[The Betrayal of Private Equity Funds] Another Redemption Suspension Occurs, Financial Authorities Once Again React Late

Rhyme Ear Optimus Redemption Suspension... Financial Supervisory Authorities Criticized for Poor Management
Insider: "No Investor Risk Monitoring System, Only Late Inspections Each Time"
Lack of Mutual Checks Among Asset Manager, Custodian, and Distributor Also Cited as Cause

[Asia Economy Reporters Jihwan Park, Eunmo Koo] Just as the shock from the Lime Asset Management fund redemption suspension incident, which caused losses of around 1.7 trillion KRW last year, was beginning to subside, another fund redemption suspension accident occurred involving Optimus Asset Management, a specialist alternative investment firm, putting the financial supervisory authorities’ inadequate oversight under scrutiny. Although liquidity issues at Optimus had already surfaced early this year, the authorities’ delayed response failed to prevent the damage. Experts are calling for the urgent establishment of a mutual monitoring system among fund-related parties to prevent repeated incidents in the private equity fund market.

According to the financial investment industry and authorities on the 30th, the Financial Supervisory Service (FSS) deployed personnel from the Asset Management Supervision Bureau to conduct a written survey-style inspection of 1,786 private equity funds managed by 52 specialized private equity firms from November last year to January this year. During this investigation, the FSS failed to detect Optimus’s asset substitution, where funds intended for investment in public institution revenue bonds were instead invested in private bonds of unlisted companies. This was because it is difficult to verify the consistency between actual and reported assets and the soundness of investment assets through written documents alone. However, the FSS reportedly identified some issues such as maturity mismatches and excessive inclusion of private bonds in Optimus’s funds. Since the fund structure was not as complex as Lime’s, these were not considered major problems, and it was only after the incident broke out that on-site inspections were conducted on the 19th.

The financial authorities now face an even greater burden due to the Optimus private equity fund redemption suspension incident. Since last year, the FSS has been criticized for delayed initial responses and being preoccupied with after-the-fact measures in incidents such as the Lime fund and German derivative-linked securities (DLS) cases. A similar large-scale accident has recurred while the aftermath of previous incidents remains unresolved.

A financial investment industry official said, "If the financial authorities relaxed regulations such as the qualified investor requirements for private equity funds and capital requirements for collective investment business operators, they should have also prepared pre- and post-safety measures anticipating various side effects accordingly. Without mechanisms to assess investor risks, inspections inevitably come too late every time."

Among experts, the reason for the recent series of private equity fund redemption suspension incidents is primarily attributed to the lack of proper mutual checks and balances among asset management companies, custodians (custodian banks and administrative agencies), and distributors. The Capital Markets Act originally divided the operators of private equity funds into these four entities to secure trust in transactions through mutual oversight. However, contrary to the original intent, the common consensus is that the balance of power among them is skewed, leading to the current incidents. Asset management companies that create the funds hold most of the hegemony, while the others remain passive with little incentive to check them.

In particular, custodial banks were structurally in a position to know that the assets listed in the fund specifications, which are central to this incident, were not actually traded. This is because fund asset execution is not done directly by the asset manager but follows the asset manager’s instructions to the custodian bank.

A private equity fund manager explained, "The custodian bank’s custody sales department structurally cannot avoid knowing when the asset manager instructs them to purchase assets completely unrelated to the promised bonds. However, as the custodian bank acts as a trustee executing funds and handles numerous funds daily, it mechanically follows the asset manager’s instructions without verifying whether the execution matches the promised instructions." Distributors are also uninterested in whether the actual assets are properly purchased, focusing instead on expanding sales volume.

The lack of proper verification of fund investment assets in the field is due to economic logic. For example, the Optimus Creator No. 37 fund, which raised 15 billion KRW, has total fees of about 160 million KRW (1.06%). These are divided among the asset manager (0.3%, 45 million KRW), distributor (0.7%, 105 million KRW), custodian (0.04%, 6 million KRW), and administrative agency (0.02%, 3 million KRW). Except for the asset manager and distributor, the gains from managing this fund are not significant. The fund manager said, "If incentives for custodian companies are increased to enhance their monitoring incentives, it could balance the currently skewed power among the fund operation stakeholders."

Additionally, there are calls to significantly strengthen penalties so that those who commit illegal acts once can never re-enter the capital market. While guaranteeing autonomy in the private equity fund market, the severity of punishments should be increased if problems arise with asset managers or distributors afterward.

A securities industry official criticized, "In Korea, even if one earns hundreds of billions of won through illegal activities, fines or punishments are disproportionately small. Because the gains outweigh the losses even if caught later, a ‘one-shot’ mentality prevails, leading to widespread reckless behavior."