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U.S. Department of State

Diplomacy in Action

2010 Investment Climate Statement - South Korea


2010 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
April 2010
Report
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OVERVIEW

The Republic of Korea (ROK) is being widely heralded as one of the first countries to recover from the global financial crisis. Many credit the ROK’s rebound to fundamental reforms made in the aftermath of the 1997-98 Asian financial crisis, when Korea made rapid progress in reforming its financial institutions and capital markets. At that time, the Korean government sold its interest in a number of large, high-profile companies to foreign investors, and many Koreans in general began to see more foreign investment as something positive, even necessary, for the nation. In addition, the Korean government took steps to strengthen competition policy and enacted measures to enhance foreign investment incentives, and to allow non-Koreans to own land and real property. Although the Roh Moo-hyun government's (2003-2008) ambivalent attitude toward foreign investment led to a decrease of foreign direct investment (FDI), the inauguration of President Lee Myung-bak in 2008 reversed this trend. Inward FDI rebounded to USD 11.7 billion in 2008 and 11.5 billion in 2009. Service industries accounted for more than two-thirds of FDI in 2009, as opportunities in those sectors showed the greatest promise. Noteworthy improvements in the protection of intellectual property – recognized by the removal of the ROK from the Special 301 Watch List in 2009 – continue to improve the foreign investment climate. The ROK’s rapid recovery from the financial crisis and prominent role as host of the upcoming November 2010 G20 Summit are likely to make Korea even more attractive to investors.

The United States retains the largest single-country share of foreign direct investment (FDI) in Korea, totaling USD 41.8 billion or about 26 percent of Korea's total stock of FDI since the 1960's. The European Union as a whole has invested USD 56.5 billion (35.2 percent of the total) followed by Japan with USD 23.9 billion (13.9 percent). Overall, FDI decreased 1.9 percent year on year in 2009, to USD 11.5 billion on a filing basis. The financial, transportation and other service sectors are expected to absorb the most FDI in Korea in the near future, largely through mergers and acquisitions (M&A), in line with global trends.

Foreign portfolio investment into Korea peaked in 2004 and continued to decline after then at a substantial pace through 2008, due in large part to foreign investors’ securing profit and adjustment of their portfolio in emerging markets as whole. After Korean financial markets bottomed out in March 2009, the foreign portfolio investment has been resurgent. Aggregate foreign investment ceilings at the Korean Stock Exchange (KSE) were abolished in 1998. At the end of 2009 foreign shareholders owned 32.6 percent of KSE stocks and 7.8 percent of the tech-heavy KOSDAQ Index shares.

The environment for FDI in Korea would benefit from an improvement in the consistency of the ROKG’s interpretation, transparency and timeliness in the application of regulations. These regulatory issues can discourage FDI by creating uncertainty for investors and fostering an impression that Korea remains hostile to foreign investment. Although Korea boasts a hard-working, educated and highly productive workforce and high levels of institutional labor protections, foreign investors cite volatility in labor-management relations as an issue that can hamper direct investment. The highest levels of the Korean government remain committed to maintaining a welcoming environment for foreign investors, ensuring a "level playing field" for foreign investors, and reforming labor laws.

The Korea-U.S. Free Trade Agreement (KORUS-FTA) would be a major step to enhance the legal framework for U.S. investors operating in Korea. All forms of investment would be protected under the KORUS-FTA agreement, including enterprises, debt, concessions and similar contracts, and intellectual property rights. With very few exceptions, U.S. investors will be treated as well as Korean investors (or investors of any other country) in the establishment, acquisition, and operation of investments in Korea. In addition, these protections would be backed by a transparent international arbitration mechanism, under which investors may, at their own initiative, bring claims against a government for an alleged breach of the KORUS-FTA chapter. Submissions to investor-state arbitration tribunals would be made public, and hearings would generally be open to the public.


TABLE OF CONTENTS
General Openness to Foreign Investment
5


Basic Investment Rights

Conversion and Transfer Policies
8
Expropriation and Compensation
9
Dispute Resolution
9
Performance Requirements and Incentives
10
Right to Private Ownership and Establishment
10
Protection of Property Rights (Including Intellectual Property)
11


Systemic Issues

Labor Issues
14
Corporate Governance and Investment Decision-Making
17
Transparency of the Regulatory System
20
Capital Markets and Portfolio Investment
21


Country Risk Issues

Political Violence
23
Corruption
23


International Arrangements

Bilateral Investment Agreements
25
OPIC and Other Investment Insurance Programs
25


Foreign Trade Zones and Free Economic Zones
27


Foreign Direct Investment Statistics
28


GENERAL OPENNESS TO FOREIGN INVESTMENT

The Korean government's attitude toward foreign direct investment is positive and senior policy makers clearly realize the value of FDI. In his first years in office, President Lee Myung-bak has espoused a foreign investment-friendly philosophy. He has taken important steps to reverse the former Roh Moo-hyun government's (2003-2008) ambivalent attitude toward foreign investment and push back against a vocal minority of the Korean public opposed to foreign direct investment (FDI). President Lee Myung-bak, who was inaugurated in 2008, promised more practical and transparent market opening to drive another foreign investment boom, and FDI rebounded to USD 11.7 billion in 2008 and USD 11.5 billion in 2009.

Despite these improvements and attitude changes, however, FDI in Korea is still at times subject to insufficient regulatory transparency, including inconsistent and sudden changes in interpretation of regulations, high labor costs and an inflexible labor system, underdeveloped corporate governance, and lingering economic domination by the country's remaining conglomerates "chaebol".

Korea's Foreign Investment Promotion Act (FIPA) and related regulations categorize business activities as either open, conditionally or partly restricted, or closed to foreign investment. Restrictions remain for 29 industrial sectors, two of which are entirely closed to foreign investment. The Korean government reviews restricted sectors from time to time for possible further openings. According to the Ministry of Knowledge Economy (MKE), the number of industrial sectors open to foreign investors is well above the OECD average.

FIPA features include:

  • Simplified procedures, including those for FDI notification and registration;

  • Expanded tax incentives for high-technology FDI;

  • Reduced rental fees and lengthened lease durations for government land (including local government land);

  • Increased central government support for local FDI incentives;

  • Establishment of “Invest Korea,” a one-stop investment promotion center within the Korea Trade Promotion Corporation to assist foreign investors;

  • Establishment of an Ombudsman office within the IPC to assist foreign investors.

MKE published its 2009 Consolidated Public Notice on March 4, updating new code numbers and titles for business sectors in accordance to the ninth revision of the Korea Standard Industry Code (KSIC). According to the 2009 Notice, the number of KSIC industrial classifications of business sectors increased from 1,121 to 1,145 and by the reclassification, business sectors where foreign investment is restricted increased from 28 to 29.

The following is a current list of Restricted Sectors for Foreign Investment. Figures in parentheses denote the Korean Industrial Classification Code:

Completely Closed

o Nuclear power generation (35111)
o Radio broadcasting (60100)
o Television broadcasting (60210)

Restricted Sectors (partly open not more than 25 percent)

o News agency activities (63910)


Restricted Sectors (partly open not more than 30 percent)

o Publishing of newspapers (58121)


Restricted Sectors (partly open less than 30 percent)

o Hydro electronic power generation (35112)
o Thermal power generation (35113)
o Other power generation (35119)


Restricted Sectors (partly open less than 33 percent)

o Satellite and other broadcasting (60229)

Restricted Sectors (partly open less than 49 percent)

o Program distribution (60221)
o Cable networks (60222)
o Wired telephone and other telecommunications (61210)
o Mobile telephone and other telecommunications (61220)
o Satellite telephone and other telecommunications (61230)
o Other telecommunications (61299)


Restricted Sectors (partly open not more than 50 percent)

o Farming of beef cattle (01212)
o Inshore and coastal fishing (03112)
o Transmission/distribution of electricity (35120)
o Wholesale of meat ( 46312)
o Coastal water passenger transport (50121)
o Coastal water freight transport (50122)
o Scheduled air transport (51100)
o Non-scheduled air transport (51200)
o Publishing of magazines and periodicals (58122)

Open but Regulated under the Relevant Laws

o Growing of cereal crops and other food crops except rice and barley (01110)
o Domestic commercial banking except special banking area (64121)
o Asset management service (64201)

In categories open to investment, foreign exchange banks must be notified in advance of applications for foreign investment. (All Korean banks are permitted to deal in foreign exchange, including branches of foreign banks.) In effect, these notifications are pro-forma, and approval can be processed within three hours. Applications may be denied only on specific grounds, including national security, public order and morals, international security obligations, and health and environmental concerns. Exceptions to the advance notification approval system exist for project categories subject to joint-venture requirements and certain projects in the distribution sector.

Relevant ministries must still approve investments in conditionally or partly restricted sectors. Most applications are processed within five days; cases that require consultation with more than one ministry can take 25 days or longer. Korea changed its procurement law effective in 1997, to comply with its accession to the WTO Government Procurement Agreement. The Government's procurement law no longer favors domestic suppliers over foreigners, but some implementation problems remain.

Restrictions on foreign ownership of public corporations remain, although ownership limit levels have been raised. Currently, foreign ownership is limited for government-controlled utilities. Foreign ownership in Korean telecommunications companies and cable networks is limited to 49 percent. The Korean government intends to privatize many of the remaining state-owned corporations, but this process was slowed by the global financial crisis.

The Ministry of Strategy and Finance (MOSF) administers tax and other incentives to stimulate advanced technology transfer and investment in high-technology services. There are three types of special areas for foreign investment -- Foreign Economic Zones, Foreign Investment Zones and Tariff Free Zones -- where favorable tax incentives and other support for investors are available (see Section VI.)

A Korean government initiative to encourage research and development (R&D) in strategic industries -- the New Growth-Driving Forces (NGF) program -- wound down in 2004. In its place the Korean government has increased its R&D budget to local areas from 27 percent to 32 percent to support its 21st Century Frontier R&D Project, designed to raise Korean technology to the level of the G8 countries. Focusing on information technology, biotechnology, nanotechnology and new materials, the Korean government launched development programs in 20 new strategic areas at the end of 2003, at a total cost of USD 3.5 billion. Much Korean government-funded R&D taps the expertise of foreign partners. In January 2009, the government also picked 17 industries as NGF – industries related to the green technology sector, high-tech & fusion sector, and high value-added sector.

From 2004 to 2009, numerous global companies including Google, Texas Instruments and other U.S. firms opened R&D centers in Seoul. In February 2010, Qualcomm announced it would set up a technology R&D center in the ROK and also invest around USD 4 million in a local digital audio chip maker.


BASIC INVESTMENT RIGHTS


Conversion and Transfer Policies: The Korean government has substantially removed restrictions on financial transfers into and out of Korea. Prior to 1999, the Foreign Exchange Control Act and associated regulations strictly regulated foreign exchange transactions. The Korean government subsequently liberalized transactions in medium-and long-term overseas borrowings, purchase and sale of local real estate, and trading in over-the-counter (OTC) stocks and bonds.

In 1999, the Foreign Exchange Transaction Act (FETA) fully liberalized all current-account transactions by business firms and banks, and pared down a formerly long list of restricted transactions to five items, most of which cover foreign exchange transactions by individuals. A second-stage liberalization dismantled most of the remaining restrictions in 2001. Only transactions that could harm international peace or public order, such as money laundering and gambling, remain controlled. Three specific types of transactions were not liberalized:

1) Non-residents are not permitted to buy won-denominated hedge funds, including forward currency contracts;

2) The Financial Services Commission will not permit foreign currency borrowing by "non-viable" domestic firms; and

3) The Korean government will monitor and ensure that Koreans firms that have extended credit to foreign borrowers collect their debts. The Korean government has retained the authority to re-impose restrictions in the case of severe economic or financial emergency.

Capital account liberalization under the Foreign Exchange Transaction Act has also been extensive. All capital-account transactions are permitted unless specifically prohibited. In addition, 72 of the 91 transactions specified by the OECD code of liberalization of capital movements now are permitted. Non-residents may open deposit accounts in domestic currency (won) with maturities of more than one year and may engage in offshore transactions and issue won-denominated securities abroad.

The right to remit profits is granted at the time of original investment approval. Banks control the now pro forma approval process for FETA-defined open sectors. For conditionally or partially restricted investments (as defined by the FETA), approval for both the investment and remittance rests with the relevant ministry.

When foreign investment royalties or other payments are proposed as part of a technology licensing agreement, the agreement and the projected stream of royalties must be approved either by a bank or the Ministry of Strategy and Finance (MOSF.) Again, approval is virtually automatic. An investor wishing to enact a remittance must present an audited financial statement to a bank to substantiate the payment. To withdraw capital, a stock valuation report issued by a recognized securities company or the Korean appraisal board also must be presented. Foreign companies seeking to remit funds from investments in restricted sectors must first seek ministerial and bank approval, after demonstrating the legal source of the funds and proving that relevant taxes have been paid.

Expropriation and Compensation: Korea follows generally accepted principles of international law with respect to expropriation. The law protects foreign-invested enterprise property from expropriation or requisition. If private property is expropriated, it can only be taken for a public purpose, and only in a non-discriminatory manner. Property owners are entitled to prompt compensation at fair market value. The U.S. Embassy in Seoul is not aware of any cases of uncompensated expropriation of property owned by American citizens.

Dispute Resolution: Serious investment disputes involving foreigners are the exception rather than the rule in Korea. There exists a body of Korean law governing commercial activities and bankruptcies that constitutes the means to enforce property and contractual rights, with monetary judgments usually levied in the domestic currency. Foreign court judgments are not enforceable in Korea.

Although commercial disputes can be adjudicated in a civil court, foreign businesses often feel that this is not a practical means to resolve disputes. Proceedings are conducted in Korean, often without adequate translation. Korean law prohibits foreign lawyers who have not passed the Korean Bar Examination from representing clients in Korean courts. Civil procedures common in the United States, such as pretrial discovery, do not exist in Korea. During litigation of a dispute, foreigners may be barred from leaving the country until a decision is reached. Legal proceedings are expensive and time-consuming and lawsuits often are contemplated only as a last resort, signaling the end of a business relationship.

Commercial disputes may also be taken to the Korean Commercial Arbitration Board (KCAB). The Korean Arbitration Act and its implementing rules outline the following steps in the arbitration process: 1) parties may request the KCAB to act as informal intermediary to a settlement; 2) if unsuccessful, either or both parties may request formal arbitration, in which case the KCAB appoints a mediator to conduct conciliatory talks for 30 days; and 3) if unsuccessful, an arbitration panel consisting of one or three arbitrators is assigned to decide the case. If one party is not resident in Korea, either may request an arbitrator from a neutral country.

When drafting contracts, it may be useful to provide for arbitration by a neutral body such as the International Commercial Arbitration Association (ICAA). U.S. companies may wish to seek local expert legal counsel when drawing up any type of contract with a Korean entity.

Korea is a member of the International Center for the Settlement of Investment Disputes (ICSID). It has also acceded to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention). Korea is a member of the International Commercial Arbitration Association and the World Bank's Multilateral Investment Guarantee Agency (MIGA). It is important to keep in mind that Korean courts may ultimately be called upon to enforce an arbitrated settlement.

Performance Requirements and Incentives: South Korea does not maintain any measures notified to the World Trade Organization (WTO) as being inconsistent with TRIMs requirements, nor does the ROKG maintain any measures that are alleged to violate the WTO's TRIMs text. Korea ceased imposing performance requirements on new foreign investment in 1989 and eliminated all pre-existing performance requirements in 1992. The ROKG has no requirement that investors purchase from local sources or export a certain percentage of output. There is no ROKG requirement that Korean nationals must own shares in foreign investments or that technology be transferred on certain terms. The Korean government does not impose "offset" requirements on investors to invest in specific manufacturing, R&D or service facilities. There are also no government-imposed conditions on permission to invest.

The Korean government allows the following general incentives for foreign investors:

  • Cash grants for the creation and expansion of workplaces for high-tech business plants and R&D research centers;
  • Reduced rent for land and site preparation for foreign investors;

  • Grants for establishment of convenience facilities for foreigners;

  • Reduced rent for state or public property; and

  • Preferential financial support for investing in major infrastructure projects.

Right to Private Ownership and Establishment: Korea fully recognizes rights of private ownership and has a well-developed body of laws governing the establishment of corporate and other business enterprises. Private entities may freely acquire and dispose of assets; however, the Fair Trade Act may limit cross-ownership of shares in two or more firms if the effect is to restrict competition in a particular industry.

Korea liberalized its property ownership law in 1998. The Alien Land Acquisition Act (as amended) grants even non-resident foreigners and foreign corporations the same rights as Koreans in purchasing and using land. Korea took further steps to liberalize its property ownership laws by implementing the Real Estate Investment Trust (REIT) Act in 2001, which supports sound indirect investments in real estate and restructuring of corporations. The REIT Act allows investors to invest funds through an asset management company, and in real property such as office buildings, business parks, shopping malls, hotels and serviced apartments.

Almost no restrictions remain on foreign ownership of stock in Korean firms. As of 2000, Korean law permits foreign direct investment through mergers and acquisitions with existing domestic firms, including hostile takeovers. Nonetheless, no hostile takeovers have occurred in Korea in part because of the lack of relevant implementation regulations for the Foreign Investment Promotion Act. In addition, the political environment for hostile takeovers remains unfriendly. In December 2009, the Ministry of Justice proposed poison pill legislation that would protect domestic companies from hostile foreign takeover bids. The National Assembly will review the bill in the 2010 spring session.

Protection of Property Rights (Including Intellectual Property):

Korea’s progress on Intellectual Property Rights led to its removal from the Special 301 Watch List in 2009. The importance of IPR protection has increased in recent years as the digitization of Korea’s economy has significantly enhanced the ability to produce and spread unauthorized reproductions of copyrighted material. With Korea’s products and trademarks enjoying global success, Korean creators of intellectual property stand to benefit from improvements in the domestic intellectual property regime. In addition, although significant progress has been made, concerns remain with respect to book piracy in universities, street vendor sales of illegally copied DVDs, counterfeiting of consumer products, protection of undisclosed test and other data for pharmaceutical marketing approval, and a lack of coordination between Korean health and IPR authorities to prevent the issuance of marketing approvals for patent infringing products.

The Ministry of Culture, Sports, and Tourism (MCST) amended its Copyright Law in July 2009 to include a “Three Strikes” program against illegal file-sharing. Under the amended law, users who download illegally will be sent a warning letter, which counts as a strike. Three strikes will lead to a suspension of that user’s internet account by the Internet Service Provider. In December 2009, MCST reported that the Korea Copyright Commission has issued 19,800 corrective recommendations since the law was amended. No corrective orders to suspend a user’s internet account have been issued.

In 2009, the ROKG, coordinated by MCST, continued its progress on IPR enforcement in several areas, and appears to remain committed to fighting piracy in its various forms. However, MCST’s staff shortfall affects its software piracy efforts and remains a concern. The staff cuts date back to the integration of the Ministry of Information and Communication into MCST as part of President Lee’s governmental reorganization. MCST is currently requesting increased funding and staff from the Minister of Public Administration and Security.

MCST has stressed that despite the decrease in staff, it has made efforts to ensure that all central and municipal government agencies are using properly licensed software, and next year plans to carry out a similar review at the corporate level. In the meantime, MCST plans to provide a counseling service for corporations so that they properly manage their software licenses.

MCST held its second annual 100-day campaign against off-line pirated copyrighted material, known as the “100 Day Seoul Clean Project,” from April until August of this year. MCST noted it plans to continue this project on an annual basis. During the 100 Day Seoul Clean Project, MCST and Korean law enforcement raided street vendors and stores selling pirated DVDs, CDs, software, and books. According to MCST’s statistics, seizures of pirated material increased 24 percent to 214,199 illegal items, and prosecutions increased 46 percent to 544 cases, compared to the numbers from last year’s campaign. Additionally, MCST has promised to carry out anti-book piracy enforcement activities on Korean campuses at the beginning of semesters.

The ROKG has also demonstrated a renewed commitment to investigating and prosecuting "topsites." Little known to the general public, topsites are computer servers that hold tens of thousands of pirated software, games, music and movie files. ROKG ministries met with music industry stakeholders to discuss investigatory techniques. The ROKG has expressed to US Embassy Seoul its intention to carry out enforcement actions against topsites.

Korean patent law is a “first to file” regime. Although the law is fairly comprehensive and affords protection to most products and technologies, a U.S. company must be registered with the Korean Intellectual Property Office (KIPO) to obtain legal protection. KIPO has amended relevant laws regarding restrictions on patent term extension for certain pharmaceutical, agrochemical, and animal health products that are subject to lengthy clinical trials and domestic testing requirements. An issue of continuing concern, however, has been the lack of coordination between the Korean Food and Drug Administration and KIPO and related issues that have resulted in the granting of marketing approval for unauthorized copies of pharmaceutical products.

Korea’s Trademark Act has been amended to strengthen provisions that prohibit the registration of trademarks without the authorization of foreign trademark holders by allowing examiners to reject any registrations made in "bad faith." Despite this change, the complex legal procedures that U.S. companies must follow to seek cancellation have discouraged U.S. companies from pursuing legal remedies. In particular, problems still arise with respect to "sleeper" trademark registrations filed and registered in Korea without authorization in the late 1980s and early 1990s, when KIPO was still developing a more effective and accurate trademark examination and screening process.

Korean laws on unfair competition and trade secrets provide a basic level of trade secret protection in Korea, but are insufficient in some instances. For example, some U.S. firms, particularly certain manufacturers of chemicals, pet food, cosmetics, and food products, face continuing problems with government regulations requiring submission of very detailed product information, such as formula or blueprints, as part of registration or certification procedures. U.S. firms report that, although the release of business confidential information is forbidden under Korean law, in some instances, government officials do not sufficiently protect this proprietary information, and trade secrets appear to have been made available to Korean competitors or to their trade associations.


SYSTEMIC ISSUES

Korea boasts a hard-working, educated and productive workforce and high levels of legal labor rights and protections. Nevertheless, foreign investors cite volatile labor-management relations as an investment impediment. According to a 2009 World Economic Forum study, Korea fell from 13th to 19th place in the world in terms of overall competitiveness, partly due to what the WEF report characterized as an inflexible labor market. Although, at 10.5 percent as of 2008, Korea's unionization rate is not especially high, unions can be forceful in making demands on wages, benefits, and working conditions.

Some Korean analysts argue that more attention should be paid to finding ways to promote labor mobility while stimulating the job market. One problem, according to some academics, is the standard practice of promoting within companies. Workers’ inability to secure employment at an equivalent wage and rank at another company negatively impacts labor mobility. Exploring ways to better connect workers with employers could promote labor market efficiencies. Vocational training in Korea lags behind other countries with a similar level of development. Current programs could target their participants more carefully, keep the training programs small in scale, and ensure that the training results in a qualification that the market recognizes and values.

Reforms in the pension system would also help labor mobility. In the Korean system, government employees and schoolteachers can carry their pension rights when they quit one occupational plan and enter another. But there are no such linkages between the National Pension Scheme (NPS) and occupational pensions. The lack of portability puts such relatively mobile workers at a disadvantage and discourages movement between the public and private sectors. More broadly, Korea lacks a portable 401(K)-type system for corporate pensions.

Although the Korean government, labor, and management sectors still struggle to resolve conflict, there are mechanisms in place to improve communication. The previous administration instituted a Tripartite Commission (Labor, Employers and Government) to address dysfunctions in the labor sector. The Federation of Korean Trade Unions (FKTU), one of Korea’s two umbrella union organizations, regularly participates in negotiations with government and labor and, in response to the global financial crisis, agreed to a “social pact,” limiting demands for wage increases in return for management’s promise to avoid lay-offs. Nevertheless, the other labor federation – the Korean Confederation of Trade Unions (KCTU) – refused to negotiate with the government and management and conducted strikes throughout the year with more planned for 2010. On January 1, 2010, the National Assembly passed a labor reform law governing the timing for implementing two controversial changes first approved by the legislature in 1997. Without such revisions, both changes would have automatically become effective in January 2010. Under the revised law, however, new restrictions banning companies from paying wages to full-time union leaders will be implemented from July 2010 and the ability to form multiple unions at a single workplace will go into effect in July 2011.

Gradual implementation of the five-day workweek began in July 2004 and 49.8 percent of employees are actually working under the system as of August 2009. As part of this implementation plan, the system was expanded to the public sector in July 2005.

Korea joined the International Labor Organization (ILO) in December 1991. However, Korea still has not ratified the basic ILO conventions on Workers Rights (Convention 87 on freedom of association, Convention 98 on the right to organize and collective bargaining, and Convention 151 on public service employees' right to organize), and a number of international and domestic labor groups have filed complaints against the Korean government with the ILO's Committee on Freedom of Association.

In 1997, Korea amended its labor laws to permit more than one national labor federation. Korea now has two national federations, the Korean Confederation of Trade Unions and the Federation of Korean Trade Unions, along with some 1,600 distinct labor unions. Also, in 1997, the government repealed its ban on intervention by "third parties" in labor disputes, thus enabling labor unions to seek outside assistance and counsel.

Corporate Governance and Investment Decision-Making: Investors and financial markets remain wary of corporate governance in Korea despite significant improvements since the 1997-98 Asian financial crisis. Concerns about corporate governance often reduce the price/earnings ratios to levels lower than comparable companies elsewhere. Korean policy makers acknowledge that foreign investors often exact a "Korea Discount" when dealing with Korean companies or in making investment decisions. As the Chairman of the Korean Free Trade Commission (KFTC) stated in 2005, "the main reasons for the Korea Discount are opaque accounting techniques, less respect for minority shareholders, insufficient openness and excessive control by controlling families."

Large gaps exist between the ownership and control of a significant number of firms in Korea, with many traditional "chaebol" conglomerates still controlled by their founding families, despite the family's relatively small ownership stakes. Korea's accounting reform plan and Code of Best Practices are admirable efforts, but more can be done in these areas as well. Increasing participation by foreign investors and stockholders, modernizing business-government relations, and infusing professionalism in the corporate culture could go a long way toward improving corporate governance.

Korea's development strategy in the latter part of the 20th century, which transformed the country from one of the poorest nations in the world to a member of the OECD, created a number of structural legacies that increased the country's vulnerability during the 1997-1998 Asian financial crisis. At that time, Korea's generally weak corporate governance framework was compounded by a history of government-directed financing, creating significant "moral hazard" -- that is, the assumption that government would make good all losses and not permit large companies to fail. This allowed large segments of the corporate sector to become excessively leveraged, increasing vulnerability. Korea responded to the financial crisis by implementing a number of corporate reforms that improved accounting transparency, promoted corporate restructuring, and strengthened the nation's insolvency framework. Nonetheless, corporate governance reforms remain incomplete.

Although the Anti-Monopoly and Fair Trade Act has been amended repeatedly – most recently in March 2009 -- the practical impact of Korea's laws and policies regulating monopolistic practices and unfair competition, however, has been limited by the long-standing economic strength of the chaebol. Management control at the Korean chaebol continues to involve complicated webs of cross-shareholdings among chaebol affiliates, and many chaebol still conduct business based on family and personal connections. Vestigial chaebol-government relations can also sometimes influence the business-government dialogue, to the detriment of foreign and small and medium-sized enterprises (SME's). Thus, chaebol influence in the Korean economy may sometimes cause practical business problems for foreign investors. SME suppliers, for example, may be reluctant to deal with foreign firms for fear of jeopardizing a prized chaebol relationship. Obtaining access to credit may be complicated by the privileged relationships competing chaebol enjoy with local banks -- although this is mitigated by the fact that regulations limit a bank's exposure to any single chaebol group's companies to 25 percent of capital, and stipulate that 25 percent of all banks' lending, at least, must go to SME's.

There are several large Korean corporations that have transformed themselves into well-managed multinational corporations that have adopted "best practices" in corporate governance consistent with U.S. and international standards. Some of their "best practices" include more frequent board meetings covering real operational issues; boards with more independent board members and fewer or no founding family members; a nominating committee for the board; financial report certifications; and frequent and substantive outside audits.

Foreign ownership is also playing a significant role in promoting corporate governance reform in Korea. Korean firms with significant foreign investment, for example, are generally understood to be more reluctant to participate in government-sponsored bailouts of troubled firms, impacting the evolution of Korean financial markets. As foreign investors now own about 60 percent of the shares in some of Korea's top companies and nearly 33 percent of stock listed on Korea's main stock exchange, the rights of minority and non-Korean stockholders are becoming more clearly expressed.

Under Korea’s 2005 Securities Class Action Act, minority shareholders are able to file class action suits for manipulation of share prices, false disclosure of information, and accounting malpractice. The first class-action suit was filed in April 2009 by 1700 shareholders against Jinsung, a KOSDAQ-listed maker of machine parts, for losses allegedly caused by accounting fraud. The case settled out of court in January 2010 for approximately USD 2.5 million.

The Korean government is currently implementing an accounting reform plan, taken largely from the U.S. Sarbanes-Oxley Act, aimed at making Korean accounting standards consistent with rigorous international standards. Under the 2007 roadmap, the International Financial Reporting Standards (K-IFRS) will become Korea’s Generally Accepted Accounting Principles by 2011. In parallel, a committee of Korean private sector experts has established a Code of Best Practices in response to a tasking by the finance ministry. The voluntary recommendations included in this Code are in line with OECD principles, and the Korea Exchange (KRX) has reinforced the importance of the Code by requiring that companies listed on the Korea Stock Exchange (KSE) provide information to investors about the extent to which they conform to the Code. Following are some of the key recommendations contained in the Code of Best Practices:

  • Easing of ownership thresholds to allow small shareholders greater rights to inspect company books;
  • Having outside or independent directors make up at least half (rather than a quarter) of the board members of listed companies;

  • Establishing a nominating committee to choose board members, with at least half of the committee consisting of outside directors;

  • Ensuring that outside directors are truly independent, with no interests in the company, the management, or the controlling shareholder;

  • Having the board of directors meet at least once every three months; and

  • Requiring that companies have audit committees consisting of at least three directors, of which two-thirds are outside directors.


Transparency of the Regulatory System: The Korean regulatory environment can pose challenges for all firms, both foreign and domestic. Laws and regulations are often framed in general terms and are subject to differing interpretations by government officials, who rotate frequently. This creates frustrations for foreign investors that are looking for certainty in the Korean market. The KORUS FTA includes many provisions designed to address such issues.

The Korean government may restrict investments which disrupt production of military products or equipment, or if the company the foreigner is investing in exports items that may be later used for military purposes differing from their originally intended use. Foreigners linked to a country or an organization that may pose a threat to national security will also be subject to limitations on their investments in Korean firms. Related government agencies must ask MKE to review the case within 30 days of a foreign investor filing an application for regulatory approval, and MKE needs to make a decision within the following 90 days. Older bureaucratic practices designed to influence the decisions of businesses and investors through prescriptive regulations are sometimes still encountered.

According to Korea's Administrative Procedures Act, proposed laws and regulations (Acts, Presidential Decrees or Ministerial Decrees) should be published and public comments solicited for at least 20 days prior to promulgation. Draft bills are often available on the web sites of relevant ministries, without notice that they have been published. The rule-making process often remains non-transparent, particularly for foreigners. Proposed rules are sometimes published with insufficient time to permit public comment and industry adjustment. For example, regulatory changes originating from legislation proposed by members of Korea's National Assembly are not subject to public comment periods. When notifications of proposed rules are made public, they usually appear in the Official Gazette, but not consistently, and only in the Korean language; thus, much of the 20-day comment period can be exhausted translating complex documentation.

President Lee Myung-bak has made regulatory reform one of the key elements of his economic policy, and progress is expected to be gradually achieved. President Lee established and heads the National Competitiveness Committee to identify measures to improve Korea’s competitiveness, including regulatory reform. Likewise, the Prime Minister’s Deregulation Taskforce Team, the Corporate Resolution Center and the standing Regulatory Reform Committee focus on regulatory reform as well.

Capital Markets and Portfolio Investment: Financial sector reforms are often cited as one reason for the ROK’s rapid rebound from the global financial crisis. Financial sector reforms have aimed to increase transparency and investor confidence, and generally purge the sector of moral hazard. Since 1998, the Korean government has recapitalized the banks and non-bank financial institutions; closed or merged weak financial institutions; resolved many non-performing assets; introduced internationally-accepted risk assessment methods and accounting standards for banks; forced depositors and investors to assume appropriate levels of risk; and taken steps to help end the policy-directed lending of the past. These reforms addressed weak supervision and poor lending practices in the Korean banking system that helped cause and exacerbate the 1997-98 Asian financial crisis.

In the course of stabilizing Korea's banking sector during the Asian financial crisis, the Korean government injected public funds, thereby acquiring de facto ownership of many of Korea's commercial banks -- although it publicly committed to refrain from interfering in bank lending and management decisions, except with regard to prudential supervision. In late 2002, the Korean government began its ambitious plan to re-privatize the banks under its control, with the program initially scheduled to end by the first quarter of 2005. Much of this re-privatization has taken place, although the government continues to own the majority of shares in Woori Bank and minority shares in some other banks. Foreign banks are allowed to establish subsidiaries or direct branches. Further relaxation of regulations has widened foreign access to Korea's capital markets and permitted foreign financial firms to engage in non-hostile mergers and acquisitions of local financial institutions. Currently, foreign interests control three of Korea's eight major commercial banks: Citibank Korea (formerly KorAm Bank); Korea Exchange Bank and SC/Korea First Bank.

Korea routinely permits the repatriation of funds, but reserves the right to limit capital outflows in exceptional circumstances, such as situations when uncontrolled outflows might harm the balance of payments, cause excessive fluctuations in interest or exchange rates, or threaten the stability of domestic financial markets. The Korean government did not impose such restrictions either during the Asian financial crisis or the global financial crisis, where sharp capital outflows played a major role.

Foreign portfolio investors now enjoy good access to the ROK stock market. Aggregate foreign investment ceilings in the Korean Stock Exchange (KSE) were abolished in 1998, and foreign investors owned 32.6 percent of KSE stocks and 7.8 percent of the KOSDAQ as of the end of 2009. The market turnover rate was 199.56 percent of market capitalization in 2009. Retail investors are extremely active in the Korean stock markets. More than 80 percent of KSE and KOSDAQ retail trading is conducted online. Thus, a large majority of retail investors are day traders, implying a constant source of volatility for the markets. The Korean government permits stock purchases on margin, requiring that transactions be settled within three business days.

Portfolio investors have shown less appetite for the smaller, more volatile, technology-rich KOSDAQ or for Korean fixed-income investments. Since the 1999 collapse of the Daewoo Group in 1999, Korea's largest corporate bankruptcy, the country's bond market has been almost moribund, as sellers have far outnumbered buyers. The total assets of Korea's commercial banks as of the end of September 2009 were 1,177 trillion won, or about USD 1.1 trillion.

Short-term interest rates, at around 2.6 percent, remain competitively high. Inflation, meanwhile, remained at 2.8 percent throughout 2009. The spread between short-term money (the overnight call rate) and long-term money (the benchmark 3-year corporate bond rate) rose from its 54-plus basis points maximum in 2007 to 153-basis points in 2008 to 318-basis points in 2009. As a countermeasure against financial instability and potential economic recession, the Bank of Korea (BOK) cut its target rate six times by 325-basis points from 5.25 percent in August 2008 to a record-low level of 2.0 percent in February 2009.

COUNTRY RISK ISSUES

Political Violence: Korea does not have a history of political violence directed against foreign investors. The Embassy is unaware of any politically motivated threats of damage to foreign-invested projects or foreign-related installations of any sort, nor of any incidents that might be interpreted as having targeted foreign investments. Labor violence unrelated to the issue of foreign ownership, however, has occurred in foreign-owned facilities in the past.

Corruption: Despite significant improvements in recent years, Korea's political structure still tolerates a degree of non-transparency in the formation of laws and regulations. When combined with still-inadequate institutional "checks and balances" and a societal structure heavily based on personal ties, opportunities and incentives for corruption and influence peddling sometimes occur.

Bribing a Korean official is a criminal act. Penalties for bribery range from probation to life imprisonment, depending on the amount involved. Legislation has been approved bringing Korea into compliance with the OECD initiative against international bribery. The Supreme Prosecutor in each province is responsible for ferreting out corruption. Many business leaders and officials, including former ministers and former presidents, have been found guilty of corruption in recent years, sometimes for offenses committed years earlier. Few have paid heavy fines or served much time in prison. Amid spreading public sentiment denouncing bribery and corruption, particularly after the April 2000 general legislative election, civic groups have become very vocal and achieved considerable progress by identifying supposedly "corrupt" officials and working against their re-election. Public outrage helped propel Roh Moo-hyun, viewed by many as an untainted outsider, to the presidency in 2003. Roh's campaign to curb corruption notwithstanding, Roh was indicted after he left office in 2008 for corruption and in 2009 committed suicide in the midst of the investigation.

The controversial Anti-Corruption Law passed by the National Assembly in 2002 is now in effect. Most notably, this law created the Korea Independent Commission against Corruption (KICAC), which was semi-autonomous and empowered to investigate public complaints of corruption at every level of government. The Anti-Corruption & Civil Rights Commission (ACRC) was launched in 2008 by integrating the Ombudsman of Korea, the KICAC and the Administrative Appeals Commission. With the consolidation of these three organizations, the public is provided with one-stop service to address public complaints, file administrative appeals and fight corruption. The ACRC assesses the levels of integrity of public sector organizations each year by surveying citizens. The ACRC also evaluates the anti-corruption initiatives taken by public organizations on a regular basis. The ACRC makes recommendations to help government entities to amend ambiguous, corruption-prone laws and intuitions, and periodically asses the implementation of recommendations. It is also conducting the Corruption Impact Assessment (CIA), an analytical mechanism designed to indentify and remove corruption-causing factors in advance in laws and regulations.

The National Assembly passed an Anti-Money Laundering Bill in 2001. That legislation met the objectives of the Financial Action Task Force on Money Laundering's forty recommendations, and created a Financial Intelligence Unit (FIU) to trace suspect accounts and transactions and to facilitate international cooperation. The government has cooperated fully with U.S. and United Nations efforts to identify and shut down sources of terrorist financing.


INTERNATIONAL ARRANGEMENTS

Bilateral Investment Agreements: The United States has a bilateral Treaty of Friendship, Commerce, and Navigation with Korea, which contains general provisions pertaining to business relations and investment. During former Korean President Kim Dae-jung's visit to the United States in 1998, President Clinton and President Kim agreed to negotiate a Bilateral Investment Treaty (BIT) between the two nations. However, negotiations in 1998 and 1999 stalled after the two sides could not resolve differences on certain issues. The Korea-U.S. FTA contains strong, enforceable investment provisions that will go into force if the agreement is approved and implemented.

OPIC and Other Investment Insurance Programs: U.S. investments in Korea are eligible for insurance programs sponsored by the U.S. Overseas Private Investment Corporation (OPIC). OPIC has not, however, guaranteed any U.S. investments in Korea since June 1998, when OPIC reinstated coverage it had suspended in 1991 due to concerns about worker rights. Coverage issued prior to 1991 is still in force. Korea has been a member of the World Bank's (IBRD) Multilateral Investment Guarantee Agency (MIGA) since 1987. The Ruby Tuesday franchise used an OPIC loan in 2005 to open its first restaurant in the ROK.

FOREIGN TRADE ZONES AND FREE ECONOMIC ZONES

Korea aims to attract more foreign investment by promoting its six Free Economic Zones (FEZ): Incheon (near Incheon Airport, to be completed in 2020); Busan/Jinhae (in South Gyeongsan Province, to be completed in 2020); Gwangyang Bay (in South Gyeongsan Province, to be completed in 2020); Yellow Sea (in South Chungcheong Province, to be completed 2025); Daegu/Gyeongbuk (in North Gyeongsan Province, to be completed in 2020); and Saemangeum/Gunsan (in North Jeolla Province, to be completed in 2030). The FEZs differ from other zones designated for foreign investment in their focus on creating a comprehensive living and working environment with biotechnology, aviation, logistics, manufacturing, service and other industrial clusters as well as international schools, recreational facilities, and international hospitals. In 2009, the National Assembly passed the Special Act on Free Economic Zones to increase tax benefits for investment, increase the FEZ infrastructure budget, and streamline the approval process for land development.

There are also six Foreign-exclusive Industrial Complexes in Korea in different parts of the country, designed to provide inexpensive plant sites, with the national and local governments providing assistance for leasing or selling in such sites at discounted rates. In addition, there are four "Free Trade Zones" in Iksan, Gunsan, Daebul and Masan where companies may pursue their business with government support, but without the usual legal requirements such as approval procedures for export and imports and customs duties. There are also seven Foreign Investment Zones designated by local governments to accommodate industrial sites for foreign investors. Special considerations for foreign investors vary among these options.

A good source of information on Korea's various free trade zone schemes is the government-run "Invest Korea," an inward investment promotion organization under the Korea Trade and Investment Promotion Agency (KOTRA). It can be reached at:

Invest Korea, KOTRA Bldg. 300-9
13, Heolleungno, Seocho-gu, Seoul, Republic of Korea
Tel:(82-2) 3460-7545
Fax:(82-2) 3460-7946/7
http://www.investkorea.org

The Korean government also continues to put significant effort into programs to enhance the quality of life in Korea for foreign investors and their families. There are 46 foreign schools in Korea and two big foreign schools in the Incheon FEZ will open their doors in March 2010 and August 2011, respectively. The government more recently launched three-year programs aimed at enhancing the foreign investment climate in Korea. The Korean government has improved the legal framework for those areas by revising the FEZ Act and the Foreign Investment Act to provide cash grants for foreign investments of more than USD 10 million.


FOREIGN DIRECT INVESTMENT STATISTICS

(USD Millions)

Annual Flow

Cumulative Stock


2007
2008
2009
2009
Total Inward FDI
10,515
11,711
11,484
160,512
United States
2,329
1,328
1,486
41,808
EU
4,344
6,339
5,297
56,468
Japan
990
1,423
1,934
23,890
China
385
336
161
2,676
Other
2,467
2,285
2,606
35,670





Total Outward FDI
29,556
35,981
13,353
188,895
China
7,123
4,841
1,811
40,007
United States
4,105
5,919
2,912
34,071
EU
3,013
2,987
1,264
21,165
Japan
797
608
363
3,530
Other
14,519
21,626
7,003
90,1222


Source: The Export-Import Bank of Korea and Ministry of Knowledge Economy

Note: This data is based on the notification of cases. The 2009 outflow is data reported for the first nine months of the year.



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