Foreign fund managers say the South Korean government has resorted to old-style arm-twisting tactics to make them bail out credit card companies, in a replay of tactics that regulators had supposedly moved beyond.

Credit card companies sprang up in 2001 and 2002 as the vanguard of Korea's consumer-led growth, but the government slammed the brakes when household lending surged last year by 30%, with half of that in the form of cash withdrawals. The predictable result: a surge in non-performing loans, with W8 trillion of delinquent payments as of January 30, a 23% rise from the previous month.

Exploding non-performing loans crippled the companies' ability to meet their enormous debts or raise new capital. They had financed themselves primarily by selling bonds, and there is today W88.8 trillion ($72 billion) of credit-card company debt outstanding (about a quarter of the nation's total deposits). Of that, investment trust management companies (ITMCs) hold W25.5 trillion, about 29% of the total.

Attention focused on this only following the March 11 admission by SK Global that it had lied about its losses and debt. Because most ITMCs' money market funds held SK Global debt, the scandal kicked off a run on ITMCs, and put a spotlight on what other skeletons they might have in their closets. Thus their enormous exposure to credit-card company debt became an issue, because it was now apparent that these companies, burdened with exploding dud loans and cut off from the ability to raise capital, were no longer able to meet their obligations. The result: W30 trillion of redemptions while ITMCs dumped as much credit-card paper as they could.

Although foreign fund managers acknowledge the government had to act to calm the situation, they balk at the methods subsequently used. Partly this is because foreign ITMCs had very little exposure to credit card companies. But mainly it's because the government has reverted to a whisper campaign to force them to comply, even when such actions force them to breach regulations.

First, it became clear that pledges by ITMCs to treat all customers equally were made in bad faith. Although executives at the Financial Supervisory Service called for equal treatment, and the ITMCs' CEOs promised such at an emergency session of the Korea Investment Trust Companies Association (Kitca) in early April, savvier institutional clients were able to escape.

ITMCs owned by securities companies paid out fully to the early institutional redeemers, but were forced to reduce payout offers as liquidity evaporated, according to foreign rivals. It is not clear how retail investors, typically less aware of market events, were treated. ITMCs owned by domestic banks either assumed ownership of the underlying assets in return for cash or purchased the fund shares back from institutional clients, thus transferring the risks to the banks' balance sheets. Only afterward were money market funds closed to all redemptions, in order to salvage the credit card companies.

Of the W88.8 trillion in outstanding debt from credit card companies, some W12 trillion ($9.7 billion) is due on or before June 30. The FSS, perhaps hoping this crisis would sort itself out in an orderly fashion by then, told local and foreign banks through its Financial Policy Committee to create a fund to buy up half of that. Foreign banks expect to get their cash back on June 30, but some fund managers question whether they will.

Furthermore, it told ITMCs that they must roll over the remaining credit card debts they hold in their money market funds.

Foreign fund managers resisted, noting that in some cases they had already established redemption schedules with their clients, closed their money market funds and paid out whatever was left to all shareholders. But more importantly, they pointed out that doing so would force them to breach FSS regulations.

One wrinkle complicating the position of ITMCs is that their money market funds' exposure to credit-card company debt is actually a lot longer than it appears. Domestic ITMCs in particular bought trillions of won worth of 'rollover option commercial paper', in which credit card companies issued bonds with tenors as long as two years, but with a three-month optional rollover. These dressed-up bonds delivered a yield up to 6%, adding a lot of juice to staid money market funds. The FSS did not question the nature of these instruments in money market funds - which by law can invest in paper no longer than one year, and with a weighted average duration no longer than 90 days.

This flagrancy is coming home to roost because the FSS has told ITMCs that they must not only rollover any credit-card company bonds that mature on or before June 30, but that they must rollover them over a term longer than they initially planned.

This has foreigners complaining because it means that if they bought a one-year bond in its eighth month, say, with the expectation of holding it for only four months, they are now stuck with it for one year. This also blows their weighted average durations out of whack.

For local ITMCs that have gobbled up option CPs, they may be forced to hold onto those bonds for over two years - obligations that the credit card companies are unlikely to be ever able to pay.

What galls foreign fund managers is not that the government took forceful steps, but that it did so through verbal commands, sometimes mixed with threats, and refused to put anything in writing. Worries over compliance breaches were smoothed over with assurances that the regulators would overlook these at audit time. Resistance was met with threats of audits and a slander campaign, say foreign fund managers. "It became clear that we either played along or we'd be effectively out of business," says one.

In the meantime everyone is waiting to see what happens on June 30, when credit card companies are supposedly to be held accountable for their debts to ITMCs. For foreign players, the experience has left a bitter taste. From their point of view, the government is to blame for having allowed credit card companies run amok, and then forced all ITMCs to bail them out.

Ultimately, most foreign players took a cautious approach toward investing in credit-card company debt, and this affair will not seriously undermine their operations. But local ITMCs are heavily exposed; the fallout in the credit card industry is now being transferred to the fund management industry. Come June 30, keep an eye out for how the big domestic ITMCs fare.