Korea and financial hub

By John Walker

For a number of years Korea has been exploring ways of achieving its vision of becoming a financial hub. Through the FN Hub team in the Financial Supervisory Service and other initiatives the government has been aggressively reaching out to financial institutions globally to enlist their support in assisting the development of Korea’s financial sector. The plans for hub status are ambitious and from time to time there have been doubts raised about how realistic they are given competition from other hubs such as Singapore and Hong Kong.

I have thought about this and the answer is quite obvious. As successful entrepreneurs know, often the best businesses are those that offer a niche product. As I travel around emerging Asia I often get comments about the very high quality of infrastructure in Korea and its world leading transparent process for bringing capital into the development of new infrastructure. Indeed Korea’s infrastructure is the envy of many emerging and developing nations (and many developed nations too). I also get many comments about the competitive, high quality Korean construction and operations and maintenance companies.

In recent weeks we have seen headlines about the success of Korean companies winning overseas construction contracts. Towards the end of 2012 Samsung Engineering won $1.5billion power project and Doosan Heavy won a $1billion water desalination deal in Saudi Arabia and the list goes on. Overall local builders won overseas construction orders of $64.9 billion in 2012, up 10 percent from a year earlier.

However, despite this great success by builders and operators, apart from Export-Import Bank of Korea (EXIMbank), which is doing a fine job, Korean capital involved in such projects is quite scarce compared to both Japanese and Chinese banks and investment institutions. Compared to Japanese and Chinese companies Korean companies appear to have had the least support from Korean financial institutions in winning cross border infrastructure transactions. It should be noted that global infrastructure debt funds are beginning to strongly emerge which will increase even more with competition from other countries, such as Singapore.

Since the global financial crisis in 2008, European banks who were the dominant project finance lenders in Asia have begun to pull back to their home countries. Japanese and Chinese banks have begun to aggressively step in to fill this growing vacuum. In fact it was announced in the last week of December 2012 that Japanese banks hold the second, third and fourth rankings of banks by dollar value of project finance deals they arranged. This puts them well ahead of European stalwarts who used to dominate this sector.

Why are banks in Asia strengthening their presence in infrastructure finance? Banks in Japan, for example, are doing this because they have the cash to lend but little prospect for growth at home. They are also doing it to assist Japanese construction and operation companies win projects. In this way the Japanese economy benefits from construction company profits and the financial institutions can also make lending and equity investment profits. Effectively they are taking many bites from the one juicy apple. The issue for Korea is that it is taking less bites from the apple and going without additional profit for the financial sector.

Banks and other investors are also strengthening their presence because of the very low interest rate environment confronting most nations.

Infrastructure investment provides appealing and steady returns. The average dividend yield of the asset class has historically surpassed that offered by other equity securities and currently exceeds yield offerings among many fixed-income securities. This is why more and more global banks and institutional investors are focusing on this sector.

Also infrastructure in Asia alone is a huge growth industry. By 2050 Asia per capita income will rise six folds in purchasing power parity terms, resulting in 3 billion additional affluent people. Between 2000 and 2006, around a million people were lifted out of poverty every week in East Asia. By 2025 more than 2 billion people in Asia ― a quarter of the world’s population ― are expected to live in cities. All this is anticipated to require up to $8 trillion of new infrastructure investment by 2020 to support the current level of economic growth.

What does all this potentially mean for Korea? Korea has world class construction and operating companies that are active in a range of markets. They are winning projects. Korea is recognized in emerging Asia as a role model for the development of privately financed infrastructure ― it is the example of what Indonesia, the Philippines and Vietnam could become. Korea has huge investment institutions and healthy banks. Korea’s own infrastructure is unlikely to require significantly more capital and it is in a very low interest rate environment which will challenge the profitability of banks.

All of these factors seem to me to place Korea in a perfect position to take a leadership role in developing and financing a large proportion of the infrastructure needs of the emerging world.

However, as mentioned earlier its financial sector is lagging behind competitor nations.

Korean institutions are uniquely placed to participate more actively in cross border financial infrastructure investment but they need a strategy. This could be achieved through a combination of approaches.

First, a policy driven approach could include things like a Government debt fund and meaningful offshore green-field infrastructure investment funds.

Second, a financing structure driven approach where financing structures are used to access the cheaper funding costs of multilateral agencies such as ADB. Third,

·a big picture driven approach where a structure could be established for a broader level of involvement by Korea banks. EXIMbank overseas investment structure is not enough on its own. This approach could involve initiatives such as establishing a Project Finance Centre of Excellence in Korea which could help give banks the necessary expertise to evaluate investments.

Finally, if Korea could develop such a strategy using the above approaches and bring a coordinated focus to its natural advantages in the areas of privately financed infrastructure it could well become the hub for Asian infrastructure finance. It could dominate this niche by utilizing its capital, its own track record and knowledge to build a specialist asset management industry for both equity and debt capital investing into Asia’s growth.

For some time now policy makers and regulators have been struggling to define how Seoul and Busan will establish themselves as sister hubs in Asia. Perhaps this idea is one the new administration could include in its deliberations on the future of the finance industry in Korea.