Regulators try to revive Korea’s equity capital markets

South Korea’s financial regulators have been goaded into action after a string of disasters in the IPO market.

Chunky, billion-dollar-plus IPOs from corporate heavyweights, including Hyundai Oilbank and SK Lubricants, have fallen by the wayside in recent months, highlighting some of the regulatory issues that make the IPO market so tricky in South Korea. And Samsung BioLogics, which was one of the biggest, hottest share deals ever in the country’s history, has turned into a huge embarrassment: the share issue, which was snapped up by some of the leading names in the international investment community, is at the centre of an accounting fraud investigation.

The scandal has spurred greater scrutiny around corporate spin-offs and listings.

All in all, this has been one of the worst years in a decade for South Korean IPOs, with a sharp drop in the amount raised. No wonder the regulators are taking a closer look at listing hopefuls and pondering ways to improve the IPO market.

“After the Samsung BioLogics crackdown, scrutiny of companies’ accounting has become more rigorous, so approvals are taking longer,” says a Korea country head at a bulge-bracket bank.

In addition, the Financial Services Commission (FSC), which is the top regulatory agency that oversees a cluster of other regulators, has turned its attention to some of the issues hampering the IPO process, announcing measures to reform the capital markets so that companies are less dependent on bank loans and state guarantees and can issue bonds and equities more easily.

One area where the FSC wants to make changes concerns the rigid approach to pricing that weighs down IPOs while syndicates of banks try to determine a fair valuation for the listing hopeful.

The FSC says IPO rules will be eased to allow advisers more room to manoeuvre when it comes to pricing and allocating shares.

Further details of the amendments will be announced in the first quarter of 2019, according to the regulator. But overall the FSC, under its chairman Choi Jong-Ku, expects the reforms to help boost Korea’s IPOs.

“Currently, the role of IPO advisers in bookbuilding, pricing and allocation of shares is quite limited by regulations, which give [few] incentives for IPO advisers to play an active role in identifying and listing promising companies,” the FSC said in an emailed comment. “[The] IPO regulation reforms are intended to allow IPO advisers more autonomy in the IPO process with greater responsibility.”

A Seoul-based ECM banker says of the proposals: “Advisers will be given more power to control IPOs, rather than regulators such as the Korea Exchange and FSC. There will be an obligation for more due diligence, but it will be backed by independent advisers such as law firms and accounting firms.”

You only have to look at what went wrong in 2018 to understand how pressing these issues had become.

Rewind to the early weeks of the year and you find an investment community filled with hope that this would prove a banner 12 months; investors and bankers geared up for a series of widely anticipated – and in some cases long-delayed – IPOs.

A report from Seoul-based Eugene Investment and Securities predicted the total value of domestic initial stock sales completed during the calendar year would reach a record $7.2 billion.

Refiner Hyundai Oilbank was the first to break cover.

In January, the refining arm of Hyundai Heavy Industries named six banks to underwrite its planned $1.8 billion IPO, including Bank of America Merrill Lynch, Citi and NH Investment Securities.

A month later, SK Lubricants hired five underwriters, including Citi, Credit Suisse and Samsung Securities, with the aim of completing its $1.5 billion initial stock sale by July. 

Others soon jumped on board. Early in the second half, CJ CGV, the country’s leading chain of multiplex cinemas, applied to list its Vietnam unit on the Korea Stock Exchange, with the aim of raising $116 million.

“Korean corporates seeking to list [their] overseas assets at home is a theme we expect to endure,” says Byungil Lim, Korea country head at UBS.

Rising support from a government keen to champion a new generation of corporate leaders in sectors ranging from robotics and artificial intelligence to fintech, also pointed to a good year ahead for the Kosdaq.

In April, two months after attracting $130 million from investors including China’s Tencent Holdings, Kakao Games (an arm of internet firm Kakao) filed for a $150 million initial stock offering on the tech-rich junior board.

Except it didn’t work out that way at all. As the second half of the year wore on, the fizz and froth began to dissipate. Stock sales were delayed, then postponed indefinitely, and bankers scrambled around for credible reasons to explain the cancellation of yet another share offering.

“The second half of the year has been a disappointment, in terms of transaction volumes,” says Park Jin-Hei, country chief executive and president at Citi. “It’s not an easy place to be in for issuers. I wouldn’t call it a bear market exactly, but it’s definitely quiet out there.”

That’s putting it mildly. SK Lubricants, part of the sprawling SK Group of companies, was the first to run into trouble. Bookbuilding on its IPO began on April 21, with the aim of selling 12.8 million shares. Bankers set the price range at between W101,000 and W122,000 ($90.2 to $109). But within six days, the sale was dead after the firm failed to achieve the minimum valuation target.

SK tried to sweeten the deal, promising a 75% dividend payout ratio, translating into a 7% yield, but to no avail.

Underwriters were accused of over-pricing a tough deal in a volatile market, a charge that is easy to make and often sticks, but harder to prove.

To be sure, the Kospi index had a rough year, losing momentum after a promising start and dropping nearly 20% between the beginning of February and the end of November. In October, the government announced the creation of a $440 million fund designed to prop up the market by investing funds directly in stocks listed on the main board and the Kosdaq.

After the SK Lubricants fiasco, Hyundai Oilbank was next to scrap its capital-raising plans.

South Korea’s smallest refiner by capacity filed its listing papers with the securities regulator in July and got the nod a month later. But in October, blaming market conditions, it said it would delay its sale until March 2019 at the earliest.

It’s not the first time either firm has set out to sell shares to investors, only to beat a retreat. This was SK Lubricants’ third go at a listing, after attempts to raise $1.5 billion in 2013 and 2015 both failed, while Hyundai Oilbank has laboured over its own stock offering for the better part of this decade.

“They’ve spent at least five years trying to get that sale done,” sighs one local investment banker. “I don’t think it will ever happen.”

If anything, the news got worse as the year wore on. Kakao Games shelved its stock sale in October, pledging to revisit plans in early 2019. CJ CGV waited until November before deciding not to debut its Vietnam unit on the Kospi, blaming poor sentiment and a lukewarm response to the book-building process.

In total, six Korean firms halted their IPO plans after the start of September, despite being cleared by the securities regulator and passing a review process carried out by Korea Exchange, the country’s only securities exchange operator. 

According to Dealogic data, just $2.25 billion-worth of initial stock offerings were completed during the first 11 months of 2018, putting it on track to be the worst year for primary equity sales this decade.

In contrast, the previous year had a bumper crop of standout stock offerings, for example from mobile games maker Netmarble, which raised $2.3 billion in April 2017, and biotech specialist Celltrion Healthcare, which completed its $896 million stock offering in July.

In all, 77 IPOs were completed in 2017 and raised $7 billion, according to data from Dealogic.

Perhaps the biggest setback of 2018 was caused not by a decision to shelve a listing, but by the news that one of the biggest IPOs of recent years might have to be completely unwound.

The case involves one of Korea’s largest corporations, Samsung BioLogics, a contract drugmaker and a unit of the chaebol Samsung. Its IPO in October 2016 was a resounding success: it raised W2.25 trillion, or a little under $2 billion, which at the time made it Korea’s second-largest-ever share sale.

Samsung retained control of the biotech firm via two of its divisions, Samsung C&T and Samsung Electronics. But the listing attracted a host of big names from the institutional investor world, including BlackRock, The Vanguard Group and Norges Bank Investment Management.

The shares outperformed from day one, more than doubling in value over the first 12 months.

Then in the middle of November 2018, the Financial Supervisory Service (FSS) abruptly suspended trading in the company’s shares, saying it had fraudulently inflated its value ahead of its public offering. The regulator fined Samsung BioLogics W8 billion, called for its chief executive to be fired and ordered the Korea Exchange to carry out a review to decide if the company should be delisted.

The FSS also banned Samjong KPMG and Deloitte Anjin from auditing the firm for five and three years respectively.

Samsung BioLogics denied the charges and vowed to fight the ruling in court. A delisting would have been a terrible setback for both subsidiary and parent, given the big commercial bet Samsung has made on biotech.

The stock market regulator decided in mid December not to delist the company. The exchange said the firm’s financial stability and continuity of business outweighed its lack of management transparency. The exchange will continue to monitor the company’s efforts to improve transparency for three years.

Given the seriousness of the problems, companies hoping to sell shares in Korea now face increasingly lengthy delays from scrupulous regulators. Once a company has obtained a preliminary listing approval from Korea Exchange, it has six months to complete an external audit from both its official accountants and the national accounting federation.

In early 2018, the FSC added another layer of complexity, by deciding to analyze the finances of every large corporate aiming to sell shares. Its logic was fair and there for all to see. Too many large stock sales, the regulator argued, were scrapped after launch or flopped on debut.

Hyundai Oilbank and SK Lubricants are examples of deals that were scrapped, yet again. The IPO of budget carrier T’way Air was one of the few to slip through the net in 2018 and is a good example of a deal that flopped. It priced its $207 million initial stock sale at W12,000 per share in August, well below the guidance band of W14,600 to W16,700. Its stock fell on debut, then spent the next three months in freefall, before rebounding.

Deteriorating market conditions, notes Citi’s Park, have certainly “had a negative impact on new listings”.

A Seoul-based investment banker adds that 2018 “has been especially challenging because of the strengthened accounting process, which distorts the IPO preparation process, and makes it all but impossible for an issuer to control the duration of an audit”.

Korea’s plethora of regulators (the FSC is a government agency with authority over financial policy and regulatory supervision, whose functions are carried out by the Securities and Futures Commission, or SFC, and subordinate bureaus including the FSS) would argue that beefing up the oversight of public offerings, while irksome to bankers and the big firms they advise, was a necessary and even a welcome development.

Given the accusations levelled at Samsung BioLogics, and concerns about aggressive IPO pricing, some say they may well be right.

But while larger corporate names navigate complex new rules and deal with additional paperwork, the new proposals from the FSC will help smaller firms. 

The legislation is a work in progress: the FSC, which is still gauging reaction to its proposals from financial and professional services firms and the investor community, is expected to issue more concrete proposals in the first quarter of 2019.

So far though, it’s clear that the regulator expects the door to swing both ways. The new guidelines set out to expand the role of bankers and other IPO managers when, say, allocating stock and setting an initial price guidance.

Under present rules, “you have to file a price before launching and have to price the deal within a 20% range of that,” says a Hong Kong-based equity syndicate head. “If you don’t, then you have to go back and officially file for a new pricing level. And the filing has to happen quite early in the process, so it is quite hard to come up with a level you are confident with.”

Such limitations deter bankers from seeking out new business in the country’s equity capital markets. But the regulator is willing to rectify the issue.

Individuals who have seen the documents say the FSC will also hold IPO managers more accountable for the firms they advise.

That, says one banker, “would encourage underwriters to employ more risk managers, forensic accountants, specialist lawyers, to cover all their bases. It’s a clever move from them as it outsources more of the responsibility to us.”

The rule change also aims to populate the IPO market with more nimble and innovative young firms, and fewer hoary old corporate offcuts from Korea’s chaebol, with the regulator widely expected to raise the threshold for the smallest share offering to W10 billion in early 2019, from W1 billion at present.

“Hopefully, these new rules will bring us in line with international practices, instilling stringent underwriting requirements and leading to higher fees,” says a Seoul-based investment banker. “IPO fees are ridiculously tight – hopefully we will see them rise from around 1%, where they are now, to closer to the 4% or 5% mark. More local brokers and international banks will engage with the IPO market, and that in turn should lead to more listings.”

After the torrid year Korean bankers and issuers have endured, that would be welcome news indeed.