Insights

The Korean Stewardship Code Must Adopt an Implementation Grading System
to Function as an ‘Enforceable Standard’

 ㅣ Karl Yang, Founder & Executive Director of KoSIF ㅣ

The Korean Stewardship Code (Principles on the Fiduciary Responsibilities of Institutional Investors) is undergoing its first comprehensive revision since its inception ten years ago.

This revision draws attention as it expands the applicable asset classes from listed equities to bonds, infrastructure, real estate, unlisted equities, and overseas assets, while formally incorporating ESG and sustainability factors into the scope of fiduciary duty.

Defining the scope of stewardship activities beyond proxy voting to include constructive dialogue, shareholder proposals, litigation, and the expansion, reduction, exclusion, or divestment of investments represents clear progress. Differentiating responsibilities between asset owners and asset managers and drawing proxy advisors and ESG rating/data providers into the 'chain of responsibility,' are also meaningful changes.

This revision should not be viewed merely as a minor adjustment to behavioral guidelines for institutional investors. It represents a meaningful institutional reform coming at a crucial moment—when ESG is no longer an auxiliary element of corporate management but a core criterion for capital allocation, and when Korea's capital market must strengthen investor protection and market trust to leap into an advanced market.

However, while the proposed amendment points in the right direction, its force is severely inadequate, leaving the impression that it is still far from becoming an ‘enforceable standard.’ Although it declares the incorporation of ESG, the mechanisms to drive actual changes in investment and corporate behavior remain weak.

Furthermore, while emphasizing capital market modernization, the structure to hold institutional investors substantively accountable beyond formal participation and policy disclosures remains deficient. The core issue is that while the scope of the Stewardship Code has broadened, the execution power and accountability required to enforce it have not been proportionally strengthened.

ESG Must Be Viewed as a Core Principle of Capital Allocation, Not an Auxiliary Item in Investment Analysis

The amendment’s inclusion of ESG factors and sustainability in the scope of monitoring investee companies is a clear step forward. However, defining ESG primarily through the lens of 'financially material factors' poses a distinct limitation.

The essence of ESG is not limited to assessing how short-term environmental and social issues impact individual corporate value. Rather, its core lies in 'Double Materiality'—examining how corporate activities impact the environment and society, and what consequences those impacts ultimately bring to the stability of the economy and the market as a whole over the long term.

Climate change, biodiversity loss, supply chain human rights violations, industrial accidents, and community conflicts may not immediately manifest in a company's short-term financial performance. However, over time, these issues transform into regulatory costs, litigation risks, asset impairments, insurance risks, supply chain disruptions, and reputational damage. Ultimately, ESG risks are a matter of long-term investment returns and are inextricably linked to the sustainability of the entire market.

Particularly, major public pension funds like the National Pension Service (NPS), large institutional pensions, insurers, and mega-asset managers act as 'Universal Owners' invested across virtually all industries and enterprises. Even if a specific company boosts short-term profits by externalizing pollution and social costs, if doing so damages overall economic productivity and erodes the value of other companies within the portfolio, the collective interest of investors has not increased.

Therefore, the Korean Stewardship Code must explicitly reflect double materiality and systemic risk perspectives beyond individual companies' short-term financial materiality. Concurrently, legal and institutional enhancements must be made under the current Financial Investment Services and Capital Markets Act to broaden the interpretation of institutional investors' fiduciary duty—shifting from 'prioritizing short-term returns' to 'comprehensive and long-term value creation.' Only then can asset managers actively address systemic risks without the fear of litigation.

Omitting Climate Change from the Main Text Ignores the Demands of the Era

Climate change is not merely one of many ESG items; it is a representative systemic risk that disrupts the structure of the entire capital market. The energy transition, carbon pricing, extreme weather events, stranded assets, and supply chain realignments directly alter corporate cash flows, cost of capital, and industrial competitiveness.

Yet, the proposed amendment fails to explicitly mention climate change in its main text, leaving it to be addressed in future guidelines instead. Official press releases also present the explicit inclusion of climate change merely as a task for subsequent practical guidance (to be included in the explanatory handbook). This is a stopgap measure that falls far short of global investment shifts and the demands for capital market modernization.

Global investors are already demanding that companies disclose not only greenhouse gas emissions, but also science-based climate transition plans, interim reduction targets, capital expenditure (CapEx) alignment, climate policy lobbying activities, Scope 3 emissions, and plans for a Just Transition.

In a climate where global pension funds are divesting from or voting against companies with inadequate climate responses, ignoring these standards in the Korean market does not protect domestic companies; rather, it increases the overall cost of capital for Korean firms and undermines international trust.

Climate change must not be an optional reference item; it must become a mandatory subject of verification under fiduciary duty. Institutional investors must rigorously evaluate whether an investee company's transition plan aligns with science-based reduction pathways and whether its capital expenditures match its declared reduction targets.

The Starting Point for Capital Market Modernization is Strengthening Institutional Accountability

Capital market modernization cannot be achieved solely through index inclusion or the expansion of foreign investment. It requires trustworthy rules, transparent decision-making, minority shareholder protection, independent boards, and responsible institutional investors working in tandem.

The Korean capital market has long suffered from controlling-shareholder-centric management, low dividends, capital inefficiency, opaque mergers and spin-offs, inter-affiliate transactions, treasury stock abuse, and a lack of board independence. A significant portion of the so-called 'Korea Discount' stems from these governance risks and a lack of market trust.

The Stewardship Code is the core internal market mechanism designed to correct these very issues. Market discipline is established when institutional investors monitor value-destroying corporate actions, hold boards accountable, protect the rights of minority shareholders, and demand long-term value creation.

However, while the proposed amendment requires institutional investors to establish and disclose policies, it fails to specify how their actual actions will be evaluated or held accountable. In reality, what capital market modernization demands is not the 'possession of policies,' but the 'quality of action.'

Institutional investors must be rigorously evaluated on how independently they judged management proposals, how they responded to critical issues causing corporate value destruction, and what follow-up steps they took after failed engagements.

‘Comply or Explain’ Must Not Become a Shield against Accountability

The amendment remains a non-binding soft law, applying the 'Comply or Explain' framework to participating institutions. The problem lies in the absence of standards to evaluate the thoroughness and legitimacy of those 'explanations.'

If an institution fails to comply with a principle yet retains its participant status simply by submitting boilerplate excuses such as "difficult to apply due to investment strategy characteristics" or "unable to implement due to internal circumstances," the Stewardship Code will inevitably devolve into an idle declaration rather than an enforceable norm.

To modernize the capital market, a far more robust implementation framework must be introduced for large public pension funds, insurers, mutual aid associations, and major asset managers. When failing to comply with a principle, they should be required to transparently disclose alternative management measures, improvement timelines, designated personnel in charge, and implementation outcomes, rather than offer simple explanations.

Institutions that repeatedly offer inadequate explanations should face staged actions, including requests for remediation, rating downgrades, public warnings, and suspension of participation status. Voluntary norms should not mean that accountability itself is left voluntary.

Implementation Reviews Must Be Credible Verifications, Not Formalistic Audits

A significant change in this revision is that the Development Committee will review the implementation level of institutional investors' fiduciary duties, and participating institutions will be required to submit annual activity reports.

However, review criteria, evaluation methods, public disclosure of results, appeal procedures, and sanctions for persistent non-compliance remain vague. If implementation reviews operate merely as paper-based audits that check the existence of policy documents and public disclosures, the practical effectiveness of the system cannot be expected.

Predictability and comparability are crucial for capital market modernization. Asset owners must be able to judge which asset managers faithfully execute long-term value creation and ESG risk management. To facilitate this, the implementation levels of participating institutions should be assigned public evaluation grades (e.g., Leading, Faithful, Partial, Formal, Critical Non-compliance) alongside detailed results. The credibility of the Stewardship Code stems not from the number of participating institutions, but from the rigor of the reviews and the independence of the evaluations.

Expanding Applicable Asset Classes Must Not Remain Symbolic

The amendment expands the code’s potential application to bonds, infrastructure, real estate, unlisted equities, and overseas assets. However, leaving the actual application entirely to the discretion of each institution is disappointing.

This undermines the consistency of ESG risk management. It is a logical contradiction to apply ESG criteria to a company's equity while ignoring them when purchasing corporate bonds issued by the same company. If an investor engages on equity investments in coal power or mega-development projects but applies no separate standards to project financing (PF) or infrastructure investments, real shifts in capital allocation cannot be expected.

Institutional investors should disclose code application across their entire portfolio and explain reasonable grounds and alternative management plans if specific asset classes are excluded. Furthermore, detailed guidelines tailored to the characteristics of each asset class—such as refinancing conditions for bonds, board participation and contractual terms for private/unlisted investments, and environmental and safety risks for infrastructure and real estate—must be established swiftly.

Engagement Must Be Evaluated by Outcomes of Change, Not Frequency of Dialogue

The amendment emphasizes constructive dialogue and staged engagement activities with companies. However, clear targets, deadlines, and escalation standards for engagement activities are missing.

If an institutional investor reports years of dialogue with a company, yet the company's behavior remains entirely unchanged, that is not successful stewardship. Engagement should not be measured by increasing the frequency of meetings, but by driving substantive shifts in corporate decision-making, risk management, and capital allocation.

Mandatory escalation guidelines must be introduced, following a clear sequence: Notice of Concern  Management Dialogue  Board Consultation  Open Letters & Collaborative Engagement  Voting Against Proposals  Shareholder Proposals & Voting Against Director Appointments  Investment Reduction & Divestment. Particularly for critical issues such as climate transition, industrial accidents, and governance failures, explicit deadlines must be set, with engagement levels and intensity escalated immediately if improvements are not made.

Reflecting Engagement Outcomes Remains ‘Discretionary’—It Must Lead to Investment Decisions

The amendment stops at discretionary language, stating that engagement outcomes 'may be reflected' in investment decisions. This is the single most fatal limitation of the current revision.

If an institution analyzes a company's ESG risks, conducts dialogue, confirms a failure to improve, and yet its investment decisions remain unchanged, stewardship becomes nothing more than 'promotional rhetoric' detached from the investment process.

Critical engagement outcomes must be quantitatively factored into corporate valuation, discount rates, risk premiums, portfolio rebalancing, and ultimate divestment decisions. If an institution chooses not to reflect these outcomes, it should be required to document reasonable grounds internally and explain them externally. For ESG to function practically in capital markets, it must move beyond information disclosure to drive real changes in the cost of capital and capital allocation.

Exercise of Voting Rights Is the Core of Capital Market Discipline

Voting rights are the most fundamental and powerful tool for institutional investors to hold boards and management accountable. The amendment's requirement to publicly disclose specific reasons for 'for,' 'against,' 'abstain,' and 'neutral' votes is a positive step.

However, boiler-plate public statements are insufficient. For items that significantly impact corporate value and minority shareholder interests—such as mergers, spin-offs, treasury stock disposals, director appointments, executive compensation, governance restructuring, and climate strategies—detailed justifications for each company and agenda item must be publicly disclosed.

When an investor votes contrary to proxy advisors' recommendations or when a conflict of interest exists, explaining the resolution process and reasoning clearly is essential to establishing proper market discipline.

No Independence for Institutional Investors Without Conflict of Interest Management

Institutional investors in Korea's capital market face structural conflicts of interest. Representative examples include asset managers affiliated with financial groups exercising voting rights on group affiliates, asset managers hesitating to vote against proposals from key corporate retirement pension clients, and public pension funds being exposed to political pressure.

Although the amendment requires establishing and disclosing conflict-of-interest policies, concrete procedures to guarantee independence during major conflicts remain lacking. For significant conflict-of-interest cases, independent committee reviews, external expert evaluations, and ex-post disclosure of voting rationales must be made mandatory. Furthermore, conflicts of interest arising from proxy advisors and ESG rating agencies simultaneously offering consulting and evaluation services must be strictly managed.

Asset Owners Must Lead Long-Termism in the Market

The amendment appropriately highlights the role of asset owners—such as pension funds and insurance companies—and outlines provisions for manager evaluations and fair compensation structures.

However, the reality of the mandated investment market remains trapped in 1-year short-term returns and low-fee price wars. Expecting long-term engagement activities from asset managers while evaluating them based on short-term performance is a structural contradiction.

Asset owners must mandate quantitative scoring for ESG analysis capabilities and stewardship performance in Request for Proposals (RFPs) when selecting and evaluating asset managers and extend evaluation cycles to the medium-to-long term. Mandated investment contracts should explicitly outline engagement goals, voting principles, and penalty measures for non-compliance. In particular, when large public funds like the National Pension Service firmly establish principles of responsible investment, systemic improvements across the entire asset management industry can follow.

Capital Market Modernization is Inseparable from ESG

Some dismiss ESG as a mere burden on corporations or an issue of non-financial values, attempting to treat it separately from capital market modernization. However, these two agendas are inextricably linked.

A properly functioning ESG framework means that companies transparently disclose environmental, social risks, and governance issues; boards fulfill their long-term responsibilities; and investors faithfully incorporate these factors into capital allocation and voting decisions.

This is a core process that reduces information asymmetry, mitigates agency problems, rationalizes corporate capital costs, and enhances long-term investor confidence.

A sound ESG framework is a prerequisite for a healthy capital market. A market that tolerates opaque governance and irresponsible institutional investors can never be considered an advanced market, regardless of its trading volume. For Korea's capital market to truly leap into advanced market status, it must go beyond providing convenient trading environments for foreign investors and demand long-term accountability from both corporations and institutional investors alike. The Stewardship Code serves as that vital infrastructure.

Moving Beyond 'Expansion of Scope' toward a 'Norm of Responsibility and Outcomes'

This revision holds undeniable significance as it transitions the Korean Stewardship Code away from its early, voting-centric focus toward broader horizons encompassing ESG, sustainability, asset owner responsibilities, and multi-asset classes.

However, the current framework still leans heavily on 'formal compliance'—drafting policies, publishing them on websites, and reporting activities. The system must now transition into an 'enforcement framework' that identifies critical ESG risks, sets targets and timelines for engagement, escalates actions sequentially when progress stalls, reflects outcomes in voting and capital allocation, and subjects final results to rigorous verification.

The Stewardship Code is not a mechanism designed to pressure corporations. It is a market discipline intended to simultaneously enhance long-term corporate competitiveness and sustainable investor returns, establishing ESG as a foundational principle of capital allocation.

For this revision to bear real fruit, satisfying ourselves with an increased number of participating institutions is not enough. It must change the actions of institutional investors, alter corporate decision-making, and ultimately transform the flow of capital.

The scope has expanded. What is needed now is depth of responsibility and strength of execution. If the Korean Stewardship Code is to become a practical norm leading capital market modernization, it must take the next step forward—from a 'Code of Declaration' to a 'Code of Action and Outcomes.'