Legal & Regulatory Briefs – Spring 2014

South Korea Lowers Barriers for Retail Investors

Source: Yonhap News Agency, AVCJ, Kim & Chang Legal Newsletter

South Korea’s Financial Supervisory Commission will allow domestic retail investors to indirectly invest in private equity, thereby broadening access to the asset class for investors and growing the pool of capital available to private equity funds. The reforms will broaden retail access to private equity by permitting mutual funds to have exposure to the portfolio companies of private equity funds.

Accredited investor rules throughout emerging and developed markets typically proscribe retail investors from investing in private equity funds due to the long-term and illiquid nature of the asset class. Currently, the South Korean threshold for “qualified investors” is the ability to invest at least 1 billion won (roughly US$94,750) for private equity funds and 500 million won for hedge funds.

The announcement is part of the FSC’s “Plan to Strengthen Competitiveness of Korea’s Financial Industry” (the “Plan), a broader effort to stimulate South Korea’s capital markets that includes planned reforms to policies related to private funds. Other changes encompassed within the Plan include a shift from requiring advance registration for newly established funds to a notification within 14 days of establishment; additionally, private equity funds will be permitted to invest up to 50% of their net assets into derivatives and real estate and to provide debt guarantee and collateral.

The reforms are expected to come into effect in late 2014, pending Korean parliamentary review.

Hong Kong Broadens Tax Exemption for Private Equity Funds

Source: EY Global Tax Alert

The Financial Services Development Council of Hong Kong has proposed to exempt private equity funds that are incorporated or registered outside of Hong Kong from taxation. The measures would also allow for special purpose vehicles, which private equity funds often utilize to structure investments, to be tax exempt in Hong Kong. Furthermore, the FSDC PE fund that was at no time held by fewer than five persons would be regarded as being “bona fide widely held,” thereby changing the threshold for invoking the Deeming Provisions. This proposal is less onerous than the current threshold of 50 persons and would thereby exempt more investors from taxes earned by offshore funds.

This proposal extends to private equity the exemptions under the Safe Harbor Rule, which has exempted non-resident persons from Hong Kong tax on certain transactions since 2006. The proposed Extended Safe Harbor rule should apply to a private equity fund that invests into portfolio companies which are incorporated outside of Hong Kong, do not undertake any business in Hong Kong and own less than 10% of their net asset value in Hong Kong real estate. Taken together with proposed exemptions of SPVs under a PE fund and the proposed changes to the Deeming Provisions, the FSDC proposed measures are a welcome development by private equity fund managers and investors.

Draft Promotion and Protection of Investment Bill proposed in South Africa

Source: White & Case Client Alert

In November 2013, South Africa’s FSB published the Draft Promotion and Protection of Investment Bill, which narrows provisions on expropriation and investors’ recourse to international arbitration. The move occurred after South Africa cancelled its bilateral investment treaties with major European countries, including Belgium, Netherlands, Luxembourg, Germany, Spain and Switzerland.

The Bill has sparked concerns among investors, as it proposes to remove recourse to international arbitration in the event of a dispute. Foreign investors would instead have to rely upon mediation with the South African Department of Trade. In comparison, bilateral investment treaties typically allow foreign investors to employ international arbitration to settle investment disputes.

Foreign investors have also expressed frustration that the Bill narrows the definition of expropriation in that it provides for “just and equitable compensation” rather than compensation at “full market value.” It does, however, roll over existing guarantees against state seizure of assets.

Proposals to Change Disclosure Requirements for Australian Superannuation Funds

Source: Asian Venture Capital Journal (AVCJ)

In 2013, the federal government of Australia required superannuation funds to publish full details on their portfolio holdings. In a private equity context, the legislation required disclosure not only of the funds but also the assets in which the fund has invested. The industry expects regulations to be reversed, as the government reopened consultation on the bill in March. This disclosure system was scheduled to come into effect on July 1, 2013, but had been deferred for 12 months.

Offshore GPs are not obliged to approve the disclosure of their portfolio holdings, but Australian-based fund managers have little choice but to comply with the new regulations, should they be fully implemented.

Some speculate that foreign PE firms will respond by refusing to accept investments from superannuation funds, thereby potentially denying Australian investors the opportunity to invest in some top-performing managers.

FSB & IOSCO Methodology on Systemically Important Non-Bank/ Non Insurance Financial Entities

Source: Financial Stability Board

In January, 2014, The Financial Stability Board, in consultation with the International Organization of Securities Commissions (IOSCO) proposed a methodology to identify non-bank, non-insurance (NBNI) financial entities that are systemically important to the global financial system, i.e., “too-big-to-fail.” The consultative document also explains how the failure or distress of a NBNI financial entity could pose a threat to global financial stability.

According to the FSB, “Systemically important financial institutions (SIFIs) are institutions whose distress or disorderly failure, because of their size, complexity, and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.”

The first step in reducing the systemic and moral hazard risks posed by systemically important financial institutions (i.e., “too-big-to-fail”) is to create methodologies to identify these entities. These methodologies have already been developed for banks and insurers; the proposed framework extends them all other financial institutions (to investment funds, finance companies and market intermediaries). It applies to private equity and venture capital funds, as a subset of investment funds.

There are five overarching “impact factors” that are common to all NBNI financial entity: size, interconnectedness, substitutability, complexity and global reach. The consultation will produce indicators for each impact factor tailored to specific types of NBNI entities, such as investment funds.

The methodology has its origins in the 2011 Cannes Summit, where G20 tasked the FSB to consult with IOSCO to prepare methodologies to identify systemically important NBNI financial entities.

The methodologies were open for public consultation until April 7th. Once the identification methodologies have been finalized, the FSB will develop incremental policies within the existing framework to address the systemic risks that these entities posed.