 financial laws and decrees,
including 639 individual regulations. Of that total, the 13
task forces identified 101 laws, decrees and rules that
could be improved or eliminated, including 85 that need
extensive modification, 13 recommended for elimination and 3
items marked for later review.
The ministry also created its own "zero-base regulation
reform task force" charged with pushing things forward,
while keeping the public and industry informed.


9. Taking inspiration from the Prime Minister's Regulatory
Reform Committee, the MOFE teams conducted a "zero-base" re-
examination of the need to keep each regulation.
Importantly, the teams were tasked to review Korea's
financial regulations from the perspective of the parties to
be regulated, rather than the perspective of those who
regulate -- the more typical approach. The groups'
philosophical mandate stated that they should:

-- Overhaul irrelevant, redundant or excessive regulations
that restrain creative activity by the private sector;

-- Streamline or eliminative ineffective regulations;

-- Lower barriers to entry for financial firms;

-- Improve equality among the various financial business
sectors; and

-- Enhance international integrity to stay in line with
global standards.


10. Among the specific results of the "zero-base" review,
the experts recommended the following major regulatory
changes:

-- Permit solicitation by insurance planners and investment
consultants;

-- Permit indirect investment funds to invest in credit
derivatives for hedging purposes;

-- Permit banks to buy and sell commodity derivatives and
financial derivatives;

-- Ease regulations on foreign currency asset management
ratios for insurance companies;

-- Ease regulations on loans to the same borrower by mutual
savings banks;

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-- Lower regulatory thresholds for establishing financial
holding companies;

-- Lower entry barriers for the credit rating business;

-- Expand the criteria for issuers (originators) of asset-
backed securities;

-- Ease approval requirements for controlling shareholders
of insurers;

-- Ease restrictions on opening branches for mutual savings
banks; and

-- Abolish the securities issuer registration system.


12. Meanwhile, the Consolidation Act will merge Korea's
Securities and Exchange Act, Futures Trading Act, and other
capital market-related laws under a single law. Some of the
major elements of this proposal include:

-- Financial Services Deregulation: Current restrictions
that strictly separate securities, futures, asset
management, trust services and other financial services
businesses (excluding banking) are to be removed to allow
financial services companies to offer multiple financial
services;

-- Broader Scope for Financial Investment and Products:
Financial investment and other related products are to be
broadened from the current "positive list" system, which
enumerates what is allowed, to a "negative list" system that
enumerates what is not allowed, to encourage greater
investment and better financial products; and

-- Deregulation of Indirect Investment: Current
restrictions that recognize only trust investments (in the
form of beneficiary certificates),corporate-type investment
companies (mutual funds),and private equity funds as
indirect investment vehicles are to be removed so that other
entities recognized under the Commercial Code can be
included as indirect investment vehicles.

COMMENT: PROSPECTS FOR SUCCESS
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13. Some local critics have noted that barriers to business
linkages between the banking and securities sectors were
eliminated over 20 years ago in several leading Western
markets -- making the Korean rules changes not so much
courageous as overdue. Even so, foreign financial servie
providers have welcomed the new measures as evidence of the
Korean government's intention to try to make good on the
promise inherent in the "financial hub" vision originally
outlined by President Roh Moo-hyun when he took office three
years ago.


14. Overdue or not, MOFE's reform plans are timely.
Domestic financial institutions need to re-position
themselves to take better advantage of demographic changes
and the excess liquidity currently sloshing around Korean
financial markets. The Korean government has reason to hope
that the newly-announced reforms will lead to the genesis of
homegrown investment banks and asset management firms that
will be fully-equipped for global competitiveness.


15. The Consolidation Act and MOFE's other deregulation
initiatives are certain to be closely examined in the
National Assembly, precisely because the legislation could

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have a major impact on various Korean financial
institutions, especially banks and insurance companies.
Weaker Korean banks and some insurance firms will likely
seek to water down or slow down MOFE's proposed changes,
both before and after it submits legislation to the National
Assembly. It is also possible that other ministries will
seek to retard the initiatives, seeing them as a MOFE power
grab. However, given the Roh Administration's apparently
strong commitment to the initiative, and the widespread
sense in Korea that financial sector reform is still a work
in progress, which needs to be pushed farther forward, the
Embassy remains sanguine that at least the lion's share of
MOFE's dream will see the light of day.


16. A final observation: The new round of financial reforms
is also well-timed for U.S.-Korea bilateral economic
relations. Our bilateral discussions on financial services
reform in the U.S.-Korea Free Trade Agreement talks -- if
handled in such a way as to complement MOFE's plans -- could
provide a useful adjunct to MOFE's own campaign for reform.
Still, we should be careful to make sure that the two
efforts proceed in parallel, but not directly-linked tracks,
so as not to allow nationalism to become a counter-argument
to MOFE's self-initiated reform measures.

VERSHBOW