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- Introduction to Global Financial Dispute Resolution Regimes and Their Domestic Implications [24-03]
- Senior Research Fellow Lee, Hyo Seob / Jul. 19, 2024
- 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.
- Market Accessibility of Korean Capital Markets: Viewpoint of Foreign Institutions [24-02]
- Senior Research Fellow Choi, Soon Young / Jun. 28, 2024
- 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.
- Analysis of Pension Tax Systems: Characteristics and Directions for Improvement [24-01]
- Senior Research Fellow Kim, Kab Lae and others / Mar. 14, 2024
- 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.
- Impact of carbon risk in the Korean economy and the importance of portfolio carbon neutrality [24-06]
- Research Fellow Kim, Minki and others / Feb. 26, 2024
- In recent years, the international community has been demanding for more extensive and intensified greenhouse gas reduction efforts and actions to promote climate change response, which has become a major challenge and issue for companies and capital market participants. The Korean government has declared carbon neutrality by 2050, revised 2030 NDC upward and proposed detailed implementation plans. Also, the EU has announced a proposal to introduce a carbon border adjustment mechanism, which might accelerate internal and external efforts for climate change. In this regard, the carbon price is expected to increase gradually, and there is a global consensus that the carbon price must increase further than the current level to achieve the goal of carbon neutrality in 2050.
Based on this background, this study aims to estimate the impact of rising carbon prices on Korean companies and industries through a simple model, and this study is purposed to to highlight the importance of carbon risk and the need to proactively manage the carbon risk for domestic companies and capital market participants. In addition, by investigating and introducing various decarbonization investment methodologies that have been discussed and utilized overseas, we hope to help domestic financial investment companies and institutional investors effectively manage their portfolios’ carbon risk.
The results of our analysis of the impact of carbon price increases on domestic companies are as follows. First, the increase in carbon price, which is generally following the carbon neutrality pathway, leads to an increase in financial losses for companies in almost all industries. Second, this increase in financial losses leads to a worsening of credit risk, such as default. This trend is more pronounced in industries with high GHG emissions. Finally, we examine the impact of carbon risk in a model that takes into account the interaction among industries and find that the cost shock of carbon emissions is estimated to have significant spillover effects not only on high-carbon industries, but also on their associated low-carbon industries. The results of this empirical analysis suggest the importance of carbon risk for domestic companies and capital market participants and the need to prepare for it in the future.
Next, we investigate portfolio construction methodologies that investors can use to effectively manage carbon risk. Regarding this subject, our findings can be summarized as follows. First, internationally, there has been an ongoing discussion about how to reduce the carbon risk of a portfolio while still having similar risk-return characteristics to benchmark indices. Second, the key to these low-carbon investment methodology is to minimize the uncertainty of capital returns and the potential for greenwashing while maintaining the carbon neutrality of the portfolio. It is the most important to provide decarbonization incentives for companies in the portfolio by managing portfolios in such a way that investors could continue to invest and take engagement to the firms as a shareholder. Third, by applying the decarbonizing portfolio construction methodology used abroad and using GHG emission data of listed companies in the Korean stock market, the simple empirical results show that by setting appropriate parameters, an optimal portfolio can be constructed that achieves carbon neutrality of the portfolio while minimizing the opportunity cost for investors. Based on the contents of this paper, we expect that the Korean capital market will be able to utilize those decarbonizing investments methodologies in various ways in the future.
The impact of carbon risk on domestic companies and the implications of decarbonization methods and practices that have been consistently utilized overseas are quite clear. However, the Korean capital market still has not yet been able to vitalize decarbonizing investments for the most of domestic investors. Carbon risk is likely to materialize in the near future, and Korea economy will not be an exception. As we move toward carbon neutrality, the impact on invested companies and portfolios will be clear if the carbon price reaches the adequate level. Therefore, investors need to consider carbon risk as a material risk to their investment portfolios and promote efforts and actions to response the risk. Voluntary efforts by domestic companies and industries will be also important, but it is very critical that investors, as shareholders of companies, set carbon neutrality targets and promote sustainable investing for the future.