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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.
- Introduction of E-money and Payment Institution in Korea: Issues and Challenges [23-20]
- Senior Research Fellow Lee, Sungbok / Oct. 25, 2023
- The discussion of introducing the E-money and Payment Institution (EMPI) has been revisited in Korea, sparking debates of pros and cons, while the issues raised so far have not been sufficiently resolved. Banks raise concerns that such an introduction may allow industrial conglomerates to enter the banking industry without a legal banking license, potentially weaken the principle of same conduct, same risk and same regulation, and pose threats to the stability of the payment settlement and financial system. On the other hand, fintech firms and credit card companies advocate for the positive impacts of introducing EMPI, foreseeing enhanced competition in money transfer services, greater competition in financial services, cost reduction in financial transactions, and increased benefits for financial consumers.
Interestingly, these issues are rooted in four primary factors that mostly have been overlooked. First, although an EMPI is distinct from a bank, it could be argued to be similar to a bank depending on the ways of providing financial services. Second, payment default risk arises because real-time money transfers are processed through deferred net settlement (DNS) and for this reason direct or indirect participation in the retail payment system in Korea is allowed only through collective decision-making of banks. Third, anticipated money movement can create a conflict of interests between EMPIs and banks. Lastly, it is uncertain whether the positive impacts claimed by fintech firms and credit card companies would materialize through the introduction of EMPI.
When looking at cases in the UK, EU, Singapore, and the US that have introduced schemes akin to the EMPI, the issues raised in Korea have not been reported. These jurisdictions do not classify or regard them as a bank. In addition, even non-banking financial institutions can directly participate in their own retail payment system or indirectly participate by making a private agreement or contract with a bank without concerns about payment stability. It is also hard to find any reports suggesting significant money movement and enhanced competition in financial services. However, as incidents of failure to manage customer funds or abuse of money laundering occur, there is a trend to improve and strengthen related regulations to protect customer funds and expand financial inclusion.
In conclusion, it may be a priority to resolve concerns about payment stability before introducing the EMPI whose positive effects are not certain. This involves adopting a real-time gross settlement system as soon as possible and improving unique features of the existing participation in the retail payment system. To introduce the EMPI first, it should revise relevant regulations such as limits on third-party operation of financial services so that positive effects can actually be realized, and strengthen related regulations to prevent problems such as potential digital run and reverse discrimination against depositors.
- A Decade of Comprehensive Financial Investment Business Entities in Korea: Evaluation and Development Strategies to Become "Korean IBs" [23-14]
- Senior Research Fellow Lee, Hyo Seob / Aug. 07, 2023
- A decade has passed since South Korea introduced its ‘comprehensive financial investment business entity (CFIBE, hereinafter)’ framework in May 2013. On this significant milestone, this paper evaluates how Korean CFIBEs have developed their businesses in alignment with policy objectives and proposes development strategies to gain a competitive edge over global investment banks.
Among other aspects, this study examines how Korean CFIBEs have performed in relation to the four policy objectives outlined at the outset: Expansion, profitability and business differentiation, corporate financing expansion, and risk capital provision. For the past decade, Korean CFIBEs achieved quantitative growth in expansion and profitability, with their equity capital and net revenues rising 148% and 650%, respectively. Their qualitative performance is somewhat disappointing, with 70% to 80% of their revenues still derived from brokerage and principal investment, showing no indications of business diversification. Their quantitative performance is outstanding as their credit provision increased twentyfold over the past decade. However, Korean CFIBEs are ranked between 20th and 30th, and 60th and 70th in Asian ECM/DCM and M&A, respectively, showing their weaker capacities in corporate finance compared to global peers. Furthermore, they fell short of meeting expectations as providers of risk capital since a significant portion of their corporate loans were tied to SPC and real estate assets, with only a modest amount of capital invested in equity in innovative venture firms.
The second part of this report proposes development strategies for CFIBEs based on a comparative analysis of the business strategies of Korean CFIBEs and global IBs. A SWOT analysis suggested that CFIBEs have an edge in retail and structured financing, while disproportionately concentrating on ELS, DLS, and debt guarantees to real estate PF. This shows that they lack in diversity in corporate financing services while falling short of business differentiation. Their external opportunities include accelerated digitalization, growth in new southern countries, and increased demand for wealth management. Conversely, they are confronting threats, including increased competition from players entering bigtech and fintech sectors, the blurring of boundaries in financial services, growing political and economic uncertainties, and the climate crisis.
On the path toward becoming Korean IBs, CFIBEs should fully leverage their technological strength in ICT for expanding their presence abroad in brokerage and principal investment. Based on Korea's business development company scheme and M&A activities, they need to strengthen their corporate financing capacity, and join hands with pension funds and sovereign wealth funds. As part of their preemptive measures to future changes in the financial services industry, it is advisable for Korean CFIBEs to recruit additional ICT staff, increase investments in infrastructure, and concentrate their resources and capabilities on digital finance and transition finance. Additionally, in the long run, further efforts are needed to enable CFIBEs to participate in payment and settlement services for corporations. Furthermore, CFIBEs should make efforts to enhance their risk management capabilities by enhancing their remuneration schemes and internal controls.
- On the Use of Artificial Intelligence in the Financial Services Industry and its Potential Risks [23-13]
- Research Fellow Noh, Sungho / Jul. 25, 2023
- In recent years, the escalating race to develop Artificial Intelligence (AI) and the resulting technological advancements have sparked the interest of participants in the financial services industry. Beneath this heightened interest, however, lies concerns regarding the increase of market risk due to a limited understanding of the technical features of AI. This paper provides an overview of how AI functions and identifies the associated risk factors through a concrete example.
A key feature of AI that has recently gained prominence is the rule-based, inductive learning capabilities using the framework of machine learning. The machine learning process consists of two technical elements: data and algorithms. The rapid growth of modern AI can be attributed in particular to the development of algorithms and the expansion of data. On another note, this also pertains to the core risk factors associated with these two elements, indicating potential challenges in interpreting results or assessing data relevance. More specific to market participants and their related areas, such risk factors may have consequences in larger prediction errors stemming from past data biases, arbitrary interpretations of generated results, and reduced efficiency due to underestimations and false positives.
This study proposes policy responses in three steps to minimize the core risk factors and the consequent damages expected as a result of AI use. Above all, it is advisable to accurately recognize and monitor the core elements of machine learning-based AI to effectively mitigate the potential damages arising from the complex and non-transparent nature of data collection and learning algorithms. Additionally, it is necessary to establish a clear legal framework and regulatory accountability for AI-generated content. This will internalize potential risks and thereby contribute to the responsible development and utilization of AI.