Korea Capital Market Institute

As global warming leads to more frequent natural disasters and economic uncertainty, there has been a growing international voice to actively respond to climate change by reducing greenhouse gas (GHG) emissions. In line with international recommendations, the Korean government has set a nationally determined contribution (NDC) goal to reduce GHG emissions by at least 40% of 2018 levels by 2030. To achieve the NDC, the emissions trading system (ETS), which covers over three-quarters of GHG emissions, will play a key role. In addition, as the fourth plan period is scheduled to begin in 2030, it will be important for the emissions trading system to function smoothly based on market mechanisms for the next five years. We examined the current status and systems of emissions trading markets in major countries, including the EU ETS, California Cap & Trade, and the North American RGGI ETS. We found that, unlike Korea, the emissions trading market is relatively active based on the supply and demand mechanism. In the EU ETS, emission allowances are classified as financial investment instruments, and various participants, including financial institutions and other specialized investors, participate in the spot market. Furthermore, the futures market was opened in the early 2000s, and emission allowance futures are actively traded on more than 10 times larger scale than the spot market. In both the California Cap & Trade and the North American RGGI ETS, third parties, such as financial institutions, as well as ETS participating companies, are active participants in the emissions trading markets. The emission allowance futures markets also have proven to be highly efficient, with emissions price discovery, hedging, arbitrage, and other mechanisms to maintain the efficiency of the emissions market. As both the European and North American ETSs do not set a banking limit, there has been no persistent oversupply of emission allowances, and the quantity-based market stabilizer (EU MSR) and price-based stabilization mechanisms through auction market have been introduced and conducted, respectively. The Korean emissions trading market has been in a state of oversupply due to the high proportion of free allocations and banking restrictions. As a result, emission allowance prices have been declining since the second half of 2019, and despite the price decline due to a lack of participants, a lack of buyers and price volatility have been observed frequently. There has been a problem of trading concentration and price volatility at the time of emission allowance settlement, inconsistency between on-exchange and over-the-counter prices, and a rather high proportion of over-thecounter transactions. Comparing the system of the Korean emissions trading market with those of major countries, Korea has a supply-dominant market with a high proportion of free allocations and strict banking restrictions. In addition, participants in the emissions trading market are limited to allocated companies and market makers, and price stabilization measures are not effective, which exposes the secondary market to high price volatility. Also, Korea does not have an emission allowance brokerage firm and has not introduced futures or emissions ETP markets. Therefore, it is necessary to effectively improve the emissions trading system based on market mechanisms to achieve the 2030 NDC. First of all, the proportion of paid allowance allocation based on auctioning should be gradually increased, and market stabilization measures reserves that are managed outside the total allowance should be included in the total allowance. The banking restrictions should be abolished or significantly relaxed, and the scope of market participants in the spot and auction markets should be expanded to include financial institutions and pension funds. To revitalize the emissions trading market, it is necessary to improve the pricing mechanism of the emissions trading market by gradually expanding the number of heterogeneous participants with different objectives by introducing brokerage trading, futures, ETFs and ETNs. In addition, it is needed to introduce European-style quantity-based stabilization measures and U.S.-style price-based stabilization measures to stabilize the emissions trading market and establish discipline to minimize unfair trade in emissions allowances.  

The structure of the housing finance, which is shaped by institutional characteristics, the degree of financial market development, and housing finance policies of each country, holds significant implications from a macroeconomic perspective. In Korea, it has become crucial to establish a housing finance system that enhances macroeconomic stability as households’ interest in homeownership has significantly increased amid persistent concerns about excessive household debt. Examining the characteristics of housing finance systems in major countries reveals that housing finance systems have evolved in distinctly different forms, depending on the institutional characteristics, government policies, etc. Therefore, when referencing housing finance systems of other countries, it is essential to consider their institutional backgrounds and specific circumstances. Nevertheless, a common feature observed in major countries is that their housing finance systems are designed—or directed through government policies—to mitigate household exposure to interest rate risk by utilizing capital markets. The U.S. and Denmark supply long-term fixed-rate mortgage loans to households through Agency MBS and covered bonds, respectively, thereby transferring interest rate risk from households to capital market investors. Although mortgage markets in Canada and Japan are not predominantly centered around fixed-rate loans, these countries utilize public housing finance institutions to support the securitization of mortgage loans, making fixed-rate mortgage loans increasingly available to households. In many countries, the prevalence of variable-rate mortgage loans can be partially attributed to factors related to loan supply. When banks and other deposit-taking institutions dominate the mortgage market, their heavy reliance on deposit funding naturally incentivizes them to offer variable-rate loans to mitigate interest rate risk. However, excessive exposure of the household sector to interest rate risk can undermine macroeconomic stability, necessitating policy measures to manage households’ interest rate risk at an appropriate level. Considering the experience of major countries, leveraging capital markets is the most effective approach to expanding long-term fixed-rate mortgage loans, and the government needs to play a key role in driving this systemic change by implementing housing finance policies. Recently, financial authorities have been pushing to expand the share of mortgages with a fixed-rate term of five years or more, as variable-rate mortgages and hybrid mortgages do not sufficiently protect households from interest rate risk and may weaken macro-financial stability. This paper examines specific policy measures to expand the share of long-term fixed-rate mortgages in Korea including revitalization of the covered bond market and the institutionalization of mortgage banks. First, the covered bond market needs to be fostered to expand long-term fixed-rate mortgage lending in Korea. Some countries provide valuable insights into how covered bond markets can be effectively established. For instance, Denmark  has established a large-scale covered bond market centered on pass-through covered bonds, transferring prepayment risk to institutional investors. Canada and Australia, as non-euro, non-EU countries, have actively and efficiently utilized covered bonds, while Switzerland has successfully developed a large domestic currency-denominated covered bond market as a non-euro, non-EU country. In light of this, we propose the following six measures to foster a Korean covered bond market tailored to Korea’s specificities: (1) Developing both European and Korean covered bond markets as issuance markets simultaneously, (2) Establishing a domestic covered bond market focused on medium- to long-term bonds (5, 7, 10, and 15 years), (3) Developing the yield curve for Korean won-denominated covered bonds, (4) Adopting German (bullet) covered bonds, in parallel with Danish (pass-through) covered bonds, (5) Developing benchmark covered bonds while supporting non-benchmark covered bonds, (6) Managing the number of covered bond issuers. In addition, we propose to introduce mortgage banks and related schemes to foster more competition to expand long-term fixed-rate mortgages. It needs to move away from the current housing finance structure, which relies on banks to provide long-term fixed-rate mortgages. To this end, it is necessary to create an environment where mortgage banks play a key role in providing long-term fixed-rate mortgage loans, thereby fostering competition with the banking sector. This paper proposes enacting a strict Mortgage Bank Act, as is the case in Denmark, under which licensed mortgage banks would either utilize the Korea Housing Finance Corporation’s securitization program or directly issue covered bonds to raise funds. The cases of Denmark and the U.S. demonstrate that mortgage banks, which have established a specialized business model for long-term fixed-rate mortgage loans by leveraging fintech and long-term bond issuance (covered bonds or MBS), are able to successfully compete against traditional deposit-taking institutions in the housing finance market.  

The global foreign exchange (FX) market, the largest among global financial markets, has traditionally relied on major banks as primary liquidity providers. However, since the late 1990s, rapid advancements in FX trading infrastructure, spurred by the adoption of electronic trading technologies, have driven significant changes in market substructures. First, there has been a noticeable decline in interbank FX trading. Major banks are minimizing their FX position exposures by expanding dealer-to-customer netting or intrabank transactions, which has led to a reduction in the chain of transactions required to clear positions resulting from dealer-to-customer transactions. Second, the shift in liquidity providers within the FX market is accelerating. This change is primarily attributed to non-bank entities’ increased participation in interbank markets through prime brokerage services, as well as the growing role of principal trading firms (PTFs) specializing in algorithm-based FX trading. Third, the adoption of electronic trading systems has underscored the importance of the dealer-to-customer market. Major dealer banks’ proprietary electronic trading platforms, as well as the electronic trading system where multiple liquidity providers simultaneously offer bid prices, have stimulated both quantitative and qualitative growth in the dealer-to-customer market. Fourth, algorithmic trading has expanded rapidly in parallel with the proliferation of electronic trading systems. This enables global asset management companies or hedge funds to pursue strategies aimed at reducing transaction costs and minimizing market impact. These structural changes in the global FX market have generally brought about benefits, such as the cost reduction in back-office operations through trading automation, increased price competitiveness from a diversified participant base, and additional cost savings from the diversification of trading platforms and expanded algorithmic trading. However, these changes have also presented challenges in FX market data management, affecting liquidity estimation and the representation of price data. In contrast, Korea’s FX market lags significantly behind its global counterpart, primarily due to limited progress in FX market liberalization and substructure improvements. Notably, Korea is more than 20 years behind the global FX market in terms of the development and utilization of electronic trading systems. In response, the Korean government has recently undertaken various initiatives to advance the FX market, including enhancing market substructures by permitting dealer-to-customer electronic trading and implementing measures to further open the market to foreign financial institutions. To effectively narrow the gap between Korea’s FX market and the global FX market, it is worth considering the following measures. First, incentives are needed to encourage offshore financial institutions to actively participate in the Korean FX market. To this end, Korea should meet the requirements of overseas financial institutions by enhancing credit support for Registered Foreign Institutions (RFIs) and extending trading hours to ensure that global services for foreign customers contribute to increasing domestic interbank transactions. Second, it is crucial to encourage infrastructure development to alleviate the operational burden of after-hours trading associated with offshore market opening. The unique practice of allowing trading in the domestic market until 2 a.m. is not likely to serve as a sustainable long-term approach. Therefore, domestic banks should consider implementing automated trading systems through Application Program Interfaces (APIs) to support electronic solutions for night-time dealer activities. It is also recommended that domestic banks and financial institutions make continuous investments to benefit from the advancements in electronic trading systems. Third, it is worth considering expanding FX prime brokerage (PB) services to facilitate liquidity provision. Given the stagnation in interbank market trading volumes in Korea, diversifying market participants as liquidity providers through PB services could bring positive changes to the domestic FX market’s liquidity supply structure, while broadening and deepening the market. Fourth, after the growth of RFIs’ participation in the market becomes evident, infrastructure development should focus on enhancing the versatility of electronic trading systems for dealer-to-customer transactions. Based on the market conditions following liberalization, it is necessary to utilize Multi Bank Platforms (MBPs), which are commonly used in the global FX market, to develop a more integrated structure encompassing both wholesale and retail FX trading. Fifth, it is essential to establish a 24-hour trading system for the Korean won, which aligns with international practices. Once market liberalization achieves its objectives, such as increased trading volumes, the establishment of electronic trading systems, and improved market efficiency, Korea should pursue the integration of the Korean won into the global FX market’s 24-hour trading framework, thereby solidifying its position as a truly international currency.

This article examines the characteristics of special bonds in the Korean bond market and analyzes the surge in Korea Electric Power Corporation (KEPCO) bond issuance in 2022 to assess the impact of a rise in special bond issuance on the bond market. For special bonds, their credit ratings are primarily determined by the potential for government support rather than the issuer’s financial standing. Consequently, special bonds are typically issued with high credit ratings, resulting in lower yields compared to private sector bonds. In addition, they are exempt from the requirement to file a securities registration statement, which significantly streamlines the issuance process and allows for faster issuance compared to private sector bonds. In 2022, when KEPCO’s bond issuance surged, the company primarily relied on bond issuance to raise funds amid substantial operating losses, leveraging the feature of the Korean bond market where special bonds can be swiftly issued at lower borrowing costs. However, as the issuance volume rapidly rose, a serious supply-demand imbalance emerged, forcing KEPCO to issue bonds at higher rates. This, in turn, placed upward pressure on market interest rates and dampened investment demand for private sector bonds, which have relatively lower creditworthiness compared to special bonds. As the expansion of special bond issuance negatively affects private sector bonds, their issuance needs to be effectively and systematically managed. State-owned enterprises have a strong incentive to raise funds through the issuance of special bonds, due to their lower funding costs and simplified issuance process. However, their excessive issuance could disrupt the overall bond market in Korea. To mitigate this risk, it is necessary to ensure that special bond issuance remains at a level that does not adversely affect market stability, while also considering improvements to the issuance system. Meanwhile, starting in 2024, state-owned enterprises in energy sector will see a significant increase in bond maturities. Although these enterprises have moved out of operating losses, but their operating conditions have not improved sufficiently to repay the maturing special bonds. Thus, they need to prepare a refinancing plan that utilizes various borrowing instruments in a balanced manner so as not to affect the bond market.

As the sales of complex and high-risk financial products, such as Hong Kong H-index ELS and interest rate-linked DLF, have increased, the amount of damage to financial consumers due to mis-selling has also risen. Despite substantial financial losses suffered by consumers due to mis-selling by financial companies, recovering damages often involves lengthy processes and high legal fees. In response, major countries like the U.S., U.K., and Japan have introduced various alternative dispute resolution systems to reduce the legal costs and time associated with civil litigation and to support quick compensation. In the U.S., organizations such as the CFPB, FINRA, and AAA provide various forms of financial dispute resolution, including settlement, mediation, conciliation, and arbitration. In the United Kingdom, the Financial Ombudsman Service (FOS), an independent non-profit organization, is responsible for resolving financial disputes. The FOS’s conciliation decisions are unilaterally binding, meaning that once a financial consumer accepts a decision, the financial firm must comply. Additionally, the UK’s Financial Services Compensation Scheme (FSCS) has established a system allowing financial consumers to receive compensation from a pre-established fund if they are unable to recover their investments due to mis-selling or poor advice on funds, structured products, etc. In Japan, each financial industry operates a designated dispute resolution organization. For the financial investment industry, FINMAC handles financial complaints and disputes. FINMAC is independent of the Financial Services Agency and mediates disputes between financial consumers and financial companies related to investment products, crypto assets, STOs, and more. FINMAC’s conciliation decisions are conditionally binding, meaning that if a financial consumer accepts a decision, the financial company must comply. In Korea, financial dispute resolution is managed by the Financial Supervisory Service Dispute Resolution Committee, the Korea Exchange Market Monitoring Committee, the Financial Investment Association Dispute Resolution Committee, and the Consumer Dispute Committee of the Korea Consumer Affairs and Consumer Services Commission. Among these, the Financial Supervisory Service Dispute Resolution Committee plays a significant role in cases involving the incomplete sale of financial investment products. Historically, general financial consumers in Korea have experienced lower compensation rates compared to other major countries, longer compensation times, and lower acceptance of settlement decisions by financial companies. Korea’s financial dispute resolution system is somewhat limited in diversity, operating primarily through dispute mediation. There are many opinions that it needs to be more independent and specialized. Specifically, the Financial Supervisory Service’s Dispute Mediation Committee is inadequately staffed, leading to ineffective dispute resolution. Additionally, the mediation decisions of the FSS are not unilaterally binding, and financial companies often do not accept these decisions. Furthermore, there is no collective dispute settlement system for cases of mis-selling, which limits the ability of many victims to receive appropriate relief. Therefore, it is necessary to improve the Korean financial dispute resolution system to provide quick compensation to financial consumers and reduce legal costs. First, the independence and expertise of the Financial Supervisory Service’s Dispute Mediation Committee should be enhanced, and its staffing and budget should be expanded to strengthen its practical functions. Second, to improve the effectiveness of the financial dispute resolution system, introducing a Japanese-style limited one-sided binding mechanism should be considered. For one-sided binding to be effective, it is essential to enhance the independence and professionalism of dispute resolution organizations and ensure access to justice. Third, the introduction of a consumer protection relief fund system should be considered in the medium to long term to provide direct relief to ordinary financial consumers in financial disputes. Fourth, the introduction of a collective dispute mediation system should be considered to strengthen the relief available to general financial consumers, including the elderly and financially vulnerable.

The repurchase and retirement of treasury shares are key shareholder return policies along with dividend payment. However, listed companies in Korea tend to be reluctant to retire treasury shares, opting instead to hold and utilize them. As of the end of 2022, 67% or more of listed companies held treasury shares, but there were only 54 cases of retirement in 2022, indicating that only 2.2% of all listed companies retired treasury shares. This reluctance is primarily driven by the discretion afforded to listed companies in utilizing these shares. The 2011 amendment to the Commercial Act permitted companies to freely use treasury shares, while it failed to include provisions to prevent companies from abusing treasury shares and undermining shareholder value for the purpose of bolstering their control. Under the current system, companies may hold treasury shares without retiring them and later dispose of these shares to affiliated shareholders with voting rights, particularly for important corporate decisions. Furthermore, companies may circumvent restrictions on the allocation of new shares to a third party by disposing of treasury shares, which results in the equivalent outcome. In cases of corporate spin-offs, treasury shares can be utilized to strengthen control through the allocation of new shares. By contrast, other major economies such as the US, the UK, Germany, and Japan do not recognize any rights associated with treasury shares and provide no regulatory arbitrage regarding the allocation of new shares to third parties and treasury share disposition. This helps prevent the issues observed in Korea. Fundamental regulatory reforms are needed to prevent the arbitrary use of treasury shares and encourage their retirement. Above all, it is crucial to stipulate that treasury shares are not granted any rights, which can prevent companies from exploiting legal loopholes through arbitrary interpretation. In addition, disposing of treasury shares to specific agents, which has the same effect as the issuance of new shares, should be subject to restriction to protect shareholder interests. It is also necessary to adopt measures for shareholders to seek remedies for unfair disposition of treasury shares.