South Korean insurance firms look set to find it harder to buy foreign real estate – already a tough task thanks to Covid-19 – as their local regulator moves to tighten rules around investment into illiquid assets after their sharp rise in inflows in recent years.

Korea’s Financial Supervisory Service (FSS) in June reportedly announced that domestic securities firms must strengthen their investment screening process, particularly for overseas real estate, including by doing mandatory on-site due diligence on prospective purchases. 

The requirement will also eventually be applied to domestic insurance companies, said Claire Choi, head of research for Korea at CBRE. She did not say when that might happen. 

Claire Choi, CBRE

The property services firm expects the move to affect insurers with a high proportion of overseas real estate holdings, Choi told AsianInvestor. Such allocations will be reduced to lower the risk they face from the ongoing global economic disruption, she added.

The FSS had reportedly launched a task force in June to draw up risk management guidelines for alternative assets after Korea's alternative investment fund market has trebled in value to W240 trillion in the five years to June 2020.

Moreover, Korean insurers' foreign alternative asset allocations grew from less than 1% to between 2% and 6% in the five years to June 2019, in respect of firms rated by Moody's Investors Service.

The FSS is understood to be concerned about the liquidity of such strategies if insurers were to need capital quickly. Especially given that Covid-19 has increased the level of economic uncertainty. (See also box below, 'Rating agency concerns over alternatives push'.)

AsianInvestor’s emailed queries to FSS about the recent move went unanswered. In addition, requests for feedback emailed to 20 Korean insurance executives received almost no response. One senior executive said it would be sensitive to comment on the requirements.

The FSS also appears to have been more closely scrutinising the reserve capital levels of Korean insurers in relation to their offshore property holdings since the first half of the year.

“About five months ago we started seeing inquiries regarding insurance company reserve requirements from our asset manager clients, who arrange for the insurance companies to invest in overseas real estate,” Spencer Park, Hong Kong-based counsel at law firm Dechert, told AsianInvestor.

SHORT-TERM CAUTION...

It makes sense for the regulator to monitor whether the various reserve requirements are being met given that there have been predictions of a drastic drop in global real estate valuations, added Park. Solvency rules require firms to hold reserve capital according to the level of investment risk in their portfolios. As a result, insurers will likely take a more conservative, risk-averse approach to foreign property investments, he noted.

Anbang: A cautionary tale

Certainly there are cautionary tales for insurance firms pouring into overseas property amid poor controls, not least the early-2018 fall from grace of Chinese group Anbang. The firm was taken over by the mainland authorities after a rampant global spending spree on real estate assets.

In the shorter term at least, Korean insurers may adopt a more conservative investment approach, agreed Kim Young, a financial institutions analyst at credit rating agency Moody’s Investors Service. He said this was also partly in preparation for new solvency rules under Korean Insurance Capital Standard (K-ICS) and for IFRS 17, a new accounting standard for balance-sheet liabilities. Both will take effect in 2021. 

"We expect insurers to buy more long-dated fixed income assets to lengthen their portfolio duration as a priority this year and, if possible, invest more in domestic infrastructure and real estate projects," Kim said. Government fiscal stimulus will support social infrastructure projects, he pointed out.

Another reason the watchdog is urging insurers to conduct their own due diligence is because it wants them to enhance their investment processes, said Joseph Lee, co-chief executive and president at Seoul-based Igis Asset Management, a specialist property investor. But such a move will pose particular challenges for overseas investments currently, as staff will have to undergo quarantine after doing on-site inspections, he told AsianInvestor.  

....VS LONG-TERM APPETITE 

Indeed Korean overseas real estate investment had already sharply declined this year amid the pandemic, before the FSS issued its guidelines: for the first half it totalled $2.5 billion, a fall of around 50% from the same period last year, by CBRE data. Lockdown measures and travel restrictions in many advanced countries amid have made it difficult for asset owners to do on-site due diligence, hindering deal-making.

Hence there is strong pent-up demand to deploy capital offshore.

Despite the planned rule changes, Korean insurers and pension funds are likely to continue to invest more in foreign real estate over the next three years as they seek stable income amid heightened market volatility and in light of increased liquidity as a result of government stimulus measures, CBRE's Choi said.  

CBRE estimates this combined group of institutional investors will deploy a further $53 billion into real estate property over the next five years, though more selectively than in the past. She declined to comment on the current investment level.

Logistics property has become and is likely to remain a major focus, for instance, while office and retail assets are losing traction, with the pandemic having accelerated these shifts in demand.

Ultimately, the FSS’s new requirements seem likely to favour Korean insurers with international offices that can more easily do overseas due diligence.

RATING AGENCY CONCERNS OVER ALTERNATIVES PUSH

Rating agencies, such as Moody’s Investors Service and its Seoul-based subsidiary Korea Investors Service, have been raising questions since last year about the uptick in alternative investments by Korean insurance firms seeking higher yields.

“We [have become] more concerned [about Korean insurers’] growing overseas alternative investments in recent years given these alternative investments tend to lack active secondary markets and as such are less liquid and more prone to mark-to-market valuations,” Kim Young, analyst for financial institutions group at Moody’s, told AsianInvestor.

This raises the risk that insurers may not be able to sell such assets, or could only do so at deep discounts, during times of market distress.