[Rapid Growth of Asset Management Firms] Poor Staffing and Internal Controls... Worsened the Private Equity Fund Crisis

More Than 6 Out of 10 Asset Management Firms Operate with 20 or Fewer Employees
Small-Scale Asset Management Firms Cite 'Personnel' and 'Internal Control' as Challenges

[Asia Economy Reporter Kum Boryeong] Criticism is being raised that the insolvency of asset management companies exacerbated the private equity fund (PEF) crisis. The Lime and Optimus incidents are analyzed to have originated from shortcomings in compliance and risk management. More than six out of ten asset management companies operate on a small scale with fewer than 20 employees, resulting in a severe shortage of necessary personnel where they are needed. As competition among asset management companies intensifies, a structure has also been created where survival depends on meeting the demands of distributors, such as producing OEM (Original Equipment Manufacturer) funds.

According to the Korea Financial Investment Association on the 22nd, as of the end of March, there were a total of 90 asset management companies with 10 or fewer employees. This accounts for 30% of the 300 registered asset management companies. There were also 104 companies with 11 to 20 employees. In total, 64.6% of asset management companies operate on a small scale with 20 or fewer employees.

The biggest challenges for small-scale asset management companies are 'personnel' and 'internal control.' Although the number of employees does not necessarily reflect a company's capability, the structure is inevitably vulnerable to risks compared to large asset management companies. In particular, the limitations of support departments such as compliance are prominent.

Recent incidents involving Lime and Optimus are also analyzed to have been halted due to deficiencies in compliance systems and risk management functions. Lime Asset Management, for example, managed about 6 trillion won last year but had only 54 employees as of June 30, 2022, before the crisis erupted. Optimus Asset Management had only 12 employees as of March 31 this year. This is a stark contrast to comprehensive asset management companies, which have anywhere from around 100 to 900 employees.

An asset management company official explained, "Large asset management companies benefit from economies of scale, so they operate in some form, but smaller firms are likely to have only operational personnel." He added, "Ultimately, whether it is Lime or Optimus, the incidents are related to compliance or risk management." Another asset management company official said, "Large firms invest heavily in compliance to manage reputational risk, building systems and even fighting with managers to prevent unilateral decisions. In contrast, small asset management companies prioritize survival, so they do not invest in personnel unless necessary, and if they do, they prefer to hire one more manager."

The number of asset management companies increased significantly starting in 2015. The Capital Markets Act was amended to require private equity fund management companies to register with at least 2 billion won in capital, a minimum of three professional management personnel, and physical facilities comparable to public fund managers. The system shifted from licensing to registration, allowing anyone who met the requirements to enter the market. Later, the capital requirement was lowered to 1 billion won. As the entry barrier lowered, the establishment of private equity fund managers increased, and cases of investment advisory firms converting to private equity fund managers also rose. Lime Asset Management started as an investment advisory firm in 2012 and transformed into an asset management company in 2015. Although the increasing number of asset management companies raised the demand for personnel, the talent pool itself was not large, so compliance and risk management personnel remained insufficient.

A structure also emerged where small asset management companies had no choice but to create funds according to the demands of distributors such as securities firms. As the number of asset management companies surged, the initiative in product sales shifted toward distributors. OEM funds are a representative example. OEM funds are funds created according to the orders or requests of fund distributors and are prohibited under the Capital Markets Act. NH Nonghyup Bank was fined 2 billion won by the Financial Services Commission last month for ordering funds from Fine Asia Asset Management and Aram Asset Management using the OEM method from 2016 to 2018, splitting them into private equity funds with fewer than 49 investors to evade public fund regulations. As of early 2018, Fine Asia Asset Management and Aram Asset Management had 33 and 10 employees, respectively.

A financial investment industry official said, "Once an OEM fund is created, management fees can be earned and assets under custody increase, so such cases occasionally occur." Another industry official stated, "The biggest goal for small asset management companies is to break into at least one distributor, and to do so, they sometimes create products according to the distributor's demands."

Additionally, the relaxation of regulatory requirements for general investors to revitalize the private equity fund market is also analyzed as a factor behind various incidents. In 2015, the Financial Services Commission lowered the minimum investment amount from 500 million won to 100 million won. As a result, the private equity fund market grew from 172 trillion won at the end of 2014 to 414 trillion won at the end of March this year.

Following the successive private equity fund crises, financial authorities are proposing improvement measures. The Financial Services Commission will raise the minimum investment amount for general investors from 100 million won to 300 million won starting at the end of this month. For asset management companies, internal controls for risk identification and management will be strengthened. A securities firm official predicted, "With the minimum investment amount raised to 300 million won, the pool of potential clients to whom products can be recommended will shrink, allowing a focus on more professional investors or institutions. Even if incidents occur, the number of affected investors will decrease."

The Korea Financial Investment Association is also promoting measures to restore trust in the capital market, which has plummeted due to ongoing private equity fund crises. They plan to produce and distribute manuals and checklists for internal controls of professional private equity fund managers to enable immediate practical use. They also plan to provide consulting support to companies found to have vulnerabilities through comprehensive investigations.

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