[ANALYSIS] New Capital Markets Act weighs on smaller PEFs

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Larger fund managers capitalizing on regulatory reform

By Park Jae-hyuk

The enforcement of the revised Financial Investment Services and Capital Markets Act from Thursday this week has created a stir over the possibility of widening the gap between large and small private equity firms (PEFs) here.

In contrast to bigger firms that view the regulatory reform as an opportunity to start lucrative new businesses, smaller ones are facing greater challenges in their fundraising, causing concerns about their sustainable operations.

"The revision could solidify the dominance of large companies in the nation's private equity industry," an industry insider said on condition of anonymity.

The new law categorizes funds raised by PEFs into the "general funds," in which individuals can invest, and "institution-only funds" that only allow investments from institutions and certain professionals.

Previously, such funds were classified as hedge funds and those used for involvement in the management of companies. However, the classification system has been changed to better protect retail investors, after a series of fiascos involving hedge funds that caused massive damage to non-professionals.

"Institutions and experts, who can manage risks, are allowed to invest in institution-only funds," the Financial Services Commission (FSC) said in a press release earlier this year. "Regulations on the operation of those funds will be minimized to enhance autonomy in management."

The specific examples of institutions and experts are specified in the enforcement decree of the law.

They include sovereign wealth funds, the Bank of Korea, pension funds, mutual aid associations and special entities, such as the Korea Deposit Insurance Corp. and the Korea Asset Management Corp. Listed companies and foreign investors can also make investments, if they are considered to have expertise and experience.

Among unlisted firms, companies that invested more than 50 billion won ($42 million) in financial products over the past year can invest in institution-only funds.

As a result, minor PEFs that do not have enough of a track record to draw the attention of large institutional investors have become unable to continue relying on unlisted small- and medium-sized enterprises (SMEs), when raising their funds.

Some of them are said to have sought advice from law firms to hasten their raising of funds, before the new law takes effect.

"Smaller PEFs that raised funds from SMEs are expected to suffer significant damage to their operations," a lawyer specializing in the capital market said.

Financial experts anticipate several small-size PEFs to be expelled from the market.

"Because individuals were able to invest in funds intended to participate in business management, some companies used PEFs as detours to raise money," Hana Institute of Finance researcher Ahn Seong-hak said in report. "As a result, the market was crowded with small-size PEFs."

The entrance to the Financial Services Commission (FSC) in the Government Complex Seoul / Courtesy of FSC

Discrimination against KDB, IBK

Another controversy is that the Korea Development Bank (KDB) and the Industrial Bank of Korea (IBK) have been barred from using their private equity departments in lending activities and real estate investments, even though the revised law enables PEFs to carry on such businesses.

The financial authorities decided to continue to impose previous regulations on institution-only funds managed by banks and insurers, in order to protect depositors and policyholders.

Most financial holding companies avoided this restriction, as they are running their private equity businesses through their securities or asset management subsidiaries.

However, the two state-run banks still have their own private equity departments.

The regulatory measures are expected to make KDB and IBK less attractive to institutional investors, when the banks compete with other PEFs to raise funds.

Main beneficiaries

While smaller firms and state-run banks are facing difficulties from the new law, major PEFs are enjoying benefits from the eased regulations.

IMM Private Equity set up a wholly-owned private debt firm named IMM Credit Solution last year, following the FSC's announcement of revising the Capital Markets Act. The subsidiary drew attention in May for acquiring a 40 percent stake in SK lubricants for 1.1 trillion won.

VIG Partners, which has specialized in investing in mid-size companies here, also established VIG Alternative Credit in May, after appointing former Goldman Sachs Asian Special Situations Group executive director Han Young-hwan to lead the subsidiary.

Glenwood Private Equity hired former Dominus Investment Chief Investment Officer Lee Chan-woo to task him with establishing and leading Glenwood Credit. STIC Investments also plans to enter the market next year, based on its experience of managing multiple special situation funds for startups.

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