Allowing Foreign Investors Direct Access to Domestic ETFs: Capital Market Globalization and Liquidity Prospects

Amidst the recent strong upward trend of the KOSPI index driven by the rally in semiconductor and AI-related stocks, an impending institutional change is poised to serve as an additional catalyst for growth.

Background and Core Policies of the Regulatory Reform

The Financial Services Commission (FSC) is advancing a regulatory reform that fully allows foreign investors to directly invest in domestic Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) to enhance their accessibility to the Korean capital market. As of May 2026, while the entry and exit of foreign capital into the domestic equity market are relatively unrestricted through the 'omnibus account' system, ETFs and ETNs have been excluded from the permissible trading assets, creating constraints for global institutional investors in their asset allocation strategies.

This measure focuses on officially adding ETFs and ETNs to the lineup of tradable products in foreign omnibus accounts by amending the Financial Investment Business Regulations. This is part of structural maintenance to elevate South Korea's capital market regulatory environment to global standards and to resolve the structural 'Korea Discount' phenomenon.

Ripple Effects on Market Liquidity and the ETF Market

1. Inflow of Global Liquidity and Improved Supply and Demand

If direct investment in ETFs by foreign investors is permitted, foreign capital, which has been concentrated in individual stocks, is expected to diversify into passive funds encompassing themes, sectors, or broad market indices. The inflow of global liquidity into specific sector-based ETFs, such as semiconductors, AI, and Value-up related funds, will significantly improve the overall supply and demand stability of the Korean stock market. This provides an effective channel to absorb the demand from foreign institutional funds seeking to bet on the growth of the Korean market while hedging the volatility risks associated with individual stocks.

2. Synergy with the Corporate Value-up Program

Considerable synergy is anticipated in conjunction with the government-driven Corporate Value-up Program. As the pathway opens for foreign capital to directly invest in Value-up ETF series centered on undervalued blue-chip stocks, a virtuous cycle can be expected where domestic companies' efforts to enhance shareholder returns and improve corporate governance translate into tangible rewards in the form of foreign liquidity.

3. Strengthening Product Competitiveness in the Asset Management Industry

With the influx of foreign capital, the global product development capabilities of domestic asset management companies will also be put to the test. Moving beyond passive ETFs that simply track indices, the expansion of the Active ETF and smart beta product lineup will accelerate to satisfy the diversified appetites of foreign investors. Ultimately, this will yield a positive spillover effect by offering high-quality investment choices to domestic investors as well.

Tax Restructuring and Future Implementation Schedule

Resolving the Dividend Income Tax Withholding Issue

Under the current system, one of the primary bottlenecks when foreign investors trade domestic ETFs is tax processing. Technical challenges remain, including the withholding tax standards on fund distributions and the responsible withholding entities. Financial authorities are currently coordinating closely with the Ministry of Economy and Finance to resolve these issues. The core agenda is how to systematically reflect the differences in withholding tax rates by country according to various tax treaties.

Implementation Timeline and Utilization of No-Action Letters

Once the tax restructuring is complete, the policy is scheduled to take effect following a notice of regulatory changes. Considering the strong market demand for adoption, financial authorities are actively reviewing a plan to issue no-action letters to brokerages and asset managers whose systems are ready, allowing for early implementation even before the formal regulatory amendment. Consequently, visible market opening is highly likely to occur as early as the second half of this year.

This policy, which lowers the borders of the capital market, represents more than just the expansion of investment products; it will serve as a testing ground to prove the maturity of the Korean financial market. From a long-term perspective, it is evaluated as a core driver that will support the strengthening of the global competitiveness of the domestic asset management industry and a stable upward trend for the KOSPI index.