Article

Strategies ahead of capital market integration

Many people have long voiced the need to improve the competitiveness of Korean financial institutions by easing excessive regulations that form barriers to entry into other sectors.

著者：Hwang Hyung-june

First published on 8月 30, 2006
min read


"It is high time for Korean companies to start asking themselves what they can do best in a unique and differentiated manner." Many people have long voiced the need to improve the competitiveness of Korean financial institutions by easing excessive regulations that form barriers to entry into other sectors. Now, in an effort to reform those financial regulations and provide better protection for investors, the Korean government has announced plans to enact the "Capital Market Integration Act.'' But, perhaps not surprising, the new rules are having huge repercussions in the financial world. The Act, which proposes to consolidate the laws governing the capital market, introduces a functional regulatory system that groups financial activities of the same economic nature. It also creates a comprehensive system that defines various investment products as it allows financial investment companies to expand their business boundaries and strengthen investor protection. By stimulating a wide variety of fund products, the Act is expected to create a virtual cycle in which the introduction of various securities-related products expands the existing capital market. That expansion, in turn, will increase the demand for more securities-related products. Eventually, as the securities market becomes increasingly efficient, more and more companies will actively raise funds directly through the securities market, leading to the ongoing growth of the capital market. The result: an advanced capital market with wider opportunities for those financial institutions trying to expand their businesses and generate higher profits. The government and the financial industry hopes the Act will serve as a launching pad for a more dynamic financial market in Korea. By most accounts, the new regulations appear to be a golden opportunity to make an enormous leap forward. However, there is no guarantee that the actual changes in the market will match such theoretical expectations. On the contrary, financial institutions have anything but smooth sailing ahead because few top financial managers have yet to create effective strategies necessary to cope with the changing competitive landscape. The measures discussed thus far remain too high level and lack a basic execution plan. And as large securities firms develop only vague strategies, small and mid-sized brokerage firms haven't even begun to grapple with the issues facing them. Risk of Building Scale Without Strategy Going forward, Korean brokerage firms have much to learn from the British, who experienced a similar situation two decades ago. During the financial "Big Bang'' of 1986, the U.K. introduced the Financial Services Act (FSA), which lifted the barriers in its financial sectors, allowing for universal banking, and regulated similar financial functions to protect investors. Such changes triggered the rapid growth of the U.K. capital market. However, it also devastated the local financial institutions, which saw high potential in the capital market and diversified their businesses to compete on a global basis. These local players, large and small, hoped to be all things to all companies. To do so, they focused on top-line growth and often invested heavily to enhance their equity-related global competitiveness. In the initial phase, there appeared to be a lot of winners. However, the local companies began to suffer from losses related to bad loans and deals gone bad. The problems were compounded by the entry of U.S. investment banks, which were way ahead of local players in terms of experience and systems. Finally, local financial institutions were sold to a few large commercial banks, mostly under unfavorable terms. Only three or four years after the Big Bang began, local players found ruined. The U.K. example provides invaluable lessons to Korean financial institutions. The global capital market and its key players are currently much more sophisticated than Korean players. With markets lagging, Korean financial institutions will need to decide how to differentiate themselves, rather than blindly pursuing economies of scale. They would be wise to take a step back and assess their own capabilities and analyze the complete market outlook before arriving at their specific action plans. Without a sound strategy, financial institutions will not be able to survive—let alone succeed—in their journey. Strategy Key to Become Winners The development of the capital market implies intensifying competition. Even though many foreign banks have already entered the Korean market, their presence will solidify as the capital market evolves. They will invest heavily in people, or try to build relationships, or even cut prices to obtain business. All that will certainly make life difficult for domestic players. Of course, the outlook is not completely gloomy. Despite the challenges that the local U.K. banks faced following the introduction of FSA, today most are doing just as well as their U.S. counterparts. The same is true in Japan. However, to succeed, Korean financial institutions will have to take a measured, disciplined approach by asking themselves, "What are we really good at?'' "What are the things that we know better than anybody else?'' and "How can we put together a better deal for a better price and meet customer needs faster?'' As logical as this may sound, many are reluctant to follow that course of action. Yet it holds the essence of competitive strategy. At Bain & Company, we have found three principles to guide you through some of the potentially rough waters ahead: First, select a course most suited to the characteristics of the Korean financial industry, where Korean players can best leverage their assets. Prior to 1986, many European companies depended on bank loans instead of looking to the securities market. After the Big Bang, financial institutions in the U.K. faced numerous trials that continued into the following decade. Eventually, they began to select markets in which they could most confidently compete. They decided to focus on the fixed-income business because they saw the potential to fully leverage their big balance sheets. Fixed income was also more predictable and repeatable than the equity business, thus allowing for easier entry. In addition, the business was less dependent on star performers, making it more profitable and sustainable. For example, they did not have to hire merger & acquisition (M&A) advisers, who were at that time highly paid and very difficult to retain. As such, local banks in the U.K. successfully built a strong presence in the fixed-income market where they had a competitive edge compared with U.S. investment banks. By contrast, U.S. banks that focused on equity struggled as the tech bubble burst and the stock market grew sluggish in early 2000. Today, fixed income is by far the biggest driver of investment banking in Europe and around the world. Second, pioneer unique markets and capabilities that are not easily copied by others. It's no coincidence that Paris is the center of the global derivatives market, with its prestigious financial engineering schools and its eagerness to nurture such talents. At the heart of the derivatives market lies BNP Paribas, a leading French bank that learned early on to leverage its strengths in France's favorable environment. Used as a way to help companies manage the risks associated with the exchange rate, interest rates and balance sheets, derivatives have become a big part of the banking business. And BNP is the best by far. The example highlights the importance of pioneering and developing new business areas where Korean players can excel, taking into account the culture, educational background, business practice and other various factors. It is high time for Korean companies to start asking themselves what they can do best in a unique and differentiated manner. Third, globalization needs a strategy. There are two prerequisites to successful globalization strategy. The first is to define the points of differentiation and then to build the corresponding capabilities before entering a new market. Following the Big Bang, for instance, U.K. banks decided to pursue globalization. Since they didn't have the European continental connection, they thought their best strategy was to go to New York and try to build a book of businesses there. They made huge investments to compete head-to-head in New York with established players such as Goldman Sachs, Morgan Stanley, and so on—often with disastrous results. The other prerequisite is to centralize your core competencies while having a broad view of the market. Once you have developed a differentiated value proposition, focus your core competency strengths at the headquarters level, and push the focus on selling to the branches in various areas. And remember: Roles and responsibilities will need to be clearly defined as well. BNP bases its derivatives business in Paris because it makes sense to do so: Related university programs are there, and the city offers favorable accounting treatment. Staff is sent to London to generate derivatives deals, but the booking and management is done in Paris because that's where the people and the skills are. Likewise, Korean players will want to build the skills generally in one place and not try to spread themselves across the region. The deals can be generated out of Hong Kong, Shanghai or Kuala Lumpur, but the structuring, management and administration should be done by a centralized group of people back in Seoul as much as possible. Learning the key areas in which to excel and maximizing the opportunities will be some of the toughest challenges facing Korean players. The more you study the British and French examples, the more implications you will be able to draw for the future strategy for financial institutions in Korea.

"It is high time for Korean companies to start asking themselves what they can do best in a unique and differentiated manner."

Many people have long voiced the need to improve the competitiveness of Korean financial institutions by easing excessive regulations that form barriers to entry into other sectors.

Now, in an effort to reform those financial regulations and provide better protection for investors, the Korean government has announced plans to enact the "Capital Market Integration Act.''

But, perhaps not surprising, the new rules are having huge repercussions in the financial world.

The Act, which proposes to consolidate the laws governing the capital market, introduces a functional regulatory system that groups financial activities of the same economic nature.

It also creates a comprehensive system that defines various investment products as it allows financial investment companies to expand their business boundaries and strengthen investor protection.

By stimulating a wide variety of fund products, the Act is expected to create a virtual cycle in which the introduction of various securities-related products expands the existing capital market.

That expansion, in turn, will increase the demand for more securities-related products.

Eventually, as the securities market becomes increasingly efficient, more and more companies will actively raise funds directly through the securities market, leading to the ongoing growth of the capital market.

The result: an advanced capital market with wider opportunities for those financial institutions trying to expand their businesses and generate higher profits.

The government and the financial industry hopes the Act will serve as a launching pad for a more dynamic financial market in Korea. By most accounts, the new regulations appear to be a golden opportunity to make an enormous leap forward.

However, there is no guarantee that the actual changes in the market will match such theoretical expectations.

On the contrary, financial institutions have anything but smooth sailing ahead because few top financial managers have yet to create effective strategies necessary to cope with the changing competitive landscape.

The measures discussed thus far remain too high level and lack a basic execution plan. And as large securities firms develop only vague strategies, small and mid-sized brokerage firms haven't even begun to grapple with the issues facing them.

Risk of Building Scale Without Strategy

Going forward, Korean brokerage firms have much to learn from the British, who experienced a similar situation two decades ago. During the financial "Big Bang'' of 1986, the U.K. introduced the Financial Services Act (FSA), which lifted the barriers in its financial sectors, allowing for universal banking, and regulated similar financial functions to protect investors.

Such changes triggered the rapid growth of the U.K. capital market. However, it also devastated the local financial institutions, which saw high potential in the capital market and diversified their businesses to compete on a global basis.

These local players, large and small, hoped to be all things to all companies. To do so, they focused on top-line growth and often invested heavily to enhance their equity-related global competitiveness.

In the initial phase, there appeared to be a lot of winners. However, the local companies began to suffer from losses related to bad loans and deals gone bad.

The problems were compounded by the entry of U.S. investment banks, which were way ahead of local players in terms of experience and systems.

Finally, local financial institutions were sold to a few large commercial banks, mostly under unfavorable terms.

Only three or four years after the Big Bang began, local players found ruined.

The U.K. example provides invaluable lessons to Korean financial institutions. The global capital market and its key players are currently much more sophisticated than Korean players.

With markets lagging, Korean financial institutions will need to decide how to differentiate themselves, rather than blindly pursuing economies of scale.

They would be wise to take a step back and assess their own capabilities and analyze the complete market outlook before arriving at their specific action plans.

Without a sound strategy, financial institutions will not be able to survive—let alone succeed—in their journey.

Strategy Key to Become Winners

The development of the capital market implies intensifying competition. Even though many foreign banks have already entered the Korean market, their presence will solidify as the capital market evolves.

They will invest heavily in people, or try to build relationships, or even cut prices to obtain business. All that will certainly make life difficult for domestic players.

Of course, the outlook is not completely gloomy. Despite the challenges that the local U.K. banks faced following the introduction of FSA, today most are doing just as well as their U.S. counterparts.

The same is true in Japan. However, to succeed, Korean financial institutions will have to take a measured, disciplined approach by asking themselves, "What are we really good at?'' "What are the things that we know better than anybody else?'' and "How can we put together a better deal for a better price and meet customer needs faster?''

As logical as this may sound, many are reluctant to follow that course of action. Yet it holds the essence of competitive strategy.

At Bain & Company, we have found three principles to guide you through some of the potentially rough waters ahead:

First, select a course most suited to the characteristics of the Korean financial industry, where Korean players can best leverage their assets.

Prior to 1986, many European companies depended on bank loans instead of looking to the securities market.

After the Big Bang, financial institutions in the U.K. faced numerous trials that continued into the following decade.

Eventually, they began to select markets in which they could most confidently compete. They decided to focus on the fixed-income business because they saw the potential to fully leverage their big balance sheets. Fixed income was also more predictable and repeatable than the equity business, thus allowing for easier entry.

In addition, the business was less dependent on star performers, making it more profitable and sustainable. For example, they did not have to hire merger & acquisition (M&A) advisers, who were at that time highly paid and very difficult to retain.

As such, local banks in the U.K. successfully built a strong presence in the fixed-income market where they had a competitive edge compared with U.S. investment banks.

By contrast, U.S. banks that focused on equity struggled as the tech bubble burst and the stock market grew sluggish in early 2000.

Today, fixed income is by far the biggest driver of investment banking in Europe and around the world.

Second, pioneer unique markets and capabilities that are not easily copied by others. It's no coincidence that Paris is the center of the global derivatives market, with its prestigious financial engineering schools and its eagerness to nurture such talents.

At the heart of the derivatives market lies BNP Paribas, a leading French bank that learned early on to leverage its strengths in France's favorable environment.

Used as a way to help companies manage the risks associated with the exchange rate, interest rates and balance sheets, derivatives have become a big part of the banking business. And BNP is the best by far.

The example highlights the importance of pioneering and developing new business areas where Korean players can excel, taking into account the culture, educational background, business practice and other various factors.

It is high time for Korean companies to start asking themselves what they can do best in a unique and differentiated manner.

Third, globalization needs a strategy. There are two prerequisites to successful globalization strategy. The first is to define the points of differentiation and then to build the corresponding capabilities before entering a new market.

Following the Big Bang, for instance, U.K. banks decided to pursue globalization. Since they didn't have the European continental connection, they thought their best strategy was to go to New York and try to build a book of businesses there.

They made huge investments to compete head-to-head in New York with established players such as Goldman Sachs, Morgan Stanley, and so on—often with disastrous results.

The other prerequisite is to centralize your core competencies while having a broad view of the market.

Once you have developed a differentiated value proposition, focus your core competency strengths at the headquarters level, and push the focus on selling to the branches in various areas.

And remember: Roles and responsibilities will need to be clearly defined as well.

BNP bases its derivatives business in Paris because it makes sense to do so: Related university programs are there, and the city offers favorable accounting treatment.

Staff is sent to London to generate derivatives deals, but the booking and management is done in Paris because that's where the people and the skills are.

Likewise, Korean players will want to build the skills generally in one place and not try to spread themselves across the region.

The deals can be generated out of Hong Kong, Shanghai or Kuala Lumpur, but the structuring, management and administration should be done by a centralized group of people back in Seoul as much as possible.

Learning the key areas in which to excel and maximizing the opportunities will be some of the toughest challenges facing Korean players.

The more you study the British and French examples, the more implications you will be able to draw for the future strategy for financial institutions in Korea.