[Opinion] Where to Go, Private Equity Funds, and the Financial Industry

It is said that the Temple of Apollo at Delphi, where the omphalos?the navel of the earth?is located, had three inscriptions. The first is the famous "Know thyself," and the second, less well known, is "Nothing in excess." If the first maxim symbolizes Socrates, the second can be represented by Aristotle, the philosopher of the Golden Mean. His 'Nicomachean Ethics' establishes the Golden Mean as the highest value of happiness and ethics for the individual within the community, and presents the demanding requirement of 'practical wisdom (phronesis)' to achieve it. Since there are no fixed values at the extremes in worldly matters, attempting to adopt a middle value requires, at every moment of action, a wise judgment through excellent intellectual ability to determine the most appropriate value in each situation.

In our financial sector, there is one ultimate earnest wish. The solemn hope to become the 'Samsung Electronics of finance' or the 'Korean-style Goldman Sachs' seemed unlikely to be realized and was rather pitiful and sad, much like Kim Young-dong’s song "Where to Go." However, the recent revitalization of private equity funds (PEFs) and hedge funds, centered on management participation-type private collective investment schemes, has cast a ray of light on the path toward that goal. The characteristics of our people?intelligent, diligent day and night, and quick in actions such as grabbing a cup from a vending machine and making coffee?made private equity funds a perfect match. The development of PEFs, only about 15 years old, and hedge funds, just over 10 years, has shown hope and confidence that, while large-scale conventional battles with global investment banks may be difficult, local guerrilla warfare is worth trying.

However, since the second half of last year, a series of dark clouds have been gathering over private funds, following massive losses in overseas interest rate-linked derivative-linked funds (DLFs) and the Lime Fund incident, raising concerns that the financial industry may lose its way. The Lime Fund incident was initially hard to understand, as it involved suspending redemptions after investing in high-risk mezzanine securities of small and medium enterprises (convertible bonds or bonds with warrants). Now, however, losses have occurred in overseas trade finance fund investments, which have a high possibility of being Ponzi schemes, inconsistent with the reputation of being the country’s top hedge fund. Moreover, serious allegations of incomplete sales by banks during the fund sales process have led to civil and criminal lawsuits, worsening the situation further.

Given these circumstances, financial authorities have focused their policies on strengthening regulation and supervision. The Financial Services Commission has tightened hedge fund regulations by raising the minimum investment amount for general investors from 100 million won to 300 million won, restricted bank sales of high-difficulty private funds (with principal losses exceeding 20%), and implemented a total volume regulation capping sales of equity-linked trusts (ELTs) containing derivative-linked securities at around 40 trillion won as of the end of November last year. The Financial Supervisory Service has reinstated comprehensive inspections of financial companies, which were abolished in 2015, and plans to significantly increase related organizations and personnel to strengthen consumer protection. This series of regulatory trends is likely to intensify further as the Lime Fund incident spreads.

Although private funds and Korea’s financial industry seem lost in the dark clouds, the response of financial authorities so far is considered appropriate, as extinguishing the fire must come first. Especially, thorough measures are required against banks’ incomplete sales, which have continued from KIKO to DLFs and now the Lime Fund. However, it would be better to extinguish the fire effectively to enable a swift recovery. Therefore, when considering additional measures in the future, it is necessary to adopt a delicate, surgical approach based on the value of the Golden Mean. Whether liked or not, private funds and derivatives stand at the forefront of the path our finance must take. Although there may be trials, it is hoped there will be no failures. Both financial authorities and the industry should not only look ahead but also maximize the practical wisdom gained from overcoming adversity to carefully seek the direction of where to go. Thus, it is hoped that this crisis will be overcome well and the long-standing earnest wish will continue to be pursued.

The third maxim of the Delphi Temple, almost unknown, is said to have been "If you guarantee, you will perish." All three maxims warn against hubris, the fatal arrogance of imperfect humans, befitting the temple.

Seong Hee-hwal, Professor, Inha University School of Law