The amendment to the Financial Investment Services and Capital Markets Act (the “FSCMA”), which restructures the regulations on private collective investment vehicles (or “private funds”), including investor protection measures, was promulgated on April 20, 2021 and will take effect on October 21, 2021.  Under the amended FSCMA, (i) private funds, which were classified into two categories based on the investment objective of the fund (i.e., management participation or hedge funds for non-management participation) will be re-classified based on the target investors as “institutional” private funds (which are funds sold to institutional investors) and “general” private funds; (ii) the limit on the number of investors in a private fund will be increased from up to 49 investors to up to 100 investors; and (iii) for general private funds, new measures to strengthen investor protection will be implemented. 

Please refer to the following link for the newsletter titled “Amendment to the FSCMA on Private Fund Regulations” which includes details on the amendment to the FSCMA.

On June 23, 2021, the Financial Services Commission (the “FSC”) announced the proposed amendments to the Enforcement Decree and Enforcement Rules of the FSCMA and the Regulations on Financial Investment Business (collectively, the “Proposed Amendments”).  The Proposed Amendments are expected to take effect on October 21, 2021 in line with the amended FSCMA.
 

1.   Unification of Regulations on Investment Management

Under the amended FSCMA, the regulations governing private funds will be unified.  Key details of the Proposed Amendments in relation to the unified regulations governing private funds are as follows:
 

• Issuance of loans

Under the current FSCMA, only “private funds for qualified investors” (i.e., hedge funds for non-management participation) are permitted to issue loans using the fund’s assets.  Under the Proposed Amendments, all private funds are permitted to issue loans as part of its management activities (provided that, the investors in such private funds must be limited to only institutional investors).  However, the amended regulations prohibit private funds from directly issuing loans to individuals or certain entertainment, gambling and other businesses or indirectly issuing loans to such entities through lending businesses or online investment-linked financial businesses.
 

• Limitation on borrowing and leverage

The current FSCMA specifies different limits on the amount a private fund may borrow (leverage) based on the type of private fund.  For example, a hedge fund may borrow up to 400% of its net assets, while a private equity fund may only borrow up to 10% of its net assets.  The amended regulations provide that all private funds will be permitted to borrow up to 400% of net assets.  However, the resale amount for a repurchase agreement (RP) of securities and the sale amount for a short sale (i.e., securities borrowed and sold) will be deemed borrowing when calculating the leverage ratio, since the relevant transactions in essence constitute borrowing. 
 

2.   Changes to Regulations on Institutional Private Funds
 

• Scope of investors for institutional private funds

Under the amended FSCMA, only “institutional investors and persons equivalent thereto” are permitted to invest in an institutional private fund, and these investors are regarded as those with the necessary expertise and risk profile.  No individuals—other than foreigners, officers or management personnel of the relevant General Partner (“GP”)—may invest in institutional private funds.  

The Proposed Amendments specify the scope of “institutions” that may become investors (limited liability partners) in institutional private funds.

• Registration requirements of GP of institutional private funds

Under the Proposed Amendments, to register as a GP of an institutional private fund, the applicant is required to have at least two experts in the areas of institutional private fund management, securities management or real estate management. 

The term “investment management experts for institutional private funds” means (i) a person who has at least three years of work experience managing institutional private funds or (ii) a person who has at least three years of work experience as an officer or employee of certain financial institutions, professional investment institutions or general partners of institutional private funds and has completed certain training as determined by the KOFIA.

Other than the above investment management personnel requirements, the GP registration requirements are the same as the existing GP registration requirements for private equity funds.
 

3.   General Private Fund Regulations Strengthened for Investor Protection
 

The Proposed Amendments strengthen the investor protection regulations by imposing a duty on distributors, trustees and other service providers to check and monitor the management of general private funds.  These new measures only apply to general private funds, and not to institutional private funds.  The Proposed Amendments set forth the relevant details as follows:
 

• Preparation and delivery of key product disclosures

Private asset management companies (the “Private AMCs”) are required to prepare and provide “key product disclosures” to the distributors, and the distributors are required to deliver them to general investors during the solicitation and sale of the fund.  The Proposed Amendments set forth the items to be included in the key product disclosures, including a summary of the fund, investment strategy, major target assets and risk factors, and also set forth the methods of delivery of the key product disclosures to include (i) delivery in writing, (ii) mail or e-mail, or (iii) text message via mobile phone or other electronic communication equivalent thereto.
 

• Distributor’s prior verification of key product disclosures

Distributors are required to verify whether the content of the key product disclosures prepared and provided by the Private AMC conforms to the collective investment agreement (i.e., the fund documents) prior to the sale of the general private funds.  The Proposed Amendments provide that the content of the key product disclosures to be verified by the distributor will include (i) whether the risks associated with the investment are properly described and (ii) whether the major target assets, investment policies and investment strategies conform to the collective investment agreement.
 

• Distributor’s monitoring of management and request for correction

As the distributors are required to confirm whether the management activities of the Private AMC conform to the key product disclosures after the sale of the general private funds, the Proposed Amendments set forth (i) the criteria and method for the distributors’ confirmation regarding the Private AMC’s management after the sale, (ii) the distributors’ request to the Private AMC to withdraw, amend or rectify the management activities so that they conform to the key product disclosures and (iii) if the Private AMC fails to comply with such request, the distributor must report to the FSC and notify the investors.

In addition, the Proposed Amendments stipulate that the act of managing collective investment assets in violation of the key product disclosures constitutes an unsound business activity of a collective investment manager (which includes a Private AMC).
 

• Trustee’s monitoring of management

Trustees are required to confirm that the Private AMC’s management activities do not violate applicable laws and regulations, the articles of incorporation/trust deed or the prospectus, and, if there is a violation, are required to request that the Private AMC correct such violation.  The Proposed Amendments define the private funds subject to such obligation of the trustees as (i) general private funds targeted to general investors and (ii) general private funds for which investors are private or public funds (targeted to general investors) in a fund-of-funds structure.  

In addition, the Proposed Amendments require the trustee to confirm whether the details of the statement on the collective investment assets and details of the collective investment assets in the custody and management of the trustee, including the category and quantity of the collective investment assets, are consistent as of the end of each quarter.
 

The Proposed Amendments will be subject to regulatory review and the Ministry of Government Legislation’s review from August to September 2021.  Following the resolution of the State Council and the Vice-Ministers’ Meeting in October 2021, the Proposed Amendments will be amended and enforced as of October 21, 2021, in line with the enforcement date of the amended FSCMA.  In addition to the introduction of the Act on the Protection of Financial Consumers, the strengthened regulations on private equity funds are expected to lead to substantial changes in the business environment of financial companies, including distributors and trustees.