South Korea is scrapping capital-gains taxes on locally domiciled funds that invest in overseas equities - which is good news for most fund management companies but irksome for those providers that rely on overseas-domiciled funds, which will continue to be taxed.

The leader in that market is Fidelity Investments, which has around 50% of the W10 trillion business. Local firms that have partnered with foreign fund houses to import their Sicav (Luxembourg-domiciled) funds will also have to rethink strategy. Local executives say this includes CJ Investment Trust and Samsung Investment Trust, among others.

The Ministry of Finance and Economy has pushed for the tax break in order to manage the won's exchange rate and slow down capital flight. Currently, a fund that invests primarily in overseas equities must impose a capital gains tax of 15.4% if the gain is $40,000 or less; larger gains are taxed progressively as high as 37%. There is no such tax on funds investing in local securities. The change is expected to come into force for onshore funds within a month or so but remain in place for internationally domiciled funds.

Some rivals are taking delight in the new rules, which they hope will blunt Fidelity's momentum. Fidelity and to a lesser extent BlackRock (after its acquisition of Merrill Lynch Investment Managers) have enjoyed the lion's share of the offshore market, which has more than doubled in size in less than two years.

But other rivals believe Fidelity will be able to maintain its lead. First of all, taxes on high-net worth individuals will not be affected, which render these capital-gains issues moot. Secondly, Fidelity has an awesome marketing machine that can adapt to the new environment.

Some wonder whether the firm will spin out 'mirror' funds that replicate its Sicav products but within a locally domiciled master-feeder structure. One rival suggests that, given Korea's small size in Fidelity's overall business, the costs may be considered too high to be worth it.

Fidelity executives won't say what their strategy is. "Our goal is to provide investors with choice, both onshore and offshore," says David Mitchell, marketing director in Seoul. He declined to say whether mirror funds are on the table, but says, "Regardless of any decision we make, Fidelity will be ready with options."

Regardless of whether the tax changes impact businesses like Fidelity's, those firms that have taken the lead in selling won-denominated funds that invest in overseas equities believe they will benefit.

MiraeAsset claims the leadership with 23% of market share and $3 billion under management. Other providers with substantial businesses in locally domiciled, internationally invested funds include the joint venture Shinhan BNP Paribas as well as the wholly owned units of Franklin Templeton, PCA Asset Management and Schroders.

This market is new, having only emerged last year when Mirae and Templeton introduced the first of these funds. It is growing fast: now about $12 billion, the market has doubled in only the past three months, says Oh Hee-yeol, managing director at Woori Investment & Securities, a distributor of investment products.

Introducing Sicav funds to Korea is time consuming and foreign firms such as Temleton and Allianz Global Investors opted to build a local equities franchise first. (Fidelity also has a capability in local securities.) Once the master-feeder structure was established and investors' appetite for overseas funds became apparent, providers have begun to roll out a variety of products denominated in won and based locally.

Nonetheless the tax change does not sound the death knell for Sicav funds in Korea. "Sometimes Sicavs will still make sense," notes one foreign funds executive. This includes niche products that are too focused to justify the costs of setting up a unique fund for the Korean market. It also applies to specialist products that require expertise, which a foreign house may prefer to keep in the United States or Europe, rather than give away its secrets.