Korea Faces Uphill Battle to Become Financial Hub
President of International Investment Advisers
For four years, we have been hearing about Korea’s financial hub plan, and a few months ago, Ministry of Finance and Economy finally published its ``Financial Hub Initiative in Korea,’’ setting forth its grand plan to transform Korea into a regional financial powerhouse, basically, a Hong Kong or Singapore for Northeast Asia.
With so much financial commerce conducted entirely online today, one wonders if a need even exists for any regional financial ``hubs.’’ Stock markets in North America and Europe are planning mergers and multinational corporations already have tentacles on every continent. For those financial institutions needing a presence in Northeast Asia’s time zone, why not just use Hong Kong? Most importantly, for non-Korean companies, is there really any value to listing on the Korean Stock Exchange?
Even if the financial hub initiative in Korea were meaningful today, its stated goal of ``attracting foreign financial institution’’ will be far from an easy task.
The Korea Development Institute (KDI) recently conducted a survey of 103 foreign companies already in Korea, and the country received the lowest score as a financial hub candidate, behind Hong Kong, Singapore and Shanghai. Only a tiny 3 percent viewed Korea as competitive in the areas government regulations and labor-management relations.
In its financial hub presentation, the ministry touts its existing free economic zones (FEZs) ? Incheon, Busan and Gwangyang.
But the truthful reality with these FEZs only casts doubt on the financial hub. In 2005, hamstrung by taxes and regulation, the three FEZs were only able to attract a measly $240 million of foreign investment, while the Pudong New Area in China lured in a staggering $5.6 billion.
Even some government officials with authority over one of these FEZs gave their own FEZ a score of 52 out of 100, according to the National Assembly’s Budget Office.
Just as an example, last year, it took one foreign company nine months getting through a 17-step approval process to launch its Korean venture. Then, after permission was finally granted, the company was still unable to begin construction because of other regulations.
Making Korea an economic powerhouse is clearly an uphill battle. So, here are a few practical suggestions for how this goal might be accomplished:
Do Not Prosecute Foreign Bankers for Making Profits
Foreign financial institutions are in the business of making a profit. Lone Star did a huge favor for the Korean people by bailing out Korea Exchange Bank, which was obviously on the ropes at the time.
Lone Star took a big chance on this distressed asset, so they deserve every penny of profit they earn from their investment.
As long as the Lone Star investigation, attempted extradition and prosecution continue, the financial hub initiative in Korea is absolutely impossible, for obvious reasons.
When LG Investment & Securities sold its stake in Polish Petro Bank for a 50 percent profit, the Polish government did not raid their offices and try to nullify the deal. Neither should Korea prosecute foreign financial institutions that make a profit here. This is Korea, not Zimbabwe.
Do Not Let Foreign Banks Get Shut Down by Strikers
An absolute prerequisite for any financial institution considering establishing a satellite office anywhere is being able to hire a lean, low-cost, highly-productive workforce, which can be deployed efficiently and discharged when tasks are complete.
However, the labor-management environment is exactly the opposite of this in Korea today. Foreign financial institutions have read all the headlines about bank computers being smashed, executives locked in safes, and demonstrations in the street against merger and acquisitions (M&As), CEO appointments and etc.
A few foreign banks who dared to buy into Korean banks earlier announced that there will be no layoffs, before making a tender offer, capitulating before any discussion of downsizing even began.
The problem can be attributed to Korea’s socialistic labor laws. Like France, layoffs are prohibited in Korea, unless your company is in or near bankruptcy.
Shielded by these laws, Korean bank workers perpetuate one of the most inefficient work environments in the world, with a row of tellers, in front of a row of sub-managers, in front of a row of senior managers.
In the age of Automated Teller Machines (ATMs) and electronic-bills, what foreign financial institution wants to get stuck with a vast horde of workers with lifetime employment guarantees?
Make Korea Listings Attractive by Ending Corporate Governance Discount
Hundreds of large North American and European companies have stock listings in Hong Kong and Singapore, and Korea would like its stock market to attract some of this business for its financial hub plan. However, large international public companies will not be willing to list on a market suffering from a corporate governance discount, such as Korea.
Korean regulators waste a lot of time promulgating petty business controls, which impede the healthy monopolistic impulses of listed companies. Such controls do nothing to alleviate the ``Korea Discount.’’ Instead, why not unleash Korea’s pension funds?
In North America and Western Europe, there are pension funds, such as CalPERS, which defend the interests of their clients by voting their large stakes to boost share price and dividends, courageous enough to declare war on the biggest CEOs in America.
In Korea, there is $378 billion of pension money, but only about 10 percent of it is invested in the equities market, compared with 65 percent, for example, in Australia.
And, unlike CalPERS, that 10 percent always rubber-stamps any and all value-destroying mismanagement.
Just imagine how fast the ``Korea Discount’’ would disappear if Korea’s vast pension funds had a normal equity allocation and aggressively voted their shares for management whose practices boost dividends and share price.
Do Not Renege Treaties
Another stated goal of the financial hub initiative in Korea is ``internationalization of financial transactions.’’ If international financial institutions are to be attracted to Korea, then they will certainly expect all treaties designed to facilitate business transactions to be honored.
Korea’s Special Withholding Procedure, which took effect on July 1, 2006, does exactly the opposite.
Your financial institution may get 100 percent rock-solid approval from the authorities of one of Korea’s treaty partners, but Korea’s Special Withholding Procedure establishes a new, grueling 11-point permission process, basically overruling the treaty partner’s approval of your local presence.
It’s like Korea is enacting laws in other countries. No other country in the world has a treaty-killing procedure like this.
We live in a world of multinational companies, which have offices around the world. These companies have an obligation to their shareholders to boost profits in any way they can, including minimizing taxes jurisdictionally.
It’s no different than selling your cars in Switzerland because it’s more profitable to do so. Sophisticated international financial institutions will simply avoid Korea if it reneges its taxation treaties with the Special Withholding Procedure and other hostile policies.
End Tax Discrimination Against Foreign Financial Institutions
A stated goal of the financial hub initiative in Korea is a ``foreigners-friendly environment.’’ If foreign financial institutions are to be attracted to Korea, they want to know they will be on a level playing field with domestic financial institutions, especially regarding taxation.
But just last month, Korea’s Assembly passed a bill giving tax exemptions on funds investing in overseas stocks, but these funds had to be locally-based, and funds set up by foreign asset management firms in foreign nations were excluded.
Major players like Fidelity had no choice but to set up awkward and costly ``mirror funds’’ based in Korea as a workaround.
Also, foreign investment companies and pension funds must pay a 0.30 percent transaction tax with every stock sale they make.
For a $100 million fund with a 100 percent turnover ratio, that 0.30 percent adds up to a lot of money.
Korean investment companies and pension funds, however, get favored treatment, and instead pay zero transaction tax. You won’t find either of these discriminatory tax policies in a real financial hub like Hong Kong, and they certainly are a disincentive to international financial institutions.
The purpose of the five suggestions above was to show the vast gulf between the rosy dreams of the financial hub initiative in Korea, and the depressing reality of xenophobic government policy today.
Not too long ago, the Financial Times described Korea as having ``one foot on the accelerator and one foot on the brake.’’ I think this is a very apt description.