Impact of ARFP on Korea’s financial services

First published in The Korea Herald.


A very important development in the first week of June that will bring huge benefits to the financial services industry in Korea has gone largely unnoticed here.

Finance officials and regulators from six Asia Pacific Economic Cooperation members, including Korea, who are leading the development of the Asia Region Fund Passport concluded a week of meetings in Singapore to iron out the details of the proposal and announced that it was on track to be launched in 2016.

The countries ― also including Australia, New Zealand, the Philippines, Singapore and Thailand ― aim to cut down on incompatible or overlapping financial regulations that may hinder the marketing of managed funds between participating economies.

Six other APEC members ― Hong Kong, Indonesia, Japan, Malaysia, Taiwan and Vietnam ― are also closely following the discussions on the rules and arrangements, hoping to join the initiative.

So what exactly is the ARFP, and why is it important?

Two years ago, finance ministers from Australia, Korea, New Zealand and Singapore signed a statement of intent on the establishment of the ARFP. Accordingly, it aims to “facilitate the growth and competitiveness of financial markets in the region and the fund management industry, creating a common framework that has the effect of reducing regulatory inconsistency and overlap faced by collective investment scheme operators seeking to offer collective investment schemes in multiple economies.”

Once it is established, fund managers in a participating economy will be able to offer a single product across multiple markets, which will result in a larger client base that will grow the fund size sufficiently to realize economies of scale.

At the same time, more competition, a higher number of funds and funds under management will help keep the fund sizes at an optimal level so as not to erode fund performance. Investors will also benefit from improved efficiency as direct access to offshore funds results in the elimination of an extra layer of fees and commissions charged by local operators.

According to the APEC Policy Support Unit, once the ARFP is fully up and running, it could save the region’s investors $20 billion annually in fund management costs, offer higher investment returns at the same or lower degrees of risk and encourage the establishment of locally domiciled funds that could create 170,000 jobs within five years.

In its study of the potential costs and benefits, the APEC unit said that following the introduction of the ARFP, using a conservative assumption of 20 percent increase per annum in assets under management over 5 years, almost all the involved Asian funds markets would achieve better efficiency.

Currently investors in some Asian economies have limited products available to them. This is due partly to strict regulations in those economies that have discouraged fund managers from distributing foreign funds in local markets. Without a broad range of foreign products to choose from, investors have to place the bulk of their funds in local products.

International portfolio diversification can facilitate the possibility of reducing risks only if values of cross-market correlations of returns are low. The benefits of a more optimal portfolio can be transferred to investors in the form of better returns for risks.

The ARFP can also bring significant benefits to the wider regional and global economies by supporting the recycling of savings toward productive investments that are critical for the region’s growth.

The benefits can also extend beyond financing investment needs. The ARFP can introduce to local funds industries foreign technical know-how, competitive pricing and higher standards of disclosure and performance. These promote efficiencies in the local fund industries, resulting in greater global competitiveness of the Asian funds management industry, the APEC unit has noted.

One of the measurable contributions of the ARFP to the economy is the potential increase in employment numbers in the funds industries in Asia. An essential feature of the ARFP is that it will increase the demand for funds to be domiciled in Asia. This would offer increased job opportunities, not only to manage the funds but also to service the fund structure.

What does it mean for the asset management industry in Korea?

Korea has a mature funds management industry. The first contractual-type equity investment scheme was introduced in 1970, after the promulgation of the Securities Investment Trust Business Act in 1969. The development of the funds industry experienced a setback during the Asian financial crisis in 1997-98. However, it has since quickly recovered.

Assets under management ― the sum of fund assets and assets under discretionary management ― by the 86 asset management companies totaled 685 trillion won ($616 billion) at the end of 2014, up 9.1 percent or 57 trillion won from 628 trillion won a year earlier. Fund assets increased 14 percent to 382 trillion won. Publicly offered funds increased 7.4 percent to 204 trillion won, while private equity funds increased 22.8 percent to 178 trillion won. Discretionary assets increased 3.4 percent to 303 trillion won during the same period.

The aggregate net income of the asset management companies for 2014 came to 424.8 billion won, up 14.1 percent from 372.4 billion won during the last year. A total of 20 companies reported net losses for the period.

However, despite its success, the funds industry is fragmented and markedly skewed toward equity that dominates the total funds’ AUM.

While regulators in Korea have been keen to pursue market liberalization, the industry still faces challenges. For instance, industry analysts have noted that the sale of offshore funds is facing tight regulatory hurdles, including preferential tax treatment for onshore versus offshore funds. As a result, the presence of foreign funds in Korea has been relatively weak.

The ARFP is a therefore a very good initiative to give a boost to the industry in Korea.

However, the Financial Supervisory Service should also keep in mind the risks that are involved with the creation of the ARFP.

As in any cross-border financing solution, shocks in one market can be amplified and transmitted to other markets very quickly. This can become worse given the enhanced interconnectedness and efficiencies of the transmission and intermediation process currently available.

While the deepening integration of financial markets will help promote the financing of investment, care should be taken to see that they do not accentuate the risks associated with large and volatile capital flows.

The FSS should ensure that Korea’s regulations and market practices are upgraded and harmonized in tune with regional standards. It should also keep investor protection foremost in mind, minimizing systemic vulnerabilities and maximizing market transparency before finalizing the plans to rollout the ARFP.