By Carl Delfeld of the Chartwell ETF Advisor
The iShares Korea exchange-traded fund's (EWY) trading pattern is unfortunately starting to look a bit like Japan's. The ETF's top three holdings; Samsung, Posco and Kookmin Bank account for 30% of assets and all face some market headwinds.
But the key constraint to higher South Korea economic growth and a bull market is its overegulated financial sector.
Late last year, the "Capital Markets Integration Act” came into effect and could be a building block for more significant reform. While South Korea’s banking sector was liberalized a decade ago, many financial markets were off limits to foreign institutions. South Korea sees the moves of countries like Singapore to become a regional financial services hub and this legislation is aimed at keep up with the competition.
The most significant part of the act, which will take effect in January 2009, is the move from a positive list system of regulation - under which everything that is not allowed is prohibited - to a negative list, meaning financial groups can do anything that is not expressly prohibited. Some are comparing the changes to the "big bang" in London twenty years ago.
The legislation also gives more running room for asset managers to develop new and more sophisticated products as well as permitting brokerages to provide customers with a wide variety of financial services. If South Korea can build on its strong industrial and tech foundation and broaden into a financial services powerhouse, it should have a significant impact over time. The reforms will also improve disclosure and transparency and help prevent conflicts of interest.
But some believe that the legislation does not go far enough and that South Korea needs to be much friendlier to foreign financial firms to attract the talent and resources necessary to put Seoul on the global financial map.
Another issue in these times of financial uncertainty is that Korean banks are structurally more vulnerable to credit issues than their Asian counterparts. Unlike their peers, they lend more than they attract in deposits. This is especially important since in 2007 as savers switched funds out of banks, partly as a result of deregulation, and lending volumes jumped. Last year loan/deposit ratios stood at around 120 per cent. The Financial Times notes that Korean won deposits, which made up 64 per cent of liabilities in 2003, fell to just 50 per cent by the third quarter of 2007, according to Credit Suisse.
This increasing reliance on capital market funding plus keen competition for deposits, has raised financing costs and probably depressed bank profit margins as well.
The South Korean market is trading at about 12 times forward earnings according to S&P data.
To learn more about South Korea and other Asia-Pacific markets, go to Chartwell ETF.
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