On May 27, 2019, the Capital Markets Division of the Financial Services Commission (“FSC”) proposed regulatory reforms of financial investment business activities (the “Proposed Reform”).  

According to the FSC, the Proposed Reform will give financial investment service providers (such as broker-dealers and asset managers) greater freedom in conducting their businesses and further develop Korea’s capital markets.  If adopted, the Proposed Reform will bring significant changes to regulations on Chinese wall requirements, the outsourcing of activities, and the engagement by financial investment service providers in concurrent or ancillary businesses, which will allow financial investment service providers to strengthen their role as risk capital providers and venture into more specialized sectors within the financial industry.

In November 2018, the FSC issued a press release regarding a “capital markets initiative for growth through innovation and job creation,” which included its initial plan to revamp existing rules and regulations on Chinese wall requirements and the outsourcing of activities.  The Proposed Reform appears to further elaborate on the FSC’s earlier initiative, and responds to the concerns of various market participants that the heavy regulations currently imposed upon financial investment service providers have discouraged innovation and undermined their role as risk capital providers.  Also, the Proposed Reform shows that for new sectors (such as the Fintech industry) to develop and flourish, significant regulatory change is required.

Key Features of the Proposed Reform:

1.   Chinese wall requirements

• Currently, the Financial Investment Services and Capital Markets Act (“FSCMA”) lists specific types of business activities that must be separated by a Chinese wall (e.g., separation between corporate banking and proprietary trading/financial investment services, such as securities dealing and brokerage).  This approach has been criticized for insufficiently considering business models adopted by financial investment service providers, and for the uncertainty it creates when applying these requirements to today’s sophisticated financial transactions that often require a one-stop service (for example, hedging arrangements for an acquisition financing transaction).  Instead, the Proposed Reform focuses on the nature of information that must be protected, and requires Chinese walls to be established to prevent the dissemination of material non-public information or information related to the management of a client’s assets.
• The Proposed Reform gives greater autonomy to financial investment service providers, and intends to abolish various requirements for setting up Chinese walls that are currently prescribed in the FSCMA, such as restricting directors and officers from holding concurrent positions and requiring physical separation of office spaces.  If the Proposed Reform is adopted, the FSCMA will only provide an overarching requirement to maintain sufficient internal control standards on information barriers, and the subordinate regulations will prescribe certain elements that must be included in these standards.
• Similar to the internal Chinese wall policies described above, the Proposed Reform will allow financial investment service providers to develop their own internal policies and procedures for the dissemination of information across affiliated companies.  In addition, while directors and officers of financial investment service providers are generally not allowed to hold concurrent positions across affiliates under the current regulatory regime, the Proposed Reform will relax this restriction to allow directors and officers to hold concurrent positions across affiliates so long as certain approval and reporting requirements are met and there is little concern of conflict of interests.
• In addition to prescribing Chinese wall requirements to prevent conflict of interests, the Proposed Reform also strengthens regulation on the use of the information being protected.  For example, the Proposed Reform prohibits the use of customer information for the benefit of the financial investment service providers or their officers and employees without a justifiable reason, in addition to the misuse of work-related information already prescribed in the FSCMA.  The Proposed Reform also seeks to impose aggravated penalties for the misuse of protected information in violation of internal control standards.

2.   Outsourcing by financial investment service providers

• Under the FSCMA and its subordinate regulations, work directly related to a financial investment service provider’s licensed activities is further categorized into “core functions” and “non-core functions.”  Currently, none of the “core functions” may be outsourced, while “non-core functions” may be outsourced only to licensed third-party vendors.  The Proposed Reform will allow “core functions” (other than internal control operations such as compliance, internal audit and credit risk analysis) to be outsourced to licensed third parties.
• In connection with the development of the Fintech industry and the need for financial investment service providers to work with third-party IT vendors, the Proposed Reform will allow for the receipt, delivery, execution, and confirmation of trade orders to be freely outsourced even to non-licensed third-party vendors.  Under the current FSCMA, these activities can only be outsourced to licensed third-party vendors.  Ultimately, the FSC plans to gradually expand the scope of activities that may be outsourced to non-licensed third-party vendors.
• Under the Proposed Reform, third-party vendors will be able to sub-contract upon obtaining the financial investment service provider’s consent.  However, financial investment service providers will still be held responsible for any sub-contracted activities.
• Other than outsourcing certain activities directly related to licensed activities (which will continue to require prior reporting to the FSC), financial investment service providers will only need to file a report to the FSC after outsourcing the relevant work.

3.   Concurrent or ancillary businesses

• Financial investment service providers will be allowed to file a report regarding their concurrent or ancillary businesses to the FSC after engaging in such business rather than filing the report prior to such engagement as currently required.
• The Proposed Reform also includes a regulatory framework that prevents unlawful concurrent or ancillary businesses and allows regulators to issue corrective orders.

Significance:

The Proposed Reform will likely bring greater autonomy to market participants and encourage cooperation between financial investment service providers and IT companies.  In particular, reforms regarding Chinese wall requirements will allow foreign financial investment service providers to leverage their global infrastructure and services for their businesses in Korea.

According to the FSC, a proposed amendment to the FSCMA reflecting the Proposed Reform will be submitted to the National Assembly this year.  In the meantime, a task force comprising of the FSC, the Financial Supervisory Service, the Korea Financial Investment Association, and financial investment companies is to be formed soon.  The task force will gather feedback from various market participants, develop best practice guidelines including recommended internal control standards that benchmark precedents from other global markets, and facilitate the regulatory transition.  

Therefore, the proposed amendment to the FSCMA and its subordinate regulations and the best practice guidelines will likely provide greater clarity to the changes envisioned by the Proposed Reform.