B. THE CHALLENGED PRACTICES
The investigation was directed against subsidies allegedly granted by the Government of the Republic of Korea (the "GOK") to its shipbuilding industry that benefited production between 1997 and 2000 and will benefit future production. Alleged Korean subsidies have included export guarantees, export financing, debt forgiveness, debt-for-equity-swaps, interest relief and special tax concessions in the context of preferential restructuring packages provided in order to save various shipbuilding enterprises from imminent financial collapse.
In particular, the alleged Korean subsidies that were expressly the subject of the complaint included:
||Advance Payment (Refund) Guarantees provided by the state-owned Export-Import
Bank of Korea ("KEXIM");
||Export Credit Financing provided by KEXIM; and
||Debt forgiveness, debt-for-equity-swaps and interest relief by Government-owned
and Government-controlled banks and special tax concessions by the Korean Government.4
During the visit, the Commission established that there was no evidence of any subsidies granted to the shipyards investigated under this programme.
The complaint alleged that the above-mentioned practices violated Articles 3 and 5 of the WTO Agreement on Subsidies and Countervailing Measures (ASCM) and thus give rise to a right of action under the Trade Barriers Regulation, Article 2(1) of the Regulation defines an obstacle to trade as "any trade practice adopted or maintained by a third county in respect of which international trade rules establish a right of action."
In particular, it is claimed that the KEXIM advance payment guarantee programme and export credit financing programme constitute obstacles to trade because they are prohibited export subsidies under Article 3.1(a) of the ASCM, which states that "subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance" are prohibited.
Notwithstanding the alleged prohibited nature of the above export programmes the complaint alleged that even if not found to be prohibited, such subsidies were still actionable under Article 5 of the ASCM as they caused adverse effects.
Moreover, it was claimed that the debt forgiveness, interest relief, dept-to-equity swaps and tax concessions provided to Korean shipyards were actionable subsidies in violation of Article 5 of the ASCM because they have caused adverse effects to the interests of the European Community shipbuilders.
The Korean shipbuilding enterprises claimed to have benefited from Korean Government subsidies included Halla Engineering and Heavy Industries (now called Samho Heavy Industries), Daedong Shipbuilding Co., Daewoo Heavy Industries, Hyundai Heavy Industries, Hyundai Mipo, Samsung Heavy Industries, and Hanjin Heavy Industries & Construction Co.
B.2.1 Complaint allegations
The complaint alleges that the Korean Government has engineered massive debt forgiveness, debt and interest relief, debt-to-equity swaps and tax concessions for Korean shipbuilding companies. In particular, that the Government has arranged debt forgiveness and debt and interest relief through the shipbuilding companies' major creditor banks, all of which are under direct or indirect Government control. That in some cases, the Government assistance was in the form of direct debt forgiveness and other relief by a state-owned bank. In other cases, that the banks had acted pursuant to Government control and influence over debt settlement decisions for specific industries, including the shipbuilding sector. In still other cases, that the Korean Government provided large infusions of financial support to major shipyard creditors for the purpose of debt relief. Moreover, that the state-owned banks have converted large amounts of debt into equity. Finally, the complaint alleges that the Government has excused shipbuilding firms from otherwise applicable taxes owed to the Government. It is alleged that it is only as a result of these massive government interventions that Korean shipbuilding firms were able to continue their current operations.
The 1997 crisis and the IMF package
In 1997, Korea experienced a severe foreign exchange crisis (a sharp exchange rate devaluation) that resulted in the most important financial crisis faced by Korea in the post-war period. The currency devaluation provoked significant foreign exchange losses for both banks and enterprises. The sharp increase in interest rates along with the drop of economic output that followed the devaluation prevented many debtors from servicing their debts, provoking a rapid deterioration of the loan portfolio of banks; as a result the ratio of corporate debt in the form of Non-performing Loans (NPLs) held by financial institutions increased to such an extent so as to undermine the financial stability of the financial institutions the mselves. Moreover, the financial instability of domestic markets along with the loss of confidence triggered by the devaluations made it difficult for banks to roll-over their short term foreign currency liabilities and for enterprises to raise capital to serve their debts (or roll over their loans) provoking a sharp liquidity crisis. The liquidity crisis resulted in Korea facing an unprecedented number of bankruptcies5.
The triple crisis (balance of payments crisis, financial sector crisis and corporate crisis) had a devastating effect on the Korean economy.6 As Korea had lost market confidence and was no longer able to attract new credits or roll over its existing obligations on 17 November 1997 the GOK formally approached the International Monetary Fund (IMF) for assistance. The IMF along with the World Bank and other countries then set up a US$ 58 billion rescue package supported by emergency loans (so called structural adjustment loans) to Korea to help recover its economy.
In order for Korea, however, to receive the assistance it had to agree to apply certain policies to address the fundamental causes of the financial crisis. The policies that Korea intended to implement in the context of its request for financial support from the IMF over the period 1998 to 2000 were described in several Letters of Intent (alias IMF Policy Matrix) by GOK to the IMF starting from 3 December 1997. Those letters contained the detailed Memoranda on the Economic Programme to be pursued by GOK with regards to inter alia macroeconomic policy, fiscal policy, trade and capital accounts liberalisation, labour policy and, most importantly, the financial and corporate sector restructuring.
Priority was given to reform of the banking system as this was considered a key to the success of other restructuring efforts. The GOK then proceeded with the creation of a legal framework for corporate debt restructuring including procedures for debt workouts.
The financial sector restructuring
In the financial sector reform took the form of a package of measures aiming at strengthening the financial system through the adoption of new legislation on regulatory matters (e.g. tightening up rules on accounting standards, on prudential regulations, on exposures, on connected lending) as well as through the active involvement of GOK in the restructuring of the financial institutions (e.g. taking measures on the undercapitalization of commercial banks, privatising state-owned banks, mandatory merging or transferring of assets between banks). The latter measures were implemented with the re-capitalisation of special purpose banks (Kexim, IBK and KDB), the direct provision of public funds into viable commercial banks (e.g. injection of capital), and through the alleviation of their debt burden by means of purchases of non-performing loans by the state-owned Korea Asset Management Corporation ("KAMCO").
The role of the FSC
The major responsibility for implementing GOK's plans to formulate financial supervisory policies and to enforce prudential regulations on financial institutions fell on the FSC7.
For example, as part of its regulatory responsibilities, the FSC deliberates and resolves policy matters relating to the inspection and supervision of financial institutions and securities and futures markets. The FSC also has the authority to issue and revoke the licenses of financial institutions. Legislation relating to the financial sector is drafted and submitted by the Ministry of Finance and Economy ("MOFE") after consultation with the FSC. Finally, the FSC is responsible for implementing and overseeing the restructuring of the financial sector.
The corporate restructuring
Corporate restructuring refers in general to the overall framework put in place by the GOK in conjunction with the IMF (and the World Bank) on measures to deal with corporate debt restructuring including procedures for debt workouts8. Once the framework was set up by GOK, the individual debt restructuring plans for companies were to be decided and implemented on a case-by-case basis by means of an agreement between the creditor banks and the companies. The goal of the restructuring effort was to avoid unnecessary bankruptcies.
Types of corporate restructuring
Given the complexity of the corporate restructuring process, it has proceeded in several different ways depending on the economic importance of the corporate groups (so-called "chaebols") concerned. Corporate groups were split into first-tier chaebols (the top 5), second-tier chaebols (chaebols 6 to 64) and the rest on the basis of their economic size. Restructuring then took place in three different ways:
||Through Capital Structure Improvement Plans (CSIPs ) for the top four
chaebols namely LG, SK, Hyundai and Samsung;
||through out-of-court workout plans for the Daewoo
Group9 and the second tier 6 - 64 chaebols;
||through court-supervised insolvency proceedings for the rest, including
Samho and Daedong.
The GOK stated that companies which would not be considered to be viable by creditor banks and the courts under the above processes would normally be liquidated.
In January 1998, the GOK, major creditor banks and the heads of the big-five chaebol (Daewoo, LG, SK, Hyundai and Samsung) agreed on certain key principles of corporate reform aiming at reducing their debt-to-equity ratios below 200%. The key measures agreed involved: enhance corporate transparency, eliminate cross debt-guarantees, improve capital structure, concentrate on core competence areas and reduce the number of affiliates. Moreover, the agreement also contained provisions on asset swaps and mergers between the chaebols in seven key industries so as to reduce over-capacity in the sectors involved (known as the "big deals").10
The Hyundai Group and the Samsung Group have implemented Capital Structure Improvement Plans (CSIPs).
Hyundai Heavy Industries (HHI) is a member of the Hyundai group. It is the world's largest shipbuilder accounting for more than 13% market share of the global shipbuilding market. HHI is diversified into various businesses lines such as shipbuilding (accounting for 56% of the company's sales in 1999), Engineering and Machinery, Industrial plant, Offshore and Engineering.
Samsung Heavy Industries Co Ltd (SHI) is a publicly quoted company incorporated in South Korea in 1974. It is a constituent part of the Samsung Group, South Korea's second largest chaebol. Shipbuilding is its core business, accounting for around 70% of sales but SHI is also active in a number of other businesses. As a matter of fact SHI consists of three divisions: Shipbuilding & Plants Division, Digital & Environment Business Division and Construction Division.
For details on Samsung and Hyundai see Annex.
B.2.3.2 Analysis of subsidisation
The debt restructuring pursuant to CSIPs did not involve the granting of subsidies to the shipyards investigated. The measures taken by the companies involved related to a strengthening of their financial position through asset sales, shares issues and other forms of normal corporate financing not involving the use of public funds. There is, therefore, no evidence that through the CSIPs subsidies were conferred to Hyundai Heavy Industries, Hyundai Mipo and Samsung Heavy Industries.
4 In a separate letter dated 6 February 2001 CESA requested that the Commission examines subsidies granted under a corporate bond purchase scheme run by the KDB. The program is intended to normalize the bond market, which was practically paralyzed due to excessive concern over the negative effects of structural reforms. Excluding the amount owed by companies able to repay bonds on their own and firms under court receivership, court mediation or debt workout, 25 trillion won was the amount to be backed by the KDB-led underwriting program. Under the program, companies must repay 20% of the maturing debt on their own. The KDB is responsible for underwriting the remaining 80% or 20 trillion won worth of the bonds. The program is open to all companies suffering from short-term liquidity but are judged fundamentally viable. The maturity of the bonds underwritten by the KDB is just one year. The KDB in January underwrote 756 billion won worth of bonds, or 80% of the 946 billion won in bonds that matured in that month. (Source: KDB website)
5 Corporate bankruptcies reached an unrecorded high of 3,197 firms during December 1997 alone. See "The credit channel at work" by G.Ferri, T.S.Kang, Policy Research Working Paper Series, June 1999 the World Bank. Generally, for information on the background and impact of the Korean financial crisis see the Policy Research Working Paper Series and the Discussion Paper series of the World Bank for example, the "Management and Resolution of Banking Crises" by Jose De Luna -Martinez, World Bank Discussion paper, March 2000, "Resolution of Corporate Distress" by S.Claessens, S.Djanlov, L.Klapper, Policy Research Working Paper Series, June 1999 the World Bank, "The real impact of Financial shocks" by I.Domaç and G.Ferri, Policy Research Working Paper Series, November 1998 the World Bank.
6 As GOK itself described in its 3 December Letter of Intent to IMF: "Korea's external financing situation deteriorated sharply after October 23, following the decline in the Hong Kong stock market and the downgrading of Korea's sovereign risk status by Standard and Poor's. New external financing has virtually dried up and substantial difficulties are being experienced in rolling over the relatively large amount of short-term debt (estimated at $100 billion). The won depreciated by about 20 percent against the U.S. dollar through November 30; the stock market index fell by some 30 percent to a ten-year low. Gross official reserves declined sharply, with a large amount used to finance the repayment of short-term debt of Korean commercial banks' offshore branches. While the contagion effects of developments in Southeast Asia contributed to the current crisis, the magnitude and speed of the deterioration in the financial situation owed much to the fundamental weaknesses in Korea's financial and corporate sectors."
7 The Financial Supervisory Commission ("FSC") began operation on April 1, 1998 as the supreme financial regulatory organisation under the Act on Establishment of Financial Supervisory Organisations. On January 1, 1999, four supervisory bodies including the Banking Supervisory Authority, the Securities Supervisory Board, the Insurance Supervisory Board and the Non-Bank Supervisory Authority were consolidated into a single body, the Financial Supervisory Service (FSS). The FSS enforces financial regulations under the supervision of the FSC. Accordingly, all financial institutions are subject to regulatory supervision of the FSC.
The FSC is an independent governmental organisation under the Office of the Prime Minister. The FSC consists of up to nine Commissioners, each of whom is appointed by the President of Korea for a renewable term of three years.
8 The detailed Corporate Restructuring Programme of GOK was set out in a Memorandum of Understanding dated 23 July 1998 between GOK and the World Bank
9 Originally Daewoo was also meant to apply a CSIP; however, its efforts failed and it eventually applied for a workout.
10 Petrochemicals, aircraft, railroad vehicles, power generation equipment, ship engines, semiconductors and oil refining.