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Final Report

Financial Service and Capital Market


Act in Korea

Soo Hyun Ahn


(Professor, Hankuk University of Foreign Studies)

Financial

Investment

Services

and

Capital Markets Act in Korea

2012. 12.

Soo Hyun Ahn

(Professor, Hankuk University of Foreign Studies)

Table of Contents

Chapter 1 History and Development of Financial


Market Regulation

1
I. Development of Financial Services and Markets

1
1. Introduction

1
2. Early Stage of Modernization (1953-1967)

2
3. Development of the Capital Market(1968-1978)

5
4. Market Liberalization (1979-1985)

11
5. Expansion of the Capital Market (1986-1995)

15
6. The Asian Financial Crisis and Reform Measures (1996-2003) 22
7. Enhanced Competitiveness of the Capital Market (2004-2011)
28

II. Legislative Change and Progress

31
III. Financial Regulatory Organizations

39
1. History

39
2. The Financial Services Commission and the Securities and
Futures Commission

40
3. Financial Supervisory Services

43
4. Self-Regulatory Organizations

44

- iv -

Chapter

Framework

of

Financial

Investment

Services and Capital Markets Act(FSCMA)

47

I. Legislative Background and Process

47

II. Main Features and Framework

50
1. Comprehensive Approach

50
2. Function-based Regulation

52
3. Expanded Scope of Financial Investment Businesses

56
4. Increased Investor Protection

57

III Structure of FSCMA

58
1. Overview

58
2. Regulation of the Financial Investment Businesses

60
3. Regulation of Securities Issuance and Disclosure

61

Chapter 3 Definition and Classification of Financial


Investment Products

63

- v -

I.

Introduction

of

the

New

Definition

of

Financial

Investment Products..................................................................63
1. Definition of Financial Investment Products

63
2. Classification of Financial Investment Products

67

II. Definition and Classification of Securities

68
1. Definition of Securities

68
2. Classification of Securities

69

III. Definition and Classification of Derivatives

71
1. Definition of Derivatives

71
2. Classification of Derivatives

72

IV. Distinction between Securities and Derivatives

73

Chapter 4 Regulation of the Financial Investment


Service Industry

75
I. Classification of Financial Investment Services

75
II. Entry Regulation

76
III. Regulation of Market Conduct

80
1. Generally

80
2. Regulations on Investment Recommendations

84
3. Preventing Conflicts of Interest

88

- vi -

Chapter 5 Corporate Disclosure: Listing and Public Offers


98
I. Corporate Disclosure System

98
1. Public Disclosure Obligations under the CC

98
2. Public Disclosure Obligations under the FSCMA

99

II. Primary Market Disclosure System

100
1. Generally

101
2. Registration Statement

104
3. Prospectus

105
4. Measures for Effective Public Disclosure Regulation

105

III. Disclosure in the Secondary Market

105
1. Generally

110
2. Periodic Disclosure

111
3. Timely Disclosure

113
4. Fair Disclosure

116
5. Voluntary Disclosure

116
6. Special Disclosure

116
7. Submittal of disclosure.................................................................................125

Chapter 6

Unfair Trading:

Statements,

Market

Insider Dealing,

Manipulation,

Unjust

Misleading

Trading

and

Unfair Practices

127

I. Overview

127
II. Prohibition of Insider Trading

128

- vii -

III. Prohibition of Market Manipulation

132
IV. Unjust Trading and Other Types of Unfair Trading

136

Chapter 7 Regulation of OTC Derivatives

139
I. Overview

139
II. Strengthening Investor Protection in OTC Derivative
Trading

144
III. Strengthening Internal Controls in the OTC Derivative
Business

145
IV. Advance Review of OTC Derivative Products

147

V. Introduction of the CCP System

147

Chapter 8 Collective Investment Schemes

151
I. Basic Definition of Fund as Collective Investment
Scheme and Other Fund-related Definitions

151

II. Characteristics of Funds

154
III. Legislative History of Funds and Regulatory Changes
under FSCMA

157
IV. Classification of Funds

158

- viii -

V. AUM by Fund

162

Chapter

Financial

Infrastructure:

Market,

Clearing

Facilities, Deposit and Settlement

167
I. Market: Korea Exchange (KRX)

167
I. Overview

167
2. Businesses

169

II. Clearing Facilities

172
1. Payment and Settlement Systems Overview..........................172
2. Main Payment and Settlement Systems.....................................176

III. Deposit and Settlement

180
1. Korea Securities Depository.....................................................180

Chapter 10 Regulation of Cross-Border Financial Investment


Services

189
I. The Effects Test

189
II. Regulation of Cross Border Dealing/Brokerage

189
III.

Regulation

of

Cross

Border

Investment

Advisory

Businesses and Discretionary Investment Management


Businesses

191

- ix -

[Table]
1. TRADE IN GOVERNMENT BONDS

4
2. NATION-BUILDING GOVERNMENT BONDS TRADING BY TRANSACTION
TYPE

3. STATUS OF THE SECURITIES MARKET: POST-GOVERNMENT OWNERSHIP 5


4. CAPITAL MOBILIZATION OF CORPORATIONS

6
5. PUBLIC OFFERING OF STOCKS AND CORPORATE BONDS

7
6. GROWTH OF INVESTMENT TRUST FUNDS

8
7. SECURITIES SAVINGS

8. EMPLOYEE STOCK OWNERSHIP UNIONS

10
9. GROWTH OF THE SECURITIES MARKET

11
10. CAPITAL MARKET GLOBALIZATION PLAN

13

11. CEILINGS ON STOCK INVESTMENT FOR FOREIGN INVESTORS


12.

TREND

LIBERALIZATION

OF

FOREIGN

INVESTMENT

AFTER

18

COMPLETE

MARKET

19

13. PLAN FOR FINANCIAL LIBERALIZATION AND MARKET OPENING

21

14. POST ASIAN FINANCIAL CRISIS RESTRUCTURING OF MERCHANT BANKS,

24

SECURITIES FIRMS, AND INVESTMENT TRUSTS


15. STRUCTURE OF FSCMA

56

16. TYPES AND DEFINITION OF SECURITIES


17.

TYPES

BUSINESSES

AND

CONCEPTIONS

68

OF

FINANCIAL

INVESTMENT

75

18. LICENSING UNITS OF THE FINANCIAL INVESTMENT BUSINESS

- x -

76

19.

PROHIBITED ACTS OF MARKET PRICE MANIPULATION

122

20. TYPES OF DERIVATIVES


21.

128

COMPARISON BETWEEN EXCHANGE-TRADED AND OTC DERIVATIVES

118
22. FSC's POLICY AENDA REGARDING THE OTC DERIVATIVE MARKETS
23. CLASSIFICATION FUNDS BY INVESTMENT ASSETS
24. AUM BY UNIT TRUST AND MUTUAL FUNDS

131

145

149

25. AUM BY PUBLIC OFFERING FUNDS AND PRIVATE PLACEMENT FUNDS

150
26. AUM BY FUNDS INVESTMENT ASSET TYPE

151
26. AUM AND TOTAL NET ASSETS OF DOMESTIC INVESTMENT FUNDS AND
OVERSEAS INVESTMENT FUNDS

152

[chart]
1. ORGANIZATION OF THE FSC

40

2. ORGANIZATION OF THE FSS

42

[Figure]
1. CLASSIFICATION OF FINANCIAL INVESTMENT PRODUCTS UNDER
FSCMA

51

2. REGULATORY FRAMEWORK OF FINANCIAL INVESTMENT BUSINESS

54
3. CLASSIFICATION OF FINANCIAL INVESTMENT INSTRUMENTS
4. DISCLOSURE PROCESS
5.

METHOD

OF

66

96

DETERMINING

- xi -

ON

PUBLIC

OFFERING/PRIVATE

PLACEMENT

99

6. DERIVATIVES TRADING VOLUME

131

7. TRUST TYPE V. COMPANY TYPE

147

8. PAYMENT AND SETTLEMENT SYSTEMS IN KOREA


9. DEPOSIT AND SETTLEMENT FLOW
10. FUND Net SERVICE FLOW

`164

169

172

[Reference]

- xii -

Chapter 1
History

and

Development

of

Financial

Market

Regulation

I. Development of Financial Services and Markets

1. Introduction

Korea's securities market has developed significantly over the past


54 years. In 1949, the Korean government began to issue
government

bonds.

In

1953,

the

Korea

Securities

Dealers

Association (KSDA) was organized, and in 1956, Korea Stock


Exchange (KSE) was established. Thus a capital market was started
in South Korea. Since then, the Korean capital market has grown
steadily in parallel with the economy.

Its growth can be divided into 6

stages: Early stages

of

modernization (1953-1967), Capital market development (1968-1978),


Market Liberalization (1979-1985), Expansion of the capital market
(1986-1995), Asian financial crisis and reform measures (1996-2003),
and Enhanced competitiveness of the capital market (2004-2011)
Recently, the Financial Investments Services and Capital Markets
Act

(FSCMA) was enacted in South Korea, in order to promote

- 1 -

the further growth of the Korean capital market. As Korea's


economy successfully overcame such international crises as the oil
shocks and the Asian financial crisis to emerge as the world's 11th
largest trading nation, the KSE (now the Korea Exchange, or KRX)
has also shown tremendous achievements, growing from unstable
beginnings into the world's 10th largest stock exchange through
consistent market liberalization.

To further advance its capital market, Korea passed the FSCMA


in 2009. A revolutionary act that introduced a single consolidated
legal framework, FSCMA laid the foundation for the further
development of the financial services industry so that it could
become a key industry driving Korea's economic development. To
realize this goal, the financial industry has been working to
enhance the competitiveness of the capital market by promoting
balanced

development

among

the

banking,

insurance

and

securities sectors.

2. Early Stages of Modernization (1953-1967)

The securities market is where stocks and bonds are traded as a


means to raise long-term funds. In Korea, securities were first
issued in 1899 when Chun-il Bank, a predecessor of Woori Bank,
was incorporated. Bonds were introduced in 1905, when the
Joseon Dynasty issued Korea's first government bonds with the
promulgation of the Government Bond Act.

- 2 -

Korea's capital market was officially organized in March 1956 with


the incorporation of the Korea Stock Exchange (KSE) with joint
contributions from banks, insurance companies and securities
companies. Although there had been previous exchanges before
the KSE, such as the Joseon Exchage

(est. 1931) and the Joseon

Stock Exchange (est. 1943), they were exclusively designed to


create capital for Japanese companies operating in Korea and
both closed in 1946. In 1949, the first Korean securities companies
and the Korea Stock Dealers Association were established in an
attempt to assist Korean companies in raising funds, but their
roles were still limited to arranging over-the-counter (OTC) trading
of certain government bonds.

With the launch of the KSE, 12 corporations, 3 government bonds


and 49 securities firms were listed. Since the fiscal conditions of
the country called for immediate and extensive capital, most of
the securities issued were in the form of government bonds. Both
securities trading and, later, settlements were permitted in the KSE,
which allowed traders to purchase large amounts of securities by
depositing a small margin with a clearing house, making the
market extremely speculative and leading to a series of market
crashes. Government bond crashes in January 1958, together with
the excess accumulation of shares of the KSE, the Korea Electric
Power Corporation (KEPCO) and other securities firms' in May 1962
made the market extremely vulnerable. As a result, it suffered

- 3 -

from settlement failures, causing the long-term suspension of the


KSE, the bankruptcy of certain securities firms and a dampening of
investor confidence in the market.

TABLE 1 TRADE IN GOVERNMENT BONDS


(Unit: million hwan1),%)

Stock
Year

Government Bonds

Total

Amount

Proportion

Amount

Proportion

Amount

Proportion

1956

3,942

56.8

2,994

43.2

6,936

100.0

1957

4,140

17.1

20,007

82.9

24,147

100.0

1958

1,802

10.8

14,820

82.2

16.622

100.0

1959

7,632

26.5

21,164

73.5

28,796

100.0

1960

2,752

17.1

13,302

82.9

16,054

100.0

1961

4,401

32.2

9,109

67.4

13,510

100.0

Total

24,669

23.2

81,396

76.8

106,065

100.0

Table

NATION-BUILDING
TRANSACTION TYPE

GOVERNMENT

BONDS

TRADING

BY

(Unit: 10,000 hwan2),%)

Securities trading
Year

Amount

Proportion

Settlement
Amount

Total

Proportion

Amount

Proportion

1956

1,023

34.2

1,971

66.8

2,994

100.0

1957

3,812

19.1

16,196

80.9

20,007

100.0

1958

3,938

26.6

10,882

73.4

14,820

100.0

1959

5,971

28.2

15,193

71.8

21,164

100.0

1960

4,314

32.4

8,988

67.6

13,302

100.0

1961

4,754

52.2

4,355

47.8

9,109

100.0

1) "Hwan" is an old Korean currency. Hwan=0.001 won


2) Hwan = 0.001 won

- 4 -

In response to these incidents, in January 1962, the Korean


government enacted the Securities and Exchange Act (SEA) and the
Commercial Code, in an attempt to create a legal framework for
the development of securities market, In order to enhance stability,
in 1963, the government converted the KSE from a corporation into
a government-owned entity, promoting the capital adequacy of
securities firms and improving the securities transaction system.

Table 3 STATUS OF THE SECURITIES MARKET: POST-GOVERNMENT


OWNERSHIP
Trading
Volume
(million
won)

Trading
Amount
(million
won)

40

L i s t e d
capital
Stock
(million
won)
16,971

57,654

26,000

17

36

22,228

317

27,039

1965

17

35

23,162

43

9,171

1966

24

26

32,451

49

11,160

1967

24

25

46,083

72

24,917

Number of
listed
companies

Number of
Securities
firms

Year
1963

15

1964

3. Development of the Capital Market

(1968-1978)

Even after such drastic measures were implemented, the Korean


securities market remained in the doldrums. In 1967, Korea
implemented economic development plans designed to modernize
its industrial infrastructure. As international borrowing was no
longer as feasible as it had once been, the securities market and
its role as a means of channeling capital to industry began to be

- 5 -

recognized. At this time, however, the securities market only had a


limited role in channeling capital to corporations, serving primarily
as

secondary

market

that

merely

traded

already

issued

securities.

From the late 1960s, the government began focusing its policies
on promoting Korea's securities market and announced that 1969
would be "the year for fostering the capital market." In addition,
the government also undertook a series of measures to boost the
securities market by enacting relevant laws and improving the
institutional framework.

Table 4 CAPITAL MOBILIZATION OF CORPORATIONS


(Unit: billion won, %)

1966

Equity
capital
External
funds
Total

1967

Amoun

Proporti

Amount

Proportion

Amount

Proportion

t
36.2

on
23.9

46.6

20.8

67.7

18.8

115.2

76.1

178.0

79.2

291.6

81.2

151.4

100.0

224.6

100.0

359.3

100.0

1966

External
funds
Indirect
financing
Direct
financing
International
Borrowing

1968

1967

1968

Amoun Proporti
on
t
115.2
100.0

Amount

Proportion

Amount

Proportion

178.0

100.0

291.6

100.0

43.5

37.8

73.6

41.3

137.5

47.1

22.9

19.8

39.8

22.4

45.4

15.6

48.8

42.4

64.6

36.3

108.7

37.3

- 6 -

* Note: Corporate credit and government loans are excluded.


** Source: Capital Cycle of Korea by the Bank of Korea, 1976

In December 1968, the government enacted the Capital Market


Promotion Act (CMPA), which encouraged corporations to become
publicly listed by providing extensive tax reliefs. At the same time,
the

state-owned

Korea

Investment

Corporation

(KIC)

was

established to take responsibility for issuing securities. Additionally,


in order to boost demand for stock investment, steps to strengthen
the securities market were undertaken. For the primary market, the
dividends

of

one-year

deposits

were

guaranteed,

and

entry

barriers for securities firms to enter the market were lowered,


requiring they simply register rather than receive approval. For the
secondary market, the securities transaction system was improved,
shifting from the later settlement system into the regular-way
system.

The Securities Investment Trust Business Act (SITBA) was introduced


in August 1969 and the regular-way transaction system was
enhanced in June 1971 to root out the deeply entrenched culture
of market speculation and to restore investor confidence.

- 7 -

TABLE 5. PUBLIC OFFERING OF STOCKS AND CORPORATE BONDS


(Unit: million won)
Stock
Offering

Sales

Year

Cases

Amount

1968

160

1969

12

1970

Cases

Total

Corporate bonds

Amount

Cases

Amount

Cases

Amount

180

2,211

12

2,221

2,068

2,068

1971

850

850

1972

955

125

1,080

35

9,928

1973

35

17,756

12

3,719

47

21,475

12

3,450

1974

12

9,227

5,110

19

14,337

59

27,870

* Source: Korea Investment Corporation

TABLE 6. GROWTH OF INVESTMENT TRUST FUNDS

Year

No.
of
issues

No. of
Management
companies

No. of
bene-f
iciarie
s

1968
1969
1970
1971
1972
1973
1974

1
1
1
3
10
17
27

1
1
1
1
2
2
3

96
102
664
1,362
1,316
10,086
74,811

Fund size
Total
Bond
Stock
types
types

(Unit: million won)


Sales balance
Toal
Bond
Stock
types
types

100
100
53
200
200
48
400
400
372
2,100
2,100
1,731
2,100
4,630
6,730
1,461
4,600 14,430 19,030
3,997
48,90 18,880
25,60
23,30
0
0
0
* Source: A Decade of Securities Supervisory Board (SSB) by the SSB

3,868
10,808
23,62
3

53
48
372
1,713
5,329
14,805
42,503

At the same time, in order to mobilize domestic capital, the


government

privatized

state-owned

- 8 -

companies

and

urged

corporations to go public by implementing securities market


promotion policies designed to boost demand for stock investment.
In December 1972, the Public Corporation Inducement Law was
enacted to provide tax incentives for companies that became
publicly listed, and to allow the government to force corporations
to publicly list by prescribing financial and tax restrictions for those
that refused.

In August 1972, the government announced the Emergency Order


for Economic Development and Stability, freezing private loans for
corporations and encouraging debt-equity swaps of private loans.
The government also promulgated the Short-term Finance Business
Act, the Credit Unions Act and the Mutual Savings and Financing
Act with the aim of institutionalizing private financing. In 1973, the
SEA regulations were revised with new stipulations added to
improve the securities registration statement, enhance external
audit

system, increase capital stock of

securities firms and

introduce book-entry clearing.

In May 1974, a Special Presidential Order was announced to


increase the supply of blue chip stocks by encouraging investors
to reduce the proportion of shares in listed companies, as well as
introduce firm commitment underwriting, establish investment trust
companies, improve the securities savings system and expands
employee stock ownership plans.

- 9 -

Table 7. SECURITIES SAVINGS


(Unit: million won)

year
Mandat
e-type
Trusttype
Total

1972
withsavin
draw
gs
als

1973
with
sa v i n
-dra
gs
wals

184

54

1,196

711

184

54

1,196

1974
withsavin
draw
gs
als
7,78 5,70
8

1,172

518

8,96

711

6,221

1975
withsavin
draw
gs
als
3, 57 3,6 0

1976
wit h
savi
-dra
ngs
wals
1 , 6 6 3,96

8
2,781
8
294
147
-

363

0
343,

6
326,

5
65,4

29
53,5

138
344,

257
330,

81
29,8

47

32

798

223

44

1973
183
58,807
147
13,262
10,043
193

1974
281
102,355
217
27,249
16,938
242

* Source: Korea Investment Corporation

The sudden growth of the securities market in the 1970s brought


with it new regulatory concerns. Thus, along with other major
reforms, the government reorganized the regulatory institutional
framework. In 1976, the Securities and Exchange Commission (SEC)
and its executive body, the Securities Supervisory Board (SSB), were
established as Korea's principal financial regulators. Measures to
support and stabilize the managerial rights of listed companies
such as tender offers, regulation of total equity investment, limits

- 10 -

ts

3
49,9

Table 8. EMPLOYEE STOCK OWNERSHIP UNIONS


1972

Asse

2
61,87

* Source: Korea Investment Corporation

Year
No. of unions
No. of members
No. of depositories associations
No. of depository shares (thousand)
Acquisition cost (million won)
Savings amount (million won)

Total

29,4

on proxy statements and the registered corporation system were


introduced. In addition, regulations on disclosure, insider trading
and restrictions on the securities transactions of executives in
securities

companies

were

also

introduced

to

promote

fair

transactions and modernize the securities industry. Additionally, the


Korea Securities Computer Corporation (Koscom) was established to
provide a computer system for the securities market.

Due to these comprehensive policies taken to stimulate demand in


securities and encourage corporations to publicly list, there have
been several significant achievements in the Korean securities
market. The number of companies listed increased from 66 in
1972 to 356 in 1978, and market capitalization during the same
period rose from KRW 246bn to KRW 2,892.5 bn, a growth of
more than 11-fold. The issuance of corporate bonds also increased
more than 30-fold from KRW 9.9bn in 1972 to KRW 326.3bn in
1978.

Table 9. GROWTH OF THE SECURITIES MARKET

Year

No. of
listed
companie
s

No. of
shareholder
s (10k)

Listed
capital stock
(mil won)

1968
1969
1970
1971
1972
1973
1974

34
42
48
50
66
104
128

40
54
76
82
103
200
200

95,585
119,902
2134,292
141,357
174,339
251,620
381,344

- 11 -

Market
Cap of
listed
stocks
(mil won)
64,323
86,569
97,923
108,706
245,981
426,247
532,825

Trading
volume
(mil share)

Stock
financing
(mil
won)

76
98
79
50
84
130
157

9,247
6,099
7,151
2,940
24,741
54,548
74,287

1975
1976
1977
1978
1979

189
274
323
356
355

291
568
395
963
872

643,315
1,153,325
1,492,375
1,913,505
2,202,262

916,054
1,436,074
2,350,835
2,892,512
2,609,414

310
591
1,272
1,368
1.561

156,255
262,255
362,452
653,062
841,432

4. Market Liberalization (1979-1985)

In the early 1980s, Korea's capital market suffered significant


upheavals. At the outset, the market was bullish with the nation's
economic

policies

focusing

on

stable

growth

and

surging

construction stock prices, thanks to the industry's performance in


overseas markets. In 1982, however, the market plunged due to
negative growth resulting from the second oil shock and the large
amount of corporate fraud discovered in April of that year.

To overcome such hardships and to revive the ailing economy,


measures were undertaken to fortify the capital market and
globalize the securities market. A new system to ensure market
pricing was introduced, entry barriers into the bond market were
eased and the market management system was improved.

In 1980, repurchase agreements, which previously had only been


utilized by the Korea Securities Finance Co. to finance securities
firms, became available to all market participants in order to
facilitate growth in the securities market and to restore investor
confidence.

The Act on the External Audit of Stock Companies

- 12 -

was also enacted, requiring stock companies valued above a


certain level to implement an external audit system.

The

government

announced

four-phased

Capital

Market

Globalization Plan in 1981. Accordingly, the Korea International Trust


(KIT) and Korea Trust (KT) were established as investment vehicles
for foreign portfolio investors. In May 1984, the Korea Fund was
listed on the New York Stock Exchange (NYSE), the first example of
indirect foreign participation in the Korean market. In addition, the
first

issuance

of

convertible

bonds

overseas

provided

an

opportunity for Korean companies to directly raise funds from


overseas capital markets.

Furthermore, a series of new measures to ease regulations were


undertaken to allow foreign investors into the domestic market
and,

reciprocally,

local

investment

in

overseas

markets.

In

December 1980, Nomura Securities established the first foreign


representative office in Seoul, followed by Merrill Lynch in 1985
and other foreign securities companies. Large Korean securities
companies were also permitted to establish overseas offices:
Daewoo, Daishin, Ssang-yong

Investment

and

LG

established

branch offices in Tokyo and New York, while Dong-seo Securities


established branch offices in Tokyo and London.

- 13 -

TABLE 10. CAPITAL MARKET GLOBALIZATION PLAN


Year

Phase 1
(1981-1984)

Phase 2
(1985-1987)
Phase 3
(1988-1989)

Contents
- Limited permission for international investment trusts
- Establishment of the Korea Fund
- Issuance of beneficiary certificates for foreign investors
- Allow foreign securities firms to open representative offices
in Korea
- Nurture financial professional in securities related institutions
- Improve legal/institutional framework for globalization
- Limited permission for foreign direct investment
- Gradual relaxation of limits on international investment trust
- Full permission on foreign investment
- Allow companies to issue and list stocks on foreign
securities markets
- Permit foreign securities firms to establish subsidiaries in
Korea, and domestic firms overseas
- Allow Korean investors to make investments in foreign
securities markets

Phase 4
(1990 - )

- Permit foreign stocks to be issued and listed on domestic


securities market

In 1982, the SEA was further revised to promote fair trading by


strengthening its regulations on insider trading and market price
manipulation,

expanding

its

disclosure

requirements

and

introducing an investment advisory system. The Act also stipulated


improved

measures

to

limit

stock

ownership,

and

improved

minority shareholder protection by introducing appraisal rights for


dissenting shareholders. In order to respond to the liberalized
securities market, limits on foreign ownership of stock were also
prescribed.

- 14 -

Meanwhile, the securities trading system was also improved by


adopting a market capitalization weighted stock price index,
providing online securities services and allowing securities to be
issued

at

market

price.

The

securities

deposit

system

was

established to circumvent outflows of investor' deposits form the


securities market, prevent any mishaps while holding securities and
enhance the effectiveness of the book entry clearing system. In
order to facilitate the money market and liberalize the bond
market, ceilings on CP issuance and corporate bond payment
guarantees were expanded in 1984, and the requirements for
issuing non-guaranteed bonds and convertible bonds were also
relaxed.

New regulations were established to institutionalize the OTC bond


market. The government revised the Commercial Code to facilitate
capital increases by setting the limits on authorized capital stock
to four times over the amount of paid-in capital, and limits on the
issuance of corporate bonds to no more than two times the
amount of equity. Tax exemptions for income resulting from capital
increases, temporarily granted under the Regulation Law on Tax
Reduction and Exemption, were restated under the corporate
Income Tax Law of 1985, with the exemption limits and duration
relaxed.

- 15 -

5. Expansion of the Capital Market (1986-1995)

From 1986 to 1995, the Korean securities market was full of hope
and vigor. Since the 1980s, market mechanisms had worked to
focus the country's economic drive toward the private sector, with
the

Korean

economy

beginning to

open

and interest

rates

beginning to liberalize. In addition, the so-called three lows - low


oil prices, low international interest rates and a low dollar
exchange rate - spurred the Korean securities market out of its
long-term bearish trend. Thanks to stable growth in the real
economy, the KOSPI recorded 1007 basis points on April 1, 1989,
the first time it had reached above 1000, and marked a dramatic
climb from its 180 points at the end of 1985. During the same
period, the market's trading volume increased from KRW 12bn to
KRW 280bn.

The vibrant growth of the securities market had a significant


impact on Korea's financial market structure. In the second half of
1980, companies began to voluntarily go public and rushed to
increase their capital through public offerings, resulting in 670
companies being listed on the market, with additional national
stocks also provided. Due to these market movements, direct
financing surpassed private credit as a means of supplying capital,
leading to a tremendous structural change in the financial market.
As the public began to increasingly invest in stocks, securities
firms began to flourish with the average amount of capital per

- 16 -

company reaching about KRW 100bn by the end of 1989. Financial


institutions

also

began

to

modernize,

adopting

advanced

computerized business processes.

In November 1987, the SEA was revised to allow investment


advisors and introduce a membership system for the KSE. The
public Corporation Inducement Law was integrated into the Law on
Fostering the Capital Market, stipulating provisions recommending
IPOs and paid-in capital increases for companies. In addition, a
series

of

measures

was

undertaken

to

encourage

venture

companies and small and medium-sized enterprises (SME) to


partake in the securities market. The OTC stock trading system
and

the

computerized

trading

settlement

system

were

both

introduced in March 1988, brokerage commissions were liberalized


and autonomy in securities companies' business was permitted
from June 1988. Plans to globalize the securities market were also
presented in December 1988, and the KSDA Investor Protection
Center was launched in January 1989.

In the second half of 1989, the international stock market bubble


burst, taking a significant toll on the Korean securities market. In
response, the government introduced measures to stabilize the
stock market by controlling its supply and demand. To reduce
supply, it established the securities issuance notice system, the
capital

increase

coordination

committee

and

the

issuance

coordination council. It also suspended the distribution of national

- 17 -

stocks, enhanced requirements for IPOs and discouraged capital


increases through public offerings.

On the other hand, the government also took measures to


stimulate market demand. For example, it encouraged securities
firms to borrow money for stock purchases, encouraged banks to
provide

loans

to

investment

trust

companies,

established

investment trust companies in rural areas and created stock


market

stabilization

funds.

Additionally,

it

encouraged

listed

companies and institutional investors to sell less and purchase


more, established the Matching Fund to create overseas demand,
created the Korea Asia Fund, and required account receivables or
outstanding loans to be repaid.

The securities market liberalization plan, which began in the early


1980s, was fully implemented in 1991 with the opening of the KSE
to

all

certified

securities

companies

in

June,

the

further

liberalization of brokerage commissions in August, and foreign


securities firms being permitted to enter the Korean market in
September. Although a Japanese securities firm had already
opened an office in Seoul during the 1980s, foreign branch offices
and joint-venture companies only became widespread after the
British securities firm Jardine Fleming established a branch in
Korea, in October 1991.

With the SEA revised again in December 1996, the ceiling on

- 18 -

foreign share holdings in local securities firms was lifted, and


foreign securities companies were allowed to establish joint-venture
companies in Korea. In March 1998, foreign investors were
permitted to establish local subsidiaries that were 100% owned by
foreign

securities firms. In

addition, domestic investors were

encouraged to invest in overseas market pursuant to the Overseas


Securities Investment Promotion Plan, announced in June 1988. In
line with the first phase of foreign currency reforms, investment
ceilings on institutional investors were completely lifted, while the
ceiling

on

individual

investors was gradually

lifted

until

full

liberalization was obtained in 1996. Foreign investment trusts and


investment advisors were permitted to hold shares in existing
domestic companies and establish representative offices in Korea
in January 1993. Foreign investment advisors were permitted to
establish branch offices in December 1995 and foreign investment
trust companies in December 1996.

In order to promote stability in the securities market, measures


were undertaken in 1992 to control supply and boost the demand
for stocks. The Bank of Korea provided special support for three
major investment trust

companies, and pension

funds were

encouraged to invest in the stock market. Additionally, financial


institutions were encouraged to purchase more and sell fewer
stocks in order to raise additional funds for the Securities Market
Stabilization Fund, and to establish a treasury fund for the three
major investment trust companies.

- 19 -

TABLE 11. CEILINGS ON STOCK INVESTMENT FOR FOREIGN INVESTORS


(Unit: %)

Year/
Month
1992.01
1994.12
1995.07
1996.04
1996.10
1997.05
1997.11
1997.12
1998.04
1998.05
2000.11

Securities listed corporations


Private companies
Public companies
All
Per
All
Per
investor
3
3
3
4
5
6
7
50
50
100
100

investor
10
12
15
18
20
23
26
55
55
100
100

investor
1
1
1
1
1
1
1
1
1
3
3

investor
8
8
10
12
15
18
21
25
25
30
40

KOSDAQ listed
corporations
All
Per
investor
5
50
100
100

investor
15
55
100
100

TABLE 12. TREND OF FOREIGN INVESTMENT AFTER COMPLETE


MARKET LIBERALIZATION
(Unit: million dollars, %)

Stocks
Bonds
Total

2001
1,300.5(16.6)
6,512.9(83.4)
7,813.4(100)

2002
1,793.7(15.6)
9,698.0(84.4)
11,491.7(100)

2003
3,415.8(19.7)
13,926.9(80.3)
17,342.7(100)

2004
9,009.0(31.8)
19,357.7(68.2)
28,367.7(100)

* Note: Figures in () refer to the proportion of stock/bond investments.


** Source: The Bank of Korea

The Korean securities market achieved significant progress in 1993,


thanks to stable growth in the real economy and capital market
liberalization. To live up to such quantitative growth, the relevant
rules and regulations were revised to meet international standards
and drive further growth. In 1993, a comprehensive revision of the

- 20 -

six laws governing securities was conducted to advance the


framework of the securities system. The Acts revised were the SEA,
the Law on Fostering the Capital Market (LFCM), the Securities
Investment Trust Business Act, the Act on External Audit of Stock
Companies, and the Certified Public Accountant Act.

To further boost the autonomy and transparency of the market,


the SEA was revised, lifting the ceiling on listed stock ownership.
In addition, listed companies were allowed to own treasury stock,
the tender offer system was improved, the securities dispute
settlement system was revised to enhance investor protection, and
the legal grounds for creating a Stock Index Futures Market (SIFM)
were established. The LFCM and other revised laws governing the
securities trust business were revised to relax limits on the
issuance of non-voting stock by listed companies. Additionally,
paid-in capital increases were no longer recommended, and CPs
and CDs were included as trusted assets.

In order to achieve balanced development between the stock and


bond markets, the method for issuing government bonds shifted
from underwriting to a competitive bidding system in January 1994.
The settlement of bonds traded between institutional investors was
required to be carried out through wire transfer via the Korea
Securities Depository in order to avoid risks and inefficiency in the
settlement process.

- 21 -

Meanwhile, in September 1993 and February 1994, respectively,


comprehensive measures were taken to further develop the bond
market and improve the CB market with the intention of balancing
development in the stock and bond markets.

The Future Trading Act was enacted in December 1995 in order to


regulate the stock index future market (SIFM, est. May 1995) and
the finance and commodity futures trading market. In addition, in
order to meet international standards, the Securities Investment
Trust Business Act was revised in December 1995, allowing
securities firms and securities investment trust companies to share
services by establishing subsidiaries, and permitting investment
advisors to shift their service into investment trust management
companies. Regulatory jurisdiction over securities investment trust
companies moved from the Ministry of Finance and Economy
(MOFE) to the Securities and Exchange Commission (SEC).

TABLE 13. PLAN FOR FINANCIAL LIBERALIZATION AND MARKET


OPENING
Year

Stock
market

Phase 1(1993)
- Lifting
investment
restrictions on
companies that
have 50% or
greater foreign
ownership
through direct
investment

Phase 2(1994-95)

Phase 3(1996-97)

- lifting the ceiling on foreign


investment
- Foreign investors living in
Korea viewed as residents
(1994)

- Further lifting
the ceiling on
foreign
investors stock
investment

- 22 -

(Aug. 1993)
- Allowing direct investment
into CBs issued by SMEs
(1994)
- Allowing the underwriting of
government bonds which
have interest rates similar to
international rates in the
primary market (1994)
- Operation of bond funds
(1995)
- Allowing international
organizations to issue
won-denominated bonds
(1995)

Bond
market

6.

THE

ASIAN

FINANCIAL

CRISIS

AND

- Allowing direct
investment in
non-guaranteed
long-term
bonds of SMEs
(1997)

REFORM

MEASURES

(1996-2003)

Due to the Asian financial crisis, 1997-2003 marked the Korean


capital market's longest recession. However, a series of drastic
reforms

and

restructuring

measures

allowed

the

market

to

successfully overcome this period of hardship, and set the stage


for it to develop on par with advanced capital markets.

In 1996, as the global financial market became smaller and


increasingly globalized, the Korean government pursued further
financial reforms and attempted to boost the capital market's
competitiveness by introducing new securities systems; the dividend
distribution system was improved in January 1996, ceilings on
treasury bond ownership were raised from 5% to 10% in February

- 23 -

1996 and the KOSDAQ market was established in July 1996 to


help venture companies and SMEs better utilize direct financing
based on the OTC Market Promotion Plan. Securities lending and
borrowing

was

permitted

from

September

1996

and

price

fluctuation limits were increased from 6% to 8%. In addition, in


order

to

encourage

domestic

companies

to

become

more

competitive in the global market, overseas investment by both


institutional and individual investors was fully liberalized without
any restrictions on the amount. In July 1997, the Stock Index
Option trading system was introduced with the Korea Futures
Exchange (KFX) established in April 1999.

At the end of 1997, as Korea received an IMF bailout package


and underwent significant corporate and financial restructuring, the
capital market faced a devastating downturn. KOSPI plunged from
653 basis points to 376 basis points in early 1997 - its lowest
level since 1980 - and 11 listed companies were forced to liquidate
or merge. In response, the government implemented the Securities
Markets Revitalization Plan, enacting the Depositor Protection Act
and introducing the Stock Option and Investor Protection Fund.
Additional measures to boost the market were also undertaken,
including raising the limits on stock investment by foreign investors,
tax exemptions for income from stocks, as well as permitting stock
splits and interim dividends.

In January 1997, the Foreign Investment and Foreign Capital

- 24 -

Inducement

Act

was

amended

to

attract

foreign

financial

institutions. The revised act eliminated the existing ceiling on equity


holdings by foreign portfolio investments in domestic securities
companies (less than 10%), and permitted foreign securities firms
to establish representative offices in Korea by simply registering.
Furthermore, in April 1998, all seven types of financial businesses,
including

securities

businesses,

were

fully

liberalized

and

investment restrictions on foreign investors were removed, thus


allowing them to establish subsidiaries.

TABLE 14. POST ASIAN FINANCIAL CRISIS RESTRUCTURING OF


MERCHANT BANKS, SECURITIES FIRMS, AND INVESTMENT
TRUSTS
Restructuring
Financial
sector

No. of
entities
at the
end of
1997(A)

MB
SF
IT

Revocation
of
authori
-zation

Merge
r

22
5
6

7
4
1

30
36
30

Bankrup
tcy/
busines
s
suspens
i-on
2
-

Total
(B)

Weight
(B/A)

29
11
7

96.7
30.6
23.3

New
entities

No. of
entities
in Jul.
2004

1
18
22

2
43
45

* Note: MB- Merchant Banks, SF - Securities Firms, IT - Investment Trusts


** Source: Changes in Competitive Structure through Financial Restructuring after the
Asian Financial Crisis by SERI in July, 2004.

Ceilings on equity holdings by domestic investment trust companies


were

relaxed

for

foreign

investment advisory services,

investment

trust

companies

and

which were permitted to set up

- 25 -

branch offices and joint-venture companies with equity holdings of


less than 50%, all of which were completely liberalized in
December

1998.

Securities

investment

by

foreign

portfolio

investments was also liberalized. In December 1997, immediately


after the Asian financial crisis, foreign portfolio investments were
permitted to make stock investments of up to 50% in a single
issue, and up to 55% of the total amount allocated for foreign
investors.

Beginning in 1997, foreign investors were permitted to purchase


equity-type beneficiary certificates for indirect investment. Later, in
September of that year, the ceiling on investment amount for
purchasing foreign beneficiary certificates in the OTC stock market
was lifted, and indirect investments in stock index options and
futures were also permitted.

The Stock Index Future (SIF) market opened in May 1996, allowing
foreign direct investment (FDI), though with some restrictions which
were later eased in July 1997. The Stock Index Options (SIO)
market also permitted FDI, imposing the same level of restrictions
as the SIF market. In May 1998, foreign investment restrictions in
the stock market (excluding public corporations), SIF and SIO
markets,

and

beneficiary

certificates

were

all

lifted,

and

investments in unlisted stocks and primary market securities were


also permitted.

- 26 -

Direct

investment

in

the

bond

market

by

foreign

portfolio

investments was allowed through bond-type country funds from


October 1996. Non-guaranteed foreign corporate bonds of SMEs
were permitted, and all investment restrictions for listed bonds
including SME bonds, government bonds and specific law bonds
were lifted. In February 1998, foreign investors were permitted to
invest in corporate-issued money market funds (MMF) such as
commercial papers, commercial bills and trade bills and other
MMFs issued by financial institutions including CDs, cover bills,
merchant bank bills and repurchase agreements.

Government efforts to relax entry barriers into the securities market


continued

to

enhanced

market

liberalization

and

boost

competitiveness. In April 1999, the SEA was again revised to ease


the requirements for engaging in securities business. The realm of
entities eligible to engage in the securities business was expanded
from

authorized

corporations.

banks

and

Additionally,

trust

the

companies

requirements

to

authorized

for

registering

investment advisory services were also relaxed: registrations, not


government

approval,

was

required

to

provide

discretionary

investment advisory services.

In consideration of the drastic changes taking place in the global


financial

environment

government

revisited

due
the

to

the

licensing

Asian
and

financial
approval

crisis,

the

system

for

financial institutions in order to meet international standards. In

- 27 -

this context, in January 2000, the institutional criteria for securities


business were laid out in detail and reasonable grounds for
nullifying approval were established, enhancing transparency within
the industry.

The business scope of securities firms was also expanded. In


1996, securities companies could purchase and preserve foreign
currency valued up to 1% of their equity, and borrow foreign
currency up to the amount needed to underwrite foreign securities.
In December 1997, the business scope was further expanded to
deal with currency exchange issues relating to bonds, stock index
futures and option investments, as well as short-term forward
exchanges.

In September 1998, the Securities Investment Company Act was


enacted,

allowing

both

company-type

investment

trusts

and

contract-type investment trust. In March 2001, wrap accounts were


introduced to meet the needs of customers in an aging society by
providing low interest rates and comprehensive asset management
services.

Later

in

December,

the

Indirect

Investment

Asset

Management Business Act was enacted in an attempt to shift


savings into investment.

Moreover, in order to live up to a more liberalized financial


environment, the financial supervision system was also reshuffled
along with the accounting and disclosure systems for corporations

- 28 -

and financial institutions were strengthened. In April 1998, the


Financial Supervisory Commission (FSC) was established. As a
consolidated supervisory organization encompassing the formerly
separate securities, banking and insurance regulators and the
Korea Non-Bank Deposit Insurance Corporation, the FSC took
responsibility for oversight over the entire financial sector with the
goal of enhancing the effectiveness of the regulatory system.

To promote transparency in accounting systems, in December 1999


the Korea Accounting Standards Board was established under the
Korea Accounting Institute to meet international standards in
accounting. In addition, to prevent fraudulent accounting, the 30
largest chaebols (a form of conglomerate) were required to
prepare consolidated financial statements, and companies whose
assets were valued at KRW 7bn or more were required to set up
an internal accounting system. In 1999 and 2003, quarterly reports
were introduced to enhance the disclosure system, and business
reports were required to be certified by both the CEO and CFO. To
enhance the credibility of accounting information, consolidated
financial

statements

were

required,

with

certified

public

accountant signing an audit opinion. Additionally, the function of


accounting supervision in the Securities and Futures Committee
was enhanced.

- 29 -

7. Enhanced Competitiveness of the Capital Market (2004-2011)

Since 2004, the capital market has undergone a revolution in


terms

of

shifting

its

function

from

merely

supporting

other

industries into a high value-adding industry in itself. Since the


Asian financial crisis, foreign portfolio investments in the domestic
securities market have surged dramatically, which in turn has
made domestic institutional investors suffer from reduced profits,
spurring the creation of short-term investments with lowered
trading commissions. Therefore, measures to stabilize the securities
market were required.

In December 2004, the Framework Act of Fund Management was


enacted, which allowed the National Pension Fund and Pension
Funds to invest in the stock market. In July 2005, the Trust
Business Act was revised to permit securities companies to
engage in the trust business, and retirement pension plans (similar
to 401(k) plans in the U.S.) were introduced with pension funds
permitted to invest in the stock market pursuant to the Employee
Retirement Benefit Security Act.

A series of efforts to improve market infrastructure and financial


laws were introduced to make the securities business a high
value-adding industry. In January 2005, the KRX, a consolidated
exchange that integrated the operations of the KSE, KOSDAQ, and
KOFEX markets, was launched pursuant to the Korea Securities

- 30 -

and Future Exchange Act of January 2004. Later in July, the


FreeBoard, a third market for non-listed stocks, was established to
support

promising

venture

companies

and

SMEs.

Finally,

in

December 2007, the Bond Quotation System (BQS) was introduced


to enhance transparency and liquidity in the OTC bond market.

In February 2009, the infrastructure for disclosing bankruptcy and


collection rates was established to facilitate a high-yield bond
market. In June, the government real-time bond index was
launched to introduce new bond instruments.

In January 2005, the SEA was revised to improve the tender offer
system and require substantial shareholding of stocks to be
reported as the number of hostile M&A increased. Later in July,
controlling shareholders of securities companies were required to
receive authorization in advance from the FSC.

In August 2007, the government enacted the FSCMA, with the Act
coming into effect in February 2009. FSCMA integrated the six
previously separate statutes governing Korea's capital market
including the SEA, the Futures Trading Act and the Indirect
Investment Asset Management Business Act in an attempt to
enhance competitiveness and promote investor confidence through
stronger

investor

protection

measures.

This

was

the

most

significant and comprehensive reform of the financial market's


legal framework, and it created a foundation for the Korean

- 31 -

capital market to develop on par with the global markets.

In 2011, the government announced its intention to revise FSCMA


in order to further innovate and improve the capital market by
nurturing advanced investment banks and introducing hedge funds.
These revisions aim to fulfill the original purpose of the Act deregulation - which had not been fully satisfied at this early
stage of its enforcement due to the global financial crisis. As a
result, the partial revision of the Enforcement Decree of FSCMA led
to the launch of Korean hedge funds. In line with this change, the
government also modified relevant regulations, enforcing more
reasonable Chinese Wall policies in the prime brokerage business
and relaxing credit extension limits for hedge funds.

- 32 -

II. Legislative Change and Progress


Since the establishment of the Korea Exchange in 1956, Korea has
introduced series of financial market related Acts including the
Securities and Exchange Act, the Futures Trading Act, the Indirect
Investment Asset Management Business Act - at every step of its
financial development, with each

Act

pivotal for

creating

regulatory framework that is fair and transparent.

The 1964 Securities and Exchange Act defined the scope of


securities issued and circulated in the Korean securities market. It
contained a series of measures against unfair securities trading
including the duty

of listed companies to report and disclose on

the issuance and circulation of securities. This duty required


companies to disclose registration statements and annual business
reports. The Act also prohibited unfair trading practices such as
market manipulation and the use of nonpublic information. The act
defined securities business as any business that buys and
sells securities or buys and sells securities on consignment,
stipulating the terms and procedures for licensing and standards
for corporate governance and financial soundness to ensure the
sufficient operation of securities companies.

The 1995 Futures Trading Act provided a legal basis for the
establishment of the Futures Exchange and introduced measures

- 33 -

that prohibited unfair trading practices such as futures market


manipulation and price manipulation, for example, by connection
spots and futures which abuse the unique trading characteristics
of futures. The law defined futures business as any business
in which a company executes futures trading for its own account
or for its clients account, drawing a distinction between the
securities
introduced

business

and

regulatory

the

futures

requirements

for

business.

The

establishing

Act
a

also

futures

business, such as the terms and procedures for licenses and the
scope of business activities.

Based on the Act, the Futures Exchange was established in 1998


but was later merged with the Korea Stock Exchange creating
the Korea Securities and Futures Exchange, a stock company
based on the 2005 Korea Securities and Futures Exchange Act.

The 2004 Indirect Investment Asset Management Act defined


indirect investment as a business that collects funds from
investors to manage assets and distribute profits accrued from the
management of assets to investors. It clearly limited the scope of
the

asset

management

business

by

defining

an

asset

management company as a financial firm operating in the


business of managing indirect investment property. The Act was
created through

consolidating the Investment Trust Act and

Securities Investment Companies Act to coherently manage the


securities investment trust system and the securities investment

- 34 -

companies system. The Act dealt with the discretionary investment


business

and

the

investment

advisory

business

that

were

previously governed by the Securities and Exchange Act, improving


the regulatory system for the asset management business as a
whole.

In February 2009, Koreas financial regulatory structure witnessed


a fundamental change in this landscape with the enforcement of
the Financial Investment Services and Capital Markets Act (FSCMA).
Enacted in 2007 to promote fair market competition, financial
innovation

and

stricter

investor

protection,

FSCMA

drastically

revamped the regulatory framework of the Korean capital market.


FSCMA abolished and replaced the previous major capital market
laws such as the Securities and Exchange Act, Futures Trading Act,
Korea Securities and Futures Exchange Act, Indirect Investment
Asset Management Act, Trust Business Act and Merchant Banks
Act.

On July 27, 2011, the Financial Services Commission (FSC)

issued

a press release announcing a proposed amendment to FSCMA.


The purpose

of

this amendment

is to

create a regulatory

foundation for the development of the Korean capital markets in


the wake of the global financial crisis by improving the financial
market infrastructure

and direct financing capability of listed

companies to maintain the market's integrity while reinforcing the


regulation of domestic investment banking and asset management

- 35 -

businesses.

The FSCMA revision bill mainly covers the following


regulations intended to promote
Korean

investment

banks,

(ii)

fives areas: (i)

the development of major


deregulation

of

Korea's

fund

management industry to meet the challenges presented by the


country's declining birth rate and aging population, (iii) reform of
Korea's capital market infrastructure, (iv) diversification of direct
financing channels, and (iv) stricter regulation of unfair trading
practices. The key provisions of the amendment to the FSCMA are
summarized below.

First

of

all, to

promote

the

development

of

major

Korean

investment banks, the bill permits securities companies meeting


certain qualifications (e.g., shareholder's equity of KRW 3 trillion) to
act as investment banks (a new category denoting comprehensive
financial

investment

comprehensive

service

providers).

financial investment

service

Such

qualified

providers shall be

allowed to engage in (i) prime brokerage services such as


securities lending and borrowing, custody service of hedge funds
assets and the provision of credit to hedge funds (subject to
execution

of

standard

prime

brokerage

contract)

and

(ii)

comprehensive corporate financing services such as corporate


lending and internalization of order executions for listed company
stock.

With such expanded business scope,

comprehensive

financial investment service providers will be subject to the BIS

- 36 -

capital adequacy requirements in addition to he net capital ratio


regulations.

The

revision

bill

also

creates

investment

service

provider

alternative

trading

system

new

category

multilateral

(ATS).

This

of

trading

will

enable

financial

facility

or

securities

companies and other financial investment service providers that


have the minimum required capital of KRW 50 billion and are
approved by the FSC to operate an alternative trading system.
Furthermore, if the transaction volume on an alternative trading
system is more than a certain amount, the operator will be able
to apply to become a stock exchange.

In such cases, the stock

exchange is additionally required to carry out self-regulatory


functions in listing and market supervision.

The proposed revision

creates also a new category of clearing business for financial


investment transactions. By introducing a licensing system for a
clearing business provider, it aims to provide clearing services for
a variety of products. The revision also lays the legal foundation
for establishing a central counterparty (CCP). All over-the-counter
derivatives which may have a significant impact on the Korean
capital markets upon default will be required to be cleared
through clearing services providers.

In order to enable fund management companies to meet the


investment needs of a client base that is becoming increasingly
diverse and to offer their clients customized investment products

- 37 -

that will be profitable and generate a steady return, the bill


makes a clear distinction between collective investments and
discretionary accounts.

As for the diversification of direct financing channels, contingent


capital will be allowed to listed companies, subject to certain
restrictions on the issue price and reasons for the issuance.

In addition, the investor protection mechanism will be reinforced.


To prevent price manipulations using unlisted securities and OTC
derivatives,

excessive

scalping

and

secondary recipients, the regulations

use

of

information

by

on unfair trading practices

will be reinforced. Specifically, unlawful acts that are currently


subject to fines such as a violation of disclosure requirements will
be subject to criminal charges, and acts causing disruptions to the
market will be punished in a more effective manner.

- 38 -

. FINANCIAL REGULATORY ORGANIZATIONS


1. History

The financial supervision system of Korea was diversified for a


long time, during which licensing, authorization, supervision and
inspection rights were scattered across institutions such as the
Ministry of Finance and Economy (MOFE), the Bank Inspection
Board, the Securities Supervisory Board, the Insurance Supervisory
Board and the Korea Non-Bank Deposit Insurance Corporation. In
the

case

of

the

capital

market,

MOFE

had

licensing

and

authorization rights for securities companies, while the FSC and


Securities Supervisory Board were the authorities for approval,
consent, order and inspection.

However, the Asian financial crisis in 1997 caused the Korean


government to reorganize its financial supervisory institutions. Right
after the outbreak of the crisis, the Korean government and the
International Monetary Fund (IMF) agreed to create an integrated
financial supervisory Body, enacting the Act on the Establishment,
Etc. of Financial Supervisory Organizations (AEFSO) in December
1997.

AEFSO

reshuffled

Koreas

existing

divided

supervision

structure and offered a legal basis for the establishment of the


Financial Supervisory Commission and Financial Supervisory Service
as an integrated financial supervisory institution. Based on AEFSO,

- 39 -

the Commission was launched in April 1998 and the Bank


Inspection Board, the Securities Supervisory Board, the Insurance
Supervisory Board and the Korea Non-Bank Deposit Insurance
Corporation were incorporated into the FSS in January 1999.
However, to address the specific aspects of the capital market, the
Securities and Futures Commission was established separately
under the Financial Supervisory Commission.

The new regulatory system, launched in 2008, reorganized the


Financial

Supervisory

Commission

into

the

Financial

Services

Commission (FSC) to maintain operational coherence between


financial policy and supervision. The FSC took over the function of
financial policy formulation form the MOFE, conducting financial
supervision, policy formulation and implementation. To support the
financial policy function of the FSC, a secretariat was created. To
ensure the independence of the financial supervision, directorship
of the FSS, which was simultaneously held by the Chairman of the
FSC, was appointed separately.

2. The Financial Services Commission and the Securities and


Futures Commission

As

government

organization,

the

FSC

is

board-style

administrative organization under the Prime Ministers Office. But


unlike other governmental organizations whose authorities are

- 40 -

designated by the Government Organization Act, the FSCs


authority is designated by AEFSO, the Presidential Decree of
Financial Services Commission and affiliated institutions, and other
Acts on financial supervision.

The FSC regulates financial policies and institutions; inspection of


and

restrictions

on

financial

organizations;

licensing

and

authorization of financial organizations; management, supervision


and surveillance of the capital market; and legal and regulatory
enactment and revision of financial policies and systems. The
commission

also

manages

the

business,

operation

and

management of the FSS, and reviews and determines the FSSs


budget and account settlement, along with the revision of the FSS
rules and regulations.

The nine commissioners of the FSC include the Chairman and Vice
Chairman of the FSC, the Vice Minister of Finance and Planning,
the Senior Deputy Governor of The Bank of Korea, the President of
Korea Deposit Insurance Corporation, the Governor of the FSS, two
persons nominated by the Prime Minister and appointed by the
President of Korea. The Vice Chair is nominated by the Chair of
the FSC and appointed by the President of Korea. The Chair and
Vice Chair each has a three-year tenure with a limit of two terms.

The Securities and Futures Commission (SFC) is responsible for


investigation of unfair business activities in the capital market,

- 41 -

establishment

and

implementation

of

corporate

accounting

standards and accounting audits, and pre-deliberation of major


issues related to capital market management, surveillance, and
inspection, as well as other matters entrusted by the FSC for
management, surveillance, and inspection of the Korean capital
market. The commissioners of SFC consist of five people, including
a Chairman who is nominated by the Vice Chairman of the FSC,
and four financial experts nominated by the Chair of the FSC.

- 42 -

3. Financial Supervisory Service

The Financial Supervisory Service (FSS) is a special legal entity that


has no capital base. It is independent from the central and local
governments, conducting public affairs as a public corporation. By
law, the FSS is not a government institution but an independent
public corporation as it aims to carry out politically neutral and
financially

specialized

supervisory

functions

over

the

Korean

financial market, free from any political or administrative pressure.

Under the guidance from the FSC and SFC, the FSS conducts
inspections of and supervision over financial institutions. It reports
the results to the FSC, as well as any follow-up recommendations
relating to the inspections, the FSC and SFC can guidance over the
FSS and the FSC can also enact general or partial suspension
orders to actions taken by the FSS or SFC when those actions are
deemed to be legally inappropriate or to go against the public
benefit, such as investor or depositor protection.

The executive body of the FSS consists of the Governor a


maximum of four Senior Deputy Governors among a maximum of
nine

Deputy

Governors,

and

one

auditor.

The

governor

is

nominated by the chairman of the FSC and appointed by the


President

of

Korea,

and

the

Senior

Deputy

Governors

are

nominated by the Governor of the FSS and appointed b the FSC.


Deputy Governors are appointed by the Governor of the FSS.

- 43 -

4. Self-Regulatory Organizations

(1) KOREA EXCHANGE

The Korea Exchange is a stock company, which aims to fix and


stabilize fair prices in the transactions of securities and exchangetraded derivatives, and facilitate the stability and efficiency of other
transactions. It established and operates the Stock Market, the
KOSDAQ Market, and the Futures Market. Under FSCMA, the Stock
Market is a market established for the trading of securities such

- 44 -

as

debt

securities,

equity

securities,

beneficiary

securities,

investment contract securities, derivative-combined securities and


securities depositary receipts. The KOSDAQ market was established
for the trading of specific securities, designated by FSCMA, such
as corporate bonds and stocks. Therefore the Stock Market and
KOSDAQ Market have clear differences in terms of the kinds of
stocks they deal in. The Futures Market is a market established by
the Korea Exchange for the trading of exchange-traded derivatives.

The

responsibilities

of

the

Korea

Exchange

include

the

establishment and operation of the Stock Market, the KOSDAQ


Market, and the Futures Market; enabling transactions of securities
and exchange-traded derivatives; transaction confirmation; debt
acquisition;

deduction;

settlement items
guarantees;

confirmation

of

settlement

securities;

and settlement amount; settlement execution

follow-up

measurers

on

settlement

failure

and

settlement instructions as a result of transactions on the securities


market and the derivatives market; reports and disclosures on
listed

corporations;

and

resolution

of

disputes

arising

from

transactions in the Stock Market, the KOSDAQ Market and the


Futures Market.

(2) KOREA FINANCIAL INVESTMENT ASSOCIATION

The

Korea

incorporated

Financial

Investment

membership

Association

organization

- 45 -

for

(KOFIA)
the

is

an

purpose

of

maintaining business order between members, assuring fair trade


protecting investors and promoting the sound development of
financial investment services. Members of the Association are
financial

investment

collective

firms,

investment

assessment

general

scheme

companies

and

administration

assessment
members

companies,

companies,

under

the

bond

conditions

prescribed by the articles of the Association.

KOFIA aims to promote fair business practices among member


companies, create a fair business culture in the securities trading
market and maximize the function of investor protection. As such,
KOFIA undertakes such activities as self-regulation to protect
investors and maintain market order among member companies;
dispute mediation between members regarding their business
activities; registration management of investment advisers and
managers; OTC trading management for non-listed stocks; and
establishment

of

dispute

mediation

self-mediation of conflicts.

- 46 -

rules

for

industrys

Chapter 2
Framework of Financial Investment Services and
Capital Markets Act (FSCMA)
I. Legislative Background and Process
FSCMA is the result of Koreas previous financial reforms, and
aims to enhance investorsconfidence in the Korean capital
market while boosting the vigor and competitiveness of the capital
market and market-related financial industries. At the time of
enactment,

the

Korean

capital

market

displayed

lopsided

structure with an anemic financial brokerage function and a strong


indirect financial market. The capital market itself was also still
very nascent compared to the highly developed real economy. The
capital markets were not fully performing its capital intermediation
function as indicated by the lack of corporations raising funds
through the capital markets.

Worse still, the lack of sound growth and improvement of capital


marketrelated financial industries served to further aggravate the
imbalance between the banking and indirect financial investment
industries. In addition, the governing laws at the time were not
able to support innovative developments of the capital market and

- 47 -

related financial markets, because the direct regulatory systems


that

separately

governed

the

securities,

futures

and

asset

management businesses created additional impediments to the


pursuit of product and service innovation in the capital market.

Regarding this aspect in particular, the Ministry of Finance and


Economy noted the following:

(i) Separate laws applied to each different financial industry within


the capital market. Securities firms, future trading companies, asset
management companies, and trust companies were regulated by
different laws. As the regulation applying to each sector were
different, there were opportunities for regulatory arbitrage and
loopholes in investor protection.

(ii) The limited enumeration of the

types of securities and

derivatives that financial companies can handle operated as a


restriction on designing, selling or brokering diverse and creative
financial investment products.

(iii)

Because

concurrently

operating

various

financial

services

(securities business, asset management business, futures trading,


and trust business) was strictly restricted, there were barriers to
improving competitiveness through integration, as compared to
investment banks in an advanced economy that provide various
financial investment services and activities (Investment banking,

- 48 -

wealth management, securities brokerage and dealing, proprietary


trading, etc.).

(iv) Because an advanced and systematic investor protection


system was not well established, it was difficult to properly cope
with misselling and unfair transactions, which undermined investor
confidence in the capital market. Restoring investors confidence
was

urgent issue to ensure the sustainable development of the

Korean capital market.

Therefore,

after

thorough

reviews

and

analyses

of

overseas

examples of financial legislative integration including the UK and


Australia, the Korean government finally decided to integrate
capital market-related laws with some necessary modifications,
considering the unique features of the Korean legal system and
structure.

In February 2006, the Korean government announced its plan for


the

integrated

consultation

capital

with

the

market

law,

drafting

industry

and

academia.

bill

in

close

The

bill

was

promulgated in August 2007 after passage through the National


Assembly in July 2007. Given that the Act would bring seismic
change in the Korean capital market by integrating various law
and regulation all at once, the government decided upon a one
and a half year phase-in period, with the law becoming effective
on February 4, 2009.

- 49 -

Legislative History of FSCMA


Feb. 17, 2006

Announcement of the enactment plan for

the Financial Investment Services and Capital Markets Act


(tentative) (Government)
Dec. 29, 2006

Submission of proposed bill to the National

Assembly (Government)
Jul. 2, 2007

Committee

Alternative bill from the Finance and Economy

(FEC)

of

the

National

Assembly

(National

Assembly)
Jul. 3, 2007

Passage of the alternative bill by FEC of the

National Assembly at the plenary session of the National


Assembly (National Assembly)
Aug. 3, 2007 Promulgation of FSCMA
Jul. 29, 2008

Enactment and promulgation of the

Enforcement Decree of FSCMA


Aug. 4, 2008

Enactment and promulgation of the

Enforcement Rule of FSCMA


Feb. 4, 2009 Effectuation

. Main Features and Framework


In

order

to

resolve

the

above-mentioned

problems

through

reforming the regulation of capital market and enhancing investor


protection, the FSCMA pursues the following four basic objectives.

1. Comprehensive Approach

- 50 -

First of all, FSCMA has a comprehensive definition of financial


investment

instrument,significantly

broadening

the

scope

of

financial instruments dealt in by financial firms. By defining


financial investment products broadly and abstractly and embracing
all financial investment products that may appear in the future as
being subject to regulation, the scope of financial products that
are available to financial investment services companies, and
which are correspondingly subject to investor protection regulation,
was expanded.

FSCMA

defines

financial

Investment

instruments

as

right,

acquired by an arrangement to pay money or any other asset at


a specific time in the present or in the future with an intention to
earn profit or avoid loss where there is a risk that the total
amount of such money or assets, paid or payable for the purpose
of acquiring such a right, may exceed the total amount of money
or assets already recovered or recoverable from the right (in this
context, this means investment risk). Any financial product with
investment risks is considered a financial investment instrument
regardless of its form or type. For instance, if bank account or
insurance policy carries investment risk, it is considered to be a
financial investment instrument. However, if there is any loss of
principal because the opposite trading partner is unable to pay
the pre-contracted amount of money or any other asset due to
bankruptcy, debt restructuring etc., the FSCMA postulates that a

- 51 -

non-investment risk exists. This encourages the market to consider


risks from the structure of financial instruments and the market
itself, rather than from credit alone, when identifying investment
risks of financial instruments.

With the introduction of FSCMA, the Korean financial market


divided every type of financial instrument developed and sold on
the financial market into those with investment risks and those
without investment risks (bank deposits and insurance policies that
guarantee the principal). This has significant meaning for the
Korean

financial

market

as

it

implies

that

certain

financial

investment instruments investment contracts, atypical indirect


investment, etc. that previously were not governed by any law and
thus contained no investor protection measures now fall under
the financial regulatory framework and controlled by FSCMA.

2. Function-based Regulation

FSCMA adopted a functional regulation system based on the


principle that each activity that has the same economic substance
should be regulated equally, no matter which financial institution is
handling

the

matter.

It

did

so

by

re-classifying

financial

investment services, financial investment products and categories of


investors based on economic substances.

For example, FSCMA integrated the previously separate regulatory

- 52 -

regimes for financial investment business areas, securities business,


futures business, asset management business, trust business, etc.
into a single regulatory regime.

The financial investment business is now classified into six areas


dealing

business,

brokerage

business,

investment

advisory

business, discretionary investment business, trust business and


collective investment business depending on their economic
functions and based on the transactions of the financial investment
instruments. Dealing and brokerage businesses offer financial
investment instruments trading and trading brokerage functions.
Investment advisory businesses provide investors with financial
advice on the value of financial investment instruments and
investment decisions.

- 53 -

Trusts take charge of the custody, disposition and management of


trusted assets as a trustee.

Collective investment businesses

manage collected money or assets from investors and distributes


the outcome of the management to the investors. Both trusts and
collective investment businesses mainly invest trusted and collective
investment assets into financial investment instruments.

FSCMA defines financial functions in terms of financial investment


instruments, financial investment business and investors.

Based on

such as understanding, FSCMA applies different market entry


requirements

(authorization,

registration),

corporate

soundness

standards, and business activities regulations to each type of


financial investment firm, based on their level of risks and their
financial functions.

FSCMA significantly strengthened investor protection measures to


bolster investor confidence in the Korean capital market. In
particular,

FSCMA takes different approaches to the professional

and ordinary investors given their different risk-taking abilities,


based on such factors as their financial proficiency and the size of
their assets. As such, FSCMA focuses on delivering effective
investor protection to the ordinary investors who are much more
vulnerable to investment risks.

FSCMA defines professional investors as those who have the ability


to take the risks accompanying their investment in light of the

- 54 -

expertise

they

possesses

in

connection

with

the

financial

investment instruments, the scale of their assets, etc. and who fall
within the categories set forth in FSCMA, such as the State, The
Bank of Korea, financial institutions, etc. However, FSCMA also
states that if a professional investor notifies a financial investment
business entity in writing of its willingness to be treated as an
ordinary investor, then such investor should be treated as an
ordinary investor.

Meanwhile, if ordinary investors wish to be treated as professional


investors,

FSCMA requires that financial investment institutions

treat them as professional investors only if they possess minimum


amount of balance in financial investment instruments (KRW 10bn
for corporations, KRW 5bn for individuals) as this ensures financial
investment institutions cannot shirk their responsibility for investor
protection.

Investors who are not professional investors are defined as


ordinary investors and when financial investment companies offer
investment recommendations to such investors, stricter regulations
on investment recommendation are applied. Based on FSCMA,
investment

recommendation

means

recommending

financial

investment services such as the trading of financial investment


instruments, or making contracts for investment advisory service,
discretionary investment, and trust service for specific investors.
FSCMA demands financial investment firms give enough product

- 55 -

information (product guidance) to investors to recommend fitting


investment instruments that suit the objectives (suitability) and to
understand the needs and purpose of the investment (Know
your customer rule), so that investors can make wise and
informed

investment

decisions.

Additionally,

when

financial

investment firms sell high-risk investment instruments such as


derivatives, derivatives combined securities and derivatives funds to
ordinary investors, they should conduct a thorough analysis of the
investors-investment

purpose,

financial

status

and

previous

investment records through interviews and other methods. If the


instruments recommended are deemed inappropriate, the financial
investment firms should report that fact to the investor and make
a record of the notification and investors confirmation in the
form the investors seal, signature, etc.

3. Expanded Scope of Financial Investment Businesses

FSCMA expands the scope of businesses that financial investment


service

business

companies

may

engage

in.

All

financial

investment service business companies are able to engage in all


or some of financial investment services as well as all incidental
businesses.

- 56 -

4. Increased Investor Protection

FSCMA
expressly

upgrades

the

investor

protection

system.

This

is

to

fulfill the suitability principle and the duty of risk

disclosure set out in the statute, to set up

a system to prevent

the conflicts of interest which may arise from expanding the


business scope of financial investment service companies, and to
reinforce public disclosure in the primary market.

- 57 -

. Structure of FSCMA
1. Overview

FSCMA is comprised of 41 Chapters in 10 Parts with many


subordinate regulations. The Enforcement Decree of FSCMA, which
is a Presidential Decree, enumerates matters addressed by FSCMA
and the regulations required to implement the stated obligations.
The Enforcement Rules of FSCMA (Ordinance of the Prime Minister)
stipulate the powers ensured by the Decree and the regulations
required

to

implement

the

stated

obligations.

Regulations

promulgated by the FSC contain articles that explain the duties


created by the Decree and the regulations required to implement
the

stated

Regulation

obligations.
on

Financial

The

FSCMA

Investment

regulations
Business,

contain

the

Regulation

on

Issuance and Disclosure of Securities, Regulation on the Return of


Short-Swing Profits and the Investigation and Reporting of Unfair
Trading Practices, Regulation on Capital Market Survey, Regulations
on Inspection and Sanction on Financial Institutions, etc. In its
regulatory

enforcement

rules,

the

FSS

defines

the

authority

entrusted to its Governor by FCMA, its decrees and enforcement


rules, the FSC Regulations and the other relevant laws and
regulations, along with requirements and documents needed for
the concrete implementation of the above-mentioned laws and
regulations.

- 58 -

TABLE 15 STRUCTURE OF FSCMA

- 59 -

2. Regulation of the Financial Investment Businesses

The Regulation on the Financial Investment Business (RFIB) is an


FSC regulation enacted in August 2008, to improve and integrate
the existing regulations on the Supervision of the Securities
Business, the Indirect Investment Asset Management Business, the
Trust Business, the Merchant Bank Industry, and Guidelines for the
Licensing of

Trust Businesses, Merchant Banks and Financial

Brokerage Companies.

RFIB defines matters that are required for the regulation and
supervision of governance, soundness, and business activities of
licensed or registered financial investment firms. However, among
the various financial investment business areas, concurrently-run
financial investment business entities such as banks and insurance
companies, which are partially licensed or registered, are not
subject to the regulations on the governance, accounting, financial
soundness, and restriction on trading with major shareholders.

RFB

also

stipulates

over-the-counter

issues regarding

(OTC)

trading

of

the

supervision

non-listed

stocks,

of

the

bonds,

commercial notes and fractional shares, OTC trading through bond


brokerage

firms

and

professional

bond

dealers,

RP

trading,

securities lending transaction, OTC trading of derivatives, trading on


the overseas securities markets and derivatives transactions on

- 60 -

exchange along with matters such as investment registration,


account opening, and the trading and deposit of securities and
derivatives of foreigners.

3. Regulation of Securities Issuance and Disclosure

The

Regulation

of

Securities

Issuance

and

Disclosure

(RSID),

enacted in February 2009, is an FSC regulation that overhauled


the former Regulation on the Issuance and Disclosure of the
Securities by adding regulatory improvements and additional
powers granted by FSCMA.

To

ensure

the

fairness

of

securities

issuance

and

investor

protection, RSID specifically defines items which investors should be


notified of in the form of descriptions in the registration statement
and investment prospectus, along with accompanying forms and
other documents.

In particular, when it comes to the registration statements of


collective investment securities and asset-backed securities and the
registration statement on mergers, business transfers and split-offs,
split-and-mergers, comprehensive exchanges or transfer of stocks,
RSID requires different documents and details to be disclosed.

RSID

defines

matters

that

are

needed

for

the

concrete

implementation of the registration of tender offers, report on

- 61 -

stocks, held in bulk, and restrictions on the solicitation to exercise


voting right by proxy. It also contains specifics regarding the types
of corporations that

should submit regular reports such

as

business reports, and the information that should be stated in


those reports.

For example, reports

acquisition

disposition

and

of

treasury

are

required

stocks

of

for any

stock-listed

corporations; any decision on the issue value of capital increase


with consideration; and any issuance of convertible bonds and
bonds with warrant.

- 62 -

Chapter 3
Definition and Classification of Financial Investment
Products
I. Introduction of the New Definition of Financial Investment
Products
1. Definition of Financial Investment Products

The FSCMA introduced a new concept of "financial investment


products". If a particular product falls under the category of
"financial investment product", it becomes subject to regulation
under the FSCMA, which determines the business scope of the
financial investment service companies dealing in such financial
investment product.

Under Article 3(1) of the FSCMA, "financial investment product" is


defined as a right acquired by an agreement to pay, at the
present time or a specific time in the future, money or any other
valuable thing, for the purpose of earning a profit or avoiding a
loss, where there is a risk that the total amount of such money
or similar, paid or payable, to acquire such right(excluding any
sums

specified

in

the

Presidential

Decree,

such

as

sales

commissions) may exceed the total amount of money or similar

- 63 -

recovered or recoverable from the right (including any sums


specified in Presidential Decree, such as termination fees).

(1) Investment Risk Requirement

The

most

important

characteristic

of

any

covered

financial

investment product is its investment risk, which is the risk that the
total

amount

recovered

or

recoverable

under

the

financial

investment product is less than the total account payed or payable


to acquire it. In other words, investment risk means the risk of
loss on the principal of the investment.
recovered

by

the

investors

due

The amounts that are not

to

bankruptcy

or

debt

restructuring of the issuer or the counterparty are not considered


an unrecovered amount in calculating amounts recovered or
recoverable. This is because credit risk is not considered as an
investment the under the definition of the financial investment
products. For example, even in case of deposits with a bank or
insurance contracts with insurance companies, there can be a
possibility

of

failure

in

collecting

the

deposits

or

insurance

proceeds due to their bankruptcy. However, traditional deposit or


insurance contracts do not fall within the concept of financial
investment products. This definition reflects the belief that it is not
reasonable to regulate financial investment products based on
credit risk, because the credit risk exists in every transaction that
has a

counterparty.

The

traditional

deposit

and

insurance

products sold by banks or insurance companies are regulated by

- 64 -

Banking Act and Insurance Business Act. Also, when an insurance


policy is terminated early, the amount that the insured may
receive is often less than the insurance premiums paid, even if
the insurance is a savings type insurance policy. However, the
FSCMA clearly provides that this type of early termination does not
turn an insurance contract to a financial investment product.

The investment risk in the context of the definition of financial


investment products means market risk. Government bonds are
issued by the government and therefore it is hard to predict the
default or the risk of lass on investment principal from the
perspective of credit risk. An investor in government bonds is,
however, exposed to the risk of loss on his/her investment
amount depending on the market interest rate], particularly when
they are traded in the secondary market.

(2) Profit Purpose Requirement

In order to qualify as a financial investment product, the product


must have "the purpose of gaining profits or avoiding losses." A
product which is acquired for the

purpose of consumption or use

is not a financial investment product. Would real estate or


commodities purchased for the purpose of investment and not for
consumption

be regarded as a financial investment product?

Some might argue that this should be the case because both
tests (i.e. the risk of loss on investment and the purpose of profit)

- 65 -

are satisfied. However, there is no necessity to regulate real estate


or commodities as financial investment products on the ground
that there is a purpose for profit. It must be determined whether
it qualifies as one of the two subcategories of financial investment
products, securities or derivatives. In determining the scope of
financial

investment

products,

the

legislative

purpose

of

"contributing to the development of the national economy by


increasing the capital market's fairness, reliability and efficiency by
promoting financial innovations and fair competition in the capital
market,

protecting

investors

and

cultivating

sound

finance

investment businesses" should also be taken into consideration.

(3) Sub-categories of Financial Investment Products

The definition of financial investment product is intended to


determine, using a functional approach, the basic characteristics of
the instruments which need to be governed by the FSCMA.
However, there is a risk of legal uncertainty if the concept of
financial investment product is prescribed only by an abstract
definition.

Therefore,

the

definitions

of

two

subcategories

of

financial

investment products, "securities" and "derivatives", and the types of


securities and derivatives are provided in the FSCMA to minimize
such uncertainty. That is, it is clearly indicated that only if the
product qualifies, as a security as a

- 66 -

derivative, would it be a

financial investment product governed by the FSCMA.

Conversely,

a product that does not need to be regulated by the FSCMA is


clearly

excluded

form

the

definition

of

financial

investment

products. A typical example of such exclusion is negotiable


certificates of deposits. if the investment risk test and profit
purpose test under Article 3(1) were the sole determinants of
whether a product is a Financial Investment Product, some
products which the FSCMA was not intended to regulate could be
included in financial investment products(for example, investment in
real estate as discussed above). This issue is resolved by
reviewing whether a product falls under the category of securities
or

derivative,

products.

the

two

Applying

allowances

or

subcategories

this

loan

method,

receivables

of

financial

greenhouse
are

not

investment

gas

emission

considered

financial

investment products. Of course, derivatives based on emission


allowances

or

sub-category

loan

and

receivables

would

be

fall

under

considered

the

derivatives

financial

investment

products.

2. Classification of Financial Investment Products

Under FSCMA, financial investment instruments are classified into


securities

and

derivatives,

over-the

counter

derivatives

and

exchange-traded derivative, based on their characteristics the


possibility of the loss being larger that the value of the principal
and the obligation of overpayment.

- 67 -

FSCMA uses

a comprehensive

definition for

the

concept

of

securities and derivatives.

Figure 3. CLASSIFICATION OF FINANCIAL INVESTMENT INSTRUMENTS

II. Definition and Classification of Securities

1. Definition of Securities
According to FSCMA, securities are defined as financial investment
instruments for which investors do not owe any obligation to pay
anything in addition to the money or asset paid at the time of
acquiring such instruments (excluding obligations to pay where an

- 68 -

investor assumes such an obligation by exercising a right to


effectuate the purchase and sale of an underlying asset).

2. Classification of Securities

Along with this comprehensive definition of securities,

FSCMA also

stipulates six types and concepts of securities: equity securities,


debt securities, beneficial certificates, securities depositary receipts
and clearly states that new types of securities such as investment
contract securities, derivative-combined securities, are included in
the category of securities.

The concept of investment contract securities did not exist in the


previous Securities and Exchange Act. Investment contract securities
means "those representing rights under a contract where a
particular investor invest money into a joint enterprised between
the investor and another person(s) (including other investors) and
is entitled to profit earned, or liable for losses sustained, based
on the outcome of joint enterprise mainly managed by the other
person(s)." The concept of the investment contract is included in
the definition of securities under the U.S. Securities Act of 1933
Section 2(a)(1) and the Securities and Exchange Act of 1934 Section
3(10). In SEC v. W. J. Howey Co. the U.S. Supreme Court ruled
that the criteria of determining whether a contract is an investment
contract that falls under the definition of securities are: (i)
investment of money due to, (ii) an expectation of profits arising

- 69 -

from, (iii) a common enterprise, and (iv) with depends solely on


the efforts of a promoter or third party. The criteria from SEC v.
W. J. Howey were reflected in the definition of investment contract
securities of the FSCMA.

Derivatives-embedded securities contain a derivatives factor in that


payment amounts can vary according to changes in value of
underlying assets or changes in underlying index. In this regard, it
can be said that derivatives-embedded securities are similar to
derivatives.

However,

the

investor

who

purchase

derivatives-embedded securities by paying full price at the time of


purchase will not suffer from losses over their initial investment
amount. Therefore, this type of product is considered a security,
not a derivatives. For example, typical credit default swaps are
derivatives,

but

derivatives-embedded

fully-funded
securities.

credit-linked

notes

Derivatives-embedded

are

securities

are classified as securities under the classification principles of


securities and derivatives, but they are treated in a similar manner
as derivatives for purpose of investor protection.

- 70 -

TABLE 16. TYPES AND DEFINITION OF SECURITIES

pe

III. Definition and Classification of Derivatives


1. Definition of Derivatives

In the FSCMA, "derivatives" means forward, option, swap contracts


with regard to underlying asset, underlying asset's price, interest
rate, index, unit or the index based on them. Qualifying underlying
assets

under

the

FSCMA

are

financial

investment

products,

currencies, commodities, credit risk and other risks inherent in


natural, environmental or economic phenomena, the price or index
or unit

of

which

can

be

calculated

- 71 -

or

assessed

in

such

reasonable

or

appropriate

manner

necessary

to

protect

the

investor.

Since derivatives determine the payment amount in the future


based on uncertainty, the question of whether it falls under
gambling can arise. The FSCMA clearly provides that it does not
constitute a crime of gambling (illegal in Korea) if a financial
investment service company conducts its business pursuant to
FSCMA. Although the FSCMA is silent on whether the validity of
derivatives can be challenged based on the gambling issue,
derivatives that meet the FSCMA requirement should be shielded
from such challenges.

Derivatives are contractual rights falling under the categories of


forwards, options and swaps. The scope of the underlying assets
are financial investment instruments, currencies (including any
foreign currency), ordinary commodities credit risks and other risk
inherent in natural, environmental or economic phenomena, which
can be computed or assessed by price, interest indicator or unit in
a reasonable and appropriate way.

2. Classification of Derivatives

Derivatives can be clsssified into two categories: exchange-traded


derivatives and over-the counter(OTC) derivatives. Exchange-traded
derivatives are traded through intermediaries, such as exchanges,

- 72 -

based on standardized exchange contracts and regulation with the


intermediary as the counterparty to the contract.

OTC derivatives are privately negotiated bilateral contracts entered


into between the contracting parties directly (typically based on
standardized agreements and contractual terms, such as those
developed by the International Swaps and Derivatives Association,
Inc.).

OTC

sophisticated

derivatives
parties (such

are

largely

entered

into

between

as financial institutions or similar

entities) for the purposes of hedging financial or portfolio risks or


for diversifying portfolios of assets.

IV. Distinction between Securities and Derivatives


The criterion distinguishing securities from derivatives is whether
there is a possibility of suffering losses exceeding the investment
principal, that is, whether an investor a financial investment
product can be obligated to make additional payment after his/her
investment in the product.

"Securities" means "those financial investment products that are


issued by a Korean national foreigner and that do not have the
obligation of making payment, for any reasons, in addition to the
money paid by the investors upon acquisition of the product
(except for the payment obligation owed by the investor upon

- 73 -

exercising his/her right to enter into a sale and purchase of the


underlying asset.)". Investors who purchase typical shares or bonds
would not be obligated to make additional payment other than
the purchase price paid upon acquisition.

On the other hand, for example, in case of stock price index


futures, the amount paid on investment is a margin, and the
investor may be obligated to make payments calculated according
to the fluctuation of stock price index; therefore, such financial
investment falls under the category of derivatives. Such criterion
distinguishing securities from derivatives is the more developed
version of what was reflected in the definition of equity linked
securities and equity-linked

warrants under the previous Securities

and Exchanges Act.

- 74 -

Chapter 4
Regulation

of

the

Financial

Investment

Service

Industry
I. Classification of Financial Investment Services
Under Article 6(1) of the FSCMA, "financial investment services" are
defined as activities conducted continuously or repeatedly for the
purpose of earning a profit, falling under one of the six categories
of businesses: dealing businesses, brokerage/arranging businesses,
collective

investment

businesses,

non-discretionary

investment

advisory businesses, and trust businesses. The classification of


financial investment service into six categories is based on the
functions of each.

A financial investment service, however, must obtain a license to


engage in each financial investment
business,

brokerage/arranging

business,

and

trust),

or

business (in case of dealing

business,

complete

collective

registration

(in

investment
case

of

non-discretionary investment advisory business or discretionary


investment management business).

- 75 -

TABLE 17. TYPES AND CONCEPTIONS OF FINANCIAL INVESTMENT


BUSINESSES

II. Entry Regulation


In Korea, there are currently 42 types of financial functions and
each function is considered the basic authorization and registration

- 76 -

unit

of

financial

investment

business.

Depending

on

the

functional regulation of a financial investment business, financial


firms willing to carry on a financial investment business can apply
for authorization for registration by selecting the entire or partial
set of authorization or registration units. Financial investment firms
that

are

already

authorization

on

or

the

market

registration

by

can

apply

selecting

for
the

additional
necessary

authorization or registration units. Dealing businesses, brokerage


businesses, trust businesses and collective investment businesses
need authorization from the FSC, while investment advisory and
discretionary investment businesses need to register with the FSC.

License and registration of a financial investment business is


granted or accepted on the basis of a business unit which can be
made by reference to: (i) six types of financial investment services,
(ii) the type of financial investment product in which the line of
business

intends

to

brokerage/arranging,

transact
which

(in
of

the

case

securities,

of

dealing

and

exchange-traded

derivatives and OTC derivatives will be dealt with; in the case of


collectives investment business and trust business where to invest
among securities, real estate, special property, short-term financial
product), (iii) the scope of business (whether the contemplated
customers are non-professional investors or professional investors).
Different entry requirements apply to each business unit. The basic
policy of entry requirement for each business unit is as follows:

- 77 -

(i) As compared to registration, the entry requirements for a


financial investment business that requires authorization are stricter.
However,

the regulators may use their discretion in applying such

requirements.

(ii) Stricter requirements apply to a business that has direct


claim-obligation relationships (dealing business), a business that is
entrusted

with

investors'

asset

(brokerage/arranging

business,

collective investment business, trust business), and a business that


is not entrusted with assets (discretionary and non-discretionary
investment advisory business).

(iii)

In

the

realm

of

financial

investment

products,

stricter

requirements apply to OTC derivatives, exchange-traded derivatives


and securities.

(iv) In the realm of investors, stricter requirements apply to


dealings

with

non-discretionary

investors

than

those

with

professional investors.
For

instance, the

strictest

requirement

applies

to

businesses

dealing in OTC derivatives to non-professional investors, whereas


the least strict requirement applies to non-discretionary investment
advisory businesses dealing in bonds with professional investors. In
order to expand its business scope, a financial investment service
company may apply for license or registration for the business
unit it plans to "add-on" to its existing business.

- 78 -

TABLE 18. LICENSING UNITS OF THE FINANCIAL INVESTMENT


BUSINESS

- 79 -

III. Regulation of Market Conduct


1. Generally

The main purpose of FSCMA in integrating the financial regulations


is to enhance the investor protection regime in order to respond
to the increasing number of complex financial products such as
those in the derivatives market. Also notable is the increased
regulation and awareness about conflicts of interest that may arise
from the integration of various capital market activities, especially
those of asset management and securities business.

Originally, the laws related to investor protection were dispersed


throughout 16 separate laws according to the types of financial
activities, such as banking, asset management, insurance, and
futures, etc. These laws were established due to the inherent
nature of the finance industry, where the basic elements of
contract formation such as the principle of private autonomy,

level playing field (equal procedural guarantees), and freedom of


contract do not

fully apply. This is substantiated by two

arguments: (1) the market failure theory notes the failure of the
market; and (2) the theory recognizes asymmetric information consumer protection is necessary due to asymmetric information in
the market. Thus the duty to explain and the principle of suitability
are the specific embodiments of the principle of good faith, which

- 80 -

eliminates information asymmetry between the solicitor and the


investor and allows the investor to make an appropriate decision
for herself and to have full responsibility for her decision.

The duty to explain and the principle of suitability are the


prerequisites for financial institutions to claim the principle of
liability with fault. The responsibility falls on the investor if the
financial investment advisor had fully explained and fulfilled the
obligation of duty to explain, whereas it falls on the financial
investment advisor

if he engaged in unsuitable investment

activities.

The original laws regarding investor protection as stated in the


Securities and Exchange Act enforce the principle of liability with
fault through the duty to explain and the principle of suitability.
For instance, Article 43, Paragraph 1 of the Futures Trading Act
states that the futures advisor must inform the investor in writing
prior to any transaction of the potential losses that can be caused
by the sales and purchases of the futures. Similar wordings exist
in Article 56, Paragraph 2 of the Asset Management Business Act
and Article 10, Paragraph 2 of the Real Estate Investment
Company Act.

These articles may in part incorporate the duty to explain and the
principle of suitability; however, they also differ. For example, the
Enforcement Decree of the Securities and Exchange Act prohibits

- 81 -

undue recommendations such as scalping under Article 36-3.


However, it does not specifically mention the duty to explain.

To summarize, FSCMA was enacted in order to prevent regulatory


arbitration and non-existence of regulation as well as to prevent
the probable conflicts of interest that can arise from allowing the
management of more than one kind of business activity. FSCMA
incorporates

the

original laws

and

newly

organizes

investor

protection regulations into regulations on investment advisement,


investment advertisement, conflicts of interest, and disclosure after
issuing of securities.

The financial businesses were originally regulated in terms of


institutional regulations, as witnessed by the regulations dispersed
over more than 16 acts. However, FSCMA takes on functional
regulations, where the specific boundaries are set in terms of
investor advisement activities, not in terms of institutions by which
the activities are carried out. Investment recommendation was
formerly defined by the Financial Supervisory Service merely as a
business rule, but in

FSCMA it has been incorporated into the

law itself.

FSCMA also differentiates ordinary investors from professional


investors, making the duty to explain obligatory towards only the
ordinary investor. The differentiation is made based on standards
such as level of expertise and scale of assets owned. Such

- 82 -

differentiation allows financial activities to take place effectively


while enforcing protection towards unacknowledged investors.

The principle of suitability is also applied in this way. Functional


regulation allows investor protection to be enforced in institutions
involved in multiple business. Although banking and insurance
activities were formerly enforced respectively by the Banking Act
and writing. the Insurance Business Act, now banking duties and
insurance activities are obligated to follow the duty to explain
under Article 47 when they are related to investment advisement
activities, such as contracting investment related deposits or
insurance contracts. Also, it is further applied to all financial
activities including futures trading businesses, indirect investment
securities businesses, and real estate investment businesses which
were formerly enforced loosely in terms of duty to explain.
Furthermore, security companies and trust companies must observe
this duty as well. This is also true in the case of investor advisory
businesses

and

discretionary

investment

businesses,

which

originally had only the duty to inform investors in

The principle of suitability mentioned in Article 46 underscores that


the advisor must recommend financial products that suit the
objectives, experience, knowledge, and wealth of the investor. Thus
the investor must not only have resonable grounds to advise a
product, but it should also suit the individual background of the
investor being advised. Before the enactment of FSCMA, such a

- 83 -

rule had not been incorporated into law but was enforced by the
Financial Supervisory Service in practice. FSCMA made this rule into
law. Furthermore, the "Principle of Appropriateness" was added in
Article 46-2 in 2009, stretching the principle of suitability into the
field of derivatives.

2. Regulations on Investment Recommendations

(1) "Know Your Customer" and the Suitability Principle

A financial investment service company must confirm whether an


investor is a professional investor or a non-professional investor.
Also, it must understand the non-professional investor's investment
purpose, financial conditions, or investment experience through
interviews

or

questions

and

confirm

these

facts

with

the

non-professional investor before recommending any investments. It


must not recommend an investment that is not suitable for a
non-professional investors in light of such investor's investment
purpose, financial conditions, or investment experience.

(2) Duty to Warn of and to Explain Risks

When a financial investment service company recommends an


investment to a non-professional investors, it must explain in a
clear manner the contents of the financial investment products, the
risks of making the investment, the structure and characteristics of

- 84 -

such investment risks, fees, early redemption conditions (if any),


and the conditions of termination/cancellation of the contract, and
must receive a confirmation from the investor that the investor
understands these factors.

In providing such explanations, the financial investment service


company shall not misrepresent or omit material facts, that is,
facts

that

can

reasonably

influence

an

investor's investment

decision or facts that can substantially influence the value of a


financial investment product).

The previous Securities and Exchange Act was silent on this duty.
The

Financial

Supervisory

Commission's

Securities

Business

Supervisory Regulations provided that when an ordinary customer


is willing to open an account to trade in derivatives, margin
transactions,

foreign

currency

securities

or

other

equivalent

transactions involving high risk, a securities company had the duty


of explanation before opening the account. Now, this duty is
reflected in FSCMA.

A financial investment service company which violated this duty of


explanation must compensate the investor for his or her losses.
The amount of losses is estimated as follows: [the total amount
the investor paid or shall pay to acquire the financial investment
product] minus [the total amount the investor recovered or shall
recover through disposing of the financial product]. The burden of

- 85 -

proof that the losses are less than estimated amount is on the
financial investment service company. FSCMA is silent on who
bears the burden of proof as to the compliance or breach of the
duty to warn of and to explain risks.

(3) Duty of Appropriateness

Even if a financial investment service company does not make an


investment recommendation to its customers, it still needs to
evaluate information about a non-professional investor, such as
purpose of investment, level of wealth and investment experience
in order to sell derivatives, derivatives-embedded securities and
collective investment securities (that invest in derivatives and the
derivatives-embedded securities) to such an investors. Furthermore,
if the product that the non-professional investor wants to purchase
is not appropriate to
the investor of (i)

such investor, the company must inform

the details about the product, (ii) the risks of

investing in the product, (iii) reasons why the product is not


appropriate to the investor in light of his/her investment purpose,
level

of

wealth]

and

investment

experience,

and

obtain

confirmation from the investor that the investor has been so


informed.

(4) Prohibition of Certain Investment Solicitation Practices

The previous Securities and Exchange Act also banned various

- 86 -

unjust solicitation practices, such as profit-guaranteed solicitation


and solicitation based on conclusive judgment. Article 49 of the
FSCMA

expanded

Notably,

FSCMA

the

range

prohibits

of

unjust

'unsolicited

solicitation

calls'

and

practices.
'continuing

solicitation against a customer's will.

For sales of OTC derivatives, visits and phone calls not made at
the investor's request are prohibited. This prohibition is not
applicable to the solicitation of securities and exchange-traded
derivatives, as the regulators and legislators believed that such
activities posed no potential threat to customer protection and
sound orderly trading in this area.

Also, if the investor receiving an investment recommendation


expresses his/her intention to decline it, then the investment
advisor must cease recommending the investment. However, in the
case of recommending investment in an insurance contract with
investment risk, recommending re-investment, after a month has
passed is permissible.

(5) Establishment of Investment Solicitation Standards

A financial investment service company is required to prepare


detailed standards and procedures with which its employees shall
comply in making investment recommendations. It is also required
to prepare differentiated standards and procedures for derivative

- 87 -

products by reference to the types of investors, taking into


consideration the investment purpose, level of wealth, experience
in investment, etc., and announce it on its internet homepage.

The Korea Financial Investment Association drafted the model form


of investment recommendation standards, which were adopted by
most financial investment service companies.

3. Preventing Conflicts of Interest

A conflict of interest is "a situation in which the self-interest of a


person may conflict with a fiduciary duty that he owes to another,
or in which a person has potentially conflicting fiduciary duties to
two or more persons."

One example is where the firm's self-interests conflict with the


interests of its client, or alternatively, where the interests of two of
the firm's clients are at odds with each other. Under the FSCMA,
the likelihood of conflicts of interest is substantially high, because
a financial investment business entity is not prohibited by the law
to concurrently run the businesses through in-house operations,
and such an entity can perform multiple functions and engage in
numerous financial activities.

While permitting concurrently-run financial investment businesses


has provided opportunities for the business to strengthen its

- 88 -

competitiveness

through

the

advantages

generated

by

the

economies of scale and scope, there has been an increasing


need for strict rules on the business conduct that could give rise
to conflicts of interest. Unless effective tools for preventing conflicts
of interest are

provided, advancing investor protections, which is

one of the main objectives of the legislation of the FSCMA, will


not be achieved. Thus, upon the integration of the separate Acts
into the FSCMA, legislators expanded the scope of regulations in
the

pre-existing

law,

such

as

Article

43

of

the

Securities

Transaction Act and Article 134 of the Indirect Investment Asset


Management Business Act, and adopted new regulations to
prevent the increased possibility of conflicts of interest expected
under the new system. Specifically, FSCMA deals with the conflicts
of interest through:

(i) the duty of good faith as a general principle;


(ii) the specific prohibition on unsound business conduct;
(iii) the establishment of internal controls; and
(iv) the cut-off of exchange of information.

The above four categories of regulatory tools are designed to


prevent conflicts of interest by regulating the business conduct of
financial

investment

business

entities.

The

following

describes the elements in each category in detail.

(1) The Duty of Good Faith as a General Principle

- 89 -

section

The Article 37, Paragraph 1 of FSCMA imposes the duty of good


faith on a financial investment business entity. The duty of good
faith not only serves as a basis for regulating the specific
business conduct mentioned in the FSCMA, but also provides a
solid ground for regulating the business conduct that is not
specifically prohibited by the provisions.

In addition to the duty of good faith stated in this general


provision,

collective

investment

business

entities,

investment

advisory business entities and discretionary investment business


entities, and trust business entities owe the fiduciary duty of due
care as well.

Article 37, Paragraph 2 prohibits self-dealing, or representation on


one's own behalf and representation of both parties, because such
conduct is highly likely to lead to a conflict of interest. This
provision is significant because it recognizes the likelihood of
conflicting interest in the financial investment business arising from
self-dealing and representation of both parties. The structure of the
provision is comparable with that of the relevant provisions such
as Article 124 of the Civil Act or Article 398 of the Commercial
Act. Prior to the legislation of FSCMA, however, there were no
provisions that stated the conditions under which a financial
investment business entity is permitted as an exception to do
self-dealing and representation of both parties. Also, it was

- 90 -

unclear whether the Supreme Court's broad interpretation of the


Article 124 of the Civil Act can be applied to the financial
investment business. Thanks to the provision, it is now clear that
self-dealing and representation of both parties that undermine the
interests of its investors cannot be allowed unless there is a
justifiable reason.

(2) The Specific Prohibition on Unsound Business Conduct

With regard to the rules on business conduct by financial


investment business entities, the entities are classified into (1)
investment traders and investment brokers, (2) collective investment
business entities, (3) investment business entities and discretionary
investment business entities, and (4) trust business entities. The
provisions in each sub-section illustrate specific examples of
unsound business conduct that cause conflicts of interest, and
prohibit such
effectively

business conduct

protect

the

interest

by the
of

entities in order to

investors.

The

following

paragraphs explain some of the unsound business conducts that


especially lead to conflict of interest and how they are ruled under
the FSCMA.

A. Self-dealing and Representation of Both Parties

A conflict of interest commonly occurs from self-dealing, which is


the conduct of a fiduciary that consists of taking advantage of his

- 91 -

position in a transaction and acting for his own interests rather


than for the interests of the beneficiaries. Article 67 forbids
investment traders and investment brokers from simultaneously
acting on their own behalf and as the investment broker for
another

party

in

single

transaction

involving

financial

investment instrument. Also, pursuing its own or a third party's


interest

by

undermining

the

interest

of

specific

collective

investment scheme, a specific investor, or a specific trust property


is listed in the respective sub-sections as unsound business
conduct, and is thus prohibited.

Representation of both parties (so-called dumping) is the conduct


of an agent representing both one party of its principals and
another party of its principals at the same time in making a
contract with each other. This conduct is highly likely to result in
sacrificing the interest of one party to benefit the other party. The
problem of dumping is not a new phenomenon in the financial
investment business. As the possibility of dumping has certainly
increased since a financial investment

business entity is now

allowed to engage in various financial investment services, FSCMA


recognizes the need to regulate the representation of both parties.
Unless there is no possibility of undermining the protection of
beneficiaries

or

sound

trade

practice,

a financial investment

business entity is prohibited to trade its investment property for


another investment property managed by itself as well as for the
proprietary property of itself or its interested party.

- 92 -

B. Front-running

When a financial investment business entity is in the superior


position of being able to acquire business-related information
before it is disclosed to the public, the entity has a motive for
using the information to accommodate its own interest. Specifically,
front-running is the conduct of a financial investment business
entity "buying or selling any financial investment instrument on its
own account, or recommending a third party to buy or sell any
financial investment instrument, before closing a trade for an order
from an investor for buying or selling such instrument that my
produce a significant impact on the price of the instrument, where
it has received such order or there is a great possibility of
receiving such order."

Article 54 regulates front-running in such an inclusive manner that


no financial investment business entity shall use information known
to it in the course of its business and undisclosed to the public,
for its own or a third party's interest without a justifiable ground.
Also, any financial investment business entity is prohibited from
buying or selling financial investment instruments on its own
account or to solicit a third party to buy or sell such instruments
before putting the trade decision into action, because the decision
itself may produce a significant impact on the price of the
financial investment instruments.

- 93 -

C. Churning

Another unsound business conduct is churning. Churning occurs


when a broker or investment advisor exercises control over an
investor's account and frequently executes trades for the purpose
of generating commission.

For churning to occur, according to the jurisprudence in the United


States, the three elements must exist: (i) the broker must exercise
control over the account; (ii) the trading must be excessive
considering the investment objectives of the customer; and (iii) the
broker must act with intent to defraud the customer or with willful
and reckless disregard for the interests of the customer. In Korea,
the rulings of Supreme Court are understood to require the first
two elements in deciding whether conduct qualifies as churning.

The FSCMA extends the scope of unsound business conduct by


providing that financial investment business entities shall not
commit "[o]ther acts specified by Presidential Decree as likely to
undermine the protection of investors or sound trade practice."
Churning is specified and prohibited by the relevant provisions of
the Enforcement Decree of the FSCMA. According to the provisions,
financial investment business entities are not allowed to solicit
ordinary investors to invest too often without considering ordinary
investors' purpose of investment, level of wealth, experience in

- 94 -

investment, etc, or to trade financial investment instruments with


the investment property too frequently, disregard the extent of the
discretion in investment, the purpose of investment, or other
factors.

D. The Establishment of Internal Controls

A system of effective internal controls addressing conflicts of


interest is an essential element in protecting the interests of
investors. The FSCMA provides mechanisms to prevent conflicts of
interest by obligating financial investment business entities to set
up internal control systems.

Article 44, Paragraph 1 requires that a financial investment


business entity shall probe and assess the likelihood of conflicts of
interest,

and

such

conflicts

shall

be

properly

controlled

in

compliance with the method and procedure prescribed by internal


control guidelines. The internal control guidelines refer to the
appropriate guidelines and procedures that shall be complied with
when its executives or employees perform their duties so as to
abide by the FSCMA and the subordinate statues, manage its
assets in a sound manner, prevent conflicts of interest, and
protect investors in every aspect.

Moreover, a financial investment business entity must appoint


compliance

officers

who

shall

be

- 95 -

responsible

for monitoring

compliance

with

the

internal

control

guidelines,

investigating

violations of the internal control guidelines, and reporting to the


audit committee or the auditors.

Preparing the

internal

control guidelines, however, does not

necessarily eliminate all the possibilities of conflicts of interest.


Thus, if it is anticipated as a result of its probe and assessment
that there is a likelihood of conflicts of interest, a financial
investment business entity is required to notify the relevant
investors thereof in advance. This provision may be interpreted to
require a notification of the likelihood of conflicts of interest in
advance, but not an informed consent of the investors.

Lastly, the Article 44, Paragraph 3 requires that a financial


investment business entity shall abstain from commencing trading
or any other transaction if it is found difficult to reduce the
likelihood of a conflict of interest.

E. The Cut-off of Exchanges of Information

The cut-off of exchanges of information, commonly referred to as


the "Chinese Wall" is a useful means of avoiding conflicts of
interest. The Chinese wall can take several forms: a formal
separation

of

powers

between

management

and

business

decision makers on the one hand and administrative functions on


the other hand; a physical separation and limited contacts

- 96 -

between personnel from different parts of the institution where


there are potential conflicts of interest. Under Article 45 of the
FSCMA, if there is a great possibility of conflicts of interest
between financial investment business run by a single financial
investment business entity, or between a financial investment
business entity and its affiliated company, the entity shall not
furnish information related to trading of financial investment
instruments,

assign

any

of

its

executives

or

employees

to

concurrently-run offices, use an office space or an electronic


computer system in common and commit other acts specified by
Presidential Decree as an act likely to cause a conflict of interest.

The Chinese wall attempts to prevent conflicts of interest by


preventing

the

flow

of

material,

nonpublic

information,

thus

allowing other departments to act freely without the influence


arising from organizational ties.

- 97 -

Chapter 5
Corporate Disclosure: Listing and Public Offers
I. Corporate Disclosure System
The corporate disclosure is a system designed to protect investors
by allowing them to make informed investment decisions and to
enhance fair trading and the overall stock market's operational
efficiency by making stock issuers and listed companies to disclose
their

major

management-related

information.

The

provisions

regarding disclosure in the Commercial Code (CC) and the FSCMA


are different in that the disclosure obligations under the CC are
mainly for the shareholders on the corporate shareholder registry
(Article 302, 474) while those under the FSCMA are for the benefit
of

general investors. The investors under the FSCMA are the

investors on the financial investors products, which is broader than


the shareholders under the corporate shareholder registry.
addition,

the

disclosure

regulations

under

the

FSCMA

In
cover

government bonds, municipal bonds, private bonds, beneficiary


certificate, depository receipt, foreign securities and etc.

1. Public Disclosure Obligations under the CC

- 98 -

It is aimed for protecting shareholders and creditors :

- Disclosure obligations on AOI, BOD Minutes


- Obligations on sending or disclosing Business Report, B/S, P/L,
CPA audit report
- Minority shareholders rights to inspect accounting books

2. Public Disclosure Obligations under the FSCMA

It is aimed for protecting present and future investors ;


Primary Market disclosure (Public offer)
- Registration Statement
- Registration Statement on Corporate Bond
- Prospectus
- Report on record of securities issuance
Secondary Market disclosure
- Periodic disclosure: Business report, Semi-annual report, quarterly
report. consolidated financial statement
- Timely disclosure: major material facts that might affect the
business management of a company
Special Disclosure:
- Public Tender Offer (Article 133(1))
- Disclosure of substantial share holding (5% Rule) (Article 147(1))
- Proxy Solicitation (Article 152(2))

- 99 -

Figure 4. DISCLOSURE PROCESS

* Note Market measures - Trading suspension, designation as administrative stock,


designation as unfaithful disclosure corporation, etc.

* source: KRX website

II. Primary Market Disclosure System

- 100 -

1. Generally

The stock markets can be divided into the primary market where
the investors first takes the issued stock by a company, and the
secondary market where the trading of already issued stock occurs
among investors. To ensure the accurate and timely disclosure of
business information regarding assets and management conditions,
etc. or security matters by listed corporations, FSCMA stipulates
certain disclosure obligations. The disclosure system under FSCMA
is divided into disclosure in the primary market and disclosure in
the secondary market.
The disclosure system under the primary market creates an
environment where investors make informed investment decisions
based on comprehensive information. Corporations that issue
securities are required to disclose public securities registration
statements, business prospectuses, records of securities issuances,
etc.
The essence of primary market regulation consists of the filing of
registration statement and the delivery of prospectus. In principle,
a public offering can only be made after filing a registration
statement with the FSC and the acceptance thereof. Entering into a
contract with an investor can be made only after the registration
statement becomes effective. After the filing of the registration
statement, the issuer in a public offering shall submit a prospectus
to the FSC, and a financial investment company cannot sell
securities or cause them to be sold to investors before delivering

- 101 -

the prospectus to the investors.


Public offering covers the mojip, i.e. the soliciting of an offer for
newly issued securities towards 50 or more investors as calculated
pursuant to the method set forth in the Presidential Decree, and

maechool, i.e. offering for sale of, or soliciting of an offer for


purchase of outstanding securities with 50 or more investors as
calculated pursuant to the method set forth in the Presidential
Decree.
Whether a public offering is at issue determines whether the
public

disclosure

obligation

exists.

Therefore,

the

offering

or

solicitation for sale of outstanding securities for investors of less


than 50 are not deemed to be a public placement and it is a
private placement such that the public disclosure rules do not
apply.
In calculating 50 persons, there is 6 month integration
rule whereby, with respect to the securities of the same kind,
the number of persons who have received a solicitation by a
method other than public offering within 6 months preceding the
date when solicitation of an offer is made are added together.
Also, the

investors with special relationship with the

issuer

(Yeon-Go-Ja) or some expert investors(Jeon-Moon-Ga) or (in case


of a public offering for sale of outstanding securities) the person
who acquired the securities at the exchange are excluded form
the calculation of 50 persons(Article 11(1), Presidential Decree of
FSCMA).

However, if there is the number of investors who

- 102 -

received solicitation of an offer is less than 50, but there is a


possibility that the securities can be transferred to 50 or more
persons within 1 year after the issuance of stocks, then the
solicitation of an offer shall be deemed as a public offering
(Article 11(2), Presidential Decree of FSCMA).
Figure 5. METHOD OF DETERMINING ON PUBLIC OFFERING/PRIVATE
PLACEMENT

There are securities exempted from filing registration statements,


such as Government Bonds (Korea Treasury Bonds, KTB) and
municipal bonds, bonds issued by public institutions or special
entities under special laws, and other securities specified in the
Presidential Decree as securities in which investors are sufficiently

- 103 -

protected

by

public

disclosure

such

as

the

debt

securities

guaranteed by Government or local government or the public


offering for sale of securities held by Government or a local
government.
The issuer is exempt from the registration filing obligation for a
small-sized offering, if neither the following conditions is met.
(i) [In the case where the proposed offering, by itself, would
become public offering based on the number of person who
received the solicitation or the application of a deemed public
offering], if the aggregate of (a) the amount of proposed public
offering and (b) the total amount of the public offering made
within 1 year prior to the proposed public offering, for which a
registration statement was not filed, is one billion won or more
(provided that if within such 1 year a registration statement was
filed, the period commencing after the filing of such registration
statement).
(ii) [In the case where the proposed offering, by itself, constitutes
a private placement, but would ultimately constitute a public
offering due to the application of the 6 month rule] if the
aggregate of (a) the amount of the proposed public offering and
(b) the total amount of the private placements made within the
preceding 6 months is one billion KRW or more.
Even if the above-mentioned exemption for a small-sized offering
is applicable, the issuer may, depending on the issue amount, be
obligated to make certain minimum disclosure (other than filing of
a registration statement).

- 104 -

2. Registration Statement
No securities shall be publicly offered or sold, unless and until a
registration statement filed by the issuer in connection with the
public offering or sale of the securities with the FSC is accepted
by the FSC (limited to cases where the total amount securities by
Presidential Decree, reaches or exceeds the amount prescribed by
10 billion KRW (Article 119(1)).
The Registration Statement is a key document in public disclosure
system in the offer and sales of securities for guaranteeing the
truthfulness of the issuer and the issued securities, thereby
preventing the securities fraud.
An issuer of securities is responsible for the filing of registration
statements

in case of (i) a public offering for a new issuance

and (ii) a secondary public offering for outstanding securities.


As for the contents of the registration statement, the summary of
the

company, matters regarding the

public offering, matters

regarding the issuer, and the documents attached including the


AOI, BOD and Shareholders meeting minutes, and etc shall be
included (Article 125(1) Presidential Decree). The representative
directors and directors who are responsible for filing have to
confirm and review as to the absence of false statement on
material information or the omission of the material information
and sign this registration statement(Article 119(5)). This was added
to

strengthen

the

management

responsibility

accounting and management policies.

- 105 -

for

transparent

As for forward-looking information, or so-called soft information,


the forecasts or prospects concerning the issuers future financial
status or results of operation may be included in a registration
statement (Article 119(3)). However, the disclosure of forward-looking
statement must meet the following conditions (Safe Harbor Rule,
Article 125(2) i, ii, iv): i) there must be an indication that the
relevant information is forward-looking information, ii) the basis for
assumptions or judgements must be specified, iii) a warning that
the forecasts may differ from the actual result must be included.
There is a Shelf-Registration statement that can be used by
well-known seasoned investors (WKSI, Article 121(6) of Presidential
Decree) and certain issuers (Article 119(2)).
If an issuer files the shelf-registration statement and it is accepted
by the FSC, the issuer is not required to separately file a
registration statement for any subsequent public offering specified
in the shelf-registration statement during the scheduled period of
the

issuance

in

the

shelf-registration

statement.

For

each

subsequent public offering, a supplement to the shelf-registration


statement shall be submitted to the FSC.
Under FSCMA,

in the case that documents, including reports, are

filed with FSC, SFC, FSS, KRX, KOFOIA or KSD, filing can be made
by an electronic document using an electronic communication
network (Article 436).
The

FSC

shall not

refuse

the

acceptance

- 106 -

of

registration

statement unless the registration statement falls in ether or of the


followings:
(i)

if

the

registration

statement

fails

to

meet

the

required

formalities; or
(ii) if the registration statement contains a false statement of
material information or omits material information
Prior to the FSC/s acceptance of the registration statement,
investment solicitation of an offer is prohibited.

3. Prospectus
The FSCMA does not provide the definition of prospectus, but it is
a document (including electronic document) prepared for the
purpose of soliciting an offer toward investors in a public offering
(Article 123, 124).
There are 3 types of prospectus: (i) prospectus, (ii) preliminary
prospectus, (iii) summary prospectus.
(i) Prospectus can be used after the effectiveness of filing the
registration statement and must be delivered to the investor before
executing a contract except where the investor is a professional
investor or certain other investor prescribed under the Presidential
Decree or investors who expressed its refusal to receive the
prospects or the investor who intends to acquire the same type of
collective investment securities that it has already acquired.
(ii) Preliminary prospectus is used during the period after the

- 107 -

acceptance of filing and before the effectiveness of the filing(Article


124(2)).
(iii) Summary prospectus is used to after the acceptance of the
filing

when

solicitation

of

an

offer

is

made

through

(a)

advertisement through newspaper, broadcasting or magazine, (b)


guide or advertisement

leaflets or (c) electronic transmission

means.
The prospectus must be submitted to the FSC on the date when
the registration statement is effective and it must be kept at the
head office of the issuer, the FSC, the KRX and the places where
the solicitation business occurs. The preliminary prospectus and the
summary prospectus must be submitted to the SFC when the filing
of the registration statement with the FSC.

4. Measures for Effective Public Disclosure Regulations


(1) Administrative Sanctions
The FSC can request for the filing of a Corrected Registration
Statement

by the

issuer (Article

122(1))

and can

impose

correction order or administrative sanctions such as the suspension


or prohibition of issuance, public offering or sales or any other
trading

of

securities

(Article

132).

An

Administrative

penalty(kwa-jing-keum) can be made up to the lesser of 3% of


the offering amount and 2 billion KRW (Article 429).
(2) Criminal Sanctions

- 108 -

The person who proceed with a public offering without filing


registration statement or violated regulation regarding prospectus,
made a false statement in registration statement or prospectus, or
representative directors who signed the registration statement with
knowledge of a false statement of material information included
therein, or the CPAs, appraisers or credit rating agencies who
certified the accuracy of the statement with knowledge of a false
statement of material information included therin or omission of
material facts, shall be sentenced to imprisonment

or to a fine

(Article 444, 446).


(3) Civil Liabilities
There is a civil liabilities provision for damages incurred by the
false statements in material facts or omission of statement of
material facts in a registration statement or prospectus. The
material facts

are

matters

which

may

materially

affect

the

investment decision by a investor or the value of the relevant


financial investment products (Article 47(3)).
The responsible persons are the issuer; directors of the issuer at
the time of filing(Article 125); persons under the Article 401-2 of
the Commercial Code who instructed or implemented the filing;
CPA, appraiser, credit rating agencies; a person who consented
the inclusion of its opinions and confirmed the content of this
opinion; a person who entered the underwriting agreement; a
person who prepared or delivered the prospectus; and the owner
of the securities offered for the public sale(Mae-chool).

- 109 -

The burden of proof regarding the willful misconduct/negligence is


shifted to the issuer and other responsible persons. There is a
rebuttable presumption of the amount of damages under the
Article 126.

III. Disclosure in the Secondary Market


1. Generally
The

system requires listed corporations

to

disclose

business

management activities related to the trading of securities among


investors

in

the

secondary

market.

Such

disclosures

include

periodic, timely, and special disclosures.


(i) Periodic disclosures : the business reports after the end of a
fiscal year, semiannual reports, and quarterly reports, etc.
(ii) Timely disclosures : major business details as outlined in the
FSCMA and the Disclosure Regulations of the KRX-Stock Market
(iii) Special disclosures : merger, spin-off, reports of business
takeover & transfer, reports of acquisition & disposal of treasury
stocks, etc.
Listed

companies

submitting

information,

in

case

disclosure and fair disclosure, must submit the following:


- The KRX accepting and examining the information

- 110 -

of

timely

- If necessary, implementing appropriate market measures


- Transmitting the information to FSC
In case of periodical report and report on material facts, etc, listed
companies must submit the following:
- The FSC accepting the information
- Transmitting the information to KRX
- Disclosing the information via;
KIND distribution system (internet website)
DART distribution system (internet website)
KOSCOM network
Others

2. Periodic Disclosure
Periodic disclosure includes annual, semi-annual and quarterly
reports.
Periodic disclosure is required for the stock-listed companies and
other companies prescribed under the Presidential Decree(a listed
company with more than 500 shareholders and etc).
Periodic

disclosure

business

details.

means
When

periodically

the

disclosing

number of

to

investors

shareholders of

the

registered corporation falls below 300 or when the submission of


business reports is impossible or ineffective due to circumstances
such as bankruptcy, etc. results and financial conditions within
fixed periods, the submission of periodic disclosure is not required
(Article 159(1))

- 111 -

As for the Business Report submission, the business results, etc.


from

the

preceding

business

year

must

be

disclosed

and

submitted to the FSC and KRX within 90 days after the end of
that business year. As for the Semi-annual Report, the business
results, etc. from the first six months of the business year must
be disclosed and submitted to the FSC and KRX within 45 days
after the end of the semi-annual period. As for the Quarterly
Report, the business results, etc. from the first three months and
nine months must be disclosed and submitted within 45 days
after the end of each quarterly term. As for the Main Statements,
matters related to the companys purpose, trade name, business
details,

officer

compensation,

finances,

and

other

matters

determined by executive orders (Article 168 Presidential Decree of


the FSCMA).
In case of a foreign company primarily listed on an overseas
exchange, it should publish the annual business report and
semi-annual/quarterly reports within 10 days from date of reporting
to the overseas exchange.
In case of the violation of periodic disclosure obligation, there are
(i) administrative penalty (kwa-jing kum)(Article 429), (ii) Civil liability
(Article 162), (iii) Criminal liability (Article 444).
(i) Administrative penalty: The FSC may impose the administrative
penalty within the limit of the 10/100 of the average daily trading
amount(no more than 2 billion KRW, if not traded or it is more
than 2 billion KRW) in case of not submitting periodic disclosure
documents or submitting false statement or omission in material

- 112 -

facts in the disclosure materials.


(ii) Civil Penalty: In case of the damages incurred by the person
who acquired or disposed of the securities issued by a company
obligated to submit the business report due to the false statement
in material facts or omission of the material facts in the annual
business report, semi-annual or quarterly report or the documents
attached thereto, the following persons shall be liable: the person
who submitted the

relevant report; the directors obligated to

submit the business report at the time of its submission; the


person falling under the Article 401-2 under the Commercial Code;
the CPAs, appraiser, credit rating agencies who certified with their
signature thereon the descriptions made in the relevant report
were true and correct; a person who consented to the inclusion of
his/her opinion on evaluation, analysis or confirmation in the
descriptions in the relevant report and the documents attached
thereto and confirmed the contents as described therein.
(iii) Criminal Liability: In case of the false descriptions in the
material facts or the ommission of material facts in the relevant
report, the person who

made the false description or omitted the

material facts or who signed the reports with knowledge of the


fact and the CPA, appraiser, credit agencies who certified the
truthfulness or accuracy of the business report with knowledge
shall be punished pursuant to the Article 444. The violation of
business report submission obligations, the violators shall also be
punished pursuant to the Article 446.

3. Timely Disclosure

- 113 -

Timely disclosure is one of the key self-regulatory measures that


the KRX instituted to facilitate the equal access to information
within the securities market on an on-going basis. FSCMA requires
important corporate information be disclosed as it occurs without
delay by implementing the Reports on Material Facts (Article 161).
The Material facts prescribed by the Article 161 include: a full or
partial

suspension

of

company,

application

of

business

rehabilitation plan under the Debtor Rehabilitation and Bankruptcy


Act, transfer of essential business or assets, among others.
Specific corporate matters to be disclosed are stated in the
disclosure regulations promulgated by the KRX. The KRX provides
the disclosure requirements for the Stock Exchange and KOSDAQ
respectively. The listed companies must report the details of
important corporate matters or management decisions to KRX
without

delay.

As

for

the

submission

deadline,

same

day

disclosure must be executed on the day it occurred, while next


day disclosure must be executed within one day.
When there are rumors or news about important corporate
matters and its equivalent, or sudden drastic changes in stock
prices or trading volumes, the KRX stock market can request the
listed corporation concerned to inquire into such rumors/news and
clarify the situation for the fair trading of securities and protection
of investors. The concerned listed corporation must comply with
such requests.

- 114 -

Matters subject to the requirement to inquire and disclose are as


follows.
-

Important

corporate

matters

(Article

of

the

Disclosure

Regulation of KRX-Stock Market)


- Important corporate matters of subsidiaries (Article 8 of the
Disclosure Regulation of KRX-Stock Market)
- Important corporate matters of REITs (Article 9 of the Disclosure
Regulation of KRX-Stock Market )
- Important corporate matters of shipping investment companies
(Article 10 of the Disclosure Regulation of KRX-Stock Market)
- Important corporate matters of SPAC (Article 11 of the Disclosure
Regulation of KRX-Stock Market)
- Matters subject to the fair disclosure (Article 12 &13 of the
Disclosure Regulation of KRX-Stock Market)
- Matters subject to the voluntary disclosure (Article 28 of the
Disclosure Regulation of KRX-Stock Market)
- Matters corresponding to the requested subjects as mentioned
above
As for compliance with the request to inquire and disclose, if a
business receives a request to inquire in the morning, then it must
reply by the afternoon of the same day. If it is received in the
afternoon, then the business must reply by the morning of the
day after. However, if a business receives an inquired disclosure
related to market conditions, then it must reply within a day of
the request.
With regard to matters apart from key management issues (a

- 115 -

portion of which is determined by bylaws), the system allows for


the disclosure of key management information or future plans
based on the self-regulated judgment of the listed corporation.
4. Fair Disclosure

Fair Disclosure rule was introduced in November 2002. The rule


requires

that

if

company

deliberately

discloses

certain

information to selective investors, the same information should also


be disclosed to the general public

in the market before the

information is provided to the selective investors. If the information


is disclosed to selective investors by accident or error, the
company

should

also

provide

such

information

to

ordinary

investors on the same day.

5. Voluntary disclosure

The listed company may disclose in its discretion the information


that might have impact on its business or the investors' investment
decision.

6. Special disclosure

(1) Disclosure of Substantial Shareholding - 5% Rule

A substantial shareholder must make a report to the FSC and KRX

- 116 -

if it holds equity securities totaling 5% or more of the total


number of issued voting shares of a company whose securities
are listed on the KRX (Article 147(1)).

As for its's application, the term "hold" means as follows;


(i) where the equity securities are owned for its own account in
the name of whomever;
(ii) where any claim for the delivery of the equity securities is held
in accordance with the provisions of law or contract (i.e., a legal
or contractual right to acquire)'
(iii) where voting rights (including the rights to instruct the exercise
of the voting rights) of the equity securities are held in accordance
with the provisions of law or contract including money trust or
collateral contract (e.g., security agreements where the collateral
taker holds the voting right);
(iv) where the power to decide on acquisition or disposition of the
equity securities is held in accordance with the provisions of the
laws or contracts including money trust or collateral contracts (i.e.,
dispositive power over the voting rights);
(v) where any right to unilaterally complete the purchase and sale
contract of the equity securities and become the purchaser to the
contract is held (i.e., a legal right to acquire where the conditions
to the contract are within the potential shareholder's control);
(vi) where any call option right whose underlying assets are the
equity securities is held; or
(vii) where employee stock options are held

- 117 -

Equity securities include any of the following issued by the issuer'


:
(i) voting shares;
(ii) warrants for new voting shares;
(iii) convertible bonds which are convertible into voting shares;
(iv) bonds with warrants for new voting shares; or
(v) exchangeable bonds which are exchangeable for any of the
securities set out in (i)- (iv) above.

In addition, any of the following issued by a person other than


the issuer are included in equity securities in applying 5% rules.
(i) securities depository receipts where the underlying securities are
any of those listed (i)- (v) above;
(ii) exchangeable bonds which are exchangeable for depositary
receipts or any or the securities issued by the issuer above; or
(iii) derivative-linked securities whose underlying assets are any of
the securities set out in (i) or (ii) or paragraph above (i) - (v);
provided the person is entitled to acquire the title to the securities
by exercising rights.

Shares that are beneficially owned by the substantial shareholder


but held in a third party's name or held by the substantial
shareholder in any of the other capacities

must be aggregated

with the substantial shareholder's other holdings (Article 147(1) and

- 118 -

133(3)). In addition, the holdings of specially related persons must


be aggregated with whose of the substantial shareholder.

As for the timing of report, if the shareholder's purpose is


participation in the management, it must make either an initial or
subsequent material change report by close of business on the
fifth business day after the disclosable event (Articles 147 (a) and
147 (4)).

If the shareholder's purpose is not participation in management, it


must make an initial report by close of business on the fifth
business day after disclosable event. When there is a change in
the holding of 1% or more of the total shares of the issuer, the
shareholder must make a subsequent report on or before the
tenth day of the month following the month in which such change
took place (Article 154(3)). In addition, a change in the purpose of
the

holding

(from

simple

investment

to

participation

in

management) must be made within 5th business days of the


change.

(2) Disclosure of Proxy Solicitation

A person who intends to solicit the exercise of a voting right by


proxy shall, prior to or simultaneously with the soliciting, deliver a
proxy form and reference materials to the shareholder. Such
person shall also submit copies of the proxy form and reference

- 119 -

materials to the FSC and the KRX no later than 5 business days
prior to the scheduled date for the delivery of such documents to
the shareholder and procured that such documents kept and the
head office, branch and other business offices, etc. during the
period of 5 business days prior to the delivery of such documents
to the shareholder until the date when the shareholder's

meeting

is finished (Article 152 and 153).

The proxy form shall be prepared in such a manner as to allow


each solicited shareholder to express whether it approves or
disapproves each item on the agenda to be resolved at the
shareholders' meeting.

Voting in violation of the above disclosure

rule would constitutes a

cause for the

cancellation of the

resolution at the shareholder's meeting. A person who suffered


damages due to the violation of the disclosure rules may exercise
a tort claim under the Civil Code.

(3) Public Tender Offer/Take-over


Public tender offer means (1) making an offer to a multiple number
of unspecified persons to purchase(including an exchange with other
securities)

voting

stocks

or

any

other

securities

specified

by

Presidential Decree(the Stocks, Etc.) or soliciting them to make an


offer to sell(including an exchange with other securities) the Stocks,
Etc.,

and

(2)

purchasing

them

outside

the

securities

exchange(including a market in a foreign country similar to it).


public

tender

offer

regulations

are

- 120 -

necessary

for

The

protecting

shareholders who may make a hasty decision to purchase the shares


without having sufficient information and providing fair treatment to
the shareholders.
The disclosure obligations for public tender offer prescribed under the
Article 133 (3) are as follows: A person who intends to make
apurchase, etcof the Stocks, etc from 10 or more shareholders
within 6 months, outside the securities exchange shall make a public
tender

offer,

if

the

aggregate

of

the

number

of

stocks,

etc

held(including those owned and similarly possessed, as prescribed


further by Presidential Decree; hereafter the same shall apply in this
Section and Section 2) by him and herself and his/her specially
related persons(referring to those who have a special relationship as
determined by Presidential Decree) or exceeds 5/100 of the total
number of the stocks, etc(including cases in which a person whose
aggregate of the number of stocks, etc. held by the person and
his/her specially related persons reaches or exceeds 5/100 of the
total number of stocks, etc. makes a public tender offer for purchase,
etc of such stocks, etc) : Provided, That stocks, etc. may be
purchased by any means other than public tender offer, in the case
of purchasing, etc. prescribed by Presidential Decree, considering the
purpose and form of purchasing, etc., and the possibility of causing
a detriment to other shareholdersinterests.
The securities eligible for public tender offer which is the term
voting stocks or any other securities specified by Presidential
Decreein Article 133(1) is by the Article 139 of the Presidential
Decree

of the Act means any of the following securities related to

voting stocks: 1. Securities issued by a stock-listed corporation, which


falls under any of the following items: (a) stocks; (b) instruments

- 121 -

representing preemptive rights to new stocks ; (c) convertible bonds;


(d) bonds with warrant; (e) exchangeable bonds with a right to claim
to exchange them with stocks under any provision of items (a)
through (d); (f) derivative-combined securities based on, as the
underlying asset, the securities under any provision of items (a)
through (e)(limited to those with rights to acquire the underlying asset
by exercising such rights); 2. Securities issued by any person other
than a stock listed corporation under subparagraph 1 and falling
under any of the following items: (a) securities depositary receipts
related to securities under subparagraph 1; (b) exchangeable bonds
with a right to claim to exchange them with securities under
subparagraph 1 or securities under item (a); (c) derivative-combined
securities

based

on,

as

the

underlying asset,

securities

under

subparagraph 1 or securities under item (a) or (b).


As for the scope of the specially related person, the term those
who have a special relationship as determined by Presidential
Decreein the Article 133(3) of the Act means specially related
persons and joint holders(Article 141 of the Presidential Decree).

The

possession similar to ownership prescribed under the Article 142 of


the Presidential Decree are as follows: 1. Where stocks, etc are
owned on a personsown account, regardless of in whose name
they are held; 2. Where a person holds rights to claim delivery of
stocks, etc. in accordance with a provision of an Act, as a result of
a transaction, or under any other contract; 3. where a person holds
voting rights(including the power to instruct to exercise voting rights)
of stocks, etc in accordance with a provision of an Act or under a
money trust deed, security agreement, or any other contract; 4.
where a person holds rights to acquire or dispose of the relevant
stocks, etc under a provision of an Act or under a money trust deed,
a security contract, a discretionary investment contract, or any other

- 122 -

contract; 5. Where a person holds rights to complete a trade by


unilateral reservation for trading stocks, etc and acquires the status
of purchaser by exercising such rights; 6. Where a person holds
contractual rights under Article 5(1) 2 of the Act to a contract for an
underlying asset of stocks, etc and acquires the status of purchaser
by exercising such rights: 7. Where a person holds stock options and
acquires the status of purchaser by exercising such option.
As for the exemption for public tender offer regulations, the Article
133 (3) of the Act and the Article 143 of the Presidential Decree
allows some exceptions for public tender offer rules. The stocks, etc
may be purchased by any means other than public tender offer, in
the case of purchasing, considering the purpose and form of
purchasing, etc and the possibility of causing a detriment to other
shareholdersinterests and these are as follows: 1. Purchase etc of
stocks, etc for the purpose of retirement; 2. purchase of stocks in
response to the exercise of appraisal rights; 3. purchase etc of
stocks, etc by exercising rights to instruments representing preemptive
rights to a new issue of stocks, convertible bonds, bonds with
warrant, or exchangeable bonds; 4. purchase, etc of stocks, etc by
exercising rights to derivative-combined securities; 5. purchase, etc of
stocks, etc from a specially related person; 6. purchase of stocks by
intermediating a trade of securities in accordance with Article 78(1) of
the Act, 7. Purchase, etc of stocks, etc specified and publicly notified
otherwise by the Financial Service Commission as cases unlikely to
undermined other investorsinterests.
As for the procedure for public tender offer, the public tender offer
usually starts with the public notice of public tender offer(Article 13)
and filing of the public tender offer statement to the FSC and the

- 123 -

Korea stock exchange(Article 134).

Then, the public tender offerer

need to send the copy of public tender offer statement to the issuing
corporations after submitting it to the Korea stock exchange(Article
135).

After preparing the public tender offer prospectus and keeping

it for public inspection, the public tender offer starts. Accepting offers
are made during the public tender period(more than 20 days after
the public tender offer period starts)(Article 137). Then pro rata
allocation(in case of the over limit offers are made) or purchase for
stocks are made. The public tender offerer send the public tender
offer notice to the tendering shareholders and file the public tender
offer result report to the FSC.
In case of violating the tender offer regulations, the person who
violates Article 133(3) or 134(1) or (2) in purchasing stocks and etc,
may not exercise voting rights for the stocks(including the stocks
acquired by exercising any right related to the stocks, etc) from the
day of such violation, and the FSC may issue an order to dispose of
such stocks, etc(including the stocks, etc acquired by exercising any
right related to the stocks etc) within a given period of time, not
exceeding 6 months(Article 145). The Financial Supervisory Service
have several measures for investor protection including the inspection
of the accounting books, documents, and other materials of tender
offerers and his/her specially related persons or tender offer agent,
and other related persons(Article 146(1)) or ordering the tender offerers
and his/her specially related person or tender offer agent to disclose
relevant facts to the public and making a correction and suspending
or prohibiting purchasing through the tender offer or taking any
measures

in

case

of

violating

the

tender

offer

public

notice

requirement under Article 136(5) or false description or omission of


material fact in the tender offer public notice(Article 146(2)).

- 124 -

The FSC also can impose penalty surcharge on violation in tender


offer public disclosure within limit of 3/100 the total amount of
contemplated

purchase

written

on

the

relevant

tender

offer

statement(or 2 billion won if the amount exceeds 2 billion won)


pursuant to Article 429(2).
The tender offerors liability for damage is prescribed under Article
142. As for the criminal sanction, the person who made a false
description or representation of a material fact in a public notice or
document such as public notice of tender offer or tender offer
statement, corrective registration statement or public notice, tender
offer

prospectus(Article

444

item

15)

shall

be

sentenced

to

imprisonment fro not more than 5 years or to fine not exceeding


200 million won.

7. Submittal of disclosures

A listed company shall submit its disclosure via the FSS's electronic
disclosure system DART (Data Analysis, Retrieval and Transfer
System)

or the

KRX's

KIND

Korea

Investor's Network for

Disclsoure System), depending on the type of disclosures.

When a report is made to the FSS via its DART System, it shall be
regarded as having also been made to the KRX.

webpage
Disclosure

submittal

FSS' s DARY System


http://dart.fss.or.kr
http://filer.fss.or.kr

- 125 -

KRX's KIND System


htp"//kind.krx.co.kr
http://kind-filing.krx.co.kr

system

- 126 -

Chapter 6
Unfair

Trading:

Insider

Dealing,

Misleading

Statements, Market Manipulation, Unjust Trading


and Unfair Practices
I. Overview
The FSCMA aims at the creation of an effective market for, and
the fair trading of, financial investment products.
on

The prohibitions

unfair trading, as well as the public disclosure system and

the regulations on the financial investment companies, contribute


to

realize

its

goal.

The

principle

underlying

the

regulations

governing the financial investment business (including expanding


the scope of financial investment products and finance investment
business area) is sufficient investor protection. FSCMA improved the
regulation
investment

of

fraudulent

products

and

transactions
introduced

with

multiple

comprehensive

financial
anti-fraud

provisions to regulate fraudulent transactions that are difficult to


regulate through traditional insider trading regulations and price
manipulation regulations.
The regulations on unfair trading under FSCMA are divided into

- 127 -

the following three types:

(i) Insider Trading (Article 174), (ii)

Market Price Manipulations (Article 176), (iii) Unjust Trading-general


fraudulent activities (Article 178).

The previous Securities and

Exchange Act prohibited 2 types of unlawful transactions: insider


trading and price manipulations.

FSCMA introduced a new

provision prohibiting the general fraudulent transactions.

FSCMA

maintains the basic structure of the regulations under the SEA, but
expands the scope of insiders, financial investment products and
trading subject to the regulations.
The securities subject to unfair trading regulations are (i) securities
(excluding the ordinary corporate bonds and beneficial securities)
issued by that corporation; (ii) securities depositary receipt related
to the securities (i) above; (iii) exchangeable bonds issued by a
company other than that corporation which can be exchanged
with (i) or (ii,; and (iv) a financial investment product whose
underlying assets are only the (i), (ii), or (iii), which are derivatives
linked securities, exchange traded derivatives and OTC derivatives.
Under the previous SEA, only the securities issued by that
corporation was regulated, but FSCMA covers the securities whose
underlying assets are the securities related to that corporation.

II. Prohibiton of Insider Trading


The stock trading by insiders itself is not unfair trading, but if an
insider takes advantage of non-public material information, then it
falls under unfair trading. The insider trading regulations are
necessary for fairness and market integrity since (i) insider trading
undermines the integrity of the markets and (ii) the delay in timely

- 128 -

disclosure of information leads the investors to discount the


securities prices of companies and will therefore increase costs of
funding on the part of the issuer.
The FSCMA expanded the scope of insiders and quasi-insiders
who are subject to the insider regulations provisions by adding
persons such as companies affiliated to the issuer, their officers
and employees, and persons who are negotiating with the issuer
(Article 178(1)). The insider in insider trading encompasses corporate
insiders, quasi-insiders, and tippees.
"Insider" refers to (i) the corporation3) (including its affiliated
company4)) or its officer, employee or agent who becomes aware
of the material nonpublic information in the course of performing
its business, (ii) a major shareholder5) of the corporation (including
an affiliate of the corporation) who becomes aware of the material
non public information in the course of exercising ones right, (iii)
an agent, officer or employee of such major shareholder who
becomes

aware

of

the

material

nonpublic

information

in

connection with its business.


"Quasi-insider" refers to (i) a person who has the legal authority to
grant approval or license, give instruction, or supervise the
corporation (including its affiliate company) or has any other power
pursuant to the relevant laws and regulation, and becomes aware
3) includes a corporations which will be listed within 6 months
4) affiliated companies under the Fair Trade Act
5) a shareholder whose shareholding ratio is 10% of more, or who exercises de
facto impact on the material non public information in connection with its
business

- 129 -

of the material nonpublic information in the course of exercising


such authority or power, or (ii) a person who has entered into a
contract with the corporation (including its affiliate company) or is
under contract negotiation with the corporation (including its
affiliate company) and who becomes aware of the material
nonpublic information in the course of entering into, negotiating or
performing such contract.
"Tippee" refers to a person who deliberately received material
nonpublic information from an insider or quasi-insider (including a
person in whose case one year has not passed from the day
when such person no longer fall under any of the insiders and
quasi

insiders)

with

knowledge

of

the

importance

of

such

information. However, the third person that receives information


from a tippee and then trades using that information(2nd or 3rd
tippees) is not regarded as an insider.
"Material nonpublic information" refers to any information that has
not been yet disclosed to the general public and may have
significant impact on the investment decision by investor. The
material non public information that is related to the business. etc
of a listed company(including a company which will be a listed
company within 6 months) does not include market information
such as change of securities policy or interest rate policy. Article
174(1) of FSCMA prescribes that no person shall use any
material nonpublic information in trading or any other transaction
involving specific securities, etc, nor allow any another person to
use it. Whether the material information is nonpublic or not
depends on the time of disclosure of such information to the

- 130 -

general public and it is defined the disclosure time of information


in the Presidential Decree as follows:
(i) Information reported to the FSC or the KRX or described in a
document reported; one day after the document is made available
for inspection as decided by the FSC or the KRX;
(ii) Information disclosed through an electronic communication
medium established and run by the FSC or the KRX: 3 hours after
disclosure
(ii) Information published through 2 or more newspapers circulated
nationwide

among

ordinary

daily

newspapers

and

daily

newspapers specializing in the economy: 6 hours after 0:00 of the


day after publishing;
(iv)

Information

broadcast

through

television

or

radio

with

nationwide coverage: 6 hours after broadcast; and


(v) Information provided through Yonhap news: 6 hours after
provision.
Therefore, any person who uses the material information before
the disclosing deadline is in violation of the prohibition of use of
material nonpublic information.
An executive or significant shareholder of a listed company shall
report to the SFC and KRX the status of specific securities held in
their own account within 5 days from the day they became an

- 131 -

executive or a significant shareholder respectively or within 5 days


from the day any change occurred (Article 173). The FSC and KRX
shall then disclose the information on their web sites, and it
enables the market participants to watch the trading of insiders of
company and inspect whether an executive or a significant
shareholder of a company is conducting insider trading using
nonpublic information.
As for the short-swing profit by a insider, FSCMA stipulates the
return of the short-swing profit. If an executive, employee or a
significant shareholder of a listed company profits by purchasing
financial investment instruments and then selling them or vice
versa within 6 months, the company may require the executive,
employee, or the significant shareholder to return the profits to the
company (Article 172). A shareholder may demand that the
corporation make a claim against the insider concerned and or
shareholder may make such a claim on behalf of the company if
the company does not file a suit against the person concerned
within 2 months of receiving the demand. This obligation to return
the short-swing profit is not related

to the willful use of non

public information by a corporate insider, but it is nonetheless a


preventive measure for insider trading.

III. Market Manipulation


Market price manipulation is the act of artificially changing market
prices or trading volume in order to mislead person about the
price of listed securities or exchange-traded derivatives for the

- 132 -

purpose of making profit from it.


Types of market price manipulations are (i) matched sales/wash
sales (Article 176(1)), (ii) manipulation through real transactions
(Article

176(2)(i)),

(iii)

manipulation

by

false

representations,

etc(Article 176(2) (ii) and (iii), (iv) manipulation through price fixing
or stabilization(Article 176(3)).

It not only covers artificial market

price change through actual dealings, but also acting with the
purpose to cause any person to misunderstand that the trading of
listed

stocks

or

exchange-traded

derivatives

is

booming,

or

misleading any person into making an incorrect assessment.


For example:
- Selling (purchasing) securities or exchange-traded derivatives in a
conspiracy

with

another

person

to

sell

the

securities

or

exchange-traded derivatives at the same price as theirs, or at


an agreed value at the same time as they sell(purchase) them;
- Appearing to trade securities or exchange-traded derivatives
without the intention of transferring the interest or rights therein;
and
- Entrusting or being entrusted with an act set forth below.
Also, the selling or purchasing with purpose to fix or stabilize the
market price is also prohibited, except for transactions in the stock
market or KOSDAQ market for the purpose of pegging or
stabilizing the price of securities as part of lawful stabilization and
market-making during the specified period of time not exceeding
30 days prior to the end of subscription period, or not exceeding
6 months from the day on which the securities were listed. The

- 133 -

investment trader shall prepare a report on manipulation for


stabilization describing the trading name of the investment trader,
the issue of securities describing the trading name of the
investment trader, the issue of securities subject to manipulation,
trading price, details of trade, day, time and the period of
manipulation for stabilization to the FSC and KRX.
Table

19

PROHIBITED

ACTS

OF

MARKET

PRICE

MANIPULATION
Act of manipulation

Detail
acts resulting

committing

in

any

person misunderstanding that the


trading

false trading

of

listed

stocks

are

booming; or to mislead any person


into making a wrong judgement
selling, purchasing, entrusting or
being entrusted with the sale or
purchase

actual trading

of

such

securities

or

derivatives to cause fluctuation in


the market price in order to attract
any person
Disseminating

rumor

that

fluctuation in the market price for


such securities or derivatives are
being caused by his/her or another
false or misleading representation

persons market manipulation; and


making

false

or

misleading

representation concerning a material


fact in trading such securities or

fixing or stabilizing market price

exchange-traded derivatives
selling or purchasing listed securities
or exchange-traded derivatives to fix

- 134 -

or

stabilize

the

market

price;

entrusting or being entrusted with


such an act

As

for

the

manipulation

introduction
(Article

of

176(4)

regulations

on

of

Article

FSCMA,

the

cross-market
207

of

the

Presidential Decree), the FSCMA prohibits (i) the price manipulations


in either the securities or futures market to earn profit from the
other market, (ii) price manipulation in either derivatives-embedded
securities or the underlying securities for the purpose of making
profit under the other securities.
According to the Article 176(4), no one shall commit any of the
following acts in connection with trading listed securities or
exchange-traded derivatives:
(i) Causing a fluctuation in, or fixing, the market price of
underlying assets of certain exchange-traded derivatives for the
purpose of earning, or causing a third party to earn unjust profits
from trading such exchange-traded derivatives;
(ii) Causing a fluctuation in, or fixing, the market price of
exchange-traded derivatives for the purpose of earning, or causing
a third party to earn, unjust profits from trading the underlying
assets of such exchange-traded derivatives; and
(iii) Causing a fluctuation in, or fixing, th market price of securities
which are linked to certain securities and specified by Presidential
Decree for the purpose of earning, or causing a third party to
earn, unjust profits from trading the securities.

- 135 -

The recent

issue related with potential manipulation of the

securities as the underlying assets of an ELS reflects this sort of


concern. Whether and under what circumstance trading of shares
as underlying assets of an ELS would constitute price manipulation
is not only related to the scope of hedging activities of ELS but
also related to the interpretation of specific text of the provision of
the FSCMA.6)

IV. Unjust Trading and other Types of Unfair Trading


The general provision prohibiting unfair trading was first introduced
in the FSCMA.

Unjust (unfair) trading refers to using unfair

means, schemes or tricks; attempting to earn money or any


interest in property by using a document containing

false

description or false representation of a material fact necessary for


preventing others from being misled; using inaccurate market
prices with the intention to attract others to trade or make any
other

transactions

in

financial

investment

instruments;

or

disseminating a rumor, using a deceptive scheme or making a


threat with the intention to trade or make any other transaction in
financial investment securities or attempt to cause a fluctuation in
the market price (Article 178).
A person who incurs damages inflicted by unfair trading has the
right to a claim for damages. The right to a claim for damages
6) Joon Park, p. 125, Consolidation and Reform of Financial Market Regulation in
Korea, Vol 6:1 National Taiwan University Law Review, 2011

- 136 -

ceases by prescription if the claimant does not exercise the right


within one year form the time he or she becomes aware of the
fact, or within three years form the time such an act was
committed.
A Person who committed unfair trading is subject to punishment
by imprisonment for up to 10 years, or a fine for up to KRW
500m.

However, when three times the amount of the profit or

loss derived from unfair trading exceeds KRW 500 mn, the fine is
three times the amount of the profit or loss derived from such
unfair trading.
There are other types of unfair trading regulations stipulated under
FSCMA as follows. (i) The discretionary sale by an officer and
employee of a financial investment service company(Article 70); (ii)
Illegal sales by an officer and employee of an financial investment
service company (Article 63) and etc.
Discretionary trading and excessive trading are the most common
disputed issues between the investors and brokers. Discretionary
trading is prohibited under the FSCMA as prescribed by Article 70,
no investment trader or investment broker shall trade financial
investment instruments with property deposited by an investor in
the absence of an order for the trading of such financial
investment instruments from the investor or his or her agent.
Excessive trading is the practice where a broker purchases and
sells stocks excessively in its size and frequency in view of the
financial resources of such customer in order to get more
commission, not in the best interest of the customer. Discretionary

- 137 -

trading and excessive trading commonly occurs since the practice


of getting commission based on the frequent trading is based on
the conflict of interests between the customer and broker. Even
though when an investor has entered into discretionary investment
contract with a broker, if the broker practices excessive trading in
view of the scope and purpose of the investment, it can be
deemed as excessive trading and regulated by the FSCMA.

- 138 -

Chapter 7
Regulation of OTC Derivatives
I. Overview
The FSCMA defines financial investment products by adopting an
inclusive approach for the different types of financial products
(Article 3) and there are 4 elements for the financial products: the
intention of investment, investment risk, transfer of money and
rights stipulated in an agreement. Specifically, investment risk
refers to the possibility that the total amount of money paid or
payable for acquiring the financial instrument may exceed the total
amount of money recovered or recoverable from the financial
investment products, and the possibility exists of losing principal
subject to the FSCMA.
A derivative is a financial investment product that is derived from
other assets, which are called the underlying assets (Article 5).
There are 3 types of basic forms of derivatives: forwards (futures),
options, swaps. A forwards contract is an agreement to buy or
sell an asset on or before a future date at a price specified at
the time of the agreement. An option is a contractual rights given
to an individual allowing him or her to buy or sell an underlying
asset at an agreed price on or before a certain date.

Derivatives

can also be classified into exchange-traded derivatives and OTC

- 139 -

derivatives.
Table 20 TYPES OF DERIVATIVES

Types
Forwards/future

Options

Swap

Interest

rates

Interest

futures/ FRA
c u r r e n c y

options

Foreign currency

futures/forward

currency options

Stock/Stock

exchange
Stock(Stock index)

Stock(Stock index)

index swap

futures

options

Credit

CDS, TRS, CLN, Syndicated CDO, etc

Others

ELW, ELS, DLS, etc

Underlying
assets
Interest rates

rate

Interest

rate

swaps
c u r r e n c y
swaps/FX swaps
Equity swaps

Table 21 COMPARISON BETWEEN EXCHANGE-TRADED AND OTC


DERIVATIVES
Category
types

Exchange-traded
derivatives
futures, options
trades in an exchange

transaction method

forwards,

options,

swaps
negotiated

between

where open trades or parties


an

electronic

standardized

- 140 -

in

trading transaction

system creates prices


transaction terms

OTC derivatives

the
privately

and individually

with customized according to

specified

underlying

assets, transaction units


and settlement months
for

trading

on

exchange
transparent

price transparency

disclosed real time


not specified

price

changes frequently

transactions

of

clearing house
daily settlement

credit risk

non-transparent
must be specified
agreed once contract is
made

clearing houses

counterparty

available to the general


public

involved
done at an exchange
does not exist as the

available

indiviuals or small and


medium

sized

enterprises with

lower

credit rating
not involved
not done
always exists

the

house

as

act

on

a is
all
are

closed

the

before

through

cash

settlements,

and

dependent

reliability

only

most
settled

contracts
by

as

are

physical

delivery at expiration

bid-ask spread
agreed
specified as a particular not specified

- 141 -

the
of

are held to expiration


for physical delivery
brokerage
fee

on

counterparties

contracts
most
contracts

some of the contracts

settlement date

as

clearing execution of a contract

contract expiration date

transaction fee

to

exchanges
counterparty

margin

by

transaction parties

not
market participants

made

and relatively

counter party

guarantee

an

decisions

date in the month of


expiration
regulated

by

the

government, association freely

regulation

and the exchange

While Koreas listed derivatives trading volume, with 3.9 billion


transactions annually, accounts for approximately 20% of the world
total, this is in stark contrast to the nations OTC derivatives
market, which accounts for just 0.2% of the world total.

The

trading volume of the Korean derivatives market has shown steady


growth in major derivatives products, increasing by 4.8%, and the
Korean market now makes up 15.7% of all derivatives traded
globally.
In

terms

of

the

total

balance

accounted

for

by

derivative

transactions, derivative transactions developed as follows.


(unit: billion KRW)

the end of 2006

the end of 2008

the end of 2010

2590000

6010000

7022000

* Source FSC press release 2011

In 2008, the FSC announced its policy statement to improve the


monitoring system in the derivatives market, reinforce investor
protection systems that

fit

for the products characteristics,

prevent the insolvency of financial institutions and the systemic

- 142 -

risks which may arise from derivative transactions, and re-establish


supervisory functions over the derivatives markets. Reflecting the
global financial crisis arising from the non-performing loans from
securitized mortgage backed securities

and credit derivative

transactions, as well as the domestic disputes related with the


KIKO transaction and other derivative investment funds, the FSC
viewed the

introduction

of

a proper

supervision system

derivatives market in Korea as essential.


Figure 6. DERIVATIVES TRADING VOLUME

- 143 -

for

According to a 2010 press release of the FSC, its policy agenda


regarding the OTC derivative markets is as follows.

Table 22 FSC's POLICY AENDA REGARDING THE OTC DERIVATIVE


MARKETS
future plans

specific description

creating trading infrastructure

legal implementation

standardizing OTC derivatives

other OTC derivatives infrastructure

TF will conduct a through research to


find the best suitable infrastructure for
OTC derivatives trading in the Korean
derivatives market
revision of the FSCMA to provide legal
ground for a CCP which specify a
definition of clearing, conditioning
for establishing CCP and measure to
secure public interest
For CCP clearing purpose, the OTC
derivatives such as IRS, CRS, CDS will
be standardized
further efforts to be made for
enhancing existing system or to create
a new trading info depository, trading
platform, and other OTC infrastructure,
considering global trend

II. Strengthening Investor Protection in OTC Derivatives


Trading
There are several provisions in the FSCMA for strengthening
investor protection.

- 144 -

(1) A listed company is treated as a non-professional investors for


the purpose of OTC derivatives transactions unless it agrees
otherwise (Article 9(5)(iv)).
(2) When selling derivative products to non-professional investors, a
financial investment service company is required to comply with
the appropriateness principle without making any recommendation
or solicitation to make an investment. If the product

is not

appropriate to the non-professional investor, the company must


inform the investor of (i) information on the product, (ii) the risks
of investing in

the product, (iii) the fact that the product is not

appropriate to the investor on the light of his/her purpose of


investment, the level of wealth and investment experience, and
obtain a confirmation from the investor that the investor was so
informed (Article 46(2)).
(3) A financial investment service company may enter into OTC
derivatives with a non-professional investor only for hedging
purposes as prescribed by the Presidential Decree of the FSCMA,
and is required to confirm such purpose and retain related
documents (Article 166(2)).
(4) The investment recommendation on derivatives cannot be
entrusted to an agent (Article 55(1)).
(5) A financial investment service company is required to prepare
differentiated standards and procedures for derivative products by
reference to the types of investors, taking into consideration the

- 145 -

investment purpose, level of wealth, experience in investment,


etc(Article 50(1)).

III. Strengthening the Internal Control on the OTC Derivative


Business
The internal control system which a financial investment service
company must establish was also reinforced. (i) A company which
is engaged in a dealing or brokerage/arranging business with
respect to OTC derivatives, and (ii) a company which is engaged
in a dealing or brokerage/arranging business with respect to
exchange-traded derivatives and has total assets of not less than
100 billion won must have one or more executive officer in charge
of derivatives business (Article 28(2)) of the FSCMA, Article 32-2(1)
of the Presidential Decree).
Each OTC transaction must be approved by said officer unless the
transaction satisfies certain requirements prescribed by the FSC
(Article 166-2(1)(iv)).
In addition, the "Model Guidelines on dealing in Derivatives" has
been amended to reflect the current changes in the derivatives
markets and its institutional developments in June 2011. Since the
size of derivatives market has been rapidly growing and the
structures of the derivatives have become more complex and
diversified, it has

become necessary to

management systems.

- 146 -

improve the risk

Since the execution of the FSCMA, the regulations on the business


activities related to financial derivatives products have been more
strict than those related to average financial products, and the
investor protections relating to derivative transactions became more
important than ever. Accordingly, the FSS revised the Model
guideline for derivatives.
The model guidelines have been commonly adopted for setting the
target levels for conducting business properly, and the FSS and
financial institutions including banks, securities firms and insurance
companies participated in preparing the model guidelines, which
were created in December 2006. The model guidelines cover
various kinds of businesses, risk management of derivatives,
valuation of the derivatives, key points in dealing with derivatives,
and the investor protections among others.

IV. Advance Review of OTC Derivatives Products


The OTC Derivatives Product Review Committee was established by
the Korea Financial Investment Association, and must review in
advance (i) the underlying assets of OTC derivatives for their credit
risk (a change in credit owing to a change in credit rating,
bankruptcy, or debt restructuring of a party or a third party) or
their risk linked to natural environmental or economic phenomena
and (ii) the OTC derivatives to be sold to non-professional investors
(Article 166-2(1)(vi)). During the advance review period, the OTC
Derivative Product Committee must take into consideration the

- 147 -

possibility of providing information about price changes of the


underlying asset in case of OTC derivatives classified as (i) above.
In case of OTC derivatives targeting non-institutional investors as
classified as risk hedging, its risk hedging structure, the adequacy
of explanatory materials to be distributed to the investors, the
appropriateness of the marketing plan (including qualification and
education of marketing personnel)

shall be reviewed (Article

288-2(4)). Other investor protection matters are also considered.

V. Introduction of the CCP system


At the G20 Pittsburgh Summit on Sep. 25th 2009, the G20 made
its statement on OTC derivatives markets. It urged the Financial
Stability Board (FSB) and members to enforce a system for
improving the transparency of market, decreasing systemic risk,
and preventing unfair transactions. The details are as follows.
By the end of 2012 at the latest, all standardized OTC derivatives
deals such as IRS, CRS, and DRS should be concluded on
exchange or on an electronic trading platform and should be
cleared through the CCP (central counterparty) clearing house. All
OTC derivatives should also be reported to trade repository. The
derivative commodities which are not reported should be rigorously
subject to the capital requirement law.
Korea is lagging behind in the area of OTC derivatives markets
compared to developed countries both in quantity and in quality.
Owing to an under-developed dealer market led by domestic
financial companies, the role of agent is restricted to an end user

- 148 -

or just selling and distributing, not developing and supplying.


Furthermore, the main financial infrastructure which is debated
internationally is still not propagated. OTC derivatives CCP clearing
houses and electronic trading platforms do not yet exist.
However, the financial authorities operate a separate financial
derivatives reporting system. The Bank of Korea manages the
foreign exchange system and the Financial Supervisory Service (FSS)
collects and compiles the reports on derivatives transactions. The
financial investment companies in Korea

must file a derivative

business report to the FSS (Article 34 of the CMA, the Article 36 of


the Presidential Decree), which is different from other supervisory
tools that finance companies use to submit raw data. In addition,
the FX reporting system

under the Article 25 of the Foreign

Exchange Transactions Act requires the financial institutions to


report FX related information to the BOK, as the central agency for
FX related information. Almost all financial institutions engage in
OTC derivative business are included in this category and thus
obligated to report to the BOK.
To further expand the OTC market, the Korean government is
supposed to introduce a central counterparty (CCP) clearing house
by end of 2012 under KRX. This will be a major step in taking
the OTC derivatives market to a level on par with other markets
around the world. After the implementation of the CCP, the market
is expected to offer increased security and transparency. The FSC
has announced that the KRX will serve as the CCP for OTC
derivatives.

The KRX has launched to develop trade data

management and reporting system for OTC derivatives, and will

- 149 -

perform a role of Trade Repository of trades to be cleared by CCP


mandatory clearing transactions. According to the plan, after
trades are cleared by the CCP, then the CCP will report the
trading details to the FSC.

- 150 -

Chapter 8 Collective Investment Schemes


I. Basic Definition of Fund as Collective Investment Scheme
and other Fund related

definitions

The FSCMA defines a fund as a collective investment scheme, that


is a vehicle for collective indirect investment where a pool of
money

sourced

from

various

investors

is

collected

into

an

investment fund that is managed by professional fund managers


or

asset

management

companies.

The

returns

from

the

investment are then shared among the investors.


The Article 6 defines the term collective investment business
as a business making collective investment (Article 6(4)). Then the
Article 6(5) defines collective investments as the activities of
acquiring, disposing of, and managing in any way such assets as
ate valuable for investment with money or similar pooled by
inviting 2 or more persons for such investment, or with a surplus
fund under Article 81 of State Finance Act, without being bound by
management instructions given from time to time by investors or
by any fund management entity, and distributing the yields
therefrom to vest in investors or any fund management entity,
provided

that

case

falling

under

any

of

the

following

subparagraphs shall be excluded:


(1) Money or similar is pooled through private placement for
management and distribution in accordance with the Acts

- 151 -

specified by Presidential Decree and the total number of


investors specified by Presidential Decree does not exceed the
number prescribed by Presidential Decree;
(2) Money or similar is pooled for management and distribution in
accordance with an asset-backed securitization plan under
Article 3 of the Asset-backed Securitization Act:
The case falls within any case prescribed by Presidential Decree,
taking into consideration the nature of the activities, the need to
protect investors, etc.
The Article 9(18) defines the term collective investment scheme
as any of the following schemes established for making collective
investment:
(1) A collective investment scheme in the form of a trust, in which
trustors, who are collective investment business entities, require
a trust business entity to invest and manage the property
entrusted to the trust business entity in compliance with
instructions

provided by the

collective

investment business

entities(investment trust)
(2) A collective investment scheme in the form of a stock company
under the Commercial Act(investment company)
(3) A collective investment scheme in the form of a limited liability
company under the Commercial Act(investment limited liability
company)

- 152 -

(4) A collective investment scheme in the form of a limited


partnership company under the Commercial Act(investment
limited partnership company)
(5) A collective investment scheme in the form of an associate
under the Civil Act(investment association)
(6) A collective investment scheme in the form of an undisclosed
association under the Commercial Act(undislcosed investment
association)
(7) A collective investment scheme in the form of a limited
partnership company that invests and manages its fund in
equity

securities,

etc.

for

participation

in

management,

improvement of business structure, corporate governance, etc,


by

issuing

equity

securities

only

through

private

placement(private equity fund)


"Privately placed fund means a collective investment scheme that
issues

collective

investment

securities

only

through

private

placement, in which the total number of the investors specified by


Presidential Decree shall not exceed the number prescribed by the
Presidential Decree (Article 6(19)).
"Collective investment property means that the property of a
collective investment scheme, the property of an investment trust,
an

investment

company,

an

investment

limited

partnership

company, an investment association, or an undisclosed investment


association (Article 6(20)).

- 153 -

"Collective investment securities means instruments by which the


equity shares in collective investment scheme(referring to the
beneficial interest in the case of an investment trust) are indicated
(Article 6(21)).
"Collective investment agreement means an agreement that
provides for the organization and management of a collective
investment scheme and the rights and duties of investors therein,
which means the trust contract of an investment trust, the articles
of incorporation of an investment company, an investment limited
liability company, or an investment limited partnership company, or
the association agreement of an investment association or an
undisclosed investment association (Article 6(22)).
"General meeting of collective investors

means a decision

making body composed of all investors in a collective investment


scheme, that is the general meeting of beneficiaries, the general
meeting of shareholders, the general meeting of partners, or the
general meeting of undisclosed members (Article 6(23)).

II. Characteristics of Funds


The outstanding characteristic of a fund is that the provider of the
investment asset is separate from the manager of the asset. As a
result, the role of the investor is limited while the investment is
being conducted. This kind of separate structure can be found
when an individual, the provider of assets, entrust his/her own
assets to a professional asset manager. However, funds are

- 154 -

different from this type of investment in that investments from


many different investors, not a single investor, are combined into
a pool that is managed by a professional asset investment
manager. Funds also different from investment arrangements made
by a group of investors combining their assets, as funds are
managed by professional managers.
Another characteristic of funds is that the investment assets are to
be

clearly

separated

from

management

company.

separation,

funds

any

Depending

are

other

assets

on

classified

the
as

of

legal

an

asset

method

either

of

trust-type

(contractual)funds that use trusts as the method of separation or


mutual funds that are established by selling shares of a fund to
investors. A mutual fund is given a corporate entity while a
trust-type fund is not.
The rationale for fund investment can be understood from both
legal

and

economic

perspectives.

From

legal

perspective,

acquiring stocks of a corporation through fund investment is


regarded as a legal act, since it concerns the obtaining of a
companys shares by providing capital. From an economic
perspective, fund investment is an act of purchasing an investment
product by investors seeking to achieve profits from investment in
indirect

investment products,

rather than participation

in the

companys management.
From a financing perspective, funds lie somewhere between
traditional indirect financing and direct financing. Like banks, the
funds act as the indirect financing institution, pool capital from
investors and act as an intermediary in the flow of money. But

- 155 -

the funds issue securities unlike banks, and due to this character,
the funds are categorized as a type of financial product. The
funds can make limited investments on a limited range of assets
such as securities and real estate to meet their fundamental
purpose of achieving a specific investment goal, which is different
compared with banks. Also, the bank loans are given back to
customers in an undisclosed market, while the fund investment is
performed in an open market. So the funds have the certain
characteristics of direct financing.
Based on several characteristics of collective investment schemes,
legal standards

applicable to the collective investment schemes

are as follows.
(1) Since it is a vehicle for managing and operating assets of
investors, the protection and the management of trusted assets
and the separation between the

custody and the management

shall be essential (Article 184, 244, 246(3) of the FSCMA, Article 21,
22, 23, 19 of the Trust Act). In this regards, the registration of the
collective investment schemes is required (Article 119, 76(3)) and
the supervision on the collective investment business are very
important. Also, for protecting investors, it is necessary to ensure
for investors to exercise their individual rights and collective rights
through the general meeting of collective investors (Article 87, 184).
(2) Since funds are dealing with lots of customers, the supervision
of investment business, the disclosure obligation of the collective
investment business (Article 89, 90), the obligations to provide
information to investors are required (Article 46-52, 59, 60, 71, 88).

- 156 -

(3) Since funds are regarded as a major market participant, it is


very important to prevent the possibility of engaging in unfair
trading of by the funds

in order to maintain market order. Also

the exercising voting rights by funds can have a great effect on


the corporate governance structures.

III. Legislative History of Funds and Regulatory Changes


under FSCMA
The history of funds in Korea started in 1969 with the enactment
of the Securities Investment Trust Business Act and the regulation
of the asset management industry by the Indirect Investment and
Asset Management Act (IIAMBA-2004). The introduction of FSCMA
brought many key changes to the asset management industry by
adopting a comprehensive definition of financial products, and
permitting

financial

companies

to

operate

different

financial

investment services concurrently in previously separate business


areas.
First of all, the legal forms of collective investments have been
expanded to include any form of investment scheme permitted
under the Civil Act or the Commercial Act, such as limited
partnership companies, limited liability companies, associations
under the Civil Act, and undisclosed associations under the
Commercial Act. The scope of the assets used in a collective
investment scheme was also expanded to include any assets with

- 157 -

monetary value. The restrictions on the types of assets allowed for


investment by each collective investment scheme have also been
eased.
In addition, as the FSCMA broke the barriers between the 6 major
areas of financial business, the funds can offer multiple forms of
investment services concurrently.
As for the strengthened investor protection perspective, the FSCMA
stipulates that a financial investment entity shall confirm the
investors suitability for the investment instrument in question and
set forth measures for preventing conflicts of interests that might
arise among various participants involved in investments.

IV. Classification of Funds


Funds can be classified into different types by a diverse range of
standards including a funds legal entity, possibility of an
additional purchase of securities, availability of early redemption,
offering method, investment region and Investment assets.
As for the legal entity, funds can take the form as an investment
trust, a corporation and an association. Depending on whether the
additional purchase of stock is allowed, funds can be classified
into open-type funds and unit-type funds.
Open-ended funds allow investors to trade their shares at anytime,
while the close-ended funds do not. As for inviting investors,
publicly offered funds are established by offering securities to the

- 158 -

general public, while private equity funds are only offered to select
investors with no more than 49 individuals (Article 268-279). There
are also domestic funds and overseas instruments, depending on
the investment region.
Table 23 CLASSIFICATION FUNDS BY INVESTMENT ASSETS
type

investment assets
b o n d
type
equity
type
hybrid
equity

securitie s

type
hybrid

fund

b o n d
type
investme
n

contract
securitie
s
fund of funds

60% or more of total assets invested in bonds


60% or more of total assets invested in equity
securities
maximum equity portion of total assets is 50%
or more
maximum equity portion of total asset is 50% or
less
60%

or

more

of

total

assets

invested

in

collective investment contract securities. If the


figure stands lower than 60%, the fund is
categorized as a hybrid equity type
40%

or

more

of

total

assets

invested

in

collective investment securities


free to include any ratio of securities in its

s h o r t - t e r m

investment assets that are mostly composed of

finance(MMF)

short-term financial instruments such as call


loans, CPs and CDs
50% of more of total assets in the collective
investment scheme invested in real estate in the

Real-estate fund

form of loans to corporations related with real


estate development and investment in other real
estate-related securities as prescribed by the

- 159 -

Presidential Decree of FSCMA


50% or more of total assets invested in special
assets that refer to investment assets other than

Special Asset Fund

securities and real estate


collective investment schemes

are

not

subject to restrictions imposed on securities, real

mixed asset fund

estate, and special

Funds can also

that

be

divided

into

CIS

contractual-type

funds and

corporation-type funds, based on the form of their legal entity.


A contractual-type of fund, known as unit trust in Korea, is a
financial arrangement where the funds pooled together from
investors are entrusted to a trustee that is required to invest and
manage

the

funds according to

instructions

from

an

asset

management company. Any beneficiary interest from the funds


management are shared among the investors. By contrast, a
corporation-type fund is a company in itself that invests its assets
and pays returns to its shareholders. The corporation-type fund is
also referred to as a mutual fund.

Figure 7. TRUST TYPE V. COMPANY TYPE

- 160 -

From a tax perspective, collective investment vehicles can operate


as a trust type, a company type, or a partnership type.

Trust type: Income earned by trust type entities are classified


into interest or dividend income based on the portfolio composition
of managed assets for income tax purposes. Taxes are not
assessed at the trust level, but are assessed on each investor.
Company type: Company type entities are assessed corporate
income tax on investment profits from investment operations. After
taxes are paid at the corporate level, net profits are distributed to

- 161 -

each investor in the form of dividend income or investment


income. This income is then taxed again at the investor level
(such as, as corporate tax for corporate investors, or individual
income tax for individual investors). To provide relief from the
double taxation on the investment profits, the Corporate Income
Tax Law (CITL) prescribes specific cases in which taxes at the
corporate level are exempted if at least 90 percent of the total
income available for distribution is paid out as a dividend
(corporate investors). For individual investors, the gross-up method
is available.
Partnership type: Partnership type entities may elect to be taxed
as a partnership from the taxable year beginning 1 January 2009.
The partnership taxation treats the partnership as a flow through
entity and not be subject to CIT. Instead, each partner would be
subject to CIT or individual income tax (IIT) based on the pro rata
shares of the profit earned by the entity.

V. AUM by Fund
At the end of 2011, the aggregate asset under management
(AUM) of unit trust stood at KRW 286.2899tn, marking an increase
of 58.8% from the 2004 figure of KRW 180.3049tn. The total AUM
of mutual funds has also seen an increase of 80.8%, from KRW
6.6878tn at the end of 2004 to KRW 12.0903tn. Unit trusts
accounts for over 96% of the total AUM in the domestic asset
management market.

- 162 -

Table 24 AUM BY UNIT TRUST AND MUTUAL FUNDS


(unit: billion won, %)

unit trust

mutual funds

total AUM

2004

180,305(96.4)

6,688(3.6)

186,993(100)

2005

193,264(94.6)

11,081(5.4)

204,346(100)

2006

222,264(94.7)

12,466(5.3)

234,615(100)

2007

283,146(95.5)

13,315(4.5)

296,460(100)

2008

346,300(96.3)

13,187(3.7)

359,487(100)

2009

319,078(96.1)

12,802(3.9)

331,880(100)

2010

302,781(96.1)

12,401(3.9)

315,183(100)

2011

286,390(95.9)

12,090(4.1)

298,480(100)

* Source: Korea Financial Investment Association

As of the end of 2011, the total AUM held by funds for public
offering was KRW 188.1458 tn, an increase of 74.4% from the
2004 figure of KRW 108.88tn. The total AUM held by private
placement funds also got a boost of 39.5% from the 2004 figure
of KRW 79.10tn to stand at KRW 110.3344tn. The portion of private
placement funds in the total AUM still stands around 37%, though
it is on a decline. Most private placement funds are assumed to
be purchased by institutional investors such as pension funds and
large companies.
Table

25

AUM

BY

PUBLIC

OFFERING

FUNDS

AND

PRIVATE

PLACEMENT FUNDS
(unit: billion won, %)

public
2004

offering private

placement

funds

funds

107,888(57.7)

79,105(42.3)

- 163 -

total AUM
186,993(100)

2005

123,769(60.6)

80.577(39.4)

204,346(100)

2006

143,299(61.1)

91,316(38.9)

234,615(100)

2007

203,250(68.6)

93,210(31.4)

296,460(100)

2008

232,931(64.8)

126,556(35.2)

359,487(100)

2009

224,640(67.7)

107,240(32.3)

331,880(100)

2010

197,501(62.7)

117,682(37.3)

315,183(100)

2011

188,146(63.0)

110,334(37.0)

298,480(100)

* Source: Korea Financial Investment Association

As for the AUM held by the different investment assets, the total
AUM held by equity-type funds recorded a huge increase from
about KRW 9tn at the end of 2004 to a whopping KRW 126tn by
the end of 2009, before dropping to KRW 104tn at the end of
2011. This decline was due to the increased redemptions after
2009 by investors who suffered losses in 2008 global financial
crisis and were seeking to recoup those losses in the market
recovery. In the same period, the figure for bond-type funds
declined from KRW 76tn to KRW 45tn. This clearly shows that the
growth of equity-type funds has driven the rise of the total assets
managed by funds.

- 164 -

Table 26. AUM BY FUNDS INVESTMENT ASSET TYPE


(unit: billion won)

equity
type

securities
hybrid
bond
equity

2004
2005
2006
2007

8,580
26,185
46,491
116,353

type
8,160
8,383
8,891
12,878

2008

140,214

13,592

2009

126,232

2010

2011

type
26,502
34,106
39,121
31,786

bond
type

sub total

MMF

derivati
ves

others

t o t a l
AUM

75,749
51,336
50,417
40,862

118,991
119,981
144,921
201,880

59,801
64,846
57,154
46,739

4,727
12,201
16,845
22,393

3,473
7,317
15,695
25,449

186,993
204,346
234,615
296,460

25,658

30,342

209,806

88,903

27,880

32,898

359,487

13,436

18,003

46,108

210,778

71,691

19,335

37,077

331,880

100,992

12,272

20,493

52,569

186,325

66,918

18,249

43,691

315,183

104,201

11,974

18,226

44,844

179,244

53,127

22,928

43,182

298,480

* Source: Korea Financial Investment Association

Funds for over-seas investment are divided into on-shore funds


and off-shore funds: On-shore funds are registered under domestic
law, having domestic investors as an investment entity and invest
30% or more of their net assets in overseas asset. Off-shore funds
are established in overseas jurisdictions and are sold to domestic
investors with the intention to invest overseas assets. The AUM of
on-shore funds posted a record growth of about 10 times from
KRW 5.6826tn at the end of 2011. As a result, the total AUM of
funds jumped from 3% to 19%, an increase of about 6 times.
However, after the dramatic growth in 2006, on-shore funds have
experienced continuous fund outflows and a sharp decrease in net

- 165 -

assets due to the global financial crisis and the end of tax
exemption benefits for on-shore funds at the end of 2009.
Table 27 AUM AND TOTAL NET ASSETS OF DOMESTIC INVESTMENT
FUNDS AND OVERSEAS INVESTMENT FUNDS
(Unit: billion won)

2004
2005
2006
2007
2008
2009
2010
2011

AUM
domestic

overseas

in v e s tm e n t

investment

funds
181,310

funds
5,683(3.0)

Total net assets


do m es tic overseas
total

186(100)

in v es tm e n t

investment

funds
184,460

funds

204,346

(97.0)
207,665

19,690

(100)
234,615

(95.8)
220,529

(91.6)
224,656

(8.4)
73,040

(100)
297,698

(75.5)
283,831

(24.5)
76,958

(78.7)
258,640

(97.0)
195,535

8,810(4.3)

5,659(3.0)
9,144(4.2)

total
190,119
(100)
216,809

21,904

(100)
262,633

(91.0)
233,687

(9.0)
8 4 , 7 3 4

(100)
288,507

(100)
360,789

(73.4)
245,354

(26.6)

(100)
288,507

(21.3)
73,240

(100)
331,880

(85.0)
257,682

(77.9)
251,398

(22.1)
63,785

(100)
315,183

(79.8)
241,840

(20.2)
56,641

(81.0)

(19.0)

(95.7)
214,925

43,153(15.0)
60,834

(100)
318,515

(80.9)
261,505

(19.1)
57,307

(100)
318,812

(100)
298,480

(82.0)
233,244

(18.0)
44,097

(100)
277, 341

(100)

(84.1)

(15.9)

(100)

* Source: Financial Supervisory Service

- 166 -

Chapter 9
Financial Infrastructure : Market, Clearing Facilities,
Deposit and Settlement

I. Market : Korea Exchange (KRX)


1. Overview
The Korea Exchange (KRX), a corporation subject to commercial
law, promotes the safety and efficiency of transactions such as the
fair pricing and buying and selling of securities and listed
derivatives. In January 2005, through a combination of the Korea
Stock Exchange, the Korea Futures Exchange, the KOSDAQ Stock
Market and the KOSDAQ Committee of the Korea Securities
Dealers Association, the KRX was established under the name of
the Korea Securities and Futures Exchange. The name was
changed to the Korea Exchange in February 2009.
The Korea Stock Exchange was founded as the Daehan Stock
Exchange, a not-for-profit corporation, in February 1956, and was
reorganized as a corporation upon enactment of the Securities and
Exchange Act in April 1962.
Owing to a stock market crisis, however, it was reorganized again

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one year later in May 1963 as the Korea Stock Exchange, a public
organization funded through joint investment by the government
and brokerage houses. As the Securities and Exchange Act was
revised

to

address

the

evolution

of

the

securities

market

environment (for example, the expansion of securities markets and


globalization of capital markets), the Korea Stock Exchange was
reformed in March 1988 as a corporate juridical person with a
membership consisting of securities companies. Since then, it has
dealt with opening and managing securities markets, listing and
managing securities, and maintaining fair trading.
As the demand increased for a domestic futures exchange as a
means for coping with fluctuating foreign exchange and interest
rates in an open economy, the Korea Futures Exchange was
established in February 1999 following enactment of the Futures
Trading Act in December 1995.
The KOSDAQ Stock Market was created in May 1996, as a venue
for off-board trading of unlisted stocks registered with the Korea
Securities

Dealers

Association.

To

promote

fairness

and

transparency in operation of the KOSDAQ market, the KOSDAQ


Committee, its decision-making body, was established within the
Korea Securities Dealers Association.
Those

intending

to

carry

out

transactions

in

securities

and

derivatives through the KRX must be admitted by the KRX board


of directors as members and be qualified as approved investment
traders and brokers. As of the end of June 2011, the KRX
consisted of 94 institutions, 87 securities trading members and 61

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derivatives traders.
The Board of Directors of the KRX is comprised of the Chair of
the Board, the Chair of the Market Oversight Commission, five
standing directors and eight outside directors. The Board of
Directors decides on issues regarding management goals; budgets
and operational plans; enactment, revision and revocation of
important rules related to the KRXs operation and management;
the handling of major assets; borrowing of large-scale properties
and long-term loans; contributions and investments to other
corporate bodies, and items to be submitted to the shareholders
meeting.

2. Businesses
(1) Opening and Management of Securities and KOSDAQ Markets
The KRX engages in the businesses of listing securities, concluding
transactions, publicizing market

prices, and improving market

systems. It evaluates whether or not to list securities. In addition, if


mismanagement at securities-issuing houses impacts the public
interest or investor protection, or causes difficulty in fair pricing
and distribution of the related securities, the KRX takes actions
such as delisting or suspending transactions for a set period of
time. In the case of delisting, even though the securities may
satisfy the requirements for delisting, their immediate delisting
could result in considerable loss of property for the investors
concerned.

The

securities

are

therefore

for

the

time

being

designated as issues for administration, and earn grace periods. If

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the cause of their designation as issues for administration is


settled, the KRX lifts the designation.
The KRX opens and manages the securities markets the stock
markets, bond markets, ETF ((ETF (Exchange-Traded Fund) is a
listed fund traded like a stock. It is designed so that its earnings
rate is interlocked with the movement of specific index and asset
prices)/ ELW(An ELW (Equity-Linked Warrant) is a new type of
security that holds a right to buy and sell stocks or receive cash
at maturity, interlocked under prescribed methods with a specific
stock price or stock index) markets and additional markets (REITs
(mutual funds specialized in real-estate investment) and mutual
funds are traded in other markets)) and provides to the public
each markets overall market prices, transaction trends and
business performance results, as well as information on foreign
markets.
The KOSDAQ market is opened and operated with less stringent
listing requirements than the stock market to facilitate the financing
of promising small and medium-sized companies, including venture
companies with high growth potentials.
The trading days of the securities and KOSDAQ markets are from
Monday through Friday, and their trading hours are from 9:00
until 15:00. In addition, pre-hours closing price trading takes place
from 7:30 until 9:00, and off-hours closing price trading is allowed
in the period from 15:10 until 18:00. Those allowed to trade
securities in the KRX market are limited to members of the KRX.
Individual investors may therefore trade in the KRX market only

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through member companies. A member submitting an order to the


KRX enters into a contract under the operating regulations of the
KRX.
The KRX notifies the member company of the results of the trade,
and the company then notifies its client. The investor should pay
the price or a bill of sale to the entrusted member company
before the third day (T+2) from the day of trading, and the
member completes the trade by settling the account with the KRX.
(2) Opening and Management of Derivatives Markets
The KRX opens, operates and manages derivatives markets, trades
and

settles

listed

derivatives,

publishes

market

prices,

and

determines the types and items to be traded.


The derivatives markets are markets intended to efficiently absorb
the risks of fluctuation in prices and interest rates in the spot
markets where many derivatives, including stock indexes and
individual stock futures and options, bond futures, currency futures
and options, and gold and pork belly futures are traded. Their
trading days are Monday through Friday and their trading hours
generally from 9:00 until 15:15. However, in the case of items
reaching their delivery days, trading hours are from 9:00 until
14:50 for the stock commodity market and from 9:00 until 11:30 for
the

interest

rate,

currency

and

gold

commodities

markets

(excepting mini gold futures).


When an investor submits an order through a member company

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which operates derivatives accounts, the KRX enters into a contract


with the member companies involved in accordance with the
specified priorities, (for example, concerning order prices and times
of reception). When an order is submitted or a contract is made,
the KRX announces the contents of the order or the results of the
contract to members and investors through its computer system.
(3) Market Surveillance
To prevent and regulate unfair trading practices in the securities,
KOSDAQ and derivatives markets, and to mediate conflicts both
between

members

and

investors

and

between

members

themselves, the KRX operates the Market Oversight Commission.


This commission monitors the markets, reviews abnormal trading(in
cases of overt fluctuation in the prices of items in the securities or
derivatives markets, or in the volume of trading, or of public
announcement, rumors or reports that could affect the prices of
traded items, it conducts reviews to check on the possibility of any
abnormal dealings) and supervises members(this is to examine
related members businesses, financial statuses, books, papers
and other items in order to ascertain whether member companies
are

in

compliance

surveillance,

with

self-regulates

the

operating),conducts

trade-related

disputes,

inter-market
determines

disciplinary actions to be imposed on members or employees as


necessary, and enacts or revises related regulations.

II. Clearing Facilities


1. Payment and Settlement Systems Overview

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Payment and settlement refer to the finalization of a direct


debtor- creditor relationship incurred as a result of spot and
financial transactions, by transferring of currency values through
some payment method.
Payment refers to the act of transferring monetary claims to
the rightful recipient by presenting cash, check or card, or through
transfer from an account.
Settlement refers to the settlement of the difference remaining
after the offsetting of credit and debt occurring from the use of
non-cash means of payment, through transfer between the current
deposit accounts at the Bank of Korea (BOK) of the financial
institutions involved(What is referred to here as settlement is a
complex concept that means both settlement and clearing. The
offsetting of the credit and debt arising from payments between
financial institutions is called clearing, and the finalization of a
debtor-creditor relationship by a financial institution through a
transfer of the total debt or unpaid difference into its BOK current
deposit account is called settlement (in the narrower sense)).
The payment and settlement system is the part of the financial
system infrastructure that covers payment methods, participant
institutions, business settlement regulations, computer

processing

systems, etc. Payment methods include cash, bills, checks, credit


cards

and

account

transfers,

and

can

be

categorized

into

paper-based payment methods that use bills, checks, giro slips,


etc., and electronic payment methods that include credit-, debit-

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and prepaid-card services, account transfers, etc.


Participant institutions can be divided into institutions that provide
payment services, institutions that operate payment and settlement
systems, and the BOK. Institutions that provide payment services
include banks, the post office, financial investment firms and credit
card companies, while institutions that operate payment and
settlement

systems,

which

are

in

charge

of

clearing

and

settlement, include the Korea Financial Telecommunications and


Clearings Institute (KFTC), the Korea Exchange (KRX), the Korea
Securities Depository (KSD) and institutions that operate businesses
related to foreign exchange settlement. The BOK operates the
nations Large-value Payment System, and simultaneously plays a
pivotal role in the payment and settlement systems by issuing
currency and by providing final settlement services and funding to
alleviate shortages of funds as lender of last resort, as well as by
supervising, improving and expanding the payment and settlement
systems.
There are three settlement methods: the Net Settlement Method, of
settling only the difference remaining after the credit and debt
between

financial

institutions

is

offset,

based

on

the

total

transaction amount during a certain period; the Gross Settlement


Method,

of

settling

the

entire

transaction

amount

without

calculating or offsetting credit and debt; and the Mixed Settlement


Method, which combines the advantages of the former two
methods. Under the Net Settlement Method only the net difference
in a debtor-creditor relationship between financial institutions is
settled, and so the frequency and value of such settlements are

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reduced. Due to differences in time between the point of payment


and the point of final settlement, however, the problem of
settlement

risks

emerges.

The

Gross

Settlement

Method

is

meanwhile advantageous in that it minimizes settlement risk since


payment and settlement occur at the same time.
However, these individualized settlements take place with greater
frequency and in larger volumes. The Net Settlement Method is
accordingly used in the Retail Payment Systems that process
transactions

having

small

monetary

amounts

but

with

high

frequency, such as transactions between financial institutions and


their customers, while the Gross Settlement Method is used in the
Large-value Settlement System that processes transactions having
large monetary amounts but

with low frequency. Settlement

systems can also be classified in accordance with the points in


time of their settlement into the Designated-time and the Real-time
Settlement Systems, and, based upon the main operating entity
involved, into the Central Bank and the Private Settlement Systems.
Payment and settlement systems act as a catalyst for economic
activity by enabling the smooth flow of the monetary settlements
that accompany economic activity. There are various risks inherent
in the payment and settlement processes, however, and if these
risks are not adequately controlled the entire financial system can
be destabilized. In this regard, payment and settlement systems
are recognized as an important part of the financial infrastructure.

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2. Main Payment and Settlement Systems


(1) Large-value Payment System: BOK-Wire+
The Large-value Payment System of Korea is BOK-Wire+2, which
began operation in April 2009. This system plays a pivotal role in
the payment and settlement systems of Korea by interconnecting
the computer systems of the BOK and financial institutions and
processing large-value fund transfers between financial institutions
in real time, by handling final settlement of interbank credit and
debt in the Retail Settlement Systems at designated times, etc. The
system also contributes to the reduction of settlement risks in
securities and foreign exchange transactions through links to the
Delivery versus Payment (DvP) and Continuous Linked Settlement
(CLS) systems.
There are two settlement systems within BOK-Wire+: the Gross
Settlement System and the Mixed Settlement System. The former
utilizes only pure gross settlement methods, while the latter
applies both pure gross settlement as well as bilateral and
multilateral

concurrent

settlement

methods.

Large-value

fund-transfer transactions requested by financial institutions at


midday are processed as soon as they are received. The net
settlement

cases

requested

by

the

Korea

Financial

Telecommunications and Clearings Institute (KFTC) are processed at


predetermined dates after calculating the multilateral net settlement
amounts, the repayment of call moneys marked with specific
repayment dates, and the retrieval of treasury funds received by
financial institutions.

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(2) Retail Payment Systems


The retail payment systems include the Check Clearing System, the
Giro System, the Financial Information Networks, and BANKPAY PG,
and because numerous small-volume payments are processed
through them, the net settlement method is usually employed.
Check Clearing occurs when numerous banks gather at a
clearing house at a particular time and exchange bills and checks
received by one bank but issued by another, and then settle the
payments.

Recently,

with

the

development

of

information

technology and enforcement of the Issuance and Negotiation of


Electronic Bills Act, fewer bills and checks are being exchanged in
paper form, while in an increasing number of cases only the
information

recorded

on

bills

and

checks

is

exchanged

separate from the actual bills and checks. The differences that
occur from the clearing of bills and checks between participant
banks are settled through the participant banks current deposit
accounts opened in the BOK.
The Giro System is a payment and settlement system through
which

giro-based

account

transfers

are

batch

processed

at

payment and settlement intermediation centers. It is a convenient


way of processing large-volume payment transactions such as
electric/telephone bills and purchase

payments. The

Financial

Information Networks are payment and settlement systems that


provide

customers

with

financial

transaction

services

and

transaction information by connecting the computer systems of

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financial institutions and the KFTC. They also constitute the core of
the Retail Settlement Systems of Korea. The Financial Information
Networks currently in operation are the Cash Dispenser (CD)
Network, the Interbank Funds Transfer (IFT) Network, the Electronic
Funds Transfer at the Point of Sale (EFT/POS) Network, the Cash
Management Service (CMS) Network, the Local Banks Information
Network (BANKLINE), the K-CASH Network, and the Interbank
Home/Firm Banking Network (HOFINET).
As a payment and settlement system used in e-commerce online,
BANKPAY PG is divided into the B2C and B2B payment and
settlement systems, depending upon the counterparties involved.
(3) Clearing and Settlement institutions under the FSCMA
A. KRX as the clearing institutions for the securities and derivatives
market
According to the Article 378(1) of the FSCMA, the KRX shall as a
clearing
acquisition,

institution,
deduction,

perform

transaction

confirmation

of

confirmation,
settlement

debt

securities,

settlement item, and settlement amount, settlement execution


guarantee, follow-up measures on settlement failure, or settlement
instruction as a result of transactions on the securities market and
derivatives market.
B. KSD as the settlement institution for the securities market and
KRX as the settlement institutions for the derivatives market

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The

KSD

is

designated

as

the

securities

market

settlement

institution which will conduct the delivery an payment of securities


(the delivery of securities and payment of funds) subsequent to
transactions on the securities market (Article 297). The KRX shall
perform delivery of items and payment of money on the derivative
market as a settlement institution(Article 378(2)).
Figure 8. PAYMENT AND SETTLEMENT SYSTEMS IN KOREA

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* Source Bank of Korea (http://www.bok.or.kr/broadcast.action?menuNaviId=649)

III. Deposit and Settlement


1. Korea Securities Depository

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(1) Overview of Securities Settlement Systems


Securities settlement refers to the settlement of the credit-debt
relationship between a seller and a buyer occurring from a
transaction in securities or bonds in the securities market, by
delivery of the securities and settling of the payment. The
Securities

Settlement

Systems

include

the

Securities

Market

Settlement System and the KOSDAQ Market Settlement System,


operated jointly by the Korea Exchange and the Korea Securities
Depository, and the Institutional Settlement Systems for Bonds and
for Stocks operated by the Korea Securities Depository (KSD).
In the Securities and KOSDAQ Market Settlement Systems, after the
KRX

decides the

securities

and

payment

amounts

to

be

transferred on settlement day by each securities firm through


clearing,

the

securities

and

payment

amount

are

settled

simultaneously, the former by book entry through a KSD depository


account and the latter by fund transfer through the KSD account
opened in the BOK. Meanwhile, settlement through the Institutional
Settlement System for bonds is performed on a case-by-case basis
and that through the Institutional Settlement System for Stocks by
the entities involved in the transactions, both under management
of the KSD, the securities are transferred in the face-to-face
market through a KSD account, while the payment amount is
settled at the same time as the securities through the KSDs
account with the BOK.
The Korea Securities Depository (KSD) is a securities depository and

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a settlement institution. The Securities Depository System was


introduced

in

order

to

facilitate

the

issuance

and

effective

distribution of securities by, first, the depositing of all securities


transacted in the securities market into centralized securities
deposits in a securities depository organization, then replacing the
settlements and actual delivery of physical securities accompanying
sales, transfers and collateralized transactions between transaction
participants
depository

with
and

book-entry

settlement

system.

system

was

Koreas
introduced

securities
after

the

securities market expanded in scale and increased in volume in


the early 1970s, in order to lower the risk of securities getting lost
or stolen in physical distribution and simplify and enhance the
efficiency of sales transaction settlement services, by amending the
Securities and Exchange Act in 1973 to add clauses regarding
central deposit and book-entry clearing services so that the KRX
could provide these services. The Korean Securities Settlement
Corporation (KSSC) was established in 1974, and as the KRX
entrusted it with these services in 1975 the KSSC began to provide
securities depository and settlement services in earnest. In 1994, as
the KSSC became the central securities depository (CSD) in line
with the Securities and Exchange Act, its Korean name was
changed to the Securities Depository, and then to Securities
Depository and Settlement in 2005, and to Korea Securities
Depository and Settlement as of 2009. In English, however, it is
referred to as the Korea Securities Depository.
(2) business
As the central securities depository, the KSD mainly provides

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services
such as the central deposit of listed securities, book-keeping entry,
securities

clearance

and

settlement

services.

On

behalf

of

depositors, the KSD also settles matters such as the exercising of


rights regarding deposited securities, and on behalf of securities
issuing houses acts as their agent in all matters related to
securities, such as the issuance of securities and the payment of
dividends.
The KSD in addition also provides services related to funds, to the
registration of bonds and debentures, to the management of
collateral, etc.
A. Securities Depository and Settlement Services
The KSD receives securities deposits by opening accounts for
banks, financial investment business entities, insurance companies,
foreign securities depository organizations, institutional investors,
etc. In the cases of general corporations and individual investors,
the KSD receives securities deposits indirectly through financial
investment

business

entities

(investment

brokerage

business

entities). To enhance the efficiency of their safekeeping and


management, deposited securities are not categorized by depositor
but rather kept together by type, and the legal relationships
between rights and duties are made clear by recording the
depositors names,
securities,

causes

for

addresses, types and quantities of


fluctuations

in

quantity,

etc.,

in

the
the

depositors account books. As of end-June 2012, stocks, bonds,


CDs and CP in custody of the

- 183 -

KSD amounted to market

capitalization of 2.6 quadrillion won.


When a securities sale has occurred, the KSD first receives the
transaction information from the KRX and the institutions involved
in the sale, then confirms that the buyer has deposited the full
payment, and finally settles the securities at the same time as the
payment through book-entry between accounts. For this purpose,
the KSD operates SAFE+ (Speedy, Accurate, Faithful, Efficient), a
securities

depository

and

settlement

information

network

that

connects to customers computers as an electronic system of


services. Looking at the securities settlement services of the KSD
by the market concerned, in the face-to-face markets the KSD
operates

the

Securities

and

the

KOSDAQ

Market

Settlement

Systems, providing securities settlement services through BIS DvP


Model III (simultaneous net settlement of securities and fund
transfers). In the off-board markets, it provides securities clearance
and settlement services by operating the Institutional Settlement
System for Bonds and the Institutional Settlement System for
Stocks. Settlements are processed on a case-by-case basis for
bonds, and simultaneously by each entity involved in stock
transactions. The volumes of face-to-face plus off-board market
settlements through the KSDs Securities Settlement Systems
reached 4,753 won in total in 2011.

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Figure 9. DEPOSIT AND SETTLEMENT FLOW

B. Services for Execution of Rights Regarding Deposited Securities,


and Transfer Agent Services
The

KSD

processes

the

dividends,

principal

and

interest,

obtainment of stocks and all other matters for every right


regarding deposited securities. The depositor and the investors,
who are the depositors customers, thus do not have to redeem
the securities from the KSD in order to exercise their rights. In
2011, the KSD exercised rights on behalf of customers to 853
trillion won worth of deposited securities.
Meanwhile, the KSD also acts as a transfer agent based on
unique functions that it performs such as depositing and settling
securities and managing de facto stockholders. Transfer agent

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services refer to the processing of matters related to stocks such


as managing the lists of shareholders on behalf of the issuing
houses, transferring the names of shareholders, assigning and
providing notification of the rights of shareholders such as the
rights to vote and to acquire new shares, issuing stocks and
paying dividends. And while these are not exclusive services of the
KSD, the KSD was the first to provide them, and to this day
remains the largest provider of transfer agent services.
C. Services Related to Foreign Securities Transactions
KSD services such as securities depository and settlement and
custodianship

over

deposited

securities

are

not

restricted

to

domestic transactions. When a Korean investor invests in foreign


currency

securities,

to

keep

the

deposited

foreign

currency

securities overseas the KSD designates a Global Custodian or an


International Securities Depository (ICSD) as the foreign custodial
organization to process settlements and act as custodian. When a
foreign investor invests in Korean securities, the KSD holds the
Korean securities obtained by the foreign investor, and acts as the
standing representative.
When a Korean company issues a Depositary Receipt (DR) in a
foreign securities market, the KSD takes custody of the underlying
shares. When a foreign company issues a DR in Korea, however,
the KSD designates an organization in a foreign market to hold
the underlying shares in the name of the KSD and to act as the
custodian of them.

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The KSD also supports the listing of Korean companies in foreign


markets, and of foreign companies in the Korean market. To
promote such cross-border securities transactions, as of June 2011
the KSD had established Cross-border Clearing Networks (CCNs) in
36 foreign markets including that of the United States.
D. Other Services
Through FundNet, a collective investment securities and asset
depository system, the KSD standardizes and automates services
ranging from the establishment, redemption and beneficiary list
management of collective investment securities (funds), to the
central deposit,

concurrent

settlement

and

fund-based

ledger

management of collective investment assets. As a specialized bond


registration institution, moreover, the KSD also provides registration
services for national housing bonds, public bonds and corporate
debentures. It acts in addition as an intermediary for securities
lending transactions, in which it lends securities and receives a
commission, for repurchase agreement sales, and for collateralized
call transactions (the short-term borrowing and lending of funds
with securities, etc., as collateral).

- 187 -

Figure 9. FUND Net SERVICE FLOW

- 188 -

Chapter 10 Regulation of Cross-Border Financial


Investment Services

I. Declaration of the Effects Test


The FSCMA introduced the effect test in Article 2, which provides
that the Act shall apply to the activities conducted overseas, the
effect of which extends to the domestic territory. However, there
are no specific standards regarding which activities performed
outside Korea have a domestic effect. It may be interpreted mean
an effect on credibility and stability of domestic capital markets or
on domestic investor protection.

II. Regulation of Cross Border Dealing/Brokerage


Under the FSCMA, in order to engage in the dealing and
brokerage business, a subsidiary, branch and business office must
be established in Korea. Conducting a Dealing and brokerage
business

through

direct

contact

with,

or

by

means

of

communication with, Korean customers without having such an


office in Korea is not permitted (Article 11, 12).
However, under certain circumstances, a foreign dealer/broker with
no subsidiary or branch offices in Korea can do business with
Korean customers.

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First, as for the primary market regulation, the Article 7(6)(iii) of the
FSCMA and Article 7(3)(v) of the Presidential Decree stipulates the
regulation that applies to primary markets activities related to
extra-territorial jurisdiction. Where a Korean issuer makes a public
offering or private placement, and (i) a foreign dealer enters into
an underwriting agreement with the Korean issuer within Korea in
accordance with the criteria set by the FSC and the act is
approved by FSC or (ii) if only the deliberation to determine the
contents of the underwriting agreement is made within Korea and
related documents are

submitted to the FSC beforehand, these

activities are not regarded as doing financial investment service


business in Korea. In order to get approval under (i) above, the
foreign dealer must have been engaged in the business at least 3
years and have equity capital of not less than 50 billion won.
Foreign dealers which participate in issuing bonds issued or
guaranteed by the Korean government bond are assumed as
qualifying (i) and (ii) above(the Article 1-5(2) of the Financial
Investment Business Regulation).
Second, as for the secondary market activities regulation, the
Article 7(6)(iii) of the FSCMA and the Article 7(3)(vi) of the
Presidential

Decree

stipulate

that

if

foreign

dealer/broker

conducts outside Korea (i) business activities with dealers/brokers


licensed under the FSCMA or (ii) receiving trade orders from a
Korean resident without solicitation or advertisement, such activities
are not regarded as financial investment service business in Korea.
Therefore, if a foreign dealer/broker is engaged in any solicitation
of a

Korean investor (regardless of whether

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institutional or

professional investors or non-professional investors), it will be


regarded as conducting business in Korea and if it is proceeded
without license, which would be a violation of the FSCMA which
may be subject to criminal sanctions(Article 11, Article 444(i)).

III.

Regulation

Businesses

of

and

Cross

Border

Discretionary

Investment

Investment

Advisory

Management

Businesses
Foreign

investment

non-discretionary

advisors

investment

can

engage

advisory

in

discretionary

businesses

for

or

Korean

residents without having an office in Korea by means of direct


communication

with

Korean

residents,

unlike

the

dealing

or

brokerage/arranging business. However, the foreign investment


advisors need to complete registration with the FSC in order to do
so, and failure to register could subject the foreign investment
advisor to criminal sanctions (Article 17 and 445(1)).
There is a registration exemption for the certain cross border
investment advisory service activities in the Article 7(6)(iii) of the
FSCMA

and

the

Article

7(3)(vii).

Providing

discretionary

or

non-discretionary investment advisory services (i) outside of Korea,


(ii) without investment recommendation or advertisement, (iii) to the
Korean government, the BOK, the Korea Investment Corporation or
an entity designated by certain statutory pension fund or other
financial

commission,

is

not

considered

to

be

providing

discretionary or non-discretionary investment advisory services.

- 191 -

To

engage

in

business

activities

for

Korean

residents

(whether

corporations or individuals) without having an office in Korea, a


registration with the FSC is required even if the business activities
are conducted on an unsolicited basis.
A non-Korean investment advisor which is duly registered with the
FSC

for

its

cross-border

discretionary

or

non-discretionary

investment advisory business with Korean residents is required to


appoint a person in charge of liaison within Korea for protection
of

investors(Article

100(2)

of

the

FSCMA,

Article

11

of

the

Presidential Decree). Banks, financial investment service companies,


certain financial institutions, lawyers and accountants are qualified
to

be

appointed

non-Korean

as

such

investment

advisor

person.
is

Such

also

required

duly-registered
to

use

an

investment advisory contract or a discretionary investment contract


with Korean residents

that is governed by Korean law and that

contains a clause that Korean courts have jurisdictions over the


disputes under the contract (Article 100(3)).

Such a non-Korean

investment advisor is required to establish appropriate standards


and procedures that should be followed by its employees in order
to prevent unsound business activities, periodically monitor and
report it to the FSC (Article 100(4) and 100(5)). Non-Korean
investment advisors are subject to these regulations because they
do not have an office in Korea and therefore there is a concern
for inadequate supervision and customer protection.
There are additional regulations applicable to duly registered
non-Korean

discretionary

investment

advisors

conducting

their

business on a cross border basis. Korean resident customers to

- 192 -

which

such

non-Korean

investment

advisors

can

provide

discretionary investment advisory services are limited to the Korean


government,

local

governments,

the

BOK,

certain

financial

institutions such as banks, certain statutory financial agencies and


institutions (such as the Korea Deposit Insurance Corporation, the
Korea Investment Corporation, the Korea Exchange, the Korea
Securities Depository) and certain statutory funds(Article 100(6),
Article 101(2) of the Presidential Decree). Also, such non-Korean
discretionary advisors are required to keep in custody with foreign
depository institution designated by Korea Securities Depository
foreign currency securities acquired as the discretionary investment
assets for customers(Article 100(7), Article 101(3) and 63(2) of the
Presidential Decree). In addition, they are required to send a
discretionary investment report at least once a month to their
customers in person or by mail or (if the customer agreed) by
electronic mail(Article 101(4) of the Presidential Decree).

- 193 -

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newly

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[2012 Capital