With the economy still hobbling along, bogged down by sluggish domestic demand that threatens to dampen the effect of the country’s roaring exports, South Korea’s government is betting on private equity funds (PEFs) as new engines to revitalise the nation’s financial markets and ultimately jump start a fully-fledged recovery.
Led by the reform-minded deputy prime minister, Lee Hun-jai, South Korea’s ministry of finance and economy recently drafted a revision for asset management laws that designates PEFs as limited partnerships in which small groups of professional investors pool long-term capital to invest in equities and companies.
When investing in corporations, the funds will aim for profits by improving corporate governance and management performance. And because PEFs are now expected to involve a much smaller number of investors acting in their own interests, the government has lifted many of the existing regulations to make investment easier.
Coaxing investors
The revision was part of a bid to coax investors to part with nearly $400bn of their idle money, hidden away in the face of rock-bottom interest rates, a dull real estate sector and a fickle stock market.
Just how reluctant the country is to make fresh investments was seen in the surge in the banking sector’s short-term money market funds. By the end of May this year, Won1540bn ($1.3bn) had flowed into the money market funds of the country’s top eight commercial banks, including Kookmin and Woori.
The development of PEFs is widely anticipated to result in the increased sophistication of South Korea’s asset management market, helping to finance economic growth to the 5% level that President Roh Moo-hyun has pledged.
Early in his tenure, Mr Lee proposed establishing a private fund worth about Won10,000bn to buy stakes in institutions awaiting privatisation, such as Woori Bank. Although that plan was soon scrapped, Mr Lee still believes a strong asset management market could ultimately protect the country from some of the unwelcome foreign capital.
As it is, Asia’s fourth-largest economy has a weak and fragmented PEF market. Although the country ranked 13th in the world in terms of the aggregate assets managed in 2002, the number of funds managed was the highest following the US. But the average amount of capital per fund came to only slightly over 2% of the $18.3m funds the US has, meaning that South Korean funds are that much more risky.
Big enough to compete
Park Jong-hyun, a professor of economics at Yonsei University, says: “The government wants PEFs to grow strong and big enough to compete and win against foreign funds that are trying to take over the host of financial institutions undergoing privatisations.”
Awaiting privatisation along with Woori Bank are two of the nation’s largest trust companies: Korea Investment Trust & Securities Co and Daehan Investment Trust & Securities Co.
Four bidders – Kookmin Bank-JP Morgan Chase & Co consortium, Hana Bank in a joint bid with Goldman Sachs Group Inc, Dongwon Financial Holding Co, and Prudential Group – are vying to acquire controlling stakes.
Woori Finance Holdings Co was chosen as the preferred bidder for LG Investment & Securities Co, the nation’s number two brokerage, which has also been fishing for a buyer since LG Group was forced to sell to pay creditors of its ailing credit card unit, LG Card Co.
Since the 1997-98 Asian financial crisis, a few major institutions have fallen into foreign hands. The trend was spurred by New Bridge Capital’s acquisition of the second-largest stake in Korea First Bank. Now, Korea Exchange Bank is controlled by Texas-based Lone Star Funds, while Hyundai Investment & Securities Co was bought out by US insurance giant Prudential.
While economic experts recognise the beneficial effect of foreign investors in the once-reclusive nation, a feeling of resentment has also been growing locally.
“We need to coax more foreign capital towards domestic investment banks and away from commercial banks. At the same time, we have to focus on nurturing more PEFs to help local investors control the banking sector,” says Park Duk-bae, a researcher at Hyundai Research Institute.
There are doubts, however, about just how effective PEFs can be in restructuring the financial and corporate sector. “We are not certain if PEFs will actually spring to life with the new laws, especially since a sweeping round of reforms has already passed through the country,” says investment banker Kim Seung-ho of Kookmin Bank, which is the country’s largest commercial lender.
Another trend the government wants to introduce to local capital markets with the more relaxed rules for regulating PEFs is a greater variety in investment portfolios. Park Sun-hwa, marketing director at Australia-based Macquarie-IMM Investment Management, says: “Although we don’t expect to see a huge rise in our sales in the near future, we are definitely getting ready to launch a handful of new derivatives products.”
This month, Goldman Sachs joins hands with domestic trust companies – such as Samsung Investment Trust & Management and Daehan Investment Trust & Securities Co – to introduce funds investing in raw materials based on data from its Goldman Sachs Commodity Index. The investment bank forecast an increased interest in such portfolios once PEFs begin to play bigger roles.
International raw material prices have been surging since early this year, with crude oil prices moving in tandem to hit record-high prices before stabilising a bit last month after the Organisation of Petroleum Exporting Countries’ decision to increase output.
Kookmin Bank is poised to pool institutional investors, pension funds and its private banking clients to form a PEF worth Won100bn-300bn. The fund would mainly dig up competent small and mid-sized firms that have gone under solely due to finance problems.
“But we can’t say when we can launch the fund because the enforcement of the revised law still seems to be a long way off,” says Kookmin’s Kim. “We see more possibility of creating funds to invest in social overseas capital or merger and acquisitions.”
Shinhan Financial Group is preparing to operate a similar fund by pooling about Won200bn-300bn. One fear about such funds and the whole plan to activate the PEF market is that companies may protest about losing management rights once they are normalised on the back of the private funds.
Doubts and loopholes
That’s not all: obtaining managerial control through PEFs remains a thorny issue, as civic groups fiercely oppose several aspects of the revised law. In a recent statement, the People’s Solidarity for Participatory Democracy (PSPD) condemned the government for flinging open doors to financial institutions for conglomerates to enter at free will, and also permitting industrial capital to tyrannise the banking sector.
“By allowing PEFs to invest more than 10% in banks, the PSPD accuses the state of perpetuating the influence of [South] Korea’s chaebol in the financial sector,” said Kim Sang-jo, head of the solidarity’s Participatory Economic Committee.
Under the form of unlimited partnership, PEFs were made exceptions to many laws, including financial holdings and Fair Trade Commission regulations. “If the government is sincerely concerned about the growing presence of foreign private funds in the domestic financial sector, it could do better by stepping up financial holding company and bank laws to tighten regulation on such foreign funds,” says Mr Kim of the PEC.
Contentious issue
The finance ministry contends that the ruling from the Fair Trade Commission, the nation’s top antitrust watchdog, that financial holding company rules apply to conglomerates with controlling shares in enterprises – either financial or non-financial – applies for a period of 10 years or more.
“There has to be a limit to how long the funds can wield control, and I believe the Fair Trade Commission was very generous to have granted such a long grace period,” says Kim Hyoung-tae, vice-president of the Korea Securities Research Institute.
The government addressed some of the other controversial issues as well by obliging financial institutions, including those owned by conglomerates, to receive approval from the Financial Supervisory Commission when seeking to acquire 20% or more in a non-affiliate.
“Whether PEFs can fully live up to expectations won’t be known until the funds grow in both size and quality,” says Mr Kim of Kookmin Bank.
