Weak Financial Oversight Harms Investors

Large private equity funds have been suspending redemptions one after another. From Lime Asset Management’s 1.6 trillion won fund to major financial scandals involving derivative-linked funds (DLFs), the Discovery Fund, and the Optimus Fund, one serious incident after another has plunged the financial market into great confusion. Even though the Financial Supervisory Service is currently exercising thorough control over everything from product prices and fee rates at financial firms to overall management, these repeated incidents have raised controversy over the function and role of the Financial Supervisory Service.

The primary cause of the recent financial scandals is that the supervisory function of the Financial Supervisory Service failed to operate properly.

In 2015, the financial authorities significantly eased regulations on private funds. The intention was to revitalize the market. However, because they failed to provide proper rules, management firms with low levels of expertise rushed into high-risk products, and this soon became a cause of financial accidents. The Financial Supervisory Service neglected its responsibility to create institutions that would allow the market to function properly and to supervise them, yet it has avoided its own responsibility and shifted the blame for these incidents entirely onto financial companies.

The Financial Supervisory Service’s follow-up measures in response to financial scandals are also controversial.

After the derivative-linked fund (DLF) scandal that broke out in 2019, the Financial Supervisory Service barred banks and insurance companies from selling private funds and trust products. It took issue with the failure to accurately inform consumers of investment risks. This measure infringes on consumers’ right to choose from a variety of products. If the Financial Supervisory Service truly wants to protect consumers, its priority should not be to ban sales, but to address mis-selling and consider ways to deliver meaningful information to consumers. A bureaucratic and administratively convenient approach aimed at blocking complaints at the source produces results that run counter to consumer protection.

The Financial Supervisory Service’s populist decisions are also causing confusion in the market.

Recently, in connection with the Lime scandal, the Financial Supervisory Service recommended full compensation for victims. Compensation of 100% of principal is the highest compensation ratio ever. As controversy arose over alleged links between the Lime scandal and political figures, it appears that a political solution was chosen without determining where responsibility actually lay. So-called government-directed finance, in which the political sphere intervenes in the private financial market, has become a major reason Korean financial firms have weak competitiveness.

Such political decision-making has a negative effect on the market.

The basic principle of investment is that investors bear not only the profits but also the associated risks and losses. It is clear that the management firms that mishandled the invested funds and the sellers that failed to provide accurate information bear heavy responsibility. However, investors who chose to invest in high-risk products with a high possibility of principal loss in pursuit of greater returns must also bear some responsibility. Political judgments that ignore the basic principles of investment will create moral hazard problems for both management firms and investors, and the financial market will inevitably shrink as a result. This is a loss for both financial companies and investors. Financial firms will be unable to develop competitive products because of excessive regulation, and that is potentially a loss for investors as well.

As poor financial products continue to disrupt the market, the overall competitiveness of Korea’s financial market is also low. As Hong Kong, once Asia’s financial hub, has seen its standing greatly shaken by political problems, foreign financial companies are relocating to other countries. Unfortunately, not a single company has chosen Korea. This is because the financial authorities’ control is too strong, corporate autonomy is too low, and the financial market remains under political influence, reducing market efficiency. The slow development of the financial market is due to the Financial Supervisory Service’s failure to perform its proper role and its neglect in establishing institutions that enhance financial competitiveness.

The more a market is one in which excellent financial products compete, the better consumers’ freedom of choice can be protected and the greater the social benefits can become. To revitalize the financial market and keep it operating stably, clear standards are needed at a level that does not undermine market autonomy. Through this, proper supervision of the market by the financial authorities must be achieved. Problems can never be solved by merely strengthening control over the financial market under the pretext of eradicating accidents. Only when financial firms become more competitive can product stability and profitability also improve. We must not forget that the best way to protect consumers is to allow financial firms to compete autonomously under rules that take the market’s function into account.

Eun-kyung Kwak, Head of the Corporate Culture Division, Center for Free Enterprise (CFE)

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Original title: 금융감독 부실이 투자자 피해 불러

Author: Eun-kyung Kwak

Date: 2020-07-17

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&pn=20&idx=22936