The sight of Chey Tae Won, handcuffed and his arms bound by rope, being led off from his court sentencing to jail on June 13, brought back unhappy memories of the late 1990s in South Korea.
Notwithstanding his conviction, Chey is still titular head of SK Corp., the $12 billion-in-sales oil refiner that is the flagship of SK Group, the third biggest of the country’s chaebol, the massive, family-controlled conglomerates that dominate South Korea’s economy. Less than four years ago, Kim Woo Choong, founder and head of Daewoo Group, then the country’s second-biggest chaebol, fled the country -- he remains a fugitive -- rather than face charges of self-dealing. Two dozen of Kim’s fellow executives weren’t so lucky: They were carted off, hands bound like Chey’s, and jailed for misstating and misappropriating Daewoo funds.
Chey, son-in-law of former South Korean president Roh Tae Woo and the principal family member running the chaebol, was convicted of manipulating the shares of various SK Group companies in a complicated plot to solidify his control over SK Corp. He and nine other executives were found guilty of overstating earnings and understating debt levels by a total of $1.2 billion at another affiliate, oil trading and distribution company SK Global Co. In all, SK Global’s debts exceed its assets by about $3.65 billion and the stricken company is teetering near collapse.
The revelations about Chey and SK Group, which first came to light at his arrest in late February, are just a taste of the bad news filtering out of South Korea’s closely connected financial community. Delinquencies on credit card debt burst through 6 percent in December and nearly hit an astonishing 12 percent by the end of May, leaving card issuers dripping red ink through the first half of 2003 and forcing them to shore up reserves. In April the new government of President Roh Moo Hyun had to step in to stop a run on investment trust companies, the country’s version of mutual funds, which as big buyers of the credit card companies’ short-term debt provided the lion’s share of their financing. In all, investors, nervous about both SK Global’s problems and the declining state of the credit card business, yanked nearly $25 billion out of the ITCs in just six weeks from late February to early April, forcing a major liquidity squeeze in South Korea’s loosely run bond market and exposing some significant structural and regulatory shortcomings. The government was forced to engineer a bailout in which banks took possession of more than half of the $8.4 billion of the credit card paper from the ITCs, while the rest was rolled over. The card companies agreed to raise another $4 billion to steady their own financial positions.
“The liquidity problem was reminiscent of previous crises in Korea revolving around managerial and supervisory problems in the ITCs and illiquidity in the bond markets,” says David Coe, a former International Monetary Fund representative in Seoul who now works for the agency in Washington.
Senior regulators, who have launched investigations into everything from the chaebol to bond market practices, don’t believe that any new disasters will emerge and think that the existing ones can be controlled. “We are able to overcome the problems,” Lee Jung Jae, who runs South Korea’s twin financial regulators, the Financial Supervisory Commission and its Financial Supervisory Service, told Institutional Investor (see box, below).
Are those problems over? Skeptics don’t expect the Roh administration to go much beyond the flurry of investigations and procedural reviews. As a result, they say, the government may again find itself in difficulty because it’s not addressing fundamental flaws, not least its own pervasive role in the financial services sector. Even some government regulators concede this problem. “In the case of nationalized banks, for instance, there are no distinct shareholders, so maybe the management doesn’t have to answer” to its owners in the same way it would in the private sector, says an official at the Korea Deposit Insurance Corp., the agency that holds the government’s shares in most of the state-controlled institutions.
The government, through the KDIC, owns the country’s two largest ITCs, Korea Investment Trust Management Co. and Daehan Investment Trust Management Co., and controls a third, Hyundai Investment Trust Management Co., which were the biggest holders of credit card debt. It also holds sizable portions of five commercial banks, including Woori Bank and Korea Exchange Bank, both of which own credit card companies; Hana Bank, the major creditor of SK Global; Chohung Bank and Korea First Bank, as well as all of one insurer and part of another. Conflicts of interest are inevitable when the government owns and regulates the same institutions. It gives the appearance, says the KDIC official, who requested anonymity, “that the government tries to manipulate” the institutions to further its political aims.
Even if, as regulators suggest, the worst of the recent crises are past, there are still substantial issues to deal with. Foreign investors like Monaco’s Sovereign Asset Management and London’s Hermes Investment Management, shareholders in Chey’s SK Corp., are fighting the company’s attempt to use some of its own funds to rescue SK Global. To the shareholders, it’s another instance of shifting resources from one chaebol company to prop up another -- which Daewoo and other South Korean conglomerates have done routinely for years.
In any event, the credit card companies must roll over an additional $19.3 billion in commercial paper this fall. If they can’t, the government will then have to decide whether to bail them out or let them be sold off or merged with stronger companies.
The Roh administration has addressed all of these issues -- but in halfway fashion: It forbid the use of government money to bail out SK Global but gave tacit approval to the controversial rescue plan for the failing company. The government-inspired bailout of the ITCs eased the bond market’s liquidity crisis but didn’t address the funds’ lax investment standards.
The recent scandals and related problems are a setback for South Korea, in part because it has made undeniable strides in strengthening and policing its financial system in the aftermath of the 1997'98 financial crisis and the Daewoo collapse in 1999. Banks’ nonperforming loans have fallen from 14 percent to 2.6 percent in the past four years, debt-to-equity ratios at the major chaebol have been cut by more than half, and private competition has gradually been allowed to play a bigger role in the economy. In II‘s most recent rating of country creditworthiness (March 2003), South Korea’s ranking rose more than any country save Russia.
The improvements -- coupled with the creation of a vibrant consumer economy (courtesy, in part, of credit cards) -- have made South Korea a model for Asian development. The Roh administration’s ability to act boldly to remain a role model is constrained by a difficult economic and political climate. “The external economic environment is highly uncertain, the global economy remains weak, the impact of SARS on the regional economy is unclear, and there are heightened tensions with North Korea,” explains the IMF’s Coe.
Instead of temporary remedies, critics like Jang Ha Sung, a finance professor at Korea University (II, April 2001), would prefer further privatization so that market forces can work. Uncompetitive chaebol, ITCs and card companies should simply perish, he says. “If the government doesn’t discriminate between good and bad companies and bails out everyone, that is against market principles,” says Jang, who runs the People’s Solidarity for Participatory Democracy, a shareholder rights group.
ROH, WHO PLEDGED TO REFORM THE CHAEBOL in last year’s presidential campaign, is doing what he can. His administration has moved quickly to try to jump-start South Korea’s faltering economy. Gross national income, which reflects a country’s overall purchasing power, fell by 1.8 percent in the first quarter of this year, the biggest drop since the fourth quarter of 1998. After impressive 6.3 percent GDP growth last year, the economy is expected to expand by no more than 3.5 percent this year.
For the first time since just after September 11, 2001, the Bank of Korea in May lowered its benchmark interest rate. Putting aside the government’s distaste for deficit spending, Roh upped first half spending by $8.4 billion over last year.
The stimulus should help, and as South Korea’s most senior government regulators and policymakers are quick to add, SK Global’s woes resulted from outright fraud -- not economic weakness. “SK was an isolated case,” Finance Minister Kim Jin Pyo assured reporters in May. Although some analysts worry that more problems will be revealed at other SK Group affiliates or at other chaebol, Kim was adamant that the damage from SK Global is “not spilling over into the entire economy.”
Regulators have also launched a sweeping investigation of the country’s four largest chaebol -- the Samsung, LG, SK and Hyundai Automotive groups as well as certain pieces of the old Hyundai empire. The Fair Trade Commission is forming a new task force to study other reforms to insure greater “transparency” and additional “checks and balances” at the chaebol, says commission chairman Kang Chul Kyu.
These kinds of changes can’t come too soon for foreign investors like Robert Clements, director of emerging markets for Hermes, which has a 0.7 percent stake in SK Corp. South Korea’s shareholder rights program “is still poor,” he says.
Sovereign, which became SK Corp.'s biggest shareholder in April when it completed acquiring nearly 15 percent of the oil refiner’s stock through its Crest Securities affiliate, is even more blunt. In late June the firm, whose officials declined to be interviewed, noted in a press release that a recent accounting conducted for SK Global “fails to address the whereabouts” of $3.7 billion “missing from” the company. Equally disturbing to Sovereign: The fact that none of the ten convicted SK executives, including Chey, has resigned from his corporate position, leaving their status unclear.
“Where on earth the billions went was never revealed,” says Oh Hogen, chairman of Lazard Asia, which is advising Sovereign in Seoul. Such discrepancies, he says, “highlight the time warp of the chaebol” in giving primacy to established family interests over newer shareholder concerns.
The sentiments of foreign investors like Sovereign and Hermes are important. Foreigners hold 35 percent of all South Korean equities, but according to the OECD, the inflow of foreign direct investment has fallen from a peak of $9.6 billion in 2000 to $2 billion last year.
Despite the pleas of investors and critics, regulators caution that they are not planning to turn the chaebol (the 30 biggest of which control more than 40 percent of the country’s assets) inside out in an open-ended search for unseemly practices. “Some investigations are performed without any clue,” says Bahk Byong Won, director-general of the Finance Ministry’s economic policy bureau. “You have to have some reason. When we have clues, we will investigate.”
The government hopes that the credit card companies have already resolved their problems. The “big three” credit card companies -- LG Card, Samsung Card and Kookmin Card -- whose operations account for 80 percent of the business, have already announced corrective measures. Kookmin plans to merge its card subsidiary back into the bank, and the other two are each pouring $336 million into their credit card affiliates to replenish reserves.
But are these measures enough to contain the problem if delinquencies continue to rise? Consumer debt has more than doubled since 1999. In all, the credit card companies lost $265 million in the first quarter of this year, and the FSS estimates their first-half loss at $1.8 billion.
The companies started to return to the debt markets in late June without incident. But the IMF’s Coe will be watching to see how the Roh administration responds if some of the companies do experience troubles later. Problems, he says, “should be resolved in a manner consistent with market principles” -- that is, companies should be sold off, dissolved or merged.
The card companies are regaining access to a bond market that many think is incapable of coping with large volumes or complicated offerings. Virtually all of the credit card issues carried double-A ratings right up to the time that the government bailed out the ITCs. Cho Dong Chul, head of the macroeconomic division at the government’s Korea Development Institute, says the rating agencies, which are regulated by the FSS, “weren’t prompt enough in adjusting their ratings.”
Analysts at the three major local agencies, Korea Investors Service, Korea Ratings and the National Information & Credit Evaluation Corp., say that the liquidity problems reflected investor worries about the SK Global scandal rather than fundamental problems at the card companies. Korea Investors Service senior analyst Richard Kim says his firm believes double-A was a “proper rating” before the liquidity crisis, and he defends the small adjustment to single-A in many of the ratings just afterward. The market, he says, just “panicked” about the SK Global scandal.
The rating agencies’ rosy view of company fundamentals is as perplexing as the generous terms of some of the credit card debt. The credit card companies’ 90-day commercial paper contained an unusual rollover option that allowed them -- not investors -- to extend their maturity, explains Y.C. Mok, a senior analyst at ING Securities in Seoul. In return, the buyers of this paper would get a higher yield. In effect, some of this short-term debt -- thanks to the automatic rollovers -- had maturities as long as a year or two, which meant that the issuers could lock in their money for a longer term and not worry about having to roll over their debt -- a big advantage as delinquencies seemed poised to rise further. Such terms, says an IMF official who prefers not to be quoted, should have prompted lower credit ratings because of the additional risk inherent in a longer-term security.
Kim Seok Dong, director-general of the supervisory policy bureau at the FSC, concedes that the bond ratings process didn’t work as it should. Shin Jae Yoon, director of financial policy at the Finance Ministry, hints that it may have to be altered. There should be “a system change in the credit rating industry,” says Shin.
The FSC’s Kim says an investigation is under way to determine the legality of some of the options on the debt. Portfolio managers at the ITCs are technically forbidden from holding any security with a maturity of more than a year. If the rollovers mean the funds were violating the rules against holding such paper, “that will be stopped,” he says.
With the government trying to avoid another liquidity drought, it’s not expected to drastically overhaul the market or the ITCs. After the 1997'98 crisis, the IMF recommended that the largest ITCs be restructured or sold to investors so that they could “introduce international best practices, especially in risk management.” The government hasn’t ever outlined specific plans to privatize Korea Investment Trust and Daehan Investment Trust, the country’s two largest ITCs, which came under government control after a $6 billion bailout during the Daewoo scandal in 1999. “The ITCs lie at the heart of the bond market, for they are the major players,” says Kang Dong Soo, a fellow at the Korea Development Institute.
The Roh administration’s difficulty in meeting critics’ demands that it privatize not just the ITCs but also the banks and insurers still in its hands was underscored again in late June. The government reached an agreement to sell its 80 percent stake in Chohung Bank to Shinhan Financial Group. The merger, however, will have to wait: Unhappy Chohung workers went on strike, forcing the government and Shinhan to agree to keep the bank operating as a separate Shinhan subsidiary for three more years. That’s progress, but not exactly at the pace shareholders would like.
Lee: Creating a favorable attitude Lee Jung Jae, chairman of South Korea’s Financial Supervisory Commission and governor of its Financial Supervisory Service, is not only one of the country’s most powerful regulators, he’s also among its most experienced.
Appointed by new president Roh Moo Hyun in March, Lee, 56, has held senior posts at the Finance Ministry, the central bank, the Fair Trade Commission and the Korea Deposit Insurance Corp. At KDIC he played a leading role in bailing out South Korea’s banks at the height of the 1997'98 economic crisis. Then in early 1999 he moved to the FSS in time to oversee the government’s takeover of several investment companies brought down by scandals at Daewoo Group, one of the country’s biggest conglomerates, or chaebol. Lee also engineered some of South Korea’s early attempts to monitor the accounting practices at these huge, family-controlled entities.
As head of the FSC and the FSS, the reserved Lee is responsible for making and carrying out financial regulatory policies. The FSC creates the legal and philosophical underpinnings for overseeing the country’s banks, brokerage firms, insurers, asset managers and other financial services providers. The FSS, in turn, executes the FSC’s directives. A native of Youngju, about 150 miles south of Seoul, Lee today ranks along with Finance minister Kim Jin Pyo as one of the country’s two most powerful financial policymakers.
Lee again finds himself in the middle of a whirlwind. The recent scandals at SK Group -- notably the chaebol’s trading arm, SK Global Co. (story) -- and problems at some of the country’s credit card issuers have raised new questions about South Korean regulators’ ability to oversee local financial institutions.
Institutional Investor Contributor Donald Kirk recently interviewed Lee at his FSC office in Yoido, Seoul’s financial district.
Institutional Investor: The troubles of credit card companies, coupled with the scandals at SK Group, evoke memories of the 1997'98 financial crisis. What is the underlying problem?
Lee: The history of Korea’s financial industry shows that Korea did not start with enough capital. Because of tremendous pressure to achieve a high level of development, every corporate insolvency would affect the development of the market. After the crisis, the government had to inject funds to clean up the market and strengthen the situation.
Has the program been successful?
Profits have much improved. The banking sector had been in the red for four years but began to show a profit from 2000. The banking sector made a profit last year of 5 trillion won [$4.2 billion]. The banking sector is making a similar profit this year.
What has been the impact of the credit card crunch and the SK Global scandal?
We did have this unfortunate event of SK Global. Because the industry is robust, we are able to overcome the problem. SK Global corporate bonds are now under the management of creditors. The banks have set aside enough provisions. Regarding credit card companies, we introduced measures in April [including capital increases and tighter management structures] for credit card companies to discipline themselves, so we believe we will not see further trouble. We have been strengthening the overall market paradigm. This effort will continue on the basis of purely commercial principles. We will strengthen regulations.
Critics say that the government, through the FSC and FSS, is compelling the banks to adopt measures against their will and, conversely, that the FSS failed earlier to provide restraints on the credit card companies.
I am aware of the criticism within the market. These measures were made on the basis of a clear and strong consensus to benefit the market. Of course, in the future it will be the market that will decide before the authority takes any steps. If the credit card companies do not follow up on their commitment, then the market will act.
What has the government been doing to reform the financial sector?
Since the economic crisis, the government has been working on improving transparency. We have set up an auditing committee, and we are setting up accounting institutions so they can create international standard accounting policies. We have installed a fire wall against interest groups, so now independent companies conduct audits.
What are you doing now to improve standards still more?
The Enron Corp. situation in the U.S. was a big alarm for our government. We are submitting a bill for accounting reform. The first purpose is to strengthen and reinforce the liability of corporate management. We have expanded the document requirements for those high in management. Auditors are forbidden from providing auditing services [like consulting] to other companies [in the same group] so there is a fire wall. Also, to ensure accuracy and objectivity of information disclosed by listed companies, they will expand their financial statements.
There has been intense debate about shareholders’ ability to file class-action suits. Where does that stand right now?
Currently pending is a bill for collective action. We believe it will be passed in due course. This bill will be rather revolutionary in changing and overhauling the financial sector.
What is your outlook for the market right now and what is the FSC’s role in encouraging the market?
The market situation both outside Korea and domestically is not so favorable. Korea is in a unique situation because of North Korea. Our growth prospect is somewhat lower than forecast because of uncertainty, and consumption is shrinking, but I have an optimistic view. The world economy and the domestic economy are expected to pick up. The government is preparing fiscal policies to deal with the situation so we will move out of the clouds in the second half of this year. It is clear it is the Financial Supervisory Commission’s role to create a favorable attitude and environment.
Disconnect at SK Telecom Pyo Mun Soo, the exuberant chief of SK Telecom Co., could barely contain himself when discussing the company’s future. Its new cellular phone devices -- enabling everything from satellite TV transmissions to credit card purchases to video-on-demand -- were destined, he boasted, to help transform South Korea’s most successful wireless services player into a global rival to powerhouses like Japan’s NTT DoCoMo. Shareholders around the world would take note, too. “Our aim is to be the most valuable company in Korea,” Pyo declared.
That was in December during a wide-ranging interview with Institutional Investor. These days Pyo has a more humble goal: He’s gamely trying to slow the stampede of foreign and local investors out of SK Telecom shares.
Just weeks after his conversation with this magazine, Pyo’s company -- with $1.26 billion in profits and $7.2 billion in sales last year -- was rocked by the jailing of Chey Tae Won, the 42-year-old head of leading oil refiner SK Corp., the flagship company of SK Group, South Korea’s third-largest chaebol, or conglomerate, and a sister company of SK Telecom. Chey, who is also an SK Telecom director, was convicted of manipulating the shares of some of SK Group’s listed companies to enhance his interest in SK Corp. Subsequent government investigations revealed serious accounting problems at SK Global Co., the chaebol’s trading arm. The government says that SK Global’s total debts exceed its assets by about $3.65 billion, and by late June its future was still being fiercely debated.
“Our main task now is to convince investors that nothing has really changed at SK Telecom and that SK Group’s problems will have no impact on the company,” Pyo, 50, told II in a May interview at SK Telecom’s headquarters, a gleaming black steel and glass office tower in Seoul’s Chong-ro commercial district.
That’s proving to be a tough sell. The company, whose shares outperformed most global telecommunications issues in last year’s market rout, is 25.6 percent-owned by two of its affiliates in the SK Group and has lost roughly 40 percent of its value since the scandal erupted. Over the past 13 months, it’s off about 70 percent.
Beyond Chey’s board membership, SK Telecom hasn’t been implicated in the scandal. But investors are nervous.
“It’s a great cellular phone company -- fantastic franchise, good potential -- but because it is part of something that’s considered rotten, investors are wary and don’t want to touch it,” says Mark Mobius, who manages $8 billion for Franklin Templeton Investments in Singapore and still holds some SK Telecom and SK Corp. shares.
Adds James Yoon, telecom analyst for BNP Paribas in Seoul, “Clearly, investors are sitting around waiting for this whole drama to play out before they dip their toes in the water.”
To coax them back in, Pyo, his executive team and directors have hit the road. In the past three months they’ve met twice with analysts and fund managers each in Hong Kong, London and New York. Their message: It’s business as usual at SK Telecom, and the company has ample cash to cope with any contingency. “We are still signing up new customers, rolling out new services. We are also on track in rolling out infrastructure for next-generation services,” says Pyo, a onetime economics professor at Boston University.
He adds: “We have plenty of money to grow on our own. We have strong positive cash flow, and if need be, we have the ability to raise money ourselves. We are not dependent on anyone for funding our growth.” SK Telecom, he insists, will meet or beat analysts’ 2003 profit expectations. The consensus estimate is about $1.37 billion.
As convincing as the cheerful, outgoing Pyo is, investors are asking serious questions about the company’s future in one of South Korea’s huge, powerful chaebol. Will SK Telecom be spun off from the other SK Group companies if SK Global fails or will it remain a part of the chaebol? Is there an expansion-minded local or foreign company with deep enough pockets to buy it? Will the Chey family (including three brothers and five other relatives who work at various SK companies), which has controlled the chaebol, its predecessor and its affiliates for nearly 50 years, be forced into a reduced role or continue to run it?
Pyo and his colleagues can’t answer these questions definitively because investors, creditors and the various SK Group companies are still trying to work them out, and the government of new President Roh Moo Hyun, who campaigned on a pledge to root out corruption at the chaebol, may ultimately have to decide them (story).
One thing is sure, investors don’t want SK Telecom dragged into the SK Global bailout put forth by SK Corp. and the major creditors of its trading arm in mid-June. Under the plan, domestic creditors have agreed to accept 38 cents on the dollar for $2.1 billion of SK Global’s debt. Foreign creditors, however, are still trying to get better terms. SK Corp., meanwhile, has agreed separately to a $714 million equity swap for the debt SK Global owes it. SK Corp. shareholders are challenging the company’s right to enter into that swap in court.
“The fear has been that SK Telecom’s cash will be milked by other companies in the group because SK Telecom is the cash cow,” says Andrew Jobson, regional telecom analyst at Daiwa Institute of Research.
Pyo insists that won’t happen: “I can categorically state that we have no intention of helping any SK Group company.”
That said, any bailout -- with or without SK Telecom’s direct participation -- will affect the company’s shares. Even at a depressed price, SK Telecom stock is a ready source of liquidity for SK Corp. if it gets the go-ahead for its SK Global rescue. SK Corp., which owns a 21 percent stake in the wireless company worth about $3 billion, could sell some portion of it to help pay for such a move. And SK Global holds 5 percent of SK Telecom (it has already unloaded about 6 percent in the last year or so). Its more than $700 million in shares are an obvious candidate for sale.
Sitting on about $3 billion in cash, SK Telecom, says Pyo, stands ready to buy back its shares to support its stock price.
As helpful as these assurances are, shareholders like Mobius are more anxious for SK Telecom to improve its corporate governance. “It doesn’t really bother me whether it is independent or part of a larger group,” says Mobius, “as long as there is transparency and the management is focused on enhancing value for all shareholders rather than using the company as a tool to expand the influence of a family.”
Shareholder activist Kim Joo Young, head of Seoul’s Center for Good Corporate Governance, agrees. He says SK Telecom and its affiliates have to reduce the Cheys’ power. Kim notes that SK Corp. and SK Global, with just 26 percent of SK Telecom shares, control 50 percent of the seats on its board. That, he says, gives the family far too much clout.
Pyo and his executive team are trying to respond to these criticisms, too. Postscandal, explains investor relations head Cho Sung Hae, SK Telecom accelerated a plan to set up audit and executive committees free of Chey family members or corporate insiders. One of the executive committee’s tasks is to nominate outside directors, who can’t be influenced by the Cheys. And a new management committee formed in March and dominated by independent directors now sets executive compensation plans and approves capital expenditure programs. These steps, says Cho, “show investors that we are a responsible company.”
What is possibly most damaging to SK Telecom is the huge diversion of management attention required to cope with the aftermath of the chaebol scandal. Pyo estimates that he and other executives now spend nearly one third of their time addressing investor concerns. Some of that time might be better spent trying to realize SK Telecom’s huge potential. Its innovative mobile data products have long since allowed the company to speed past local rivals like KT Freetel and LG Telecom to seize a 54 percent share of South Korea’s ravenous market for all kinds of wireless services. But single-mindedly exploiting opportunities isn’t as easy right now because of the questions that continue to swirl around the chaebol.
Pyo hopes that investors will eventually refocus on SK Telecom’s promising fundamentals. “There are very few cellular companies around the world that are still as profitable as SK Telecom and that have its exposure to cutting-edge technology and such a dominant share of one of the world’s largest and fastest-growing mobile data markets,” he says.
True, but investors seem more interested in what happens to the proposed rescue plan for SK Global. Whatever occurs, foreign shareholders are likely to impose -- or reimpose -- a risk premium on South Korean chaebol-related stocks. “We all thought Korea had made great strides in corporate governance after the Asian crisis, but unfortunately we are seeing more of the same,” says Mobius. -- Assif Shameen
