Achieving regulatory progress in South Korea remains a case of one step forward but one step back for fund managers.
Last week the Ministry of Finance and Economy announced a series of liberalizations it will include in a new asset management law to be submitted to the National Assembly this autumn. What it did not announce, however, is that MoFE is caving in to the demands of securities houses to crush the main desire of fund managers: direct sales to institutional investors.
Lee Kap-su, senior managing director at the Korean Investment Trust Companies Association (Kitca), says a number of fund managers affiliated to major securities companies, such as Daehan Investment Trust Management Company, Hyundai ITMC and Tongyang ITMC, oppose the move because their parents stand to lose juicy commissions from their required middleman role.
"They worry if direct sales to institutions are allowed, the commission pie will become very small," he says.
Before 1998, there was only one kind of fund management license, the investment trust company (ITC), which could establish, manage and sell unit trusts. They were not well managed and many went under during the Asian financial crisis. The regulators split the function of managing and selling unit trusts and converted the ITCs into securities companies that could then spin off an investment trust management company (ITMC). At the same time foreign players such as Franklin Templeton and Schroder Investment Management, as well as new domestic ones, began establishing ITMCs.
The government also promoted asset management companies (AMCs) that could sell mutual funds, contractual-styled pooled investment schemes, while ITMCs could sell both mutual funds and the older corporate-style contracts known as unit trusts.
But any AMC or ITMC must still sell a fund, be it to a retail or institutional client, via a securities company or a bank. Moreover because of ITMCs' heritage, brokers used to get up to 95% of the fees. Even today for many AMCs and ITMCs, they must give 70% to the broker, although a few such as Templeton say they are now giving 30%-40% away - still a high number by any international standard. The result is that institutions end up paying the same as retail so fund managers can make a decent living, while anywhere else they would be receiving substantially less.
For the past 18 months, AMCs and ITMCs have lobbied regulators to allow direct sales to institutions (they would also like direct sales to retail investors, but it is less of a priority and hasn't been pushed).
"The current set-up is a joke," says Michael Reed, country head for Franklin Templeton. "We still deal with institutional investors ourselves but then at the last minute put the trade through with a broker. The middlemen aren't adding any value."
As of the end of 2001, according to Kitca figures, the ITMC industry managed W154 trillion ($130 billion) and the AMC industry managed W6 trillion ($5 billion). Given that approximately 70% of all AMC/ITMC sales are to institutions, this lock on commissions represents a huge and easy business for securities companies.
The government seemed to agree. Fund managers report it had decided to scrap the middlemen, and were shocked at last week's warning that the rules may not be changed. The government is justifying its U-turn on the grounds that the securities companies are still struggling to get out from the burdens that ravaged the ITC industry during the crisis, such as a huge exposure to corporate bonds from the failed Daewoo Group. But irate ITMC officials note the brokers have milked them in commissions for four years now. They argue that a securities firm that still needs this crutch will never get itself into shape.
Kitca's Lee says discussions between members and MoFE are ongoing and a compromise could be reached by the end of August. But fund managers are pessimistic that they will get their way, at least this year.
Despite this setback, however, the government is taking other steps to bolster the asset management industry. It will allow insurance companies to sell mutual funds and unit trusts, which opens a new distribution channel.
It will also relax rules barring a fund manager from sharing data with affiliates. This wall was erected in 1998 following revelations of chaebol intra-group illegal business, but the government didn't consider the ramifications on international fund managers operating onshore.
The law prevented the likes of Templeton, Schroders or Fidelity from sending data about things such as portfolio holdings to the parent companies in America or Europe. This meant fund companies couldn't use the parent's trading system or its risk management systems. By making data sharing arrangements flexible, the government will let global fund providers provide more services and analysis to Korean customers.
A third plank in the upcoming legislation is to allow AMCs to also manage unit trusts. Today they can only manage mutual funds, which come with various restrictions, as they were designed to be more transparent. It left them disadvantaged against ITMCs which could sell both kinds of funds, and AMC managers have often expressed anger at the imbalance. The government is tardy but is finally redressing the issue.
Last, it will allow funds to invest in real estate assets and over-the-counter financial derivatives, although these are underdeveloped or non-existent markets in Korea. Some fund managers are sceptical about this liberalization because few locals have the requisite skills to manage the risks of these products. This is seen as an attempt by the government to jumpstart new financial markets without laying the appropriate infrastructure.