Change in Regulations Concerning Private Funds as a Result of the Amendment of the Financial Investment Services and Capital Markets Act (the “FSCMA”)
Pursuant to the amended FSCMA, effective from October 25, 2015, regulations applicable to private funds have been greatly relaxed. This amendment is also expected to have a significant impact on real estate investments that are made via private funds. Below, we discuss some important elements of the amendment that should be of interest to investors and the broader asset management industry in Korea.
New Types of Collective Investment Vehicles are Introduced to Guarantee More Flexibility in Investment Structuring
The amended FSCMA introduced the “private collective investment vehicles for professional investment” (referred to as “New Type Private Funds”), which replaces several types of private fund classifications that existed under the previous FSCMA. The New Type Private Funds are given more flexibility in their investment structuring, as discussed below:
- The regulation of the type of targeted investment assets has been removed.
Before its amendment, the FSCMA classified the types of private funds into real estate funds, securities funds and special asset funds depending on the primary targeted investment asset. In the case of “real estate funds,” whether public or private, the funds must have invested more than 50% of their assets in “real estate,” and the scope of items accepted as “real estate” was strictly restricted.
For example, if a private real estate fund intended to invest in real estate via a special purpose company (“SPC”), as is commonly done in connection with outbound investments, the equity securities issued by the SPC were accepted as “real estate” but the debt securities issued by the SPC were not accepted as “real estate.” Private real estate funds could not invest in real estate by way of acquiring the debt securities in the SPC in excess of 50% of its property and collective investment companies (which is a term used to described asset management companies in Korea) faced many restrictions in structuring their investments via the private real estate funds.
However, the amended FSCMA no longer distinguishes between such varied classifications of private funds, and thus collective investment companies can use the New Type Private Funds to invest in any type of assets. This brings significant flexibility in investment structuring. In the case of the example provided above, the New Type Private Funds can now invest 99% of its investment funds in the debt securities issued by an SPC which holds real estate.
- Many regulations on the method for managing assets have been relaxed
Previously, private real estate funds were prohibited from providing a guarantee or security to a third party. Korean financial regulators determined that even an SPC whose interests were mostly or wholly owned by a private real estate fund, would be considered a “third party” under this rule. In such a case Korean regulators did not allow a private real estate fund to support the credit standing of the SPC even if the private real estate fund intended to invest in real estate via the SPC, which in turn resulted in financing complications during transactions. In addition, private real estate funds were restricted from investing in derivatives products, since they were allowed to invest in derivatives only to the extent that the risk assessment amount arising out of those transactions was less than 100% of their aggregate net assets.
Under the amended FSCMA, the New Type Private Funds can now provide a guaranty or security to a third party for up to 400% of their aggregate net assets, and can execute derivatives transactions to the extent that the risk assessment amount is 400% or less than their aggregate net assets. As such, the New Type Private Funds can utilize more varied methods of management than previously allowed under the previous FSCMA .
Barriers to Enter the Market Have Been Reduced for the Private Fund Management Business
The amended FSCMA has eased qualification requirements of collective investment companies which manage the New Type Private Funds, and has made it easier for the collective investment companies to obtain a license.
As explained above, the previous FSCMA classified the types of funds depending on the types of primary targeted investment assets. Different capital requirements were applied to collective investment companies that were allowed to manage each type of fund, although even under the previous FSCMA, there was a certain type of private fund which was not subject to the aforementioned limitation on the type of target assets. Such funds were defined as “Mixed Asset Funds” under the FSCMA, and collective investment companies of Mixed Asset Funds had to hold at least 6 billion Korean won in capital.
However, under the amended FSMCA, the required amount of capital for a management company of a New Type Private Fund is 2 billion Korean won or more, a significant decrease from the amount of capital required for collective investment companies of a Mixed Asset Fund under the previous FSCMA. Because the barriers to the collective investment business have been considerably lowered, the have been news reports that many companies, including, investment consultancy companies are gearing up to register a collective investment business with the FSC in order to manage the New Type Private Funds.
Assessment and Outlook on the Relaxed Regulations on Private Funds
With respect to the relaxed regulations on private funds resulting from the amendment of the FSCMA, there is some ambiguity regarding the Korean regulators’ stance on certain issues. For example, pursuant to the wording of the amended FSCMA, private funds are now allowed to make investments by directly originating a loan as well as by assuming an existing loan from a financial institution, but the Korean monitoring authority has said that it will establish additional guidelines for such investments, and the direct origination of a loan is still prohibited until the guidelines are issued.
Despite certain matters that still remain unclear, the market’s overall assessment of the amendment is positive as the regulations on private funds have been sharply relaxed. The purpose of the amendment was intended by the Korean government to facilitate private funds investment by relaxing regulations and lowering barriers to the collective investment business.