Structured Finance & Derivatives 2019 Comparisons

Last Updated November 23, 2018

Law and Practice

Authors



Kim & Chang (Seoul - HQ) has been a pre-eminent firm in the capital markets practice area since its founding in 1973 and a pioneer in developing new products, having participated in landmark transactions such as IPOs in South Korea and various other jurisdictions, and public and private offerings of equity-linked securities, credit and equity-linked derivatives, ABS, hybrid bonds and straight bonds. The firm has developed a reputation for providing solutions to complex and first-impression structure, regulatory and transaction-related issues, having successfully advised clients in almost every industry sector across equity and debt products for over four decades. With 30 partners and 60 associates, the capital markets team are supported by other practices such as tax, competition, insolvency and labour to provide cutting-edge, tailored advice to our clients.

Securitisation transactions in South Korea are divided into those whose asset securitisation plans are registered with the Financial Supervisory Service (the “FSS”) in accordance with the ABS Act (“registered securitisations”) and those that do not follow the ABS Act (“unregistered securitisations”). With the continued trend of low interest rates in 2017, registered securitisations have experienced reduced demand, and with the added reduction in demand of real property-backed securitisations (which constitute a significant portion of unregistered securitisations), the overall volume of both registered and unregistered securitisations have decreased. In response, we have witnessed an increase in the use of structured finance in acquisition financing and real property investment transactions.

The most commonly used form of transaction for acquisition finance/leveraged finance transactions in South Korea is the loan transaction, by a wide margin. Other forms include bonds, convertible bonds and redeemable convertible preferred shares. 

The most frequently used structure of the loan is one in which the borrowing company creates a new SPC to act as the borrower of the loan transaction, with the borrowing company holding shares in a target company.

Recently, major securities firms are participating as lenders in acquisition finance/leveraged finance transactions more so than major commercial banks. With the development of the PEF market in Korea, we are witnessing larger PEFs acting as the sponsor in acquisition finance/leveraged finance transactions. There have not been any recent changes to the target industry of acquisition finance/leveraged finance transactions and it remains diverse across many industries.

There are no specific laws or regulations that govern acquisition finance/leveraged finance transactions themselves. However, there are a number of laws that are intended to govern the various financial institutions related to such transactions.

For example, banks are governed by the Bank Act, securities firms are governed by the Financial Investment Services and Capital Market Act (the “FSCMA”) and other lending companies are governed by the Specialised Credit Finance Business Act or other relevant regulations pertaining to the financial institutions. If the sponsor is a South Korean PEF, then it will also be governed by the FSCMA.

Typically, the loan documentation is drafted by the lender's legal counsel. In the case of a foreign-sponsored acquisition finance/leveraged finance transaction, the documentation will most likely be in accordance with LMA or APLMA format. In the case of domestic deals, the law firm acting as counsel to the lenders uses its own templates for producing the loan documents. However, the contents of the loan documents used in the South Korean acquisition finance market do not materially differ from those governed by the laws of England and Wales or the State of New York. Loan documents are usually written and negotiated in Korean, although they can be prepared in English in cases where the sponsor is a not a South Korean entity. Regardless, the governing law of the loan documents is almost always South Korean law.

The typical type of security taken in acquisition finance/leveraged finance transactions in South Korea are the pledge of shares held by the borrowing SPC in the target company, and the pledge of the relevant bank accounts of the borrower SPC.

Upstream guarantees (that is, where a subsidiary company provides a guarantee for its parent company's obligations) or collateral are generally not requested or given in South Korea. This is because, under South Korean law, the directors can be subject to civil and criminal liability for breach of fiduciary duty if they act with the intent to benefit a particular third party (which in this context can include the shareholders).

A general charge or assignment over all assets of a party is not acknowledged in South Korea. Therefore, a separate security interest should be created in relation to each type of asset. The customary forms of security in acquisition financing are (i) the pledge of shares held by the borrowing SPC in the target company and (ii) the pledge of the relevant bank accounts of the borrower SPC. As such, we provide further explanation on the requirements of a pledge under South Korean law below.

Pledge (jil-kwon): a pledge is created by the parties entering into a pledge agreement. The pledge requires the collateral provider to surrender possession of the collateral to the secured party but permits the debtor to retain title to the collateral with certain exceptions. If specifically agreed between the secured party and the collateral provider, the secured party may be able to resort to a private sale or direct acquisition of title to the collateral in addition to the judicial foreclosure.

A provision of security or a guarantee by a resident entity in South Korea to a non-resident entity requires a report to be made to the applicable FX bank.

Although there are slight differences on enforcement depending on the type of security being enforced, there are no particular procedures or significant restrictions that may impact the timing and/or the enforcement proceedings in South Korea.

The deductibility of interest payments in relation to a loan extended by a foreign controlling shareholder (an “FCS”) of the South Korean borrower may be restricted under South Korean law (International Tax Co-ordination Law). If the amount of the South Korean borrower's debt owed to an FCS or to a third party under a guarantee issued by an FCS exceeds 200% of the "net FCS equity" in the South Korean borrower, interest expenses on the excessive debt are not deductible to the South Korean borrower for corporate income tax purposes. In addition, the non-deductible interest amount is treated as dividends if the debt is owed to an FCS.

There is no explicit financial assistance rule in South Korea. However, all actions taken by the directors of the company providing financial assistance must comply with the relevant fiduciary duty restrictions. Under South Korean law, the directors can be subject to civil and criminal liability for breach of fiduciary duty if they act with the intent to benefit a particular third party. In this context, a third party includes the shareholders of the company since the prevailing view is that the fiduciary duty of directors runs to the company itself rather than to the shareholders of the company. Therefore, the directors of the target that support providing guarantees (or providing the assets of the target as collateral) with respect to the obligations of the target's parent could potentially be subject to both civil and criminal liability.

There are no particular lender-liability issues to be considered in South Korea, as long as lenders do not actively participate in a transaction structure that is forbidden by law (as explained above).

In South Korea, it is not common for the borrower or financial sponsor to engage in debt purchase transactions. Debt is not actively being traded in this jurisdiction.

In the South Korean market, since the sellers are not willing to accept a "financing-out" provision in the sale and purchase agreement (that is, where successful completion of financing by the buyer is a condition precedent for closing), it is common to obtain commitment letters to ensure the financial institution's commitment to the financing of the acquisition cost on or before the execution of the share sale and purchase agreement. The typical major representations, undertakings and events of default contained in acquisition finance documentation in Korea are not that different from the LMA or the APLMA formats.

The merger between the acquiring vehicle and the target is often used for debt push-downs. In such situations, the liabilities of the target (the surviving company) are increased by the outstanding loans borrowed by the acquiring vehicle by operation of law on the completion of the merger. Therefore, issues can arise as to whether the directors of the target will be liable for breach of fiduciary duty in approving the merger. To ensure the merger does not raise any fiduciary duty concerns, the transaction should be reviewed on a case-by-case basis.

In this regard, the Seoul Central District Court recently rendered a decision regarding the alleged breach of fiduciary duty in connection with a certain leveraged buyout (LBO) transaction. The court held that, considering the circumstances, the directors of the target should not be held liable for breach of fiduciary duty in a merger type LBO when the following are applicable (among other things): (i) a considerable portion of the purchase price (about 56% of the total) was financed through equity investment; or (ii) the merger was consummated in full procedural compliance with the applicable statutes and regulations.

There are presently no impending regulatory changes in relation to acquisition finance in South Korea.

The primary law governing the capital market and activities of financial investment business in South Korea is the FSCMA. The FSCMA is comprised of ten parts with many subordinate regulations. The Enforcement Decree of the FSCMA, which is a Presidential Decree, enumerates matters addressed by the FSCMA and the rules and regulations prescribed to be implemented under the FSCMA. The Enforcement Rules of the FSCMA (Ordinance of the Prime Minister) stipulate the powers ensured by the Decree and the rules and regulations prescribed to be implemented. Regulations promulgated by the Financial Services Commission (the “FSC”) contain articles that explain the duties created by the Decree and the rules and regulations prescribed to be implemented.

In addition, the ABS Act governs asset-backed securitisation transactions. The ABS Act, which was enacted in September 1998 to facilitate the restructuring or disposal of non-performing loans of financial institutions, has evolved into the main piece of legislation governing securitisation transactions in South Korea.

Sales receivables held by companies, loan receivables held by banks and financial institutions (including mortgaged loans) and credit card receivables held by credit card companies are the main assets that are securitised. Transactions often include both performing and distressed debt.

There are no risk-retention requirements for originators in South Korea.

Transfer legalities

In order for the sale/transfer of financial assets to be perfected against any later purchasers of the same financial assets from the transferor, or to be effective as against the debtor and a third party, the transferor must give notice of assignment to the debtor with a fixed date stamp affixed thereon (ie, a notice of assignment to the debtor by contents-certified mail via a post office in South Korea), or the consent to such assignment with a fixed date stamp affixed thereon must be obtained from the debtor.

Notification

In order for the sale of receivables to be perfected against any later purchasers of the same receivables from the seller or to be effective against the debtor and/or a third party, either (i) the seller must give notice of assignment to the debtor with a fixed date stamp affixed thereon (ie, a notice of assignment to the debtor by contents-certified mail via a post office in South Korea), or (ii) the consent to such assignment with a fixed date stamp affixed thereon must be obtained from the debtor (Article 450, paragraph 2 of the Civil Code).

In an ABS deal of consumer receivables where there are numerous obligors, it can be quite burdensome (and costly) to send fixed date stamped notices to each of the obligors. In the case of an ABS transaction under the ABS Act, if the transfer of receivables from the seller to an SPC or a trustee is registered with the FSC as required by such law, the assignment shall be effective against third parties (other than the debtors). The practice in South Korean consumer receivables transactions where there are numerous obligors is to register the transfer of such receivables with the FSC at closing, thereby ensuring perfection against third parties (other than the debtors). However, perfection against the underlying debtors requires notice to them and this notice is not sent at closing; rather, the transaction documents include notice trigger events and a notice to debtors must be sent out if any of these notice trigger events (which includes downgrading of the rating of the originator) is triggered. The costs for such notices to debtors are usually reserved separately in the deal.

Consumer protection legislation

The following are consumer protection laws that may be applicable to loans. 

Under the Act on Registration of Lending Business and Protection of Financial Users (the “Lending Business Act”), the interest rate as well as the default interest rate of the loans extended to individuals or small and medium-sized enterprises by a registered lending company may not exceed 24% per annum. The Lending Business Act also limits the interest rate of the loans extended by certain licensed South Korean financial institutions to 24% per annum and further regulates the maximum default interest rate of the loans extended by certain licensed South Korean financial institutions.

Further, the Law Concerning Regulation of Adhesion Contracts, the Framework Act on Consumers, the Act on the Consumer Protection in Electronic Commerce Transactions, etc, the Instalment Transactions Act and the Door-to-Door Sales Act provide certain special protections to consumers as set forth below.

Under the Law Concerning Regulation of Adhesion Contracts, a seller who uses standard terms and conditions should explain important terms and conditions to the customers and any clauses in the standard terms and conditions which are unfair to the customers shall be invalid.

The Instalment Transactions Act, the Door-to-Door Sales Act and the Act on the Consumer Protection in Electronic Commerce Transactions, etc, provide consumers with noteworthy protections, such as the right to receive written contract from the seller, the right to rescind the offer for purchase within seven days (in the case of the Instalment Transaction Act and the Act on the Consumer Protection in Electronic Commerce Transactions, etc) or 14 days (in the case of the Door-to-Door Sales Act) of the receipt of the concerned contract or delivery of the goods, whichever comes later, and limitation of the amount of damage claims by the seller against the customers.

Data protection legislation

According to Article 6 of the ABS Act, ABS transactions are required to register its asset transfers to the FSC, together with the securitisation asset list. There are two types: (i) a securitisation asset list for disclosure, where all personal information of the obligor, such as name, address, identification number and credit, are masked/removed and publicly available for anyone’s access; and (ii) a securitisation asset list, where all personal information of the obligor, such as name, address, identification number and credit score, are disclosed, but the information is not publicly available. In addition, in order to implement the securitisation plan, certain information on the securitisation assets are provided to the transaction parties such as (i) the accounting firm for due diligence, (ii) the rating agency, and (iii) the servicer. To preserve the confidentiality of the identity of the obligor, the names, addresses, identification numbers, etc, of the obligors are either redacted or encrypted. However, if the obligors’ personal information or personal credit information is included in the information provided to a third party, such disclosure has to be published on its websites's homepage, or a consent from or notification to the obligors is required according to the relevant privacy law.

Deferred purchase prices, etc

In typical domestic ABS transactions, the originator, as the equity holder of the junior ABS or the SPC, retains the ultimate risk pertaining to the asset pool. Deferred purchase prices are not typically used in credit enhancement structures in Korea.

"True sale"

Article 13 of the ABS Act sets forth the requirements of a "true sale" with respect to the transfer of the assets to an SPE in a securitisation transaction implemented under such law. Article 13 is a “safe harbour” provision that deems a sale as a "true sale" and does not result in the creation of a security interest (ie, a secured loan transaction).

Article 13 of the ABS Act sets forth certain conditions that must be satisfied by the transfer of assets; if such conditions are satisfied, the transfer will not be deemed to be a provision of security interest but a true sale. 

The conditions are:

  • the transfer must be by sale or exchange;
  • the right to dispose of the asset and the right to receive benefits from the asset must be vested in the transferee, provided that this shall not be adversely affected by the transferor’s right of first refusal at the time of the transferee’s disposition of the asset;
  • the transferor has no right to demand return of the assets and the transferee has no right to demand return of the transfer price; and
  • the transferee assumes the risk of the transferred assets, provided that this will not be adversely affected even if the transferor provides a warranty regarding the assets (including the warranty on the financial ability of obligors to pay under the assets).

Qualification as a “true sale” transaction must be decided on a case-by-case basis, depending on the transaction details and the intent of the parties. In practice, however, whether securitisation transactions that do not fall within the purview of the ABS Act qualify as “true sales” or “true trusts” is nonetheless decided in substance by the requirements of a "true sale" set forth in the ABS Act.

In the case of a "true sale", so long as the transfer is perfected against third parties and does not become the subject of fraudulent conveyance or avoidance by the court, the transferred assets would not be a part of the bankruptcy estate or assets of the originator in the event that the originator becomes the subject of an insolvency proceeding or a corporate restructuring proceeding.

Issuances via an SPV/trust

Both SPVs and trusts are utilised in South Korea in order to insulate the transferred financial assets from the financial risks of the originator. The ABS Act specifically provides for establishment of an SPV as a securitisation vehicle.

Minimum capitalisation requirements

An SPV may be established as long as it has a minimum capital of KRW100 (approximately USD0.10).

Required aspects of the SPV

The ABS Act provides that an SPV incorporated in South Korea shall be in the form of a limited liability company (yuhan hoesa), and that the SPV may not establish a branch nor hire an employee. Under the ABS Act and South Korean tax laws, various benefits in perfection procedures and tax benefits are granted to the SPV. There are no specific requirements regarding the status of directors or equity holders. The servicing of the SPV’s assets must be delegated to a qualified servicer, and the corporate and other administrative matters of the SPV (other than matters that require equity holders’ resolutions, matters that fall within a director’s power to represent the company and matters that fall within the power of an internal auditor) must be delegated to a business trustee. Further, in order to protect the investors' interest, the ABS Act provides that a resolution of the equity holders of the SPV which is contrary to the securitisation plan or which prejudices the rights of the holders of securities issued by the SPV shall be null and void.

Moreover, since securitisation transactions are premised on the bankruptcy remoteness from the originator, the originator may not be involved in the establishment of the SPV, nor exercise control over the SPV.

Multi-issuance vehicles/compartment companies

Under the ABS Act, an SPV may only implement one ABS plan. Therefore, multi-issuances are not available for registered securitisations. In the case of unregistered securitisations, however, no such limitations exist and multi-issuances are available. There had been multi-issuances from one SPV for conduit transactions in the past, but we have not witnessed any such multi-issuances recently. In the conduit transaction in the past, all securitised assets were segregated through an entrustment for security purpose (dambo-sintak).

Management of securitised assets

Article 11 of the ABS Act states that the servicer (who is often the originator in most South Korean securitisation transactions) shall manage the securitisation assets entrusted to it separately from its own assets (including the funds and other property rights received as a result of the administration, operation, and disposition of such assets), and prepare and maintain separate books for the administration of the securitisation assets. Therefore, the servicing agreement sets forth clear obligations for the servicer/originator to separate its own assets from the securitised assets, and any funds collected by the servicer on the securitised assets should be deposited directly into the accounts of the SPV or the trustee.

Bankruptcy-remote entities

Since an SPV may only be used for one particular securitisation transaction (with the relevant securitisation plan being filed to the regulator), the risk of commingling of the SPV’s assets with other assets is low, and therefore the securitised assets are deemed to be well insulated from bankruptcy risk.

Risk of reversal, etc

Even if the sale of the receivables is a “true sale” and is perfected against third parties, there is a possibility that a receiver in a South Korean insolvency proceeding may avoid such sale if certain conditions are met. The Debtor Rehabilitation and Bankruptcy Law (the “DRBL”) provides for two types of insolvency proceedings in respect of insolvent business entities, namely, rehabilitation proceedings under Chapter 2 (“rehabilitation proceedings”) and bankruptcy (liquidation) proceedings under Chapter 3 (“bankruptcy proceedings” and, together with rehabilitation proceedings, “insolvency proceedings”). 

The DRBL allows a bankruptcy administrator in bankruptcy proceedings and receiver of the debtor company in rehabilitation proceedings to avoid the legal acts of a debtor which are deemed to fall within one of the following categories:

  • any act (eg, payment or transfer of property) taken by the insolvent party with the knowledge that such act would harm other creditors unless the payee/transferee had no knowledge that such payment or transfer would harm other creditors;
  • any act that would harm other creditors or any repayment of debt or provision of collateral made after a suspension of payment or the filing of insolvency proceedings (the "insolvency event"), provided that the payee or the secured party had knowledge that the insolvency event has occurred or that such act will harm other creditors;
  • repayment of debt or provision of collateral made after or within 60 days prior to an insolvency event when the insolvent party had no antecedent obligation to do so at such time unless the payee/secured party had no knowledge that (i) in case such act is made after an insolvency event, the insolvency event has occurred and (ii) such act will prejudice the equal treatment of the insolvent party's creditors; or
  • any gratuitous act which occurs after or within six months prior to an insolvency event.

Please note that being “insolvent” under South Korean law with respect to the seller means that:

  • the seller’s total assets are less than its total liabilities;
  • the seller has suspended payments of its indebtedness or is unable to pay its debts generally; or
  • a petition is filed by or with respect to the seller under the DRBL.

There are presently no impending regulatory changes in relation to securitisation transactions in South Korea.

There are no laws or regulations specifically governing the transfer and sale of receivables under South Korean law. Under Article 34, paragraph 1 of the Act on Private International Law, the legal relationship between the transferor and the transferee of a receivable is governed by the laws applicable to the contract between the parties, while the transferability of the receivables and the effectiveness and perfection of the transfer is governed by the laws applicable to the receivables (ie, the laws governing the service agreement or purchase agreement between the supplier and the buyer). 

Both recourse and non-recourse factoring are feasible under South Korean law and implemented in practice, and such concepts may be implemented by incorporating the relevant provisions in the agreement between the parties.

Advanced factoring is the general approach taken in the market in South Korea; we have not witnessed many maturity factoring transactions.

As explained above, the transfer of receivables is achieved through an assignment/transfer in accordance with the relevant transfer/assignment contract.

Although providing notice to the underlying creditors is a viable commercial option that may be negotiated and is frequently undertaken in practice, it is not a legal requirement. Please note that the debtor, with respect to the receivables, must be notified in accordance with Article 450, paragraph 1 of the Korean Civil Code.

Treatment of sale of receivables as a true sale or as a secured loan are both feasible under South Korean law, and neither may be characterised as “typical” in market practice. However, sale of receivables will not be considered a true sale in recourse factoring transactions.

At present, there is no pending reform in South Korea that will have an impact on factoring transactions.

Covered bonds are governed by the Covered Bond Act in South Korea. Eligible issuers of covered bonds under the Covered Bond Act include:

  • banks licensed and established under the Bank Act of Korea;
  • the Korea Development Bank under the Korea Development Bank Act;
  • the Export-Import Bank of Korea under the Export-Import Bank of Korea Act;
  • the Industrial Bank of Korea under the Industrial Bank of Korea Act;
  • NH Bank under the Agricultural Co-operatives Act;
  • the credit business division of National Federation of Fisheries Co-operatives under the Fisheries Co-operatives Act;
  • KHFC under the KHFC Act; or
  • any other company engaging in finance business pursuant to other laws as prescribed by the Presidential Decree of the Covered Bond Act.

The Presidential Decree came into effect on 15 April 2014 and does not stipulate any additional eligible issuers other than those already set out in the Covered Bond Act. Eligible issuers of covered bonds, however, must have equity capital of not less than KRW100 billion, a Bank for International Settlements (BIS) ratio of not less than 10% and appropriate funding and operation structures and risk management procedures, etc.

The Covered Bond Act prescribes that eligible issuers may issue covered bonds up to the ceiling set by the Presidential Decree, which shall not exceed 8% of its total assets as of the end of the fiscal year immediately preceding the scheduled date of issuance; the Presidential Decree limits this to 4% of its total assets as of the end of the fiscal year immediately preceding the scheduled date of issuance. The FSC, as the South Korean financial regulator, reserves the right to restrict this further to 2% of its total assets, taking into consideration various factors such as collateralisation ratio and financial condition (including liquidity position).

An instance of issuance of contractual (structured) covered bonds in South Korea is Kookmin Bank’s offshore covered bond issuance in May 2009. Kookmin Bank developed a structure on the basis of the securitisation techniques under the ABS Act and the Trust Act that enabled the relevant asset pool to be “ring-fenced” and effectively granted dual recourse to its investors through contractual arrangements. KB's structured covered bonds were the first covered bonds issued out of South Korea and the Asia-Pacific region.

The cover pools of the covered bonds that have been issued so far have mainly included residential mortgage loans held by banks.

For covered bonds issued under the Covered Bonds Act, Article 12 of the Covered Bond Act states that, if the principal of the covered bonds is not fully repaid, covered bond holders have the right to payment from other assets of the issuer in addition to the cover pool. With the consent of the holders of at least 75% of the aggregate outstanding principal amount of the covered bonds, the FSC may issue an order to transfer relevant contracts to another eligible issuer. The issuer is required to separately manage the mortgage loans included in a cover pool from its other assets on the basis of the applicable issuance plan. The books for the cover pool must also be separately maintained and any violation may be subject to criminal sanctions. For structured covered bonds issued before the enactment of the Covered Bonds Act, it is contractually structured so that the investors will have dual recourse against both the cover pool and the general assets of the issuer.

For covered bonds issued under the Covered Bonds Act, the issuer issues the bonds without transferring the cover pool to a separate SPV as required under the Act, and thus SPVs are not used.

Article 12 of the Covered Bond Act states that, in case of an issuer’s insolvency, the cover pool shall not be subject to the issuer’s insolvency proceedings, including compulsory execution, preservative measures and stay orders.

In a household debt management meeting held on 16 April 2018, the FSC announced measures to utilise covered bonds as a means to procure funding for long-term, fixed-rate household loans. The plan is to link the allocation of eligible loans acquired by KHFC to the covered bond issuance of each bank so that KHFC acquisition of eligible loans is allocated more to banks with robust covered bond issuances. In addition, the plan is to allow banks and insurance companies to apply relaxed weighted risk standards on covered bonds starting in 2022 and 2021, respectively. Domestic issuances of covered bonds will be able to benefit from a lower commission rate paid to the FSS.

A Korean company that issues bonds secured by collateral must do so pursuant to the Secured Bond Trust Act (the “STBA”). As the provisions in the STBA are viewed as being onerous, there have not been many secured bonds issued under the STBA.

Under the STBA, a company that intends to issue secured bonds must enter into a trust agreement with a trustee, which shall be a trust company or bank registered with the FSC to engage in trust business relating to secured bonds. The types of collateral that may be used under the STBA is limited, and any enforcement procedures on the collateral must also be performed in accordance with the STBA.

There have not been many bond issuance secured by a pledge of assets in South Korea.

Under the Financial Investment Services and Capital Markets Act of Korea (FSCMA), a credit-linked note (CLN) is a type of derivative-linked security (DLS) which must be issued by a qualified financial investment company (ie, a securities dealer with a licence for handling derivatives products). Therefore, (i) there is no CLN issued by an SPV in South Korea, and (ii) the obligations under a CLN must be borne by the issuer (ie, a financial investment company). 

A financial investment company issues CLN to (i) retail investors (by way of public offering) and (ii) institutional investors (by way of public offering or private placement). Institutional investors are typically statutory pension funds, insurance companies, investment funds, etc.

Please see 5.1 Main Structures, above.

Transactions usually include debt instruments issued by South Korean corporations.

Under Korean banking regulations (reflecting BASEL III), CLN is not accepted as a way to reduce the risk-weighted assets held by a South Korean bank. As discussed in 5.1 Main Structures, above, a South Korean bank cannot issue a CLN under South Korean law.

It appears that the majority of CLNs are privately placed since it is not easy to find publicly offered CLNs. It is understood that South Korean regulators review very carefully registration statements for CLNs issued by way of a public offering.

If CLNs are publicly offered, (i) detailed information on the underlying assets must be disclosed in the offering documents and (ii) the issuer (a South Korean financial investment company) must notify the investors of the occurrence of a credit event or deterioration in the creditworthiness of the issuer.

There are no pending reforms in South Korea that will have an impact on CLN transactions.

Financial investment products are classified into (i) securities and (ii) derivatives, based on their characteristics – ie, whether or not investors owe any obligation to pay anything in addition to the money or asset paid at the time of acquiring such instruments.

Securities consist of:

  • debt securities;
  • equity securities;
  • beneficiary certificates;
  • investment contract securities;
  • derivative-linked securities; and
  • securities depositary receipts.

Derivatives can be classified into two categories:

  • exchange-traded derivatives; and
  • over-the-counter (OTC) derivatives.

Exchange-traded derivatives are traded through intermediaries, such as exchanges, based on standardised exchange contracts and regulation on the intermediary as the counterparty to the contract. OTC derivatives are privately negotiated bilateral contracts entered into between the contracting parties directly, typically based on standardised agreements and contractual terms, such as those developed by the International Swaps and Derivatives Association, Inc (ISDA).

Securities companies are the most active players in the market for structured products in South Korea.

The FSCMA generally applies to issuance and offering of structured products in South Korea. 

The issuance of derivative structured products in South Korea requires a general securities business licence, and the offering/sale of structured products requires an investment sale/brokerage licence.

As long as the requirements are met, derivative structured products that have been issued overseas may be sold in South Korea. The FSS/FSC have direct and indirect intervention authority in the issuance and offering of structured products in the country.

In the case of a public offering, an offering memorandum is required. For private offerings, there are no legal requirements. Typically, a term sheet and an offering circular/information memorandum are prepared.

Consigned sale agreements are sometimes signed to set forth the roles and obligations of the issuer and the distributor.

The distributor is required to provide explanations on the investment as a distributor/broker under the FSCMA.

Distributors are compensated by the issuer via brokerage fees.

Structured products such as ELWs are sometimes listed on the exchange for the benefit of investors; in such case, the general requirements of listing of the exchange will be applicable.

False reporting of material aspects of a prospectus may result in serious compensation obligations. Sanctions may also be imposed against the issuer to limit issuance.

There are no pending reforms or current trends in South Korea that will have an impact on the issuance and offering of structured products.

In order to engage in OTC derivatives transactions as a business, it is required to have the derivatives dealing licence under the FSCMA. In this regard, “as a business” generally means the manner of repeating certain transaction for profit-earning purpose.

Under the FSCMA, a financial investment company (ie, a dealer of derivatives products) may enter into OTC derivatives products with a “general investor” only after the financial investment company confirms that (i) such products are suitable to the counterparty, (ii) the counterparty fully understands the transactions, and (iii) the counterparty enters into the transactions only for hedging purpose. 

As for “professional investors”, there is no general restriction applying to the sale of OTC derivatives products, but individual laws and regulations applying to each investor group may have special restrictions. For example, a South Korean insurance company may not enter into the CDS as a protection seller under the Insurance Business Act of Korea. Also, whether a “trust” or an “investment trust" (ie, fund) may invest in OTC derivatives products is determined under the trust deed (or trust agreement).

The Korea Financial Investment Association (“KOFIA”), a self-regulatory organisation, announced “a standard form of the Master Agreement for OTC Derivatives Transactions in the Korean language”. It is understood that several South Korean banks and securities companies have been using this agreement, mainly in transactions with retail investors.

Also, for fx spot transactions, the “FX Agreement” has been widely used among South Korean banks. This agreement was originally announced by the Korean Federation of Banks (“KFB”), but KFB currently does not manage this agreement, which is why there is no unified form of the agreement in operation in the country.

There is no legal opinion on the enforceability of such agreements, which was issued for all members of KOFIA or KFB. Instead, certain financial institutions, from time to time, request the enforceability opinion (in particular, enforceability of the close-out netting related provisions) for their own purposes only. However, material conclusions and qualifications of such an individual opinion would not much differ from the industry opinions for the ISDA Master Agreement.

When the South Korean counterparty is a general corporation subject to the Corporate Restructuring Promotion Act of Korea (“CRPA”), the AET can be useful to avoid any unexpected stay of the netting – in respect of the repurchase agreement ("repo") or securities lending transaction – or the collateral enforcement. 

When the South Korean counterparty is an entity subject to the rehabilitation proceedings under the Debtor Rehabilitation and Bankruptcy Act of Korea, the collateral enforcement can be also stayed upon the commencement of the rehabilitation proceedings; however, AET is not absolutely required, since the “commencement” takes place a few weeks after the petition of the rehabilitation proceedings).

In general, the close-out netting under the ISDA Master Agreement, GMRA and GMSLA is legally enforceable, except as the close-out netting of the "repo" or securities lending transactions with a South Korean counterparty subject to the CRPA may be subject to the stay upon the time of sending of “notice for initiating restructuring process under the CRPA” to a leading bank.

South Korea has not introduced such “stay order by financial regulators” as yet.

Kim & Chang

39, Sajik-ro 8-gil
Jongno-gu
Seoul 03170
Korea

+82 2-3703-1114

+82 2-737-9091/9092

lawkim@kimchang.com www.kimchang.com
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Kim & Chang (Seoul - HQ) has been a pre-eminent firm in the capital markets practice area since its founding in 1973 and a pioneer in developing new products, having participated in landmark transactions such as IPOs in South Korea and various other jurisdictions, and public and private offerings of equity-linked securities, credit and equity-linked derivatives, ABS, hybrid bonds and straight bonds. The firm has developed a reputation for providing solutions to complex and first-impression structure, regulatory and transaction-related issues, having successfully advised clients in almost every industry sector across equity and debt products for over four decades. With 30 partners and 60 associates, the capital markets team are supported by other practices such as tax, competition, insolvency and labour to provide cutting-edge, tailored advice to our clients.

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