Last March 24, 2021, the National Assembly passed an amendment bill (the “Amendment Bill”) to the Financial Investment Services and Capital Markets Act of Korea (the “Capital Markets Act”) to restructure the current classification system for private equity funds and strengthen investor protections. The Amendment Bill will be promulgated into law after Cabinet Council approval, and implemented 6 months after promulgation; implementation is expected by October 2021.
The amendments contained in the Amendment Bill will bring about sweeping changes to the Korean private equity market to bring it near par to that of the US, where the convergence between private equity and hedge funds is now commonplace after over 10 years of ongoing market changes.
The following are key aspects of the Amendment Bill.
I. Restructuring of Private Equity Funds System
1. Reorganization of private equity funds classification system
The Amendment Bill modifies the classification criteria for private equity funds. Currently, private equity funds are classified by the purpose for their fund management, as (i) professional investment-type funds and (ii) management participation-type funds. Under the Amendment Bill, private equity funds will be reclassified based on the scope and scale of their investors, as (i) general private equity funds and (ii) institutional private equity funds.
Post-Amendment Requirements for Private Equity Funds
2. Application of uniform regulations on management of private equity funds
While general private equity funds and institutional private equity funds will have differing ranges of investors, the regulations for management of both types of funds will be uniformly applied on the same level currently applied to professional investment-type private equity funds. In other words, all types of private equity funds will be permitted to freely choose from a broader range of investment strategies such as equity/mezzanine investments, borrowings and lending (excluding loans to individuals); currently, such strategies are only permitted for professional investment-type private equity funds.
The Amendment Bill abolishes current requirements on management participation-type private equity funds to acquire at least 10% of voting shares and hold such shares for more than 6 months. Domestic private equity funds will thus be able to participate in management with smaller shareholdings to enhance corporate value. In addition, both general private equity funds and institutional private equity funds will be permitted to manage loan-type private debt funds (PDF), which is currently only permitted for professional investment-type private equity funds.
3. Improved regulations on number of investors
The Amendment Bill will change the Capital Markets Act’s limitation on number of investors in private equity funds from "49 or less" to "100 or less". More professional investors will thus be able to invest in private equity funds. However, the public offering regulations that limit the number of general investors in a private equity fund to 49 or less will still apply. Thus, although the limitation on overall number of investors will be relaxed with the change to “100 or less”, the limitation on general investors permitted to invest in private equity funds will remain at “49 or less”.
II. Strengthened Investor Protections
1. Enhanced management and supervision of private equity managers and general partners
The Amendment Bill introduces a new procedure for swift removal without official investigation or sanction review of inadequate managers who have failed to meet equity capital and manpower requirements for a specified time period (e.g. 6 months). While this procedure will be uniformly applied to private equity managers including investment advisory and management companies, some flexibility will also be available when investor protection considerations may not warrant swift removal or an official sanction is warranted.
The Amendment Bill also introduces general partners’ obligation to register changes (e.g. general partners are obligated to report changes in initially registered matters within two weeks of change and submit yearly financial statements), and financial authorities’ authority to inspect general partners to prevent occurrences of financial market system risks.
2. Strengthened duties on selling entities to keep management entities in check and trustee entities to monitor general private equity funds
Under the Amendment Bill, if a prospectus for core products (explaining investment strategies, targets, risks) is provided to general investors for investment recommendations and sale purposes and the relevant private equity fund product is sold to general investors, the selling entity must keep tabs on whether fund management conforms with the prospectus. If any unreasonable or improper fund management practice is discovered, the selling entity may request the management entity to correct the practice; if the management entity does not comply, the selling entity must report such practice to the supervisory authorities.
The Amendment Bill also requires trustee entities to monitor whether fund management instructions comply with applicable laws, regulations and manuals, and request correction if there is an unreasonable management instruction. In addition, securities companies offering prime brokerage services (PBS) that provide leverage such as credit lending to private equity funds must evaluate and manage the risk level of leverage.
3. Other measures for strengthened investor protections related to general private equity funds
The Amendment Bill requires external audits for private equity funds (i) with assets exceeding KRW 50 billion or (ii) with assets between KRW 30 billion to KRW 50 billion and that have issued additional collective investment securities within 6 months, to ensure fair valuation of fund assets. The Amendment Bill also requires submission of quarterly asset management reports and collective investors’ meetings for redemption postponement to ensure that investors are able to understand management information in a transparent manner.
Lastly, the Amendment Bill enhances liquidity management to prevent maturity mismatches by prohibiting establishment of open private equity funds that can be redeemed at any time, among other measures, when the proportion of non-marketable assets (assets for which no market price is calculated) is 50% or more.
