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2009 Aug/27
The Consolidation of Diversified Fund Regulations
Survey Papers 09-02
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- Research Topic Asset Management/Pension
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- Summary
- The regulatory system for the Korean collective investment funds market has been upgraded with the newly introduced law, the Financial Investment Services and Capital Markets Act(FSCMA). However, some problems still remain. One of the unsolved problems is the existence of special purpose funds which are not regulated by the FSCMA but by several other special laws. These special purpose funds were created to supply financing to certain industries which the government deemed as strategically important. Although these funds are conceptually the same as a collective investment scheme, which is the definition of a mutual fund according to the FSCMA, the regulation for these funds is conducted by separate special laws. There are many reasons why the FSCMA should regulate all collective investment funds including special purpose funds. First, the policy environment is changing. When special purpose funds were introduced, the basic regulatory scheme did not allow for the funds to invest in some alternative assets, such as real estate and other real assets. Therefore, it was necessary to make separate laws to register and regulate special purpose funds. However, under the FSCMA, collective investment funds can invest in virtually all asset classes so there is no logical reason to regulate special purpose funds with other rules. The tax environment is also changing. One important function of the special laws was to provide a tax benefit to ‘publicly placed’ special purpose funds which were open to the public. However, most funds were issued through ‘privately placed’ methods in order to avoid complex regulations that applied to ‘publicly placed’ funds. Additionally, the government now tends to reduce all tax benefits. This means that tax incentives provided to special purpose funds may be reduced and hence one important reason to regulate these funds with special laws would be eliminated. Second, special purpose funds face several limitations because of some critical regulations. In order to provide financing effectively to specific industries or sectors, each special purpose fund must invest most of its assets in predetermined industries or sectors. In addition, registered asset managers of these funds cannot engage in businesses other than managing the special purpose funds. As a result of these regulations, the fund performance may be unstable when the target industry is in recession and thereby resulting in poor investor pools and low profits for the managers. Third, there is inefficiency in the asset management industry as a whole. Applying different laws to collective investment funds, which are all essentially the same, could hamper the credibility of the markets and cause confusion to all market participants. The regulation costs could also rise due to multiple regulatory structures. However, the consolidation of all special purpose funds under the FSCMA requires the other remaining problem of the FSCMA to be solved. Under the FSCMA, the regulations for ‘privately placed’ collective investment funds are basically similar with the regulations for ‘publicly placed’ funds which need strong regulations. Under a strong regulatory environment, however, creating ‘privately placed’ high risk, high return funds such as private equity funds(PEF), hedge funds and special purpose funds, is extremely hard and the efficient management of those funds is also challenging even after they are registered. For this reason, the consolidation of special purpose funds under the FSCMA is difficult. Therefore the regulations for ‘privately placed’ funds should be eased before laws that pertain to special purpose funds are consolidated under the FSCMA regulations. The consolidation of all special purpose funds under the FSCMA should be done with two considerations. First, the different roles between the special laws and the FSCMA should be clearly outlined. The role of the special laws is to define the minimum requirements for special purpose funds and the government`s support for those funds, while the FSCMA should regulate both the funds and the managers. Second, the consolidation should be done through several steps that reflect the specific characteristics of each of the industries which are investment targets for certain special purpose funds.