Direction of Financial Regulatory Environment of Korea in 2019: Legislation Supporting Financial Innovation and Reform of Supervisory System

For 2019, it is expected that the financial regulatory/legislative environment will see further developments along two key tracks, with one track consisting of the enactment of special laws favoring new business initiatives aimed at promoting innovation in the financial business sector, and the other track consisting of legislative activity aimed at reforming and improving the existing financial supervisory system to promote greater efficiency and integration.  The following specific examples of legislation are representative of the overall direction planned for the financial regulatory environment in the year ahead.

1.  Introduction of Regulatory Sandbox – The Special Act Supporting Financial Innovation

Despite changes in the financial environment, the regulatory environment created to appropriately regulate the already existing financial business structure has imposed restrictions with insufficient flexibility to allow for the emergence of new and innovative types of financial services. For example, if a fintech company considers the launching of a new type of financial service that may in some aspects overlap or appear to have a connection to a number of different types of more traditional financial service categories, the fintech company may find that the contemplated business does not clearly fall within the scope of one coherent set of regulations, but rather would be subject to a wide array of different restrictions, licensing requirements, etc. under different sets of financial laws and regulations that did not have the new/innovative business in mind when they were created.

Under these circumstances, the Korean government has been moving forward with the introduction of the Special Act Supporting Financial Innovation (“SASFI”) with the intention of promoting the activities of new financial service providers, with regard to introducing innovative financial services, by providing limited-time exemptions or suspensions with regard to currently existing financial regulations. The SASFI was passed into law by the National Assembly at the end of 2018 and is scheduled to go into effect in April 2019.

According to the SASFI, “financial companies or companies under the Commercial Act that maintain a place of business (“fintech company”) in Korea” that, in the course of carrying out financial business activities or business activities related thereto recognized as being distinguishable from pre-existing financial service providers with respect to content, methods or form, etc., may apply to the Financial Services Commission (“FSC”) to be designated as such (i.e. as an innovative financial service) and, pursuant to passing a review by the FSC’s Innovative Finance Review Committee, may be officially designated as an innovative financial service for a certain period (up to 2 years).

Companies that receive the official “innovative financial service” designation may then enjoy a special status whereby the FSC will, during the relevant period, exempt them from the application of certain requirements that otherwise would apply to their business activities, such as certain licensing, registration and reporting requirements under various finance-related laws and regulations, as well as exempting them from compliance with requirements that would otherwise apply regarding management structure, scope of business and business soundness standards.

When the SASFI goes into effect, it is expected that new financial services will emerge, which previously could not be attempted due to onerous restrictions under existing laws, and the SASFI is anticipated to function in the future as a shock absorber to facilitate a smoother entry of innovative financial service enterprises into the regulatory system.   

2.  Expansion of Internet Banking by ICT Enterprises – The Special Act on the Establishment and Operation of Online-only Banks

As technological developments continue to affect and shape the financial industry, the financial sector has seen the emergence of banking enterprises that exist and are conducted on an online-only basis (also referred to as Internet primary banks or Internet-only banks). Until recently, some degree of related regulatory accommodations have been made in the form of adding relevant carve-outs in existing legislation, but there have been significant limits that have prevented participation by online-only banks in various areas of banking activity.

As a response to this situation, the Special Act on the Establishment and Operation of Online-only Banks (‘Online-only Bank Act”) has been enacted and came into effect on January 17, 2019.  Under the Online-only Bank Act, special regulations governing online-only banking business activities have been integrated into a coherent and whole regulatory framework, which is expected to make it easier for new participants to engage in the banking business market.

Under the previously applicable laws and regulations, excessively strict restrictions regarding the acquisition of shares of banking enterprises functioned to make it unnecessarily difficult for innovative participants to enter the banking industry.   Previously, participation by non-financial entities (Information and Communications Technology (“ICT”) companies) was limited by prohibiting them from acquiring more than a 4% shareholding ratio in an online-only bank entity.  That has now been greatly expanded to allow shareholding ratios of up to 34%.  This change is expected to open the door for innovative ICT companies to play a leading role in online-only banking.

Additionally, while minimum capitalization requirements for online-only banks have also been relaxed, it is important to be aware that certain other restrictions, in comparison to general restrictions on banks, have been tightened against online-only banks, such as restriction on extending credit to major shareholders and acquiring shares issued by major shareholders.

3. Integrated Supervisory System for the Financial Sector – The (Draft) Act Concerning Supervision of Financial Groups

As one key link in regulatory reforms relating to the finance industry, the Korean government has pushed forward with the development of an integrated supervisory system for more effective, systematical supervision and administration vis-à-vis the various financial business activities engaged in by corporate groups in the financial sector. Such initiative recognizes the importance of monitoring and regulating financial groups on a group-wide basis, rather than simply treating each corporate entity within such groups as a discrete, unconnected business entity.  In January 2018, the government confirmed its plan to introduce such integrated supervisory system and, as a pilot program beginning in July 2018, the government implemented a set of “Model Rules for Integrated Supervision of Financial Groups” to serve as non-binding guidelines for relevant regulators to follow with regard to adopting  group-wide supervisory practices vis-à-vis financial groups. A process is now underway to convert the guidelines into legally binding legislation, the centerpiece of which is the “(Draft) Act Concerning Supervision of Financial Groups (“ACSFG”)”.

Under the ACSFG, a financial conglomerate will be designated as being subject to group-wide supervision if: (i) the conglomerate’s group-wide financial assets exceed a certain prescribed total; and (ii) such financial conglomerate’s group-wide business activities include the conducting of business in two or more of the following business areas: lending and borrowing, financial investment business, and insurance. However, conglomerates/groups that are already subject to similar supervision under the Financial Holding Company Act or another special act (such as the Korea Development Bank Act) may be exempted from supervision under the provisions of the ACSFG. Also, a financial company established and operating outside of Korea may separately apply for an exemption from the application of the ACSFG, even if they belong to a Korean financial group that is otherwise subject to the ACSFG.

Under the ACSFG, relevant financial groups will be required to establish group-level risk management systems, managed by a company designated to represent the group (and, more specifically, managed by that representative company’s board of directors and a risk-management organization set up within that company). Such financial groups will also be required to comply with group-level obligations with regard to such things as adequate capitalization, insider trading prevention and avoidance of excessive risk concentrations, in addition to other group-level requirements with regard to overall business soundness and related reporting/public disclosure duties.  The ACSFG also includes provisions that call for regulatory agencies to establish a joint deliberative body to promote well-integrated supervisory approaches through inter-agency cooperation.

4. Paperless Securities – Act Concerning Electronic Registration of Shares/Bonds, Etc.

The “Act Concerning Electronic Registration of Shares/Bonds, Etc.” (“Electronic Securities Act”) was passed by the National Assembly in 2016 for the purpose of instituting an electronic registration system for bonds and shares of stock, with the aim of promoting greater efficiency in the circulation/trading of such securities, as well as to better protect the interests of the holders of such securities, among other things. Recently, the Ministry of Justice and FSC together announced details of the proposed enforcement decree for the Electronic Securities Act, which sets out the regulations to be followed in implementing the electronic registration system under the Electronic Securities Act. Pursuant to the proposed enforcement decree, the provisions of the Electronic Securities Act will go into effect in September 2019.  In order to ensure that the electronic securities registration system can be implemented smoothly, required groundwork is also currently being prepared, with the Korea Securities Depository playing a key role.

After the Electronic Securities Act goes into effect, relevant securities may be electronically registered at the request of the issuer or holder, pursuant to which the physical (paper) certificates representing the securities will be invalidated and the management of transactions involving the electronically registered securities, such as any acquisition, transfer or collateralization thereof, or exercise of rights therein, will all be managed and handled electronically in accordance with procedures prescribed by the Electronic Securities Act. 

In order to comply with the obligations under the Electronic Securities Act to electronically register shares to be issued by them, publicly listed companies will need to have provisions included in their articles of incorporation that expressly authorize electronic registration.  Any companies that are not publicly listed companies that desire to issue securities by way of electronic registration, without any issuance of physical (paper) certificates, in accordance with the Electronic Securities Act will also need to have appropriate express authorization therefor included in their articles of incorporation.

The Electronic Securities Act is not expected to have any particularly significant impact on floor trading of publicly listed shares.  Otherwise, however, it will be essential for capital market participants to be aware of the changes that will be introduced when the Electronic Securities Act comes into effect, particularly with regard to securities transactions involving Korean securities, such as shares issued by Korean companies or bonds/debt securities issued and governed in accordance with Korean law. 

Key expected benefits of the Electronic Securities Act include a reduction in the amount of time required for confirming/securing rights relating to electronically registered securities, as well as a reduction of risks associated with forgeries and the keeping of physical certificates, along with facilitating greater convenience generally with regard to various types of securities transactions. 

If you have any questions regarding this article, please contact below:
Hyunjoo Oh (hyunjoo.oh@leeko.com)
Seung A Hyun (seunga.hyun@leeko.com)
Dong Yon Kim (dongyon.kim@leeko.com)
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