FSS urges brokerages to curb high-rate competition, tighten risk controls amid IMA expansion

The Financial Supervisory Service has called on brokerages expanding their promissory note and integrated management account (IMA) businesses to strengthen financial soundness and internal controls.

The directive comes as funding volumes are expected to grow with new market entrants and a broader range of products eligible for retirement pension portfolios, raising the need to proactively manage the risk of defaults from high-rate promissory note competition and high-risk investments.

The FSS said Thursday it held a meeting at the Korea Financial Investment Association with the chief risk officers and asset management heads of nine comprehensive financial investment firms.

FSS Deputy Governor Seo Jae-wan, who oversees the financial investment sector, joined the capital markets supervision bureau chief and the Korea Financial Investment Association's securities and futures division head to discuss risk management and internal control measures related to promissory notes and IMA, as well as ways to improve the quality of venture capital supply.

Seo said the promissory note and IMA market is expected to continue growing, driven by the recent licensing of two new brokerages for promissory note business and the expansion of products eligible for retirement pension inclusion. A high level of risk management and a robust internal control framework are essential to protect investors and ensure a stable supply of venture capital, he added.

Funding raised by comprehensive financial investment firms through promissory notes and IMA has been expanding consistently. According to the FSS, outstanding promissory note funding by such firms stood at 55.93 trillion won ($41.8 billion) as of the end of the second quarter this year, while IMA funding totaled 3.64 trillion won. Combined, the two products reached 59.57 trillion won, up about 2.28 trillion won from 57.29 trillion won at the end of the previous quarter.

As funding volumes grow, so does the importance of managing risk in the investment process. The FSS urged firms to proactively prepare for potential defaults in high-risk investments, including overseas assets, amid heightened uncertainty over interest rates and share prices.

Particularly regarding high-rate promissory note products launched in tandem with the recent rise in market interest rates, the FSS said firms need to manage their offerings at a sustainable level in light of their financial soundness.

Liquidity management was also highlighted as a key area of focus. The FSS directed firms to strengthen their liquidity buffers through stress testing and contingency funding plans, and to closely review recovery plans for long-term investment assets. It also called on firms to use the newly introduced adjusted liquidity ratio regime as an opportunity to diversify the maturity structure of their funding and investment portfolios and improve their liquidity response systems.

On venture capital supply, the FSS said qualitative improvement must keep pace with quantitative growth. The outstanding balance of venture capital supplied by comprehensive financial investment firms reached 15.95 trillion won at the end of the second quarter, up 19.0 percent from 13.4 trillion won at the end of the previous quarter. The ratio of venture capital supply to promissory note and IMA funding rose 3.4 percentage points over the same period, from 23.4 percent to 26.8 percent.

However, the amount recognized under the 30 percent cap on venture capital supply stood at 11.62 trillion won, representing 19.5 percent of total funding — up 2.7 percentage points from 16.8 percent at the end of the previous quarter.

The FSS said firms should actively seek out companies with strong technology and growth potential that have been overlooked by investors, and broaden the base of productive finance by expanding investment in venture and innovative businesses.

The FSS is also working to overhaul the risk management framework for corporate finance. It is jointly developing best-practice guidelines on corporate credit risk management with the financial investment industry.

The guidelines are expected to cover organizational matters such as the expertise and independence of credit analysts and the composition of decision-making bodies, as well as screening criteria for assessing a company's business, industry and financial risks and repayment plans, and post-management procedures for monitoring changes in creditworthiness and repayment capacity.

The FSS also directed firms to strengthen internal controls against conflicts of interest that may arise in managing promissory note and IMA funds. It is working with the industry through a task force on information barrier reform to discuss standards for preventing conflicts of interest and measures for operating information barrier systems.

In connection with the recently implemented exemption from the collateral ratio maintenance requirement for margin financing, the FSS called for vigilance against the spread of so-called leveraged investing.

The FSS urged brokerages to clearly communicate their individual application standards so that the temporary collateral ratio maintenance exemption, in effect since Monday, does not cause investor confusion or fuel an expansion of margin financing. It also directed firms to strictly manage per-stock and per-borrower limits in line with existing voluntary margin financing management guidelines.

Brokerage executives at the meeting said they agreed on the importance of investor protection as funding and investment volumes grow, and pledged to actively incorporate the regulator's guidelines into their internal rules and operating procedures.

Newly licensed operators in particular said they would focus for now on financial soundness and liquidity management, and work to build investor trust through stable fund management.

The FSS has also moved to reform rules governing stock information services provided by brokerages, after cases emerged of investors unknowingly incurring fees after signing up for services such as stock recommendations and supply-demand analysis. The regulator said Wednesday it had reviewed industry-wide operating practices and drawn up improvement measures following recent complaints about such services.

The FSS said it would significantly strengthen guidance procedures before and after service sign-up so investors can clearly understand the costs they will actually bear. It also said that, in principle, services must be suspended when a free trial period ends, and that explicit investor consent is required before converting to a paid subscription.