Korean Capital Market: Now and Forward

By Jeong Bu-kyun

president of Korea Center for International Finance

The Korean government, in cooperation with the financial industry, keeps pushing for reforms in the sector in order to advance the capital market to a global level.

Such an endeavor is illustrated by the Capital Market Consolidation Act (CMCA), a landmark-to-be in the history of the Korean capital market, which was passed by the National Assembly last month.

Korea has long been making efforts to promote its capital market. The government, acknowledging the significance of the capital market in the economy, enacted the Capital Market Promotion Act in 1968.

The domestic stock market capitalization reached 961 trillion won last month, approximately 15,000 times larger than that of 1968. It is equivalent to continuous annual growth of 27 percent for the past 40 years.

Despite such fast growth, equities and bonds are the most traded securities on the market as of yet. Such a limited range is difficult to fulfill the versatile market demand and keeps the market away from opportunities to create potential value added.

The long-waited CMCA intends to realize what has been missed and to direct it to economic growth. In the aspect of global financial trend, these policy shifts are believed timely and appropriate.

Disintermediation and securitization in the current global economy steadily induce the dominance of direct finance over indirect. The U.K. and the U.S. have developed their financial sector with a focus on capital market functions, whereas the rest of Europe tends to put more efforts onto the banking side. Since the late 20th century, the U.K. and the U.S. appear to have won the race.

Another factor responsible for the significance of the capital market advancement is the rising era of asset management, which is capital-market-centered.

Global population aging speeds up the growth of pension funds. Emergence of alternative hedge and private equity funds, and sovereign wealth funds built on trade surpluses is also a contributing element. The CMCA also quite timely conforms to these changes in the local capital market.

South Korea, the world's 12th largest trading economy, is pursuing its ambition of becoming a financial hub.

It should be noted that financial hubs such as London, New York, Hong Kong and Singapore have also been major international trade centers. Moreover, Korean financial institutions now hold the potential for international competition.

An economy, once it achieves a certain level of growth, changes from capital-deficient to capital-surplus. Korea, after successfully recovering from the financial crisis, has gone through such a change.

In addition, public funds, including foreign exchange reserves and the National Pension Service, enable Korea to pursue ``buy-side'' strategies.

The U.K. and the U.S. capital markets were established on colonial trade and the Industrial Revolution. Singapore and Hong Kong have employed commercial capital from merchandize trade and government-run pension funds.

Higher demand for asset management driven by a capital surplus intensifies the pressure for a capital market upgrade.

Capital markets can be a buffer in the event of an economic shock. In the past when the economy was small, the banking sector did neutralize impacts of a certain shock. It is doubtful if they could do that today.

An episode reflecting this is the bankruptcy of the Hanbo in 1997, a failed attempt for a bailout by loan-extension. Now the volume of conglomerates is comparable with that of financial institutions.

The economy should boost stability by spreading out corporate risks through capital market operations.

Lastly, the capital market upgrade will provide more opportunities for financial firms. Companies can become more diversified and capable for economies of scale. Mark Shapiro, a former director of McKinsey & Co., stressed at a seminar in Seoul in 2002 that economies of scale and scope would soon also be applied to the financial sector and only highly diversified mega institutions would be able to thrive.

Now, Let's consider strategies to overcome the obstacles on the road to an advanced capital market.