Setting the record straight on Korean segregated accounts
05 March 2014
Category: News, Asia, Korea
By Hank Morris
It was recently reported on an online news platform that the Korean authorities intend to ban segregated accounts starting in January 2015. In fact, the term “segregated accounts” is not accurate in the sense that although the single-investor funds commonly used by institutional investors in the country are essentially the equivalent of segregated accounts, they are in fact standard domestic Korean market unit trust funds. They have all of the legal and compliance-related requirements that any fund in Korea must have: a trustee bank, fund accounting and a fund management company that is authorised and registered to operate in the domestic fund management market.
In a de facto sense, since most institutional investors invest into funds where each institution is the sole investor, the funds are equivalent to segregated accounts, but they are not in de jure terms since they must meet all of the regulatory restrictions that are applicable to any fund that is set up in the domestic Korean market.
If the change actually goes through – and as yet there has been no official statement from the Korean Financial Supervisory Service (KFSS) to confirm it – it is likely that the major companies in the Korean fund management industry will welcome the change. According to the general manager of one large international fund management company with operations in the country; under the current practice, institutional investors sometimes ask fund management companies to bundle the equivalent of a few million dollars of equities along with a few million dollars in fixed-income assets into a single bundled fund upon which they pay an incredibly small three-to-five basis points to the manager for managing it.
The fund manager takes a loss for managing such a small account. Most are only willing to provide the service under an agreement that a greater amount of funds at a much higher fee level will be given to the manager to manage for the client within a short period of time. Meanwhile, the fund manager has to operate the small existing account at a loss. The trustee bank and fund accounting company also incur losses on these small institutional investment funds since they are paid a fee based upon the size of assets under management.
Most fund managers in Seoul, whether foreign or Korean, want to manage funds that exceed the average size of the funds currently under management in the country, about US$29 million. There are approximately 9,900 funds in Korea, but since domestic investors often hold assets for less than a year, the actual number of funds closed and launched during the course of a year is much higher than the number of funds at any given point. Both retail and institutional investors often have holding periods of less than one year, which is another reason operational costs are on the high side. The administrative burden involved in the routine launching and closing of large numbers of funds is significant.
If the suggested changes do come into effect, the downside may be the banning of single investor funds, resulting in fewer options for smaller institutional investors as these would have few options other than to invest as much smaller participants in co-mingled funds dominated by much larger institutional investors. Still, fund managers, the banks and service providers such as trust banks and fund accounting companies should welcome the change if it takes place.
Average fund sizes would likely go up, perhaps substantially, and there would be far fewer funds launched. All of this could add up to good news for fund managers and service providers from a revenue stream perspective. Of course, competition will remain at high levels in any case in the Korean market. But when institutional investors have to put their money into larger funds – and pay higher fees on those funds – the net beneficiary should be the investment management industry.
To be very clear, however, the suggested change – if it is confirmed later this year and actually does take effect in January of next – will apply only to the domestic Korean market. It would not change the current segregated account system whereby foreign fund managers that wish to manage money for Korean institutional investors in global markets outside of the country register their companies with the Korean authorities. And then, when granted a license for offshore segregated accounts management, may solicit accounts from Korean institutional investors. This system involves genuine segregated accounts management and it will continue unchanged.