The Financial Services Commission issued a preliminary notice of rule changes on February 3 regarding the Enforcement Decree and Enforcement Rules of the Financial Investment Services and Capital Markets Act (FSCMA) and subordinate regulations on financial investment businesses and the issuance and disclosure of securities. The rule changes being proposed address the following. First, there will be legal grounds established for fractional investment platforms issuing beneficiary certificates and securities lending intermediary platforms (both currently operate under the regulatory sandbox program). Second, trading exchange traded funds (ETFs) and exchange traded notes (ETNs) will be made possible via alternative trading system (ATS). Third, IPO bookrunners will be required to conduct due diligence and prohibited from accepting compensation outside the confines of the contract. Other rule changes include the following—making backdoor listing (where a larger sized non-listed firm determined by corporate value merges with a smaller sized listed firm) subject to listing review, allowing more types of foreign currency-denominated bonds (supranational bonds and Korean paper) to be included in the foreign currency repurchase agreements (repos) offered to investors, and raising the limit on retail investors’ over-the-counter (OTC) bond transactions in small scale, which are eligible for same-day transaction settlement (T+0), to KRW10 billion from KRW5 billion currently.
The rule changes are put up for public comment until March 17 and expected to take effect from June 16 this year after going through a legislative review and a successive approval process.
Establishing Legal Ground for Fractional Investment
Fractional investment involves the sale of a share in underlying asset, such as real estate and intellectual property, after it has been securitized, and takes the form of public offering of securities. In general, it can take the form of issuing either non-monetary trust beneficiary certificates or investment contract securities. Under the current legal framework, investment contract securities can be issued once the submitted securities registration has been accepted. However, there is currently no legal ground for the issuance of non-monetary trust beneficiary certificates, so that it has been operating under the regulatory sandbox program.
Therefore, the rule changes being proposed will establish a new investment intermediary service to provide a legal ground for the issuance of non-monetary trust beneficiary certificates for fractional investment until June, while also establishing measures for overseeing the issuance of beneficiary certificates.
First, since fractional investment through non-monetary trust beneficiary certificates involves the fractional investment platforms securing underlying assets first and then arranging the issuance of beneficiary certificates and selling them to investors, a new small license unit will be created to regulate investment intermediary businesses handling beneficiary certificates. Their equity capital requirement will be set at KRW1 billion, the same level currently in place for the intermediary businesses dealing with funds investment. Moreover, they will be subject to the same net capital ratio (NCR) requirement and investor protection regulations on advertisement and duty to explain currently applied to securities companies.
Second, since there is currently a revision bill of the FSCMA authorizing the issuance of non-monetary trust beneficiary certificates pending at the National Assembly, the issuance on non-monetary trust beneficiary certificates will be first allowed under the Asset-backed Securitization Act for the time being. In other words, when a fractional investment platform operating in the capacity of an investment intermediary business dealing with beneficiary certificates has secured underlying assets, or when a qualified financial company or listed corporation (under the Asset-backed Securitization Act) has entrusted underlying assets in its holding, the issuance of non-monetary trust beneficiary certificates becomes possible in accordance with the Asset-backed Securitization Act. Once the FSCMA is amended accordingly, issuing non-monetary trust beneficiary certificates will become more generally available.
Third, the screening process for securities registrations will make sure that underlying assets of non-monetary trust beneficiary certificates meet the criteria specified under the guidelines on trust beneficiary certificates’ underlying asset requirements introduced in December 2023. The same level of regulatory supervision currently in place under the regulatory sandbox program will continue to be observed for the periodic and ongoing disclosures regarding trust assets, assessment of the value of underlying assets, and investment limits.
Fourth, once the revision of the FSCMA is completed, it becomes necessary for fractional investment platforms to obtain a newly created license. Since they will be legitimately authorized to operate fractional investment platforms with licenses, the current designation system making use of the regulatory sandbox program will no longer be in operation, and only in exceptional cases will the screening be made available to promote the introduction of innovative financial services. In the meantime, regulatory groundworks for establishing distribution platform service for beneficiary certificates, which is the issue not dealt by the current revision proposal, is expected to be completed by the end of September this year together with those on the establishment of unlisted securities platform service.
Fifth, under the current regulatory sandbox program, fractional investment service providers concurrently operate the issuance and distribution services at the same time. However, in the future, a clear line will be drawn between the issuance and distribution services to prevent conflicts of interest. Thus, during the legislative revision process, fractional investment service providers will need to make a choice between the two and apply for the license in a timely manner when the revised law takes effect. Meanwhile, those currently operating under the two-plus-two year operating period granted under the regulatory sandbox program can continue to maintain their status or apply for the licensed status early if they choose to do so.
Establishing Legal Ground for Securities Lending Intermediary Service
The intermediation between lenders and borrowers of securities through digital platforms qualify as intermediation of securities lending transactions. Thus, a small license unit will be newly created to regulate these investment intermediary services in the area of securities lending. By obtaining a small license, businesses will be able to provide securities lending brokerage services currently performed by Korea Securities Depository, Korea Securities Finance Corporation, and securities firms. Their equity capital requirement will be set at KRW1 billion for those opening up service to retail investors and at KRW500 million if their service offering is confined to qualified professional investors.
The scope of their service offering will be limited to the matching of lenders and borrowers as it is currently observed under the regulatory sandbox program. These securities lending intermediary platforms will not be subject to the regulations on the management of collateral assets and the matters pertaining to disclosures since they are handled by Korea Securities Depository, Korea Securities Finance Corporation, and securities firms.
Follow-up to ATS Operation Plan
Following up to the ATS (alternative trading system) Operation Plan introduced in May 2024, the below rule changes are being proposed.
First, exchange traded funds (ETFs) and exchange traded noted (ETNs) will be added to the list of tradable items by ATS. A new licensing unit will be established to screen the qualification of ATS to ensure the sufficient capacity to trade ETFs and ETNs (equity capital requirement of KRW10 billion), aside from the existing licensing unit established for the trading of stocks and depository receipts (equity capital requirement of KRW20 billion). Thus, Nextrade, which is expected to be launched soon, will be allowed to trade ETFs and ETNs after obtaining the new license being introduced through the proposed regulatory change. Related rules will also be updated accordingly. When an investor directly engages in the transaction of leveraged or inverse ETFs and ETNs, the investor protection rules applied on highly complex investment products, such as the mandatory recording and cooling-off period, will not be applied as in the case with the same types of transactions taking place at the KRX.
Second, ATS will be exempted from the net capital ratio (NCR) rule, and the regulatory supervision over financial soundness of ATS will be carried out based on the maintenance of equity capital requirement. Accordingly, the thresholds for invoking timely corrective actions will also be changed to the equity capital standards from the NCR standards currently in place. The thresholds now stand 100 percent of NCR for issuing a recommendation to make management improvement, 50 percent of NCR for issuing a request, and zero percent of NCR for issuing an order. However, these will be changed to 100 percent, 85 percent, and 70 percent of the equity capital requirement, respectively.
Third, when ATS makes changes to its fees or invests KRW10 billion or more in its computer facilities, it becomes subject to deliberation by the market efficiency promotion committee. This committee deliberates on cost issues to help reduce the transaction costs in the securities and derivatives markets. Currently, the KRX, KSD, Korea Financial Investment Association (KOFIA), and KOSCOM are subject to deliberation by the committee. Since the fees and costs charged by ATS can also have significant impact on the transaction cost of the securities market, any changes to ATS fees after being launched will become subject to deliberation by the market efficiency promotion committee.
Fourth, funds, trusts, and investment mandates are currently able to purchase the securities owned by their affiliated securities firms only through the KRX. Since the ATS also offers a market for listed securities where bids and offers are executed through price competition, funds, trusts, and investment mandates will also be allowed to purchase securities through ATS in the future.
Other Regulatory Revisions
First, as a follow-up to the plan for improving the IPO management process introduced by the Financial Supervisory Service (FSS) in May 2024, IPO lead managers and bookrunners will be obligated to carry out due diligence and prohibited from accepting any compensations outside the confines of the contract.
Second, backdoor listing, in which case, a larger sized non-listed company merges with a smaller sized listed company, will become newly subject to listing review. Currently, listing review is conducted only when a larger sized non-listed company (determined by two or more of the following factors—asset, capital, and sales volume) merges with a smaller sized listed company or when the largest shareholder of the listed company becomes the largest shareholder of the non-listed company.
Third, foreign currency-denominated repurchase agreements (repos) offered to investors by securities companies will be able to incorporate supranational bonds and Korean paper along with foreign government bonds. The newly added types of foreign currency-denominated bonds need to have rating A or higher from at least two international credit rating agencies, and information about the issuer and market price should be displayed on the website of securities companies. In addition, Korean paper needs to meet additional criteria suitable to be offered to qualified institutional buyers (QIBs). With more types of bonds eligible for inclusion, it is expected to help promote more transactions of foreign currency-denominated repos.
Fourth, the limit on retail investors’ bond transactions in small scale, which are eligible for same-day transaction settlement (T+0), will be raised to less than KRW10 billion from less than KRW5 billion currently. The settlement period for over-the-counter (OTC) bond transactions usually range from T+1 to 30 business days in principle. However, for the convenience of retail investors, small scale bond transactions by retail investors have been eligible for same-day transaction settlement (T+0). Since, the current limit of less than KRW5 billion has remained the same since 2003, the upward adjustment takes into account price increases and expansion in retail investors’ bond investment.
Fifth, when making a sale through the K-OTC market operated by KOFIA or when making a public offering in small scale through an underwriter, it is exempted from having a deposit money management agreement with a bank or securities company. The deposit money management agreement is intended to prevent issuers and sellers from directly having access and managing deposit money. However, in the abovementioned cases, the securities company overseeing the sale or managing the public offering handles deposit money, so that it becomes unnecessary to have a separate agreement regarding the management of deposit money.
* Please refer to the attached PDF for details.