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Fostering Private Equity Using a Law-First Approach: Lessons from South Korea

  • Sung Eun (Summer) KIM (a1)
Abstract

In 2004, South Korean lawmakers introduced sweeping legislation to regulate Korean private equity funds. I describe this Korean regulatory initiative as a ‘law-first’ approach to financial regulation: the laws first clearly outline the terms of an ideal private equity structure, and private equity funds and their managers are required to comply with such terms to gain entry into the Korean private equity market. Elsewhere, private equity funds are referred to as shadow banks, with the descriptor ‘shadow’ referring to the funds’ ability to remain outside of the regulatory purview. Attempts to regulate private equity funds and other shadow banks more extensively have been resisted with claims that such regulation will go either too far and regulate shadow banks out of existence, or not nearly far enough as shadow banks expediently exploit loopholes to navigate around new regulation. This article presents the Korean private equity regulatory regime as a counterexample to the existing discourse by showing that private equity funds can survive, and in some cases thrive, under a law-first regulatory approach.

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BA (Seoul National University), JD (Harvard Law School) and admitted to the New York and California bars (both currently inactive). Assistant Professor of Law and Director, Korea Law Center, University of California, Irvine, School of Law. I wish to thank Afra Afsharipour, Funmi Arewa, Jonathan Glater, Joan Heminway, Hwang Lee, Soonkoo Myoung, Donna Nagy, Jeff Schwartz, and Chris Whytock for their helpful comments and discussions on earlier drafts, and Christina Tsou and Jessica Pierucci of the UC Irvine Law Library for their invaluable research assistance.

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1. For a survey of various approaches to financial regulation, see John Armour et al, Principles of Financial Regulation (OUP 2016) 86, 505, 551. As between formal versus functional approaches, Korea can be said to take a functional approach to financial regulation, which regulates financial instruments according to their function rather than by the type of institution that is offering such financial instruments. See Ministry of Justice of the Republic of Korea, ‘Introduction of the Financial Investment Services and Capital Markets Act’ (International Affairs Division, Ministry of Justice, Republic of Korea 2013) 6467 .

2. For a primer, see Kim, Hwa-Jin and Chen, Alice Z, ‘Private Equity in Korea: History, Industry and Policy’ in Hwa-Jin Kim (ed), Korean Business Law (Edward Elgar 2012) 199 , and Kang, Hee Jeu and Kim, Hyun, ‘The Present and Future of Private Equity Funds (PEF) in Korea’ in Hwa-Jin Kim (ed), Korean Business Law (Edward Elgar 2012) 218 .

3. Jong Hyun Park, Joon B Kim, and Byoung Kwon Park, ‘Private Equity in South Korea: Market and Regulatory Overview’ (Thomson Reuters Practical Law Country Q&A 8-521-4346, 1 February 2015) <https://uk.practicallaw.thomsonreuters.com/8-521-4346> accessed 5 February 2018.

4. The Financial Supervisory Service (FSS)’s private equity fund registry is updated on a monthly basis and provides the name of the fund, the name of its executive partner, the date of formation (or registration) and the total committed capital amounts.

5. Jung Mi Kang, ‘Sa-mo-tu-ja fund-ui hyeon-hwang-gwa gwa-je’ [The Current Status and Future of Private Equity Funds]’ (The Bank of Korea Reports & Research Papers, December 2007) <www.bok.or.kr/down.search?file_path=/attach/kor/537/2008/11/1226528873751.pdf&file_name=%EC%82%AC%EB%AA%A8%ED%88%AC%EC%9E%90%ED%8E%80%EB%93%9C%28PEF%29%EC%9D%98+%ED%98%84%ED%99%A9%EA%B3%BC+%EA%B3%BC%EC%A0%9C.pdf> accessed 5 February 2018.

6. The term ‘shadow bank’ was coined by Paul McCulley in his remarks at the Federal Reserve Bank of Kansas City’s Economic Symposium in September 2007, see McCulley, Paul A, ‘Teton Reflections’ (PIMCO Global Central Bank Focus, 5 September 2007) <www.pimco.com/en-us/insights/economic-and-market-commentary/global-central-bank-focus/teton-reflections> accessed 20 February 2018. See also Schwarcz, Steven L, ‘Regulating Shadow Banking’ (2011-2012) 31 Review of Banking & Financial Law 619, 623 (explaining shadow banking and their less regulated status); Moosa, Imad A, ‘The Regulation of Shadow Banking’ (2017) 18 Journal of Banking Regulation 61 (arguing that shadow banks should be regulated like traditional banks).

7. Gordon, John Steele, An Empire of Wealth: The Epic History of American Economic Power (Harper Perennial 2005).

8. Gretchen Morgenson, ‘Private Equity Funds Balk at Disclosure, and Public Risk Grows’ The New York Times (New York, 1 July 2016).

9. Na Jeong-ju, ‘Indigenous Private Equity Funds Flourish’ The Korea Times (Seoul, 15 October 2013).

10. Bain & Company, ‘Global Private Equity Report’ (Bain & Company 2011), <www.bain.com/Images/2011-02-24%20REPORT%20Global%20Private%20Equity%20report%202011%20-%20MEDIA.pdf> accessed 21 January 2018.

11. Stockham, Alex J, ‘H&Q Asia Pacific Says Good-Bye to Good Morning in S. Korean Exit’ (PrivateEquityCentral.Net 9 April 2002) <www.hqap.com/PDF/news/H&Q%20Asia%20Pacific%20Says%20Good-Bye%20to%20Good%20Morning%20in%20S.%20Korean%20Exit.pdf> accessed 21 January 2018.

12. Robertson, Justin, ‘Financial Returnees as New Agents in East Asia: The Case of Korean Private Equity Funds’ (2013) 18 New Political Economy 579, 589 .

13. Yoon Joo Hwang, ‘Jag-nyeon gu-jo-chil-cheon-eog “sil-tan” yu-ib M&A-ui kko-chi doe-da [Dry Powder of 9.7 Trillion Korean Won Flowers M&A in 2013]’ (E-Today News, 20 May 2014) <www.etoday.co.kr/news/section/newsview.php?idxno=917573> accessed 1 February 2018.

14. For a detailed discussion of the causes, management, recovery, and prospects of the Asian Financial Crisis, see Chang, Ha-Joon, ‘The 1997 Korean Crisis: Causes and Consequences’ in Edmund Amann and Ha-Joon Chang (eds), Brazil and South Korea: Economic Crisis and Restructuring (Institute of Latin American Studies, University of London 2004) 107 .

15. Pattnayak, Sanja Samirana and Chadha, Alka, ‘Role of International Monetary Fund, World Bank and Asian Development Bank in Tackling Financial Crises in Asia’ in Kallidaikurichi E Seetharam (ed), A Tale of Two Crises: A Multidisciplinary Analysis (Routledge 2013) 73 .

16. Saito, Kunio, ‘Korea’s Economic Adjustments under the IMF-supported Program’ (IMF Regional Office for Asia and the Pacific 1998) <www.imf.org/external/np/speeches/1998/012198a.pdf> accessed 15 December 2017.

17. Dong Hyun Sohn, ‘Gi-eob gu-jo-jo-jeong-eu-lo ju-mog-pat-neun sa-mo-tu-ja-peon-deu [Corporate Restructurings Shed New Light on Private Equity Funds]’ (Shinhan Bank Future Strategy & Business Development Report 2008) <http://img.shinhan.com/cib/ko/data/FSB_0907_08.pdf> accessed 1 February 2018.

18. Robertson (n 12) 581.

19. Financial Supervisory Service (FSS), ‘Sa-mo-tu-ja-jeon-mun-hoe-sa Sil-mu-an-nae [PEF Handbook]’ (FSS 29 December 2016) 10 <www.fss.or.kr/download.bbs?bbsid=1207388946537&fidx=1483057732755> accessed 1 February 2018.

20. ibid 10.

21. Ja-bon-si-jang-gwa geum-yung-tu-ja-eob-e gwan-han beob-ryul (자본시장과 금융투자업에 관한 법률) [Financial Investment Services and Capital Markets Act] (promulgated by the National Assembly, 3 August 2007, effective 4 February 2009) Act No 8635. The FSCMA was enacted in 2009 to introduce a single consolidated legal framework to govern the financial services industry which encompasses banking, insurance, and securities. For a primer, see Park, Joon, ‘Consolidation and Reform of Financial Market Regulation in Korea: Financial Investment Services and Capital Markets Act’ (2011) 6 NTU Law Review 91, 142 .

22. Park, Jung Hoon, ‘Sa-mo-tu-ja-jeon-mun-hoe-sa (Private Equity Fund) do-ib-bae-gyeong mich gyeong-gwa [Private Equity Funds: Implementation and Progress]’ (2005) 10 BFL 45, 46 .

23. The FSC is an administrative organization under the Prime Minister’s Office and is responsible for financial policy and supervision. The FSS is an independent public corporation that is responsible for the supervision and examination of financial institutions. For an overview of the Korean financial regulatory landscape, see Ministry of Justice (n 1) 49–55.

24. Park (n 22) 51. For example, to resolve issues around the question of how to regulate special investment vehicles (SIVs), the Korean regulators’ response was to set baseline standards which would allow private equity funds to use SIVs but with the caveat that the regulators would promptly close any loopholes which would allow private equity funds to use SIVs to avoid legal restrictions that would otherwise apply. Park notes that setting rules to curb general partners’ moral hazard was a special area of concern for policymakers in designing such regulatory responses.

25. Jackson, Howell E, ‘Regulation in a Multisectored Financial Services Industry: An Exploratory Essay’ (1999) 77 Washington University Law Quarterly 319, 321 .

26. ibid.

27. Athanassiou, Phoebus (ed), Research Handbook on Hedge Funds, Private Equity and Alternative Investments (Edward Elgar 2012) 159 .

28. Zoltan Pozsar et al, ‘Shadow Banking’ (Federal Reserve Bank of New York Staff Report July 2010, Revised February 2012) <www.newyorkfed.org/medialibrary/media/research/staff_reports/sr458.pdf> accessed 1 February 2018.

29. In US securities regulations, the term ‘sophisticated investor’ is used to refer to investors who have the capacity to appreciate the complexities and risks of investing in the capital markets or possess the opportunity and resources to bargain for protections when entering into these investments.

30. FSCMA, art 269 (Partners and Contributions).

31. FSCMA, art 269(1) (Partners and Contributions). Each investor in any collective investment scheme holding 10% or more of the equity interests of the private equity fund shall be counted for purposes of Article 269: FSCMA, art 269(2) (Partners and Contributions).

32. There is an exception for marketable securities, but this exception may only be invoked with the consent of all other partners. FSCMA, art 269 (Partners and Contributions).

33. FSCMA, art 268(1) (Incorporation and Registration).

34. FSCMA, art 268(3) (Incorporation and Registration).

35. FSCMA, art 268(8) (Incorporation and Registration).

36. These and other private equity regulatory reforms were introduced on 24 July 2015 and went into force on 25 October 2015.

37. The standard private equity structure is created by an investment manager or sponsor (sometimes referred to as an ‘executive partner’ in Korean private equity regulation) who solicits investors in the private equity fund to make investments in a portfolio of companies.

38. FSCMA, art 278 (Dispositions against Private Equity Funds).

39. ibid.

40. ibid.

41. ibid.

42. FSCMA, art 270 (Methods of Management of Property of Private Equity Fund).

43. ibid. One example of a carve out is the 2009 amendment of FSCMA which relaxed certain restrictions on private equity activity, but only for funds specifically targeting small size companies and capital structure improvements: FSCMA, art 278-3 (Special Cases concerning Private Equity Funds for Corporate Financial Stability).

44. ibid. Some of these restrictions were further relaxed in 2015 as described later in this Section.

45. FSCMA, art 270 (Methods of Management of Property of Private Equity Fund).

46. ibid.

47. FSCMA, art 270(6) (Methods of Management of Property of Private Equity Fund).

48. ibid.

49. ibid.

50. FSCMA, art 272 (Executive Partners, etc.).

51. ibid.

52. ibid.

53. ibid.

54. ibid.

55. ibid.

56. ibid.

57. Park (n 22) 51 (noting that setting rules to curb general partners’ moral hazard was a special area of concern for policymakers).

58. FSCMA, art 272 (Executive Partners, etc.).

59. FSCMA, art 272(7) (Executive Partners, etc.)

60. Kang (n 5) 22–24.

61. ibid 25.

62. Kim, Ki Hong and Won, Jong Hyun, ‘Sa-mo-peon-deu hwal-seong-hwa dae-chaeg-ui ju-yo nae-yong-gwa si-sa-jeom [The Key Provisions and Implications of Regulatory Policies to Foster Private Equity]’ (National Assembly Research Service 18 April 2014) <www.nars.go.kr/fileDownload2.do?doc_id=155978&fileName=(이슈와%20논점831호-20140418)사모펀드%20활성화%20대책의%20주요%20내용과%20시사점.pdf> accessed 1 February 2018.

63. Shin, Bo Sung, ‘Geul-lo-beol geum-yung-gyu-je heu-leum-gwa u-li-na-la geum-yung-gyu-je-gae-hyeog-ui ba-lam-jig-han bang-hyang [Global Financial Regulatory Trends and the Future Direction of Korean Financial Regulation]’ (Korea Capital Market Institute 2014) <www.kcmi.re.kr/common/downloadm.asp?fid=17568&fgu=002001&fty=004003> accessed 1 February 2018.

64. ibid 5.

65. ibid 4.

66. Merton, Robert C, ‘Operation and Regulation in Financial Intermediation: A Functional Perspective’ in Peter Englund (ed), Operation and Regulation of Financial Markets (Stockholm, Ekonomiska Rådet 1993) 17 .

67. Financial Crisis Inquiry Commission (FCIC), The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (US Government Printing Office 2011) 3851 .

68. Carruthers, Bruce G, ‘Diverging Derivatives: Law, Governance and Modern Financial Markets’ (2013) 41 Journal of Comparative Economics 386 .

69. United States Senate Committee on Banking, Housing, and Urban Affairs, Senate Report No 96-958 accompanying Senate Bill 2990 (1980).

70. Small Business Investment Incentive Act of 1980, Public Law 96-477, 94 Statutes at Large 2275 (21 October 1980).

71. Romano, Roberta, ‘A Cautionary Note on Drawing Lessons from Comparative Corporate Law’ (1993) 102 Yale Law Journal 2021 , 2029, 2037.

72. Robertson (n 12) 593.

73. Kang (n 5).

74. Sohn (n 17) 36.

75. Blackstone’s CEO has commented that ‘you find it is just twenty, thirty or fifty people worldwide who ultimately drive the industry or sector.’: Rothkopf, David, Superclass: The Global Power Elite and the World They Are Making (Farrar, Straus and Giroux 2009) 45 .

76. FSS (n 19) 14.

77. FSCMA, art 269(7) (Partners and Contributions).

78. Finnerty, John D, ‘Financial Engineering in Corporate Finance: An Overview’ (1988) 17 Financial Management 14 .

79. FSS (n 19) 14.

80. ibid.

81. Private Equity Growth Capital Council (PEGCC), ‘Geographic Dispersion of Private Equity Investment in 2011’ (PEGCC 2012).

82. Hwang (n 13).

83. Sohn (n 17) 37.

84. Cha, Seonjin ‘Uamco Plans IPO as Korean Buyer of Bad Loans Sees Market Growth’ Bloomberg (New York, 2 Jun 2011).

85. FSS, ‘Gug-nae sa-mo-tu-ja-jeon-mun-hoe-sa do-ib 10nyeon-gan-ui byeon-hwa mich pyeong-ga [10 Year Review of Domestic Private Equity Funds]’ (FSS 10 March 2015) 2 <www.fss.or.kr/fss.hpdownload?file=150311_%C1%B6%B0%A3_%B1%B9%B3%BB+pef+%B5%B5%C0%D4+10%B3%E2%C0%C7+%BA%AF%C8%AD+%B9%D7+%C6%F2%B0%A1.pdf&path=/nws/nbd/> accessed 3 March 2018.

86. FSS (n 19) 2, 5.

87. FSS, ‘Sa-mo-tu-ja-jeon-mun-hoe-sa Sil-mu-an-nae [PEF Handbook]’ (FSS December 2011) 20.

88. FSS, ‘15-Nyoun, PEF dong-hyang mit si-sa-jeom [2015 PEF Trends and Implications]’ (25 April 2016) <www.fss.or.kr/fss.hpdownload?file=160426_%C1%B6%B0%A3_%6015%B3%E2+PEF+%B5%BF%C7%E2+%B9%D7+%BD%C3%BB%E7%C1%A1.pdf&path=/nws/nbd/> accessed 1 February 2018.

89. Mi Young Yang, ‘Sa-mo-peon-deu, 500man-won-i-myeon tu-ja-han-da [Investors with 5 Million KRW Can Now Invest in PEF]’ Bizwatch (Seoul, 29 May 2016) <www.bizwatch.co.kr/pages/view.php?uid=23369> accessed 1 February 2018.

90. Robertson (n 12) 597 (‘While Korean private equity manifests differences to the US model – with far fewer layoffs for example – the similarities in areas such as conducting majority control investments, installing new managers at increased pay levels, drawing on high levels of debt, foreign fundraising, lower capital gains taxation and the use of international tax havens are striking.’).

91. Watson, Alan, Legal Transplants: An Approach to Comparative Law (2nd edn, University of Georgia Press 1993).

92. Robertson (n 12) 579.

93. ibid.

94. Roberton (n 12) 580.

95. Roberton (n 12) 587.

96. Gilson, Ronald J, Hansmann, Henry, and Pargendler, Mariana, ‘Regulatory Dualism as a Development Strategy: Corporate Reform in Brazil, the United States, and the European Union’ (2011) 63 Stanford Law Review 475, 478 (citing Olson, Mancur, The Rise and Decline of Nations (Yale University Press 1982), who notes the ‘resistance of the established economic and political elite to growth-promoting reforms’).

97. Sklair, Leslie, The Transnational Capitalist Class (Wiley-Blackwell 2000) 12 .

98. Robertson (n 12) 581.

99. Robertson (n 12) 595.

100. See eg Gemici, Kurtulus, ‘Social Origins of Financial Crises’ in Kallidaikurichi E Seetharam (ed), A Tale of Two Crises: A Multidisciplinary Analysis (Routledge 2013) 37 (explaining the causes of the Asian Financial Crisis); Lee, Jong-Wha, Lee, Young Soo, and Lee, Byung-Sun, ‘The Determination of Corporate Debt in Korea,’ (2000) 14 Asian Economic Journal 333, 334 (describing the fragility of highly leveraged Korean firms and their lenders that were exposed by the Asian Financial Crisis).

101. Weiss, Linda, ‘Guiding Globalisation in East Asia: New Roles for Old Developmental States’ in Linda Weiss (ed), States in the Global Economy (CUP 2003) 245 .

102. Spamann, Holger, ‘Contemporary Legal Transplants: Legal Families and the Diffusion of (Corporate) Law’ (2009) Brigham Young University Law Review 1813 .

103. ibid 1852.

104. Ramseyer, J Mark, ‘Mixing-and-Matching Across (Legal) Family Lines’ (2009) Brigham Young University Law Review 1701 (illustrating the possibility of countries switching and borrowing across legal family lines).

105. See text accompanying n 35.

* BA (Seoul National University), JD (Harvard Law School) and admitted to the New York and California bars (both currently inactive). Assistant Professor of Law and Director, Korea Law Center, University of California, Irvine, School of Law. I wish to thank Afra Afsharipour, Funmi Arewa, Jonathan Glater, Joan Heminway, Hwang Lee, Soonkoo Myoung, Donna Nagy, Jeff Schwartz, and Chris Whytock for their helpful comments and discussions on earlier drafts, and Christina Tsou and Jessica Pierucci of the UC Irvine Law Library for their invaluable research assistance.

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Asian Journal of Comparative Law
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