"Mandatory Post-Management at Least Once a Year for Alternative Investments"... Financial Supervisory Service Announces Revision of 'Risk Management Best Practices'

Strengthening Risk Management for Alternative Investments
by Securities Firms and Asset Management Companies

In the future, domestic securities firms and asset management companies must strengthen risk management by conducting post-investment monitoring at least once a year when making alternative investments in overseas real estate and other assets.

On the 19th, the Financial Supervisory Service (FSS) announced that it plans to revise the "Risk Management Best Practices" related to alternative investments to include these measures.

As of the end of June last year, the scale of overseas real estate alternative investments by domestic securities firms and asset management companies reached 83.7 trillion KRW. They are expanding their scope into alternative investments such as overseas real estate as part of efforts to create new revenue sources and diversify. However, amid concerns over the deterioration of alternative investments due to the sluggish global real estate market, some investments have realized losses. This has increased the demand for revising the current best practices to enhance financial companies' risk response capabilities and improve investor confidence.

The FSS and the Korea Financial Investment Association formed a task force (TF) with domestic securities firms and asset management companies to prepare the revision draft. The draft reflects industry best practices throughout the entire alternative investment process, from designing risk management organizations to post-investment evaluation. It presents detailed procedures and implementation methods necessary for risk management and investor protection at each key stage.

First, the organizational management system was made more specific. The quorum and composition requirements for investment decision-making bodies such as the Investment Review Committee are rationally established to ensure the objectivity of investment reviews. Additionally, a risk management system is newly established to regularly manage alternative investment assets by subdividing them according to investment type, maturity distribution, region, and other factors.

Along with this, the draft supplements areas where review and risk analysis were previously insufficient during the investment planning stage. New policies and procedures are introduced to review and evaluate brokers and other parties who introduce alternative investment transactions and discover investment opportunities. Furthermore, considering the characteristics of different types such as investment rental, vacancy risk including mid-term contract termination is newly recognized as a major risk.

For on-site due diligence, a checklist including inspection items is newly established to support thorough and appropriate local due diligence. In addition, criteria and procedures for selecting external experts are newly created and documented to enable objective selection processes.

At the investment review stage, scenario diversification is encouraged. Sensitivity analysis for cash flow estimation is mandated to be actively utilized during the investment review stage. The role and authority of the Chief Risk Officer (CRO) are also strengthened by granting the CRO the right to request reconsideration within decision-making bodies such as the Investment Review Committee that approve investment plans.

In the post-investment management and evaluation stage, inspection items are incorporated into the checklist. New standards for asset soundness classification and impairment loss recognition are introduced to evaluate distressed assets. Moreover, post-investment monitoring of investment assets is mandated at least once a year, and assets judged to have a high likelihood of distress must be inspected on an ad hoc basis.

The FSS stated, "The revision of the best practices is expected to reduce uncertainties related to alternative investments and enhance investor confidence." It added, "The revised best practices will be finalized by mid-March this year and will be implemented after a preparation period for securities firms and asset management companies starting from April."