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