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보고서 1
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.
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보고서 1
Effect of Mandatory Auditing of Internal Control over Financial Reporting on Preventing Fraud in the Korean Capital Market [24-03]
Research Fellow Lee, Sang Ho and others / Feb. 05, 2024
Since 2019, Korea has strengthened the external verification of the effectiveness of internal control systems following the amendments to the External Audit Act. To be more exact, the verification level of the internal control over financial reporting(hereafter, ICFR) was raised from 'review' to 'audit' for listed companies with total assets of more than 2 trillion KRW. Despite the effort, there have been several large-scale embezzlement cases where the internal control system has been overrode at firms and government agencies, such as Osstem Implants and Woori Bank. Based on these events, it seems necessary to examine the effect of mandating an audit of ICFR. Furthermore, we intend to gain a comprehensive understanding of the regulation and how it should be pursued.

This study aims to investigate the effect of the mandatory audit of ICFR, introduced in 2019, in deterring the likelihood of corporate fraud, especially regarding embezzlement and breach of trust. In addition, this report intends to identify improvement measures for the effective operation of the advanced internal control system. We thereby evaluate the effectiveness of the current system and provide policy implications supported by empirical evidence.

First, we compare Korea's intensified internal control system with those of the United States and Japan and find that Korea's internal control system is the most stringent in terms of procedural rigor. However, among the significant weaknesses of the internal accounting control system, a high proportion of cases fell under the category of "insufficient funds," indicating the need for improvement of the effectiveness of ICFR.

Next, we examine the trend of embezzlement and breach of trust before and after the mandatory audit of ICFR using the staggered difference-in-differences model. We find that the incidence of embezzlement and breach of trust in the overall capital market has been declining since 2019, and the decline has been more pronounced among companies with total assets of more than 2 trillion KRW, which were initially subject to the mandatory audit of ICFR. This suggests that the regulatory reformation that reinforced the assurance level of the ICFR from 'review' to 'audit' may have the impact of enhancing the effectiveness of the internal control system and deterring the occurrence of fraud.

Based on the empirical results, this study suggests several policy implications for a more effective internal control system. First, it is necessary to further refine and quantify the sentencing guidelines for large-scale embezzlement cases to deter employees' motivation to commit violations. Next, it is necessary to grant tax benefits to ease the cost burden of designing and implementing the ICFR for a limited period. Furthermore, the incentives for executives and employees to actively contribute to the effective operation of the ICFR and to whistle-blowing need to be expanded.
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보고서 1
A comprehensive study of retail investors in the Korean ETF markets [24-02]
Senior Research Fellow Kim, Joon-Seok and others / Jan. 24, 2024
Participation of retail investors in the Korean ETF market has increased significantly throughout the COVID-19 pandemic. Before the outbreak, the cumulative net purchases of ETFs by retail investors amounted to only 6.2 trillion won. However, since then, the cumulative net purchases have risen dramatically to over 20 trillion won. The trading volume of retail investors has also increased substantially from around 15 trillion won per month before the outbreak to around 60 trillion won per month. ETFs have become a major investment vehicle for retail investors in Korea.

The most prominent feature of ETF trading by retail investors is the high proportion of trading in derivative ETFs. Since the introduction of leveraged and inverse ETFs, 60-70% of retail investors' ETF transactions have been generated from these ETFs. The problem is that leveraged and inverse ETFs are short-term, speculative products that are structurally complex and unsuitable as long-term investment vehicles. If the low cost and high accessibility of ETFs are utilized for speculative trading rather than contributing to the expansion of diversified investment opportunities, it is not desirable from the both perspective of retail investors’ investment performance and the development of the ETF market.

This paper comprehensively examines the characteristics of retail investors’ ETF holdings and transactions, and the impact of ETFs on investment performance by utilizing the securities holdings and transactions data of 136,000 Korean retail investors from January to October 2020. The characteristics of ETF investors in terms of ETF holdings and transactions can be summarized as follows. First, the number of investors who held or traded ETFs during the period analyzed is about 17% of the total investors, and they are mainly male investors with large investment sizes and experience. Second, ETF investors, compared to non-ETF investors, have a relatively high level of portfolio diversification, but they are also speculative with a high turnover rate and proportion of derivative ETFs held and traded.

The results of the analyses of the impact of ETFs on investment performance are summarized as follows. First, we find that ETFs harm retail investors' investment performance. Both the monthly portfolio return and the Sharpe ratio increase when ETF holdings and transactions are excluded from the total holdings and transactions of ETF investors. Second, we find that the negative impact of ETFs on investment performance is mainly driven by inverse ETFs. Regressions controlling for investor characteristics, risk factors, and portfolio characteristics show that both portfolio returns and Sharpe ratios decline as the percentage of holdings or turnover in inverse ETFs increases. For other ETF types, the Sharpe ratio increases with increasing holdings. Third, intraday trading in ETFs appears to improve portfolio performance. However, the magnitude of the improvement is very small. Fourth, for portfolio component replacement decisions, buying ETFs worsens portfolio returns, and selling ETFs improves portfolio returns. These results are particularly evident for inverse ETFs.

We find a positive effect of ETFs on reducing portfolio risk as a diversified investment tool, but this is overwhelmed by the negative effect of holding inverse ETFs on returns. However, it is not sufficient to interpret these results simply as a result of the upward trend of the stock market during the sample period. Retail investors' overconfidence that the market is overvalued, the lack of understanding of the structural features of inverse ETFs, and the disposition effect, whereby investors ignore accumulated losses, could all contribute to their holding of inverse ETFs during the sample period. We cannot rule out the possibility that the same negative effects could be seen with leveraged ETFs in a bear market.

To establish ETFs as a useful investment vehicle for retail investors, efforts to control the negative effects of derivative ETFs are necessary. A more rigorous review of whether derivative ETFs cause retail investors to over-trade, expose them to unexpected additional risks, provide regulatory arbitrage over other derivative products, and assess their suitability for retail investors is essential.
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보고서 1
Major Reforms in Unfair Trade Regulation and Future Challenges -Comparing the Korean, U.S., and Japanese systems- [24-01]
Research Fellow Hwang, Hyunyoung and others / Jan. 15, 2024
Unfair trading is a financial crime that causes financial damage to many investors and undermines confidence in our capital markets. In South Korea, the Financial Investment Services and Capital Markets Act regulates unfair trade, and efforts have been made to improve the system in response to increasingly sophisticated unfair trade practices. However, despite the steady efforts of supervisory authorities, unfair trade schemes continue to evolve, becoming increasingly organized and sophisticated. The number of illegal activities that are difficult to detect using existing methods is growing, and the difficulty of proving unfair trade has made it difficult to effectively prevent, detect, investigate, and enforce it.

To address these issues, a number of legal changes were made in 2023. First, the Financial Investment Services and Capital Markets Act was amended to create penalty surcharges for three types of unfair transactions, codify the method of calculating unjust enrichment, and introduce a system to reduce sanctions for self-reporters. In addition, on September 21, 2023, the Financial Services Commission, the Ministry of Justice, the Seoul Southern District Prosecutors' Office, the Financial Supervisory Service, and the Korea Exchange jointly announced a plan to improve overall market monitoring and investigation and the sanction system for unfair transactions in the capital market.

As various regulations on unfair trade are being introduced and newly discussed, it is necessary to exam how the system improvement plan can play a role in preventing unfair trade and protecting investors, as well as what needs to be improved. This report compares the cases in the United States, which has a well-developed capital market, and Japan, which has a similar legal system to Korea, to examine whether it is an appropriate way to quickly detect and punish unfair traders and protect investors who have been harmed by them.

First, the investigation system for unfair trading needs to be streamlined. Beyond collaboration and information sharing, it is important to resolve the issue of overlapping investigative and decision-making bodies by establishing a clear division of roles between agencies. In addition, investigative powers such as the right to inspect communications and the right to compulsory investigation should be strengthened to ensure prompt and efficient investigations. Second, with the introduction of the penalty surcharge system, it is necessary to design a system for rational operation. By establishing objective criteria to distinguish between criminal penalties and fines, taking into account the legal nature of the fines and their compatibility with other laws, it is necessary to achieve the purpose of introducing a fine system with prompt monetary sanctions.

Third, it is necessary to improve the efficiency of detecting unfair traders by encouraging the whistleblower program and the cooperation program. The whistleblower awards funded by penalty surcharges, a limit on rewards based on contributions, sanctions for false reports, and measures to protect public interest reporters should be specifically designed. In the case of the cooperation program, it is necessary to list the factors to be considered in determining the reduction in sanctions but to refine them by referring to the SEC rules, or to quantify the criteria for judging the cooperator based on the timing of the report, the specificity of the report, the degree of cooperation with the investigation, the statements of accomplices, the unfair gain of the cooperator, the preemptive provision of data, timeliness, and the status of the reporter. Finally, measures should be put in place to provide redress for ordinary investors. To this end, the Securities-related Class Action Act should be improved, and information, such as judgments should be provided to victims so that they can receive appropriate damages. Furthermore, in the case of unfair trade, as in the case of fraud, it is appropriate to make the recovery of victims’ damages (settlement) a special extenuating circumstances in sentencing to provide an incentive for perpetrators to compensate victims as a matter of criminal policy.

These comprehensive efforts to improve the system are expected to increase the credibility of our capital markets and contribute to the protection of investors.
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