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Korean Financial Regulators Advance Legislation to Introduce Regulatory Sandbox to Spark FinTech
The 2018 year in review in Korea was notable for the sluggish overall economy, uncertainty surrounding the geo-politics and impact on Korea due to the global trade wars, on-going concerns related to the lack of jobs and unemployment, increased taxes and burdens for businesses and families, and no meaningful improvement or clarity in the current situation for 2019. In response, the Korean National Assembly passed a legislation called the Financial Innovation Support Act (the “FinISA”) on December 7, 2018 to spark the financial services industry in conjunction with FinTech products and services. The FinISA, which will soon take effect in March 2019, is intended to lay the legal foundation to introduce a regulatory sandbox for innovative financial services, where FinTech firms test their new products and services without certain regulatory oversight pursuant to exemptions for a limited period of time (“Sandbox”). As the FinISA exempts or defers application of existing finance-related regulations for new financial technology, products or services with the purpose of fostering the creation of innovative and new financial products and services, it will also support the stabilization of such services in the financial services market at the end of the testing period and is expected that the FinISA will support a revitalization of the FinTech industry which experienced sluggish growth in recent times. In particular, as companies and investors become more interested in security tokens and Security Token Offerings (“STO”) which are regulated by the Financial Investment Services and Capital Markets Act (the “FSCMA”), there have been on-going discussions and debates as to whether the FinISA could lead to a breakthrough in the crypto-asset industry based on blockchain technology. Crypto assets encompasses those assets which utilize blockchain technology where the asset is digitalized by utilization of cryptography, peer-to-peer networks and a public ledger of verified transactions resulting in a ‘units’ of such a crypto asset without any involvement by middle-persons or brokers (e.g., cryptocurrency.
The Korean Government’s Aim to Create a ‘Safe Space’ to Foster the FinTech Industry
Regulatory sandboxes which have been implemented and operated in the United Kingdom, Australia, and Singapore have been successful in creating an environment and system that activates and facilitates the development of the FinTech industry in a methodical progression with technology dovetailing with applicable regulations. A sandbox has long been known as a place where children could come and play while interacting with one another in a safe environment – regulators have drawn on the same concept to create an interactive and safe space where businesses (e.g., start-ups and information technology companies) can test their innovative products, services, business models, and delivery mechanisms under a safe harbor without being subject to existing regulations for a certain limited periods of time. The implementation of the FinISA is an important move by the Korean government to create a regulatory Sandbox to spark innovation and growth in the FinTech industry in Korea. The regulatory Sandbox will be formed under the FinISA in conjunction with the following newly adopted key laws (1) the Industrial Convergence Promotion Act, (2) Information and Communication Technology Convergence Act, (3) Act on Special Cases Concerning the Regulation of the Special Economic Zones for Specialized Regional Development (each of which were promulgated on December 16, 2018 following the adoption of certain amendments), (4) Framework Act on Administrative Regulations (currently pending legislative review at the National Policy Committee of the Korean National Assembly), and (5) Financial Innovation Support Act. Amongst them, the Financial Innovation Support Act, which provides special exemptions to regulations in the financial services sector, has been passed by the Korean National Assembly.
1. Key Provisions of the FinISA
A. Application Procedures for FinTech Firms to be an Innovative Financial Services Provider
Under Articles 4 and 5 of the FinISA, FinTech firms organized under the Korean Commercial Code which have place of business in Korea or financial institutions duly licensed by the Financial Services Commission may apply to participate in the regulatory Sandbox with financial services acknowledged as differentiated from existing services in its content, method, and form (“Innovative Financial Services Provider(s)”).
B. Establishment of a Review Committee under the Financial Services Commission
In accordance with Article 13 of the FinISA, a Review Committee comprising of 25 members, which shall include financial services officials, ministers of the related departments and one expert in each of the areas related to technology, finance, law, and consumer rights will be established under the Financial Services Commission. The authority and role of the Review Committee will be to review applications and to designate applicants as Innovative Financial Services Providers.
C. Necessity for Innovative and Beneficial Financial Products and Services
In determining whether a FinTech firm or financial institution qualifies as an Innovative Financial Services Provider, the Review Committee will take the following into account with respect to the applicant pursuant to Article 13 of the FinISA: (1) the target consumer financial services market is in Korea; (2) the products and/or services are innovative; (3) benefits for consumers are enhanced through the products and/or services; (4) the necessity for the application of FinISA (i.e., can the relevant financial products and/or services be marketed and sold without application of the FinISA); (5) the FinTech firm or financial institution has sufficient capabilities to carry out the intended business for the products and/or services; (6) adequacy of measures to be taken to protect financial customers from any harm or injury that they may suffer in the future following the provision of the innovative financial products and/or services, including notification of the risks behind the transaction and preparation of dispute settlement procedures in case disputes arise; (7) concerns that the stability of the financial markets and financial order will be disrupted in Korea; and (8) the contingency that the application of the financial services-related laws/regulations would be circumvented or frustrated.
2. Exemptions under Existing Regulations for Innovative Financial Services Providers
Pursuant to Article 17 of the FinISA, those designated as Innovative Financial Services Providers will be allowed to test their new products and/or services for a maximum of two years subject to an extension period for one additional period of two years in an environment where certain financial laws/regulations will be exempt from application to the Innovative Financial Services Providers and their products and/or services.
The type of and the manner in which the exemptions shall be applied will be determined at the time of designation. There are a wide ranges of exceptions available to the laws/regulations which can be granted including the need for a license (i.e., approval, permission, registration, report, etc.) and matters related to corporate governance, scope of products and/or services, soundness of business, conduct of business activities, and supervision and examination by the regulatory authorities.
3. Actions to be Taken for Consumer Protection
A. Compliance with and Supervision under the FinISA
In accordance with Article 29 of the FinISA, the financial regulatory authorities will monitor whether the Innovative Financial Services Providers comply with the permitted FinTech activities and scope of business as permitted under the FinISA. They will also make determinations on whether there would be any negative impact and irreversible harm to consumers as well as any potential undermining of the financial stability of the company and/or the financial markets. Accordingly, the regulatory officials may take measures such as issuing a suspension of business order and/or modifying the scope and provision of the permitted products and/or services including a revocation of the designation as an Innovative Financial Services Provider.
B. Implementation of Protective Measures and Dispute Resolution Procedures for Consumers
Article 27 of the FinISA stipulates that in the event that there is a dispute raised by consumers against an Innovative Financial Services Provider, the burden of proof will fall on the Innovative Financial Services Provider to prove that there were no intentional acts or negligence on its part giving rise to a claim for damages in a legal proceeding. Innovative Financial Services Provider must also prepare and implement mechanisms to guarantee compensation to consumers who have sustained injuries and damages including the provision of liability insurance to cover such losses on behalf of consumers.
4. Regulatory Action by the Korean Government following the Designation Period
A. Continued Support by the Review Committee
In principle, regulatory exemptions to the Innovative Financial Service Providers will expire concurrently with the expiration of the statutory designation period. However, in order to continue the support to the financial services sector with FinTech service providers, the Review Committee may also assist in the licensing examination process of FinTech companies pursuant to Article 21 of the FinISA, and recommend legislative measures to improve the system and regulatory framework for the FinTech sector.
B. Exclusive Operating Rights to Innovative Financial Services Providers
Under Article 23 of the FinISA, Innovative Financial Services Providers have exclusive operating rights and may request that other providers refrain from releasing the same products and/or services in Korea which period of exclusivity shall be a maximum of two years from the completion of their licensing.
5. Other Sandbox Policies Incorporated into the FinISA
In addition to the establishment of the regulatory Sandbox, the FinISA has also promulgated the following financial innovation support policies:
A. Regulatory Confirmation by the Review Committee
In order to streamline and eliminate any regulatory uncertainty with respect to the licensing of the Innovative Financial Services Providers, a fast-track system to confirm procedures has been established under Article 24 of the FinISA whereby the applicants can request an administrative confirmation from the Review Committee as to whether any applicable laws, regulations, and administrative rules related to the relevant products and/or services would apply and if the applicant satisfies the requirements there under.
B. Outsourcing of Core Functions by Innovative Financial Services Providers to FinTech Companies
Under Article 25 of the FinISA, Innovative Financial Services Providers and especially those that are duly licensed as a financial institution in Korea may outsource certain core functions as authorized to conduct its financial services business and in the course of carrying out tests for the development of new innovative financial products and/or services – such core functions may be outsourced to other FinTech companies designated as agents to the extent necessary for the testing. In turn, the designated agents may receive support in the development of their new products and/or services by conducting the testing on behalf of the Innovative Financial Services Provider (previously, such core functions were permitted to be conducted only by licensed financial services institutions).
C. Financial Support to Innovative Financial Services Providers
Article 26 of the FinISA provides that the Korean government may assist in financing all or part of the expenses necessary for the operation and maintenance of innovative financial support organizations for the purpose of facilitating the creation and development of innovative financial services. In order to enable the Korean government to support the FinTech sector and its market participants companies through innovative financial services support organizations, justifications and grounds authorizing the Korean government in the provision of financial support to the Innovative Financial Services Providers have been prepared.
6. Outlook for the Regulatory Sandbox and Creation of an Enhanced and Innovative FinTech Products and Services to Invigorate the Financial Services Industry
As explained in this article, the FinISA is being introduced to spark the FinTech and the financial services industries in Korea. By way of provision of exemptions to the existing finance services-related laws/regulations with respect to FinTech, financial services institutions as well as general companies in the hopes to facilitate the introduction, development, and operation of FinTech firms which were prohibited under the finance-related laws/regulations. The FinISA will also allow many new financial products and services to be developed and introduced in Korea which were previously hindered by licensing requirements and other burdens under the current regulatory framework including the requirement of large capitalization amounts under the finance-related laws/regulations. It also aims to create an opportunity for existing financial services institutions to develop, market and sell a variety of financial products and services by easing the burdensome regulations and strict control over business activities.
Recently, the potential of crypto asset as a store of value which includes tokenization of non-liquid assets using crypto asset-based-blockchains and the expansion of liquidity of security crowd funding now attract ever more attention. The increased interest is a consequence of the limitations on the utility of token projects as a medium of exchange with highly volatile exchanges, arbitrages on rapid fluctuations in price, and where utility token projects are now undergoing a sluggish growth period. Also, projects utilizing crypto-assets in the form of security tokens are considered to be a business model that is more feasible than in the past. However, when considering the Korean government’s current cautionary policy on crypto assets over the years, it is difficult to expect a significant and meaningful positive regulatory environment in the immediate future for crypto assets in the form of security tokens which are subject to strict regulation under the FSCMA. Accordingly, many see the Korean regulatory framework as a critical barrier in realizing the potential of crypto assets and the development of the exchanges and related businesses.
Under the current circumstances, the financial services business community continues to discuss and debate the efficacy and the positive effects of the enactment of the FinISA and to what degree it will change the financial services regulatory environment in Korea. Experts have pointed out that the actual impact of the enactment of FinISA would be limited as there are concerns that the criteria for determining an Innovative Financial Services Provider are subjective making it difficult to create and establish objective standards for the licensing and approval process. However, expectations may change due to the recent policy changes by the Korean government and financial regulatory authorities which emphasize regulatory innovation in the financial services sector as a key growth engine for the financial services sector and the Korean economy. As the industry moves forward, it will be imperative to monitor the legislative discussion over the passage of any subordinate laws, regulations, and guidelines promulgated by the regulatory authorities which relate to the application of the FinISA and how it will be applied and interpreted going-forward.
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