Korea to ease rules on insurers’ currency hedging of offshore investment

Jan 25, 2017 (Gmt+09:00)

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South Korea will loosen regulations in relation to the currency hedging of insurance companies’ cross-border investments, which have been blamed to increase costs and undermine their financial stability unless protected against foreign exchange swings for more than a year.

The government also plans to lift restrictions on domestic insurers’ overseas investments to 30% of total assets within this year, according to a regulatory source.

The Financial Supervisory Service (FSS), the country’s top financial regulator, said on Jan. 24 that it will ease rules on the currency risk hedging of insurers’ overseas assets to ensure the duration, or the weighted average term to maturity, of unhedged foreign assets will be reflected as it is when the risk-based capital ratio is calculated, starting from June.

So far, overseas assets, unless hedged against currency risks for longer than a year, are booked as having a zero duration.

The regulatory body posted the forthcoming regulatory change on its website.

The regulations have been cited as the biggest stumbling block to an expansion of insurance companies’ overseas investment. They were blamed for raising interest rate risks, or widening the duration gap between assets and liabilities, and in turn sharply cutting the risk-based capital ratio, a measure of financial solvency. For those reasons, domestic insurers have protected all their foreign investments against currency risks.

But they tended to enter one-year derivative contracts, most of which need to be renewed before maturity to shore up their risk-based capital ratio. Generally, Korean insurance firms invest in foreign-currency assets which carry five or 10-year maturity.

The relaxation on the rules comes as domestic insurance companies plan to further increase the proportion of overseas assets and alternative investment this year. The outstanding volume of South Korean insurers’ holdings of foreign currency-denominated securities had snowballed to a combined $61.3 billion at the end of September 2016, compared with $29.4 billion in 2014.

“Insurance companies cannot help but look abroad to combat the low interest rate environment,” said an insurance company’s chief investment officer. “In this circumstance, the relaxed regulation on currency hedging will help increase flexibility in our asset management.”

South Korea has been easing restrictions on cross-border investments as part of efforts to funnel current account surpluses into higher-yielding overseas assets.

Last year, the financial watchdog, the Financial Services Commission which oversees the FSS, allowed insurers to invest in a broader range of foreign-currency assets beyond foreign securities rated only by international credit rating agencies.

Meanwhile, the risk-based capital ratio requirement of 8% will remain intact for unhedged foreign assets. But the insurers will be able to save hedging costs through various derivative products with different maturities, and may opt for short-term products which offer higher cross-currency swap premiums to Korean investors.

“With foreign investment assets growing and relevant regulations easing, foreign exchange management will become more important,” said another insurance industry source.

By JiHoon Lee

lizi@hankyung.com