[The Editors' Verdict] Lee Bokhyun's Top Priority as Financial Supervisory Service Governor

Two years ago, as COVID-19 began to spread domestically, the capital market reached a critical point. Securities firms suddenly faced a need to cover tens of trillions of won in funds, but short-term financing became difficult due to market stagnation. It is reported that two major securities firms nearly went bankrupt despite being profitable because they could not secure funds.

The root cause was the nearly 50 trillion won surge in the equity-linked securities (ELS) market. Securities firms issue ELS and hedge them with overseas derivatives, but as stock prices plummeted due to COVID-19, margin calls requiring additional collateral worth trillions of won for derivatives followed. As securities firms scrambled to raise emergency funds, the issuance volume of commercial paper (CP) and short-term electronic bonds (STB) surged, but investment demand from major buyers such as money market funds (MMF, MMT, etc.) rapidly shrank. As a result, short-term financing rates soared vertically, and securities firms could not secure liquidity properly even by raising interest rates.

The fire quickly spread to the project financing (PF) market. As the short-term funding market rapidly cooled, refinancing of PF-ABCP (asset-backed commercial paper) became difficult. With PF refinancing failing one after another, securities firms that had provided purchase commitments for ABCP had to bear all of it. The scale of securities firms’ PF purchase commitments was also enormous, amounting to tens of trillions of won.

The crisis was resolved when financial authorities, including the Bank of Korea, decided to provide emergency liquidity support. Additionally, global central banks, including the U.S., launched large-scale quantitative easing (QE), causing domestic and global stock markets to rise, and securities firms no longer faced margin calls. Thanks to this “global money injection,” the liquidity crisis remained a short-lived historic event.

The reason for suddenly recalling the crisis two years ago is that the current market situation cannot be said to be better than back then. The volume of ELS issued during the two-year stock price rise still amounts to tens of trillions of won, and PF investments by financial companies, including securities firms, have greatly increased. Along with interest rate hikes and reduced CP investment demand, short-term financing rates are sharply rising as they did two years ago.

The problem is that the risk of insolvency due to asset value declines, including stocks, is not limited to securities firms. Insurance companies are suffering huge valuation losses on their core bond holdings due to rising interest rates. News of defaults and loss recognition frequently comes from alternative investment assets such as overseas real estate aggressively invested in by financial companies.

Capital companies have aggressively increased high-interest PF assets by raising low-interest funds. Savings banks, which had reduced PF due to past savings bank crises, have also rapidly expanded PF assets. PF assets in the secondary financial sector have a high proportion of bridge loans, mezzanine, and subordinated loans, which carry relatively high default risks. Asset value declines are persisting long-term not only in major investment assets like bonds and stocks but also in real estate PF and overseas alternative investments.

Managing insolvencies of financial companies and maintaining financial stability during a prolonged phase of asset value decline is not easy but is essential. Both the foreign exchange crisis and the global financial crisis share the commonality that holes in financial stability led to larger, more difficult crises. This is why the new Financial Supervisory Service Governor, Lee Bok-hyun, the first prosecutor to hold the position, must prioritize and focus on securing financial stability.

Lim Jeong-su, Head of Capital Markets Department