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Jipyong News|KOREA LEGAL INSIGHT

Korean Privately Placed Funds: Way Forward

2021.02.01

1. Introduction 
 
With consecutive suspensions on the redemption of open-ended privately placed funds under the management of Lime Asset Management Co., Ltd. (“Lime AMC”) and Optimus Asset Management Co., Ltd. (“Optimus AMC”) totaling trillions of Korean won in the last two years, South Korea’s private equity market has never attracted more attention and scrutiny from the public. 
 
Under the current Financial Investment Services and Capital Markets Act (the “Act”), a privately placed fund can take the form of either (i) a private equity fund (a “PEF”) or (ii) a hedge fund (a “Hedge Fund”). PEFs adopting a so-called ‘buyout’ strategy to control an underperforming target company by acquiring a controlling interest in the same and eventually realizing high returns by disposing the shares of the target company (which, by then, would have gone through rigorous processes to achieve efficiency and enhanced value) were introduced to the South Korean private equity market in 2004 through an amendment to the Indirect Investment Asset Management Business Act. Since then they have grown exponentially to find their place in the South Korean private equity market. 
 
Hedge Funds having the characteristics of investing in relatively high liquidity assets such as stocks of listed companies, bonds, currencies and derivatives were introduced to the South Korean private equity market in July 2015 through an amendment to the Act after a series of discussions on the adaptation of a homegrown ‘South Korean Hedge Fund’ scheme. 
 
 
2. Notable Characteristics of Privately Placed Funds in Korea 
 
A. Limited Number of Investors 
 
PEFs and Hedge Funds, in which qualified and professional investors willing to take high risk for high returns participate, share a common denominator in the sense that they are both ‘privately’ (rather than ‘publicly’) placed. Principally, PEFs and Hedge Funds offer investment products to high-net-worth individuals with the capacity to, directly or indirectly, analyze and, most importantly, bear associated investment risks. In this regard, the Act (i) prohibits PEFs and Hedge Funds from offering and selling investment products to an unspecified group of individuals and (ii) limits the number of investors of a PEF or a Hedge Fund to no more than 49. 
 
The most valuable assets of asset management companies can be said to be talented and experienced core management personnel (the “Fund Managers”). The investors interact directly with the Fund Managers to determine their investment in a particular PEF or Hedge Fund and this decision is largely dependent on the relevant managing experience of the Fund Managers and the management strategies they have to offer. 
 
The structure of PEFs under the Act is generally in line with the basic attributes of privately placed funds as discussed herein (and it would also be fair to say that PEFs are managed accordingly). A vast majority of PEF investors are comprised of institutional investors such as pension funds and financial institutions. These institutional investors conduct a thorough and in-depth review of the eligibility of an asset management company which will be managing the PEF they look to invest in. 
 
In the case of a blind pool fund which tends to be bigger in its investment size, a fund is formed based on the investors’ capital commitments. Capital will later be called by the general partner for investment and then divested in each investment at its discretion in accordance with the fund’s investment policy. It is during this process where the investors are provided sufficient information concerning the investment. 
 
In the case of a project fund which is formed for a specific investment purpose, the investors are entitled to provide their opinions on certain matters after being provided with information regarding the investment by the asset management company. 
 
 
B. Exemption from Suitability Requirement 
 
In the case of Hedge Funds, their structure is not generally in line with the basic attributes of privately placed funds as discussed herein due to reasons attributable to the background and period of introduction of Hedge Funds into the South Korean private equity market and conflict of interest issues among market participants. A Hedge Fund is usually formed as an investment trust of which sales are mostly conducted through securities companies or banks under the Act. This inevitably leads to a lack of face-to-face interaction with the Fund Manager. Further, as Hedge Funds (as a form of a privately placed fund) offer and sell to qualified investors only, it is exempt from the code of conduct concerning sales associated with the suitability requirement (as set forth in Article 46 of the Act) and the adequacy requirement (as set forth in Article 46-2 of the Act). 
 
Furthermore, while Hedge Funds typically require investors’ capital to be contributed upon admission, PEFs typically require investors to make capital commitments upon capital call by the general partner. This approach is workable for Hedge Funds which invest in relatively high liquidity assets on an open-end basis (that is, free from restrictions on the redemption). It is noteworthy that the open-ended privately placed funds managed by Lime AMC and Optimus AMC were formed and managed outside the boundaries of traditional Hedge Funds. 
 
As is the case for publicly placed funds, investment assets of Hedge Funds are required to be held by a third party trustee (in most cases, banks) in order to ensure that the asset management companies manage Hedge Funds in accordance with a trust agreement and information memorandum. In addition, the administration of Hedge Funds must be carried out by a third party fund administrator. However, the appropriateness of measures taken to ensure the separation of roles undertaken by asset management companies (including the role of distributors, trustees and fund administrators) have been called into question considering the need for close communication and trust between investors and asset management companies. 
 
 
3. Conclusion 
 
It is difficult to predict how these ongoing issues surrounding privately placed funds in South Korea will end. What is clear however is that privately placed funds (especially PEFs) now form a vital part of South Korea’s capital market and there is a strong need for a sound and specialized private equity market to ensure South Korea’s independence from foreign privately placed funds.

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KOREA LEGAL INSIGHT Korean Privately Placed Funds: Way Forward 2021.02.01

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