Financial Services Commission Restricts Self-Dealing in Private Equity Funds...Regulations on Unfair Business Practices Violating Disclosure Materials

[Asia Economy Reporter Park Jihwan] Going forward, the scale of self-dealing transactions between an asset management company's own funds will be limited to within 20% of the average assets under custody for the previous March. Additionally, private equity fund management that violates explanatory materials will be defined as an unfair business practice, and the capital reserve requirements for professional private equity fund managers will be strengthened.

On the 18th, the Financial Services Commission announced that the amendment to the Financial Investment Business Regulations, aimed at enhancing investor protection and management and supervision of private equity funds, was approved at the regular meeting held the previous day. This is a follow-up measure to the 'Private Equity Fund Improvement Plan' announced by the FSC in April last year.

First, when conducting self-dealing transactions (transactions between fund assets), evaluation by a third-party independent institution such as an accounting firm or credit rating agency will be mandatory for all assets without reliable market prices.

Also, the monthly scale of self-dealing transactions will be limited to within 20% of the average assets under custody for the previous March. However, this does not apply if all investors in the funds involved in the self-dealing transactions give their consent. A Financial Services Commission official explained, "Due to the nature of transactions between fund assets, there is a possibility that the insolvency of a specific fund could be transferred to other funds, so stricter restrictions are necessary."

The financial authorities have also established investor protection measures for leveraged funds using total return swaps (TRS), which borrow multiple times the fund assets as collateral to invest. Leverage generated through total return swap contracts must be clearly reflected within the private equity fund leverage limit (within 400% of net assets). Additionally, to ensure investors are aware of the risks, the possibility of borrowing and the maximum borrowing limit of the fund must be reflected in the collective investment regulations.

Capital requirements for professional private equity fund managers have also been strengthened. Previously, maintaining KRW 700 million after market entry was sufficient, but going forward, an additional amount corresponding to 0.02?0.03% of assets under custody must be reserved. The additional funds collected will be used as a source for compensation. Furthermore, additional reserves will be mandatory to respond to proprietary asset risk investments, and the status of the manager's capital will be reported monthly to the supervisory authorities.

For professional private equity fund managers with assets under management of KRW 200 billion or more, specialized internal control and risk management checklists will be provided, and compliance details must be reported to the financial authorities.

Moreover, private equity fund management that violates the explanatory documents provided to investors will be clearly defined as an unfair business practice by the management company, and violations will result in sanctions against institutions and executives, as well as fines of up to KRW 50 million. Currently, when selling private equity funds, sales companies must provide investment explanatory materials to fulfill their duty of explanation. However, while failure to provide explanatory materials is regulated as an unfair business practice by the sales company, it has been difficult to regulate cases where the fund is managed differently from the explanatory materials as an unfair business practice.

The scope of supervisory reporting on private equity fund management risks has also been expanded to strengthen the management and supervision of private equity funds by the authorities. Unlike public funds, which report on overall fund management status, private equity funds currently only report leverage status to the supervisory authorities. Going forward, reports must include fund structure, status of investment target assets, status of non-marketable asset investments, inter-fund investment status, liquidity risk status, performance status, and related management risks and control measures.

The submission deadlines for some disclosure documents by credit rating agencies have also been extended. Quarterly credit rating performance reports must now be submitted within one month from the reference date, extended from within 10 days, and annual submissions of credit rating change tables and average cumulative default rate tables have been extended from within 20 days to within one month.

The amendment to the Financial Investment Business Regulations will take effect from the date of notification, the 18th. The strengthened capital reserve requirements for professional private equity fund managers will be enforced six months after the notification date, and the expanded reporting requirements for management companies to the supervisory authorities will apply starting from reports based on the end of June.

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