The Financial Services Commission ("FSC") and the Financial Supervisory Service ("FSS") of Korea gave a briefing on a Plan for Development of Trustworthy and Dynamic Asset Management Market on December 14, 2017. This Plan mainly covers the structural improvement for public offering fund and private placement fund for professional investors but also includes a significant improvement related to PEF. The supervisory authorities will carry forward the amendment to the Financial Investment Services and Capital Markets Act (the "Capital Markets Act") reflecting this Plan in the second half of 2018 [a relaxation of the burden of obtaining the approval for investment under the Act on the Structural Improvement of the Financial Industry (the "Financial Industry Act") (see Clause 3 below) is scheduled to be made in the first half of 2018]. 
 

This structural improvement is expected to boost more the PEF management firms' entry into the PEF market. It also seems to find a solution to the issue of PEF's investment in non-voting preferred shares that has been controversial.

 

The details of this Plan for development of PEF-related system are as follows:

1. PEF Management Firms Permitted to Establish PEF Freely

 

Under the current system, for a PEF management firm to establish a PEF, it shall meet the equity capital requirements (KRW 100 million) and separately register GP. This Plan, however, permits a PEF management firm to establish and manage a PEF without registering the GP, given that the requirements for registration of a PEF management firm are stricter than those for registration of GP. In other words, the registration of PEF management firm can be considered to include the registration of GP. Now 16 PEF management firms are known to have been also registered as GP. Given that even the equity capital requirements for PEF management firms will be relaxed (which plans a reduction to KRW 100 million from KRW 200 million), it is expected that more PEF management firms will actively hop in the PEF market. 
 
This Plan, however, does not mention whether to remove the Chinese Wall under the current system that is a barrier to restrict the flow of information between the PEF management firm and GP. Eventually, the Chinese Wall is an issue resulting from the categorization of GP services into the corporate financial business but not the collective investment business under the Capital Markets Act. It merits attention whether an improvement of this issue will be included when this Plan is actually reflected in the Capital Markets Act. 
 
Furthermore, if the entry requirements for PEF management firms are alleviated and it is possible to establish and mange a PEF without registration of a separate GP, a fair number of new players will be highly likely to register themselves as a PEF management firm instead of GP. In light of that point, this Plan seems to be a transitional phase for the supervisory authorities' long-term plan to unify the private equity fund system ultimately.

2. Expansion of the Scope of Assets Investible by PEF

 

It has been controversial whether the conventional PEF is entitled to invest in non-voting preferred shares (including convertible preferred shares, redeemable preferred shares, convertible and redeemable preferred shares, etc.). Especially, the debate has focused on which one among the methods for managing collective investment property of PEF, the investment in non-voting preferred shares can fall under, i.e., the 'investing its collective investment property so that it can exercise de facto control' (Article 249-12 (1) 2 of the Capital Markets Act) or the 'investing its collective investment property in mezzanine securities' (Article 249-12 (1) 3 of the Capital Markets Act). For reference, voting preferred shares are treated as the same as common shares under the current system. 
 
Specifically mentioning the convertible preferred shares and the convertible and redeemable preferred shares, this Plan makes it clear that 'CB, BW and similar financial instruments' will be expressly included in the assets investible by PEF. Given that point, there is a strong possibility that the system will be improved through the amendment to Article 249-12 (1) 3 of the Capital Markets Act to the effect that only non-voting preferred shares with the conversion rights are treated as the same as CB and BW. If the system is improved in this way, it will become possible for a PEF to invest in non-voting preferred shares only in the case where the PEF can acquire 10% or more of the total number of issued shares with voting rights in other company or exercise de facto control over the other company by exercising the conversion rights. On the other hand, if a PEF has the right to appoint executives while acquiring non-voting preferred shares without the conversion rights (such as non-voting redeemable preferred shares), it seems to be unclear whether it will be deemed to constitute 'investing its collective investment property so that it can exercise de facto control' (Article 249-12 (1) 2 of the Capital Markets Act).

3. Venture Capital Firm's Reduced Burden of Obtaining Approval for Investment

Where a financial institution registers GP and establishes a PEF, it shall obtain approval for investment in accordance with Article 24 of the Financial Industry Act. Since it usually takes 4~5 weeks to obtain the approval for investment under the said Act, it will take a relatively long time for a financial institution or a venture capital firm to establish a PEF management firm or a PEF. 
 

Despite this Plan for development, a financial institution which intends to register GP and establish a PEF is still required to obtain approval for investment under the Financial Industry Act. However, the process for a venture capital firm which intends to establish a PEF has been a little simplified as the 'specially-related person of the major shareholder' of the venture capital firm is excluded from the list of persons who are subject to eligibility screening. In the long term, we think it will be necessary to consider an exemption from the approval for investment under the Financial Industry Act with regard to establishment of PEF.