FSC CHAIRMAN ON LONE STAR, BANK PRIVATIZATION AND

C O N F I D E N T I A L SEOUL 001480 SIPDIS STATE FOR E, EEB - GOETHERT, EAP/K USTR FOR CUTLER AND TRICK TREASURY FOR IA/ISA/POGGI AND WINSHIP NSC FOR LOI AND PRICE E.O. 12958: DECL: 7/25/2018 TAGS: EFIN EINV ECON PREL PGOV KS SUBJECT: FSC CHAIRMAN ON LONE STAR, BANK PRIVATIZATION AND FINANCIAL DEREGULATION REF: (A) 07 SEOUL 2695 (B) 07 SEOUL 1966 (C) SEOUL 1227 Classified By: AMB. VERSHBOW FOR REASONS 1.4 B&D. ¶1. (C) SUMMARY: In a July 24 meeting with the Ambassador, Financial Services Commission (FSC) Chairman Jun Kwang-woo confirmed press reports earlier that day that the FSC was considering soon launching its review of Hong Kong Shanghai Banking Corporation (HSBC)'s qualifications as majority shareholder of Korea Exchange Bank (KEB),thereby teeing up HSBC to purchase the stake currently held by Dallas-based private equity firm, Lone Star. Jun noted the continuing sensitivity of this issue in Korea, and explained that if started, the HSBC review would require an additional 1-2 months to complete. (On July 25, the FSC officially announced that it had decided to begin the regulatory review of HSBC the last week of July.) Jun noted his commitment to resolving this long-standing issue, stressing he understood the adverse impact it was having on foreign investor's perceptions of Korea. He hoped both parties -- Lone Star and HSBC -- would view a decision to review HSBC's qualifications as a positive step forward and extend their sales contract beyond the July 31 expiration deadline. Jun also commented on his overall policy objectives encompassing financial sector reform, bank privatization (of KDB, Woori Bank, and IBK),and financial deregulation. End Summary. Introduction: Reform Goals -------------- ¶2. (C) At the meeting's outset, FSC Chairman Jun emphasized that President Lee Myung-bak has identified Korea's financial sector as a major engine of economic growth over the coming decades. Jun was committed to supporting this Presidential policy goal by pursuing (1) financial deregulation, (2) the privatization of state-owned banks, and (3) the adoption of a more client-friendly approach within the Financial Supervisory Service, the FSC's supervisory arm, by stressing customer service and bringing in more private sector expertise. (Note: At the start of President Lee's term in February, the financial policy responsibilities of the former Ministry of Finance and Economy were transferred to the FSC, whose name was changed from the Financial Supervisory Commission to the Financial Services Commission, and which then assumed the ROKG lead on key financial policy issues. End note.) Lone Star -------------- ¶3. (C) Explaining "this is the gift for your visit" (which was scheduled the preceding week),Jun told the Ambassador that he was hoping to make an announcement within the week of starting the FSC review process to qualify HSBC as a majority owner of KEB. Jun said he faced a continuing challenge in improving Korea's reputation in the international financial community, chiefly due to a widespread foreign perception that Lone Star has encountered several regulatory roadblocks in its two-year-long attempt to sell a majority stake in KEB first to Kookmin Bank and now HSBC. In this light, Jun said he wanted to tackle the Lone Star case in a productive way. While stressing that no decision had yet been finalized, he said the ROKG was leaning toward beginning the FSC review process before July 31. He explained that the FSC had recently begun communicating with Lone Star and HSBC on these deliberations. Jun noted that different views on the review still existed in the ROKG in light of the public sensitivity of the issue, but added, "I'm going to push this forward because it is "the right thing to do for the country, the economy and the financial sector." Jun said the ROKG's majority view was not to keep the review process on hold any longer, although some quarters of the ROKG were still concerned about how to deal with negative repercussions stemming from giving a signal that the sale might eventually be approved. Jun added, "This is encouraging news for you, but I will take a hit." Given the fact that the decision had not yet been announced, Jun asked the Ambassador to closely hold his comments. ¶4. (C) The Ambassador remarked that this was encouraging news, and commented that if lack of progress by July 31 led to the collapse of the KEB deal, it would hurt Korea's reputation in the international business community. Even without the deal's collapse, the longer this case dragged on, the more it damaged Korea's image. Jun replied, "I certainly agree," and in response to the Ambassador's query, Jun said that HSBC's review process would probably require 1-2 months. Once approved as a qualified majority stakeholder, HSBC would still require a separate FSC approval to purchase KEB. Jun noted the FSC's announcement of the start of the formal review might also reference a desire to see legal uncertainties resolved, adding: "It would be nice to have the initial lower court decision on the BIS-ratio understatement case as an added justification for going ahead with the sale approval." (Note: Jun was referencing the current court cases related to the original Lone Star acquisition of KEB in mid-2003. Jun did not mention waiting for any appeals to that case to play out, nor did he reference the separate court case on KEB's late 2003 purchase of outstanding shares in its credit card subsidiary.) ¶5. (C) Asked what might happen to the KEB sale (and public sentiment) if the defendants in the BIS-ratio case, none of whom are Lone Star (or HSBC) employees, were found guilty, Jun smiled and said, "Well, it seems like the worst we could do is just what they want us to do" (i.e., order Lone Star to sell its KEB shares). The Ambassador expressed the hope that the entire process of approving KEB's sale would be completed quickly since no Lone Star officials were implicated in the BIS-ratio understatement cases. Jun took the point but noted that even if there were no clear linkage between the BIS-ratio court proceedings and allegations of wrongdoing by Lone Star, the public perception persisted. He then asked the Ambassador to encourage Lone Star to undertake more public relations work with the Korean public to help put alleged Lone Star irregularities into a proper context and thus prepare the public for an eventual KEB sale. ¶6. (C) The Ambassador said he understood the sensitivity of this case, but suggested the ROKG plan to announce any final decision just before a media holiday -- pehaps on the eve of the mid-September Chuseok thanksgiving holiday, when all newspapers are shut down. Jun reiterated it was his hope that the Lone Star case be resolved as soon as possible. Jun added it was also important at the present time that both parties -- Lone Star and HSBC -- view the ROKG's impending decision to review HSBC's qualifications as a positive step forward and extend their sales contract beyond the July 31 expiration deadline of their sales contract. (Note: The London Financial Times reported July 24 that HSBC is highly likely to extend the terms of its offer beyond the deadline but may seek to renegotiate price. End note.) ¶7. (C) Separately, on July 25, the FSC formally announced that it had decided to start the regulatory review of HSBC during the last week of July. An FSC official noted his agency does not plan to grant regulatory approval of the actual KEB sale until after the court has ruled on the BIS-ratio understatement cases. (Note: These charged were filed by the Seoul Prosecutor's office in November 2006 and allege that former KEB and ROKG officials colluded in "artificially" understating KEB's value and establishing an improper below-market price. End note.) ¶8. (C) Note: Ambassador had previously noted his concerns about the upcoming July 31 deadline for the Lone Star-HSBC contract, the prospects of the deal falling apart, and the damage it would do to Korea's reputation among investors, in tour d'horizon meetings with: Blue House Senior Secretary for Economic Affairs Bahk Byung-won (July 2); Chairman of the Blue House Council on Competitiveness Sagong Il (July 14); and Trade Minister Kim Jong-hoon (July 15). End note. Bank Privatization -------------- ¶9. (C) Jun reaffirmed bank privatization as key to the success of his financial reform program. He noted he is currently pursuing National Assembly approval to sell tranches of stock in Korea Development Bank (KDB - 100 percent state-owned),Woori Bank (73 percent state-owned) and Industrial Bank of Korea (67 percent state-owned) over the next four years. While pushing ahead on this front, Jun said he had concerns about the markets' capacity to absorb this much financial equity and continues to review sequencing and combination options for the sales. For now, he felt confident he would be able to sell 7 percent of Woori Bank shares later this year, but the sale of those shares -- and 49 percent of KDB shares by 2010 -- would depend on market conditions. He added that privatization plans for the Industrial Bank of Korea (currently handling small- and medium-sized enterprise financing) have yet to be finalized, but will come late in the overall sequencing of the three bank privatization efforts. Jun added, "Financial markets are still in choppy waters, with global growth softening and energy and commodity prices remaining relatively high." Under these conditions, he was not impeding synergistic mergers and acquisitions among domestic banks but was currently urging local banks to place a higher priority on improving their risk management practices. ¶10. (C) In reply to the Ambassador's question, Jun admitted it will "not be easy" for the ROKG to obtain National Assembly approval for the FSC's recent proposal to permit a non-financial company to own up to a 10 percent share of a bank. He pointed to NGOs, academics, and National Assembly members as resistant to this proposal because they feared chaebol (Korean conglomerates) would band together in consortia to control banks through their joint ownership and thus direct the banks' lending policies. He acknowledged that the "candlelight vigil" factor was another reason to move forward cautiously on this proposal since it could create a public backlash if not viewed positively. Deregulation -------------- ¶11. (C) Moving to deregulation, the Ambassador asked if the FSC had any plans to open up the domestic market for private mortgage insurers in so-called speculative real estate zones in and around Seoul. He noted this step would help diversify the risk currently borne by the government-owned Seoul Guaranty Insurance Corporation (SGIC). Jun replied that he believed Genworth (a U.S. company spun off from General Electric's financial arm) had already raised this issue with him during a March visit by that company's CEO. Jun said he was keeping an open mind on opening up the market, "since competition in principle is good," but the FSC will need to examine the record of any new market entrants. Briefly consulting his staff at the meeting, Jun noted the FSC will proceed with the market-opening in due course, but the issue also entails the recovery of some $10 billion in public funds invested in SGIC after the 1997-98 financial crisis. Comment -------------- ¶12. (C) Jun, who received his Ph.D. at Indiana University, clearly understands the problem the Lone Star/KEB case poses for Korea's already uncertain reputation in the international investment community. Moreover, unlike some old-school Korean nationalists, Jun seems to be immune to the attractions of using KEB as a building block to create a "national champion" among Korean banks (rather than sell to HSBC). At one point in the discussion, he remarked sardonically that some of the "public protest" against the KEB sale was likely orchestrated by other Korean banks who would like to see the HSBC deal collapse so they could purchase KEB instead. In the current political environment -- with public protests over beef still occurring intermittently, and with the National Assembly still paralyzed by the parliamentary investigation of the beef negotiations -- it is clear that immediate approval of the HSBC sale would probably be a bridge too far for the Lee government. Our own contacts at KEB seem to recognize as much, and are simply hoping for some sign of progress, rather than complete resolution of the case, by the end of this month. On balance, Jun appears to have a plan in mind to move this process to resolution, and has successfully challenged the President's political advisors (who clearly would prefer to avoid this sensitive issue entirely) by beginning to implement it. More broadly, the ROKG's readiness to show some movement on this long-standing issue, despite the lingering political aftermath of the beef episode, is an encouraging sign. End comment. VERSHBOW