Korea Capital Market Institute

As the sales of complex and high-risk financial products, such as Hong Kong H-index ELS and interest rate-linked DLF, have increased, the amount of damage to financial consumers due to mis-selling has also risen. Despite substantial financial losses suffered by consumers due to mis-selling by financial companies, recovering damages often involves lengthy processes and high legal fees. In response, major countries like the U.S., U.K., and Japan have introduced various alternative dispute resolution systems to reduce the legal costs and time associated with civil litigation and to support quick compensation. In the U.S., organizations such as the CFPB, FINRA, and AAA provide various forms of financial dispute resolution, including settlement, mediation, conciliation, and arbitration. In the United Kingdom, the Financial Ombudsman Service (FOS), an independent non-profit organization, is responsible for resolving financial disputes. The FOS’s conciliation decisions are unilaterally binding, meaning that once a financial consumer accepts a decision, the financial firm must comply. Additionally, the UK’s Financial Services Compensation Scheme (FSCS) has established a system allowing financial consumers to receive compensation from a pre-established fund if they are unable to recover their investments due to mis-selling or poor advice on funds, structured products, etc. In Japan, each financial industry operates a designated dispute resolution organization. For the financial investment industry, FINMAC handles financial complaints and disputes. FINMAC is independent of the Financial Services Agency and mediates disputes between financial consumers and financial companies related to investment products, crypto assets, STOs, and more. FINMAC’s conciliation decisions are conditionally binding, meaning that if a financial consumer accepts a decision, the financial company must comply. In Korea, financial dispute resolution is managed by the Financial Supervisory Service Dispute Resolution Committee, the Korea Exchange Market Monitoring Committee, the Financial Investment Association Dispute Resolution Committee, and the Consumer Dispute Committee of the Korea Consumer Affairs and Consumer Services Commission. Among these, the Financial Supervisory Service Dispute Resolution Committee plays a significant role in cases involving the incomplete sale of financial investment products. Historically, general financial consumers in Korea have experienced lower compensation rates compared to other major countries, longer compensation times, and lower acceptance of settlement decisions by financial companies. Korea’s financial dispute resolution system is somewhat limited in diversity, operating primarily through dispute mediation. There are many opinions that it needs to be more independent and specialized. Specifically, the Financial Supervisory Service’s Dispute Mediation Committee is inadequately staffed, leading to ineffective dispute resolution. Additionally, the mediation decisions of the FSS are not unilaterally binding, and financial companies often do not accept these decisions. Furthermore, there is no collective dispute settlement system for cases of mis-selling, which limits the ability of many victims to receive appropriate relief. Therefore, it is necessary to improve the Korean financial dispute resolution system to provide quick compensation to financial consumers and reduce legal costs. First, the independence and expertise of the Financial Supervisory Service’s Dispute Mediation Committee should be enhanced, and its staffing and budget should be expanded to strengthen its practical functions. Second, to improve the effectiveness of the financial dispute resolution system, introducing a Japanese-style limited one-sided binding mechanism should be considered. For one-sided binding to be effective, it is essential to enhance the independence and professionalism of dispute resolution organizations and ensure access to justice. Third, the introduction of a consumer protection relief fund system should be considered in the medium to long term to provide direct relief to ordinary financial consumers in financial disputes. Fourth, the introduction of a collective dispute mediation system should be considered to strengthen the relief available to general financial consumers, including the elderly and financially vulnerable.

This paper introduces the perspective of foreign investors and intermediaries regarding the market accessibility of Korea’s capital markets. Korea’s capital markets, by quantitative measures, belongs alongside developed markets. However, in major market indices, mainly the MSCI stock market index and FTSE Russell bond market index, Korea is classified as an emerging market. The discrepancy between the quantitative and qualitative aspects of Korea’s capital markets comes from the market accessibility assessment, used by MSCI and FTSE Russell. In both the MSCI and FTSE Russell market accessibility assessments, foreign financial institutions play an important role in providing feedback that is used as input for market classification. To better understand why Korea’s market accessibility is regarded as being below developed country standards, interviews were conducted with major financial firms that invest and intermediate investment in Korea. The group includes global asset managers, banks, custodians, boutique investment banks, hedge funds, market makers, system traders along with ASIFMA and GFMA. The results of the interview reveals that various issues related to market accessibility are interconnected. In particular, areas of market accessibility that Korea falls behind in are not just rules and regulation, but process and practice. Interview participants emphasize that in order to improve Korea’s market accessibility, rules and regulations need to be applied more transparently and consistently. In addition, the most effective measure suggested to enhance Korea’s market accessibility is to improve communication between Korea’s financial regulators and industry with the foreign investor community.

This report analyzes the long-run causal relationship between the stock market and economic growth in OECD countries, including South Korea. Using stock market size, depth, liquidity indicators, and a vector error correction model, this report estimates the long-run causality of each indicator on GDP. According to the empirical analysis, one or more stock market indicators show a positive long-run causality on GDP in Korea, Australia, Belgium, Spain, and Mexico. In particular, the real market capitalization and turnover exhibit a positive long-run causality in Korea, implying that the increase in the stock market size and liquidity has a positive impact on the real sector. The positive long-run causality of stock market indicators on GDP tends to be observed mainly in countries with a significant increase in financial openness. What is notable in Korea's case is its significant increase in the number of listed companies per capita compared to other countries studied. Based on the findings, an additional analysis is conducted, assuming that Korea's stock market affects capital accumulation through listings. The results show that the path has a significant impact. In summary, the analyses in this report find that the real market capitalization and turnover have a positive long-run causality with the number of listed companies, while the number of listed companies has a positive long-run causality with capital stock. These results suggest that the increase in the stock market size and liquidity could facilitate more firms to go public, subsequently promoting capital formation and thereby having a positive impact on the real economy. The empirical results in this paper imply the need for continuous efforts to develop the stock market, which could play a role in driving the growth of the real economy. Korea's stock market faces several challenges that require structural improvements, such as enhancing shareholder value, improving corporate governance, and establishing a long-run investment culture, among others. It is necessary to address the structural issues in order for the stock market to serve as a solid growth driver for the real economy. This will require not only the efforts of firms and investors, but also institutional improvements and policy support to ensure consistent implementation of these efforts.

Amid the rising expectations for a domestic and international monetary policy shift after Q4 2023, this study seeks to assess whether the beginning of a rate cut period in South Korea and the US could trigger long-term government bond yields to return to the low interest-rate environment of the post-global financial crisis era.   For this purpose, this study divides the components of long-term interest rates into monetary policy and term premium factors, and examines the possibility of a return to the low-rate era. Initially, our baseline expectation regarding monetary policy was that, in the absence of a recession in both the US and Korea, the end point of the current rate cut would be at the level of the nominal equilibrium rate. Hence, we utilized a macroeconomic model to estimate the nominal equilibrium interest rate, which is the sum of the real neutral interest rate and trend inflation. Additionally, we derived the nominal equilibrium interest rate, evaluated by the bond market (the 5-year forward rate after 5 years, excluding the term premium), from the yield curve model for comparison. The analysis results indicate that the nominal equilibrium interest rate in both the US and Korea, derived from economic fundamentals and the government bond yield curve, has shifted to an upward trend since the spread of Covid-19 and remains at a higher level compared to the low-rate era. This suggests limited potential for a return to a low-rate environment from a monetary policy perspective. On the other hand, term premiums in the US and Korea could decline in the future as the Fed starts to cut rates and inflation uncertainty eases. However, it remains uncertain whether they will decline sufficiently to prompt a return to low interest rates, given that the low term premiums in both countries during the low-rate period were largely a result of the Fed's quantitative easing.  Overall, while long-term government bond yields are likely to decline in the event of a monetary easing cycle, we consider a return to previous low-rate levels unlikely. This necessitates caution when making decisions based on the expectation of a significant decline in long-term interest rates following a shift in monetary policy. However, it is worth noting the risk of a further decline and adjustment in the nominal equilibrium interest rate if trend inflation converges from its current level above the central bank's target to the target level.

As of the end of 2022, discretionary investments by asset management companies (AMCs) reached KRW 600 trillion, growing at a CAGR of 7.8% over the past 12 years. Such dramatic growth was largely driven by the expansion of the overseas sector. However, the growth of the entire discretionary investment industry, including the overseas sector, is slowing down due to the pandemic and the subsequent decline in traditional assets. The domestic discretionary investment market is perceived as heavily dependent on bond portfolios outsourced primarily by affiliated life insurance companies. The market is generally becoming more oligopolistic, with the market share of the top 5 AMCs continuously increasing to 65%. A regression analysis of the factors determining market share revealed that, in addition to strategic support from affiliated life insurance companies, the size of assets under management (AUM) and profitability of AMCs also had an impact. It was also found that an irrational fee structure has taken hold due to the market's excessive competition. Under the circumstances, an expansion in discretionary assets could have a negative impact on AMC profitability. Currently, the discretionary investment market is considered inefficient, with overheated competition among existing players making new entry very difficult. It is advised to diversify the types of discretionary assets and bolster the capabilities of AMCs to improve profitability. Many AMCs are proposing bespoke investment solutions as a future business model, which falls under the area of discretionary investment. The essence of discretionary investment lies in portfolio asset management. A key feature and strength of discretionary investment is that its decisions are based on the investor's financial status and investment purpose from the perspective of the overall assets entrusted. In Korea, the demand for this type of entrustment is increasing. However, the practice of managing funds that should be entrusted to discretionary investment through other expedient methods is inappropriate for both investors and AMCs. The regulations governing the management of retirement pension contributions that exclude discretionary investment also need to be revised as soon as possible. This is because discretionary investment is the most suitable indirect investment method from the perspective of managing pension assets by experts. In the rapidly changing asset management environment including rapid aging, the development of the discretionary investment industry, which focuses on portfolio management, can drive competitive and qualitative growth in the domestic asset management market.

The swift advancement of aging populations combined with declining birth rates is increasingly highlighting the critical role of pensions. Growing skepticism about the long-term viability of public pension systems is fueling a shift toward reinforcing private pension schemes. This shift is notably evident in key nations including South Korea. A pivotal factor in bolstering private pensions is the structure of the pension tax system. Indeed, tax incentives are the primary motivators for private pension plans. The configuration of this tax system profoundly affects how individuals allocate their pension assets and can also influence the evolution of capital markets. In South Korea, the pension framework is broadly categorized into public and private systems. The public pension system encompasses national pensions and occupational pensions, while private pensions comprise employer-based retirement plans such as Defined Benefit (DB) and Defined Contribution (DC) schemes, along with individual retirement plans like IRP and pension savings. The taxation approach for pensions predominantly adheres to the EET method. This method entails exemption (non-taxation) at the contribution phase, exemption on earnings at the management phase, and taxation at the pension income distribution phase. Challenges within the domestic private pension tax system include a lack of diversity in tax-advantaged pension plans, insufficient tax incentives to encourage the pensionization of retirement benefits, and relatively low limits on income deductions (or tax credits) compared to overseas, with inflexible limit adjustments. This study undertook a comparative examination of pension tax systems in key international jurisdictions to investigate the evolving trends in these systems. Through the analysis of pension tax systems in the United States, Japan, Australia, and Germany, it was confirmed that various tax incentives are being provided for the development of the private pension market. A critical observation from studying these international pension tax systems is the recognition that the essence of an effective pension tax system hinges on the strategic design of tax benefits for pensions. In the case of private pensions, while there are some retirement plans where enrollment is compulsory like retirement pensions, many retirement plans operate based on the voluntary will of the subscribers. The most powerful incentives to induce voluntary subscription of the participants are tax benefits. This study of international pension systems suggests several key legislative measures to develop the domestic pension tax system. Firstly, bolstering private pensions requires increasing the limits on tax benefits. Legislative reforms should allow for periodic adjustments to these limits, using economic indicators like the growth rate, inflation, and average wage increases. Secondly, to discourage the trend of opting for lump-sum withdrawals of retirement contributions, there's a need to consider higher tax rates on such lump-sum withdrawals. This approach would promote the receipt of retirement income in the form of pensions. Thirdly, the mechanism for offering tax benefits on pension contributions should shift from a tax credit method to an income deduction method. Fourthly, a variety of methods for providing tax benefits ought to be allowed. Specifically, introducing a TEE pension system could offer a new framework, where contributions are taxed, but earnings and withdrawals are exempt. Lastly, it is recommended to consider implementing a refundable tax credit system or a matching subsidy scheme for pension contributions made by socially vulnerable groups, ensuring a more inclusive and equitable pension system.