The Financial Services Commission announced plans to improve the competitiveness of corporate financing by securities businesses on April 9. Under the newly introduced plans, comprehensive financial investment business entities (“CFIBEs” hereinafter) will be subject to increased credit granting limits for corporate financing and required to supply 25 percent of capital raised from promissory notes and investment management account (IMA) for venture capital. The IMA scheme, which was first introduced in 2017 but has not been utilized since, will go through improvements. Based on the improved IMA scheme, the process for designating CFIBEs that are eligible to handle promissory notes and IMA will begin within this year. Moreover, the plans contain measures to provide incentives for overseas expansion of securities firms and regulatory reforms intended to bolster the soundness management over derivatives-linked securities (DLS) and derivatives-linked bonds (DLB). In June this year, the FSC plans to prepare and announce detailed measures to strengthen the soundness of real estate financing and liquidity management by securities firms and ways to improve rules on the soundness of CFIBEs.

FSC Chairman Holds Meeting with CEOs of CFIBEs

On April 9, FSC Chairman Kim Byoung Hwan held a meeting with the CEOs of ten major CFIBEs and introduced the government’s plans to improve the competitiveness of corporate financing by securities firms centered on regulatory improvements for CFIBEs. At the meeting, Chairman Kim and the participants discussed future directions for securities businesses in sustaining an innovative growth of our economy and promoting value-up in capital markets.

In his opening remarks, Chairman Kim underscored the important role of capital markets in making sure that our economy maintains vitality and continues to grow in the future. In this regard, Chairman Kim said that the plans being introduced today are intended to boost the role of securities businesses in corporate financing.

Since the comprehensive improvement plans will broaden the scope of securities businesses, Chairman Kim urged innovation in their business operations. More specifically, Chairman Kim said that it is necessary to boost the competitiveness of corporate financing in qualitative terms, while actively participating in value-up efforts in the capacity of both facilitator and leader. At the same time, risk management and internal control standards should be enhanced. Amid heightened market uncertainties at home and abroad, Chairman Kim said that it is necessary for securities businesses to play their part for market stabilization. To promote innovation and ensure stability in the capital markets, Chairman Kim called for close cooperation between the financial authorities and the securities business sector.

Enhancing the Competitiveness of Corporate Financing by Securities Businesses

As the Korean economy continues to grow into a mature stage, the role of corporate financing by securities businesses in supplying risk capital to companies has become increasingly essential. However, despite the external growth in quantitative terms and the expanded level of capital supply shown by securities businesses, it has been pointed out that there is still inadequate level of growth in qualitative terms. Major global investment banks (IBs) carry their own competitive edges in investment banking services, such as corporate mergers and acquisitions (M&As), bonds, stocks, etc. However, for CFIBEs in Korea, it has been suggested that they were not able to actively engage in the supply of venture capital and equity financing since they have the profit-generating and asset management structures that remain largely same as ordinary securities firms and because their investment banking service is largely centered on debt guarantees for real estate project financing.

In terms of the level of overseas competitiveness, domestic securities businesses’ competitiveness in corporate financing is deemed to be inadequate as their rankings stand below 50 among M&A, bond, and stock underwriters in the Asian market. In particular, domestic securities businesses have also been exposed to the problem of concentration on real estate financing and risk management with their short-term profit generating models amid expanded uncertainties of bond market situation in the second half of 2022.

As such, the plans being introduced today are intended to bolster the incentive structures to help enhance the competitiveness of corporate financing by domestic securities businesses and seek improvements to their soundness and liquidity regulations to ensure a stable growth of securities businesses.

Regulatory Overhaul on the Operation of CFIBEs

To facilitate CFIBEs to more actively supply corporate financing and venture capital, a sweeping overhaul of regulations will be carried out in the areas of corporate credit granting, promissory notes, and IMA.

First, CFIBEs’ corporate credit granting will be adjusted and expanded.

Unlike ordinary securities firms, CFIBEs are currently subject to the maximum corporate credit granting level of 100 percent of equity capital plus supplemental 100 percent of equity capital (the latter is restricted to credit granting to SMEs or for IB services). In this regard, adjustments will be made to the scope of corporate credit granting in the following ways—(a) credit granting to financial companies, which is not directly related to corporate financing, will be excluded and (b) credit granting to special purpose companies (SPCs) will be adjusted in accordance with the ultimate purpose of capital supply.

Next, the scope of corporate credit granting eligible under the supplemental credit granting limit will be broadened to enable CFIBEs to more actively supply capital to businesses. Since M&As constitute a key component of IB services, credit granting under the supplemental credit granting limit will also be allowed in the refinancing stage and when participating as syndicated lenders. Moreover, to strengthen the role of CFIBEs in corporate restructuring and when providing support for SMEs and middle market enterprises (MMEs), CFIBEs will also be allowed to grant credit within their own supplemental credit granting limits to the corporations that have shown improvements in their financial structures, MMEs, and for the purpose of assisting SMEs through non-recourse receivables financing.

Second, CFIBEs will be required to supply venture capital in the size of 25 percent of capital raised through promissory notes. Under the current rules, capital raised through promissory notes is managed in ways that require the allocation of at least 50 percent for corporate financing and up to 30 percent for real estate financing. However, it is necessary to expand the supply of venture capital to support innovative growth of our economy. Therefore, CFIBEs eligible to handle promissory notes and have total assets of KRW4 trillion or more will be newly required to supply 25 percent of capital raised through promissory notes as venture capital in the domestic market. The supply of venture capital can take the form of supply of funds or stock investment in SMEs and MMEs, debt securities with “A” or below ratings, purchase of primary collateralized bond obligations (P-CBOs), assisting SMEs with non-recourse receivables financing, investments in venture capital, venture capital businesses, high-yield funds, etc. Along with this, the 30 percent maximum limit currently placed on real estate financing with regard to the operation of assets drawn from the issuance of bills will be gradually lowered to 15 percent in 2026 and 10 percent in 2027. In the meantime, there will be stricter standards applied on promissory notes as they constitute investment products requiring stronger investor protections.

Third, there will be regulatory improvements made to investment management account (IMA).

IMA allows a consolidated management of customers’ deposits for the operation of assets related to corporate financing (70 percent or more) and pays profits generated to customers. CFIBEs with minimum equity capital of KRW8 trillion can assume IMA services. Since its introduction in 2017 through a revision to the Enforcement Decree of the Financial Investment Services and Capital Markets Act (FSCMA), there has not been a case in which IMA has been put to use. In this regard, regulatory improvements will be sought to add details regarding specific rules on the structure of principal payment, maturity, and maximum investment limit to promote the use of IMA as the source of corporate financing by CFIBEs and as a new investment product for investors.

In this regard, it will be made clear that CFIBEs bear the burden of paying principals for IMA products, and that they will have great leeway in how they design and structure IMA products regarding the maturity period and how earnings are paid out. However, if a specific maturity is set, payment of principal will be available only upon maturity, and if early cancellation takes place, investors may accrue losses depending on the performance of management. In addition, to make sure that IMA can work as an effective tool for supplying corporate financing, IMA will be required to include at least 70 percent of products that have minimum one year maturity. In addition, as in the case with promissory notes, IMA will be subject to the reduction of asset management limit for real estate financing (from 30 percent to 10 percent, immediately) and the duty to supply venture capital in the size of 25 percent of IMA operating assets (subject to increase gradually as in the case of promissory notes).

There will also be measures to improve the responsibility of CFIBEs in investment management and prevent conflicts of interest. The 5 percent seed investment rule currently in place for public offering funds will also be applied to IMA, and periodic management reports will be distributed to investors to provide information about IMA management to investors. Moreover, the restriction from trading own assets and cross trading will be applied as in the case with the management of trust.

Lastly, there will be measures to strengthen risk management. Since CFIBEs bear the burden of principal payment for both promissory notes and IMA, to ensure a sufficient level of risk management, the overall limit for promissory notes and IMA will be set at 200 percent of equity capital plus 100 percent of equity capital (200 percent limit for promissory notes). CFIBEs will be required to set aside loss reserves in the size of 5 percent of IMA capital under their management using their own assets, and when a valuation loss occurs, they will be required to top up loss reserves to make up for that loss. When there is a sufficient level of loss reserve set aside, only 50 percent of IMA capital under management will go into the calculation of net capital ratio (NCR) to help boost the operational capacity of CFIBEs.

Currently, securities businesses are preparing to launch IMA products that have the following features—(a) predetermined maturity date, (b) principal guarantee, (c) expectation for extra yields, (d) medium- to long-term (2 to 7 years) maturity and (e) moderate yield (3% to 8%) targets. These IMA products are expected to be put to use in various types of corporate financing and venture capital instruments—for instance, in corporate bonds, corporate loans, mezzanine investment, and venture investment—and take root as hybrid type (deposit-taking plus asset management) investment products that can generate profits for investors without having to worry about potential loss.

Designation of CFIBEs

Currently, CFIBEs are designated after a screening of equity capital, internal control, and conflicts of interest prevention mechanisms, and their eligible services vary depending on the size of equity capital (KRW3 trillion, KRW4 trillion, and KRW8 trillion levels). With the growth of securities businesses, it has been suggested that the threshold for designating CFIBEs should be set at KRW4 trillion for those eligible to handle promissory notes and KRW8 trillion for those eligible to provide IMA services. There are other regulatory upgrades and standardization required for current designation criteria.

Considering that securities businesses have been making preparations according to current designation criteria, applications for CFIBEs will be received in the third quarter of this year according to the current designation criteria of KRW4 trillion for those eligible to handle promissory notes and KRW8 trillion for those eligible to provide IMA services.

After this year, the CFIBE designation criteria will be strengthened, and the principle of stage-by-stage designation will be applied. The equity capital requirement, which is the most crucial component of the designation criteria, will be deemed as satisfactory when meeting above-the-threshold level for two consecutive periods based on year-end settlement data. Since the designation of a CFIBE can be seen as equivalent to granting an authorization to assume new services, applicants will be newly required to submit business plans and personal sanctions records (social credit). When designating CFIBEs for IMA services (those with minimum equity capital of KRW8 trillion), the largest shareholder requirement commensurate with the one currently in place for authorization for modification will be applied. Moreover, to facilitate a step-by-step expansion of corporate financing services from CFIBEs, their designation from KRW3 trillion equity capital level to KRW4 trillion (promissory notes) and to KRW8 trillion (IMA) will be made in two-year intervals.

Regulatory Reform on Securities Businesses

There will be regulatory improvements to support securities companies to more actively pursue overseas expansion and engage in corporate financing. There will also be measures intended to strengthen the soundness management of derivatives-linked securities (DLS) and derivatives-linked bonds (DLB).

First, incentives will be provided to support overseas expansion of securities companies. To gain competitive edge globally, it is required to expand businesses overseas. However, domestic entities’ profits generated from their overseas offices account for only about 4.1 percent, which stands at an incipient stage. In this regard, there will be regulatory support measures to promote overseas expansion of CFIBEs in ways that will have no disruptive effect on their liquidity and soundness management. To this end, when calculating the three-month liquidity ratio (liquid assets over liquid debts) for overseas subsidiaries, their earned surplus that can be easily converted into cash will be recognized as liquid assets. Also, when overseas subsidiaries make investments in stocks that are incorporated in the main indexes of investment grade (BBB- or above) countries, their NCR risk weights will be lowered from 12 percent to 8 percent.

Meanwhile, securities companies that are part of bank holding companies are also subject to the BIS capital adequacy ratio on a group-wide basis apart from the NCR regulation. Thus, there are obstacles to make active investments if their BIS risk weight stands high even when NCR risk weight remains low. In this regard, within the boundaries of Basel standards, improvements will be sought to reflect particular characteristics of securities businesses when calculating bank holding companies’ BIS capital adequacy ratio on a group-wide basis. More detailed measures will be announced in the third quarter of this year after having a taskforce review.

Currently, foreign currency securities owned by securities companies are required to be deposited at overseas custodian institutions in accounts held by the Korea Securities Depository. However, this restricts the use of securities for collateral and so on. Thus, to provide more leeway in making use of foreign currency securities to raise capital in foreign currencies, foreign currency securities owned by securities companies will be allowed to be deposited at overseas custodian institutions under the name of securities companies.

In addition, the scope of CFIBEs’ prime brokerage services will be expanded. Prime brokerage services offer various services, such as asset management, securities lending, and total return swaps to institutional investors. Currently, CFIBEs with KRW3 trillion or more of equity capital are able to provide prime brokerage services to funds, private equity funds (PEFs), cooperatives, etc. In this regard, an improvement will be sought to broaden the scope of entities to which CFIBEs can provide prime brokerage services. They include venture capital, real estate investment trusts, and new technology business cooperatives, which are not defined as collective investment vehicles under the FSCMA but have same characteristics as the ones mentioned above.

Moreover, the soundness management over DLS and DLB will be strengthened. Unlike bonds and promissory notes that are issued to raise funds by securities firms with their own credit, DLS and DLB constitute investment products, so that it is necessary to minimize combined usage with their own capital and maintain an appropriate level of issuance. As such, internal loan limits for DLS and DLB will be strengthened gradually (from 20 percent in 2026 to 10 percent in 2027). For calculating leverage ratios, from 2026, the same level of added rates will be applied to DLB as in the case with DLS.

Strengthening the Soundness and Liquidity Management

Reflecting upon and taking into account the previous experience of expanded bond market uncertainties in the second half of 2022, there will be measures to strengthen the soundness of real estate financing, expand and improve the application of liquidity ratio rules, and seek ways to reform NCR rules for CFIBEs with a medium- to long-term perspective. In this regard, more detailed plans will be finalized and announced in June, and key policy directions are described below.

First, for real estate financing, improvements will be made to the current rule for calculating NCR risk weight in accordance with different investment methods, such as debt guarantees and loans, so that actual risks can be reflected in more practical terms, such as the stage of development, loan-to-value ratio, the subscription and/or guarantee status, etc. Moreover, a maximum total exposure rule on real estate financing will be newly established, which will be an expanded application of the rule on debt guarantee limit (100 percent of equity capital) for real estate financing.

Second, the liquidity ratio rule currently in place for CFIBEs and DLS issuers (22 entities in total) will be applied to all securities companies, and its calculation method will be updated to take into account debt guarantees and the risk of changes in asset prices.

Third, as large scale securities companies, CFIBEs can provide both deposit-taking and credit lending services, so that there needs to be a strengthened level of soundness management over their capital. Thus, the capital soundness ratio applied on CFIBEs will be updated for medium- to long-term in a way that divides NCR by risk amount, and ways to bolster the risk weight will also be considered.

Further Plan

Most of the follow-up measures required under the plan are revisions to the Enforcement Decree and subordinate regulations, which are expected to be finalized within this year after the issuance of preliminary notice for regulatory change in the second quarter. A legislative revision bill regarding the scope of corporate credit granting is expected to be introduced in the second half of this year. Some of the measures that have not been included in the plan, such as the measure to improve the BIS capital adequacy ratio on a group-wide basis and ways to strengthen the soundness and liquidity management, will be announced in the third quarter and in June this year, respectively. Finally, designation of CFIBEs for KRW4 trillion and KRW8 trillion equity capital levels will take place in accordance with the existing designation criteria after processing applications in the third quarter of this year. In this regard, the financial authorities will guide prospective applicants to make sure that their business plans reflect regulatory improvement measures.

* Please refer to the attached PDF for details.