[Inside Chodong]Is a Single Standard Enough for Securities Firms' Soundness Regulation?

Is it truly reasonable to manage both mega-sized securities firms and small to mid-sized securities firms-whose capital scale and business areas differ significantly-under a single regulatory framework? This question has been raised for a long time. The ongoing debate surrounding the Net Capital Ratio (NCR), the core indicator of soundness regulation for securities firms, also originates from this very issue. There have been repeated criticisms over whether the current NCR formula, revised in 2016, sufficiently reflects the external growth and evolving risk structures of securities firms and whether it is effective in practice.

The clearest example of this was the ELS margin call crisis in March 2020. At that time, the shock to the securities industry quickly spread to the short-term money market, yet the NCRs of major large securities firms far exceeded the regulatory threshold of 100%. Despite appearing "safe" numerically, risks that the soundness indicators failed to capture materialized as actual market shocks.

A recent report released by the Korea Development Institute (KDI) ahead of the launch of Integrated Management Accounts (IMA) by large securities firms also reaffirms this concern. The report suggests that a differentiated regulatory approach is necessary: applying the more risk-sensitive, previous NCR methodology to large securities firms with substantial capital and broad business scopes, while maintaining the current system for small and mid-sized firms.

The NCR system originally involved dividing net operating capital by total risk exposure. However, after the 2016 revision, the formula was changed to compare the amount remaining after subtracting total risk exposure from net operating capital with the required maintenance capital. While this was intended to encourage the growth of large securities firms, it is now assessed that the system’s ability to reflect risk has been weakened.

The most significant issue is the "scale illusion." Even if the risk structure is the same, the NCR figure becomes excessively high as asset size increases. This is because, even as assets and leverage expand, the denominator-required maintenance capital-remains largely unchanged.

KDI’s analysis of the time series trends of both the previous and current NCR formulas for securities firms found that the current average value has consistently far exceeded the regulatory level, whereas the previous NCR showed a clear downward trend. In particular, for large securities firms, the previous NCR standard brought them close to the regulatory threshold.This suggests that the basic risk signal of increasing leverage is not being adequately reflected in the current NCR.

The solution proposed by experts is relatively clear: regulation should be differentiated according to the principle of "strict for large institutions, simple for small ones." This appears to be a highly practical alternative. Imposing the same soundness requirements on small firms as on large firms, regardless of their size, business scope, or risk level, may be excessive.

This approach is also in line with global regulatory trends. The United States’ broker-dealer regulatory framework is a representative example, applying simple liquidity-focused regulations to small firms and sophisticated, internal model-based risk-weighted regulations to large firms. Similarly, the European Union imposes Basel III regulations-identical to those for banks-on mega-sized securities firms, while applying relaxed capital requirements to small and mid-sized firms based on their size, business scope, and risk factors.

With the full-scale advent of the IMA era and the expected transformation of securities firms’ funding structures, improving the NCR system is no longer a task that can be postponed. Redesigning the regulatory framework to match the external growth of securities firms is not a choice, but a necessity.