[Chodong’s Perspective] Who Will Drive the Ferraris?... Reflections on Private Equity Fund Regulation

Calls for Stricter Private Equity Fund Regulations After the Homeplus Incident
But We Must Remember Their Positive Role in Corporate Restructuring and Preventing Capital Outflow

Without human selfishness, capitalism would come to a halt.

However, when selfishness becomes excessive, it turns into greed, which ultimately harms the community. This is why Adam Smith, in writing "The Wealth of Nations," envisioned humans who are somewhat more altruistic than those filled solely with selfishness. Capitalism can only function under such circumstances.

The Korean-style private equity fund (PEF) was also created 20 years ago as a result of the government's determination to curb the side effects of greed. More specifically, it targeted the "greed of foreign capital."

Immediately after the 1997 IMF foreign exchange crisis, foreign capital flooded in and bought Korean companies at bargain prices. This was when global private equity funds such as Newbridge Capital, Carlyle, and Lone Star appeared. At the time, there was neither the capital nor the expertise in Korea to handle corporate restructuring on the trillion-won scale.

To the general public, these entities were perceived as "colonial occupying forces." Employees of foreign financial firms, including private equity funds, were often featured in news reports driving exotic imported sports cars and partying every night, earning them the stigma of being "embodiments of greed."

There was frequent criticism that the restructuring of major manufacturing conglomerates and financial companies had become a playground for foreign capital. Concerns over the outflow of national wealth grew. At the end of 2004, the Indirect Investment Asset Management Business Act was revised. There was a hidden intention to create Korean-style PEFs to prevent the outflow of national wealth.

In accordance with the law, the following year saw the official emergence of private equity management firms in Korea that could buy and sell corporate control. These included MBK Partners, founded by Chairman Kim Byung-joo, who gained experience by acquiring Hanmi Bank at Carlyle; Vogo Fund (now VIG Partners), established by former Ministry of Finance and Economy Director Byun Yang-ho, who led major corporate restructurings, and Lee Jae-woo, then Korea head of Lehman Brothers; as well as IMM Private Equity and STIC Investments, both of which transformed into PEFs after years of experience in corporate restructuring companies (CRCs) and venture capital (VC).

Around the time of the 2008 global financial crisis, Korean-style PEFs played an active role. They acquired subsidiaries of conglomerates such as Doosan, Hanjin, Hyundai, and Woongjin, and successfully turned most of them around. The private sector effectively took over the corporate restructuring role previously handled by the government and state-run banks, significantly reducing the burden of massive taxpayer-funded bailouts.

At the same time, they contributed to increasing the wealth of the public. This is because many of the investors providing capital to restructuring-focused PEFs were institutions such as the National Pension Service, the Teachers’ Pension, and the Private School Teachers’ Pension. Thanks to PEFs, the investment returns of pension funds and mutual aid associations improved.

As a result, the virtuous cycle of the PEF industry that the government intended 20 years ago was achieved to some extent. However, there have also been cases where selfishness crossed the line into greed. The profit structure of PEFs is the root cause.

PEF management companies receive an annual management fee amounting to 1-2% of the total fund size, and a performance fee of 15-20% of total profits when the fund is liquidated. Naturally, the larger the fund size and the greater the number of funds, the more money the management company earns. This structure inevitably leads to an obsession with scale over substance?a pattern seen repeatedly among failing conglomerates. Most of the cases cited as management failures among PEFs have arisen from this structure.

Following the Homeplus incident, there are growing calls for explicit regulatory tightening on PEFs. But what would happen if regulations on Korean-style PEFs were strengthened?

Let's consider it very simply.

Large-scale corporate assets will inevitably come onto the market. Korean-style PEFs, hampered by regulations, will find it difficult to acquire management control. Foreign PEFs such as Blackstone and KKR will inevitably fill the gap. Even now, assets worth over 3 trillion won are essentially playgrounds for foreign funds. These firms do not rely on domestic pension funds like the National Pension Service, so indirect regulation through pension funds is also ineffective. As a result, profits that could have gone to Korean PEF managers will instead go to foreign PEFs. The "side effects of greed" from 20 years ago will be repeated.

Who will be driving the Ferraris and Lamborghinis?

When it comes to PEF regulation, we must consider the aftermath.