Poor Fund Manager Expulsions Predicted...Will the Private Equity Market Shrink?

Strengthened Regulations to Prevent Lime-Related Insolvency
Rapid Removal via Deregistration System for Insolvency Such as Capital Below 700 Million Won

101 Asset Management Firms Recorded Losses Last Year
87% of Them Are Professional Private Equity Firms
Capital Outflow from Fund Market Inevitable

[Asia Economy Reporters Hyojin Kim, Jihwan Park, Minyoung Kim] Concerns are growing that the financial authorities' private equity fund (PEF) system improvement measures, which include the expulsion of insolvent private fund management companies, will significantly shrink the domestic private equity fund market. While there is a positive effect in promoting the restructuring of small and medium-sized private fund managers, given that the PEF market has rapidly frozen since the Lime Asset Management incident, experts point out that a phased introduction of the system and strengthening of post-penalties are needed rather than purely preventive measures.

According to financial authorities and the financial investment industry on the 27th, as of the end of last year, 101 management companies, accounting for 34.6% of all managers, posted losses, and among them, 88 companies (87.1%) were specialized private fund managers. The number of domestic asset management companies, which was 93 in 2015, surged to 292 last year due to the easing of entry regulations for private fund managers.

Based on the results of the private fund status inspection conducted from November last year to January this year, the financial authorities released the "Private Fund Status Evaluation and System Improvement Plan" last month. The core content is the introduction of a deregistration system that allows insolvent specialized private fund managers, such as those failing to meet the capital maintenance requirement (70 million KRW), to be quickly expelled through a Financial Services Commission resolution without inspection procedures. Deregistration of management companies will be pursued solely based on reasons such as failure to meet capital maintenance requirements within a six-month grace period after violation, or failure to meet personnel requirements for six months, regardless of direct financial consumer damage.

The financial authorities' inspection targeted 52 management companies and 1,786 funds, identifying issues such as inadequate risk management through market discipline and vulnerability in investor protection due to some management structures. Although private funds, which are lightly regulated, should manage risks through market discipline, the roles and responsibilities of managers and others in this regard were insufficient. Some funds showed maturity mismatches, complex layered and circular structures, and leverage expansion, which could burden fund liquidity. Accordingly, the financial authorities judged that the roles and responsibilities of managers, distributors, custodians, PBS securities firms, and investors should be clearly defined to enable effective mutual monitoring and checks. Measures such as strengthening internal controls and key decision-making structures of management companies, ensuring fairness in fund asset valuation, and expanding compensation capacity through additional capital accumulation were derived for these reasons.

Currently, financial authorities are accelerating the expulsion of insolvent private fund managers. Given the high public interest due to incidents like derivative-linked funds (DLF) and Lime Asset Management's redemption suspension, they consider this an urgent matter that cannot be delayed.

A Financial Services Commission official said, "The deregistration system requires legal amendments, and it has not yet been decided whether it will be legislated by lawmakers or by the government. Consultations with related agencies have been completed, and after the formation of the National Assembly's Political Affairs Committee, the fastest method will be chosen."

The market expects rapid restructuring centered on loss-making management companies. Juyun Shin, a researcher at Hana Financial Management Research Institute, said, "Due to increased regulatory costs to comply with strengthened regulations, restructuring centered on small and medium-sized specialized private fund managers is expected to become more active."

A financial authority official explained, "More than half of specialized private fund managers are not profitable. From a profitability standpoint, it means that more than half could be removed from the market." This implies the need to prevent situations where insolvent managers cause large-scale consumer damage through reckless fund management.

If the financial authorities' regulations and their aftereffects become visible, the already contracted private equity fund market is expected to shrink further. The private fund assets under custody increased by 6.2 trillion KRW from September 2018 to September last year but only increased by 3.2 trillion KRW until last month. The growth trend noticeably slowed after Lime Asset Management announced fund repayment and redemption suspensions in October last year. The inflow of funds from institutional investors such as financial institutions slowed, and outflows from individual investors continued.

Researcher Shin predicted, "Especially, the asset size of mixed-asset funds, which have a large scale and a very high proportion of individual investors, will see the most significant contraction in growth." A financial investment industry official pointed out, "Preventive regulations cause significant side effects such as market shrinkage, leading to increased opportunity costs. Therefore, phased application of the system or the introduction of post hoc targeted regulations should also be considered."

The financial authorities are also paying close attention to market conditions. A financial authority official said, "The market is currently contracted, and management companies have little capacity to cause problems. It is necessary to approach cautiously based on a thorough review of the overall market situation."

This content was produced with the assistance of AI translation services.