Amendment to FSCMA on Private Fund Regulations

On March 24, 2021, the National Assembly passed an amendment to the Financial Investment Services and Capital Markets Act (the “FSCMA” and such amendment, “Amendment”) to substantially overhaul the Korean private fund regulations. In particular, the Amendment eliminates the existing system of classifying private collective investment vehicles (or “private funds”) by management purpose and instead regulates the funds solely based on the type of investors which the funds target. The Amendment will take effect on October 21, 2021.

The details of the Amendment are as follows, and we have prepared a list of Q&As regarding the application of the amended FSCMA to existing private funds.

1. Reclassification of Private Funds

Consolidation of private fund types: new distinction between “institutional private funds” and “general private funds”

Under the current FSCMA, private funds are classified into two categories based on the investment objective of the fund: (i) management participation (i.e., private equity funds or “PEFs”) and (ii) private funds for qualified investors (i.e., hedge funds for non-management participation), and each classification is separately regulated. In order to serve as a general partner of a PEF, the company is required to register with the regulators as a general partner, and in order to serve as the management company for a private fund/hedge fund, the company is subject to more stringent eligibility requirements and required to be registered as a private asset management company (“Private AMC”). The Amendment removes such classification and instead distinguishes between “institutional” private funds (which are funds sold to institutional investors) and “general” private funds.

The main implication of this change is that existing general partners of PEFs will be permitted to establish and manage institutional private funds, while existing Private AMCs will be permitted to establish and manage general private funds.

New market participants may apply for registration to manage either institutional private funds or general private funds, the latter being subject to more eligibility and ongoing compliance requirements.

Q: Does a previously registered PEF or PEF manager need to register again?
A: No, it is not necessary to register again. There are supplemental provisions of the Amendment that recognize PEFs registered/reported in accordance with the current FSCMA (Article 2 through Article 5 of the Addenda).

PEFs and private funds registered/reported under the current law	PEFs and private funds registered/reported under the Amendment
Specialized PEF	General PEF
Specialized collective investment vehicle (hedge fund)	General private fund
Management member of a management participating collective investment vehicle	Management member of an institutional private fund
Management participating PEF and investment purpose company	Institutional private fund and investment purpose company

Increase in the maximum number of private fund investors

While the current FSCMA and sub-regulations limit the number of actual investors in a private fund to a maximum of 49 investors, the Amendment relaxes this limit to 100 investors. However, the specific method of calculating the number of investors will be set out in the Presidential Decree, and the number of non-professional investors (who are in need of greater protection) is still limited to 49.

Q: How does the regulation on applications affect each type of investor?
A: While the regulations on the total number of investors have been relaxed, the number of investors subject to the application solicitation, which is the basis for offering and revenue, remains the same as before at 50 or more (when there are 49 or less, it does not apply to offering and revenue).

Type	Application solicitation	Number of investors	Comparison with the current law
General investor	Limited to 49 people or less	Limited to 49 people or less	Virtually the same as the current law
Institutional investor	No restrictions	No restrictions	Virtually the same as the current law
Professional investor other than institutional investor	Excluded from the determination of solicitation recipients	Included in determination of solicitation recipients	The regulation has eased from the existing limit of 49 people or less to 100 people or less

Consolidation of investment management regulations

Currently, different sets of regulations apply to PEFs and non-PEFs (hedge funds) in order to ensure that such funds are managed in compliance with their respective objectives. However, the Amendment removes such distinction and eases the regulations as follows:

Type	Current	Amendment
Management participation investment obligations	Hedge funds: May not participate in management PEFs: Must acquire 10% or more of shares with voting rights or exercise de facto control	No such classification. However, if either a general private fund or institutional private fund chooses to invest by way of management participation, they are required to exit within 15 years.
Limits on voting rights	Hedge funds: Voting rights limited to 10% PEFs: No limit	No limit
Borrowing	Hedge funds: Within 400% of net assets PEFs: Within 10% of net assets for the fund itself, and within 300% of net assets for the special purpose company	Within 400% of net assets
Loans	Hedge funds: Loans are allowed, but personal loans are prohibited PEFs: Prohibited	Loans are allowed in principle. However, funds investing in loan receivables have restrictions on investor qualifications, and funds are prohibited from lending to individuals or those prescribed by the Presidential Decree.

Q: Do the same regulations apply for mutual investment-restricted business groups or funds?
A: In accordance with the consolidated management regulations, all private funds are now subject to more stringent regulations to prevent the excessive expansion of mutual investment-restricted business groups. However, the specific regulatory methods differ as follows.

Institutional private funds: The obligation to not acquire shares of affiliates and to dispose of shares of an incorporated company within five years, which has been applied to management participating private funds that are affiliates of a mutual investment-restricted business group, is now equally applied to institutional private funds that belong to the same category.
General private funds: As restrictions on voting rights on general private funds have now been abolished, for general private funds that are affiliates of a mutual investment-restricted business group, voting rights may not be exercised on the excess shares exceeding 10% of other companies’ shares in order to prevent the expansion of control.

Changes in regulations for institutional private funds

Since institutional private funds can only be sold to classified institutional investors, the Amendment eases some of the existing regulations including:
- Management personnel requirements for registration of general partners: Currently, there is only a minimum personnel requirement to register as a general partner of the PEF. The Amendment introduces a qualification requirement by adding “certain investment management experts designated by the Presidential Decree.”
- Audit by regulatory authorities: The Amendment provides that general partners, in addition to institutional private funds, may be subject to FSC measures or audits by the Financial Supervisory Service (the “FSS”) in case it is “necessary for the stability of the financial market and transaction order.”

Q: Do general partners previously registered as PEF management members also have to meet the qualifications for investment management experts under the registration requirements?
A: Yes, although PEF management members registered at the time of the enforcement of the Amendment pursuant to Article 5 of the Addenda are considered to be management members of institutional private funds, the special provisions of Article 6 grant only a one-year grace period before they must meet the qualifications as investment management experts.

2. General Private Fund Regulations Strengthened for Investor Protection

There have been a number of high-profile incidents involving certain local private funds which resulted in substantial losses to investors. As a result, the Amendment introduces certain investor protection measures applicable to general private funds.

Private AMCs are required to prepare “key product disclosures” (but not a full offering memorandum) and provide them to potential investors through distributors. The distributors are required to verify that the content of the key product disclosures is consistent with the fund documents (i.e., collective investment agreement).
Even after the sale of the general private funds, the distributors are required to confirm that the Private AMC’s management conforms to the key product disclosure. Should there be a nonconformity, the distributors are required to request that the Private AMC rectify its management activities.

The reinforcement of the regulations discussed above, along with the introduction of new regulations relating to financial consumer protection, is expected to bring substantial changes to the business environment of financial companies (such as distributors and trustees).

Q: Are previously established specialized private funds subject to the regulations that reinforce investor protection?
A: The obligation to provide core product descriptions under Article 249-4 (2) through (7) of the Amendment; the distributor’s obligation to, among others, verify, deliver and correct the core product description; and the obligation to notify (i) do not apply to existing investors of the fund, but (ii) do apply to the first issuance of product descriptions following the enforcement of the Amendment (Article 7 of the Amendment).

Conclusion

With the Amendment, the regulatory framework related to private equity funds has been significantly reorganized. Therefore, relevant parties should familiarize themselves with the changes and prepare in advance for requirements subject to grace periods, including investment management personnel requirements. They should also review whether to amend their internal regulations and business guidelines to strengthen investor protection. In addition, closely examining the legislative trends of the Enforcement Decree and its subordinate regulations (e.g., the scope of limited liability partners of private equity funds for institutions) may be necessary.

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