Weak Oversight, Investor Devastation

A series of redemption suspensions by private equity funds are disrupting the market. One notorious example is Lime Asset Management, which incurred losses of up to 1.6 trillion won ($1.3 billion).

Many investors—not only institutional investors but also individuals who invested a significant portion of their wealth—were hit hard. There have also been other cases of mis-selling and failures involving private equity funds, such as Derivative-Linked Funds (DLFs), the Discovery Fund, and the Optimus Fund, leaving many investors devastated.

Inevitably, confidence in the Korean financial market plunged. Amid this string of disasters, the very role and function of the Financial Supervisory Service (FSS) have come under scrutiny.

The FSS is the authority that exercises broad control over financial businesses and the market itself in Korea. Its responsibilities are vast, ranging from prices and commission rates to the management of financial products launched by individual firms. Given recent events, it is clear that the FSS did not function properly. In 2015, the financial authorities relaxed regulations on private equity funds with the intention of benefiting the market.

However, without providing adequate guidance or rules, asset management companies with little expertise rushed to introduce competitive high-risk products. The safeguards put in place were far too cursory. By allowing a series of poorly designed products to enter the market, the FSS betrayed both honest market participants and consumers. The FSS’s irresponsibility cannot be obscured by the reckless conduct of corporations.

The FSS’s response after the incidents became public is also highly controversial. Following the 2019 DLF crisis, the FSS banned banks and insurance companies from selling private equity funds and trust products. It took this measure in response to criticism that it had failed to supervise financial firms properly and ensure that consumers fully understood investment risks. Curiously, however, the FSS seems to have forgotten that the problem lay not only in sales practices but also in supervision.

Banning the sale of such products is a clear violation of consumers’ freedom of choice. If the FSS were truly concerned with investor protection, it should have focused on reducing the harm caused by incomplete sales practices and minimizing mis-selling. Halting the sale of products in the market itself does nothing to provide consumers with the information they deserve. This is a complete inversion of the protection and promotion of consumer rights.

The FSS ordered Lime Asset Management to fully compensate investors for the suspension of fund redemptions. Full compensation is unprecedented. It appears to have been a political decision, made in response to suspicions that political figures might be connected to the case. One cannot help but be reminded of the chronic dysfunction caused by government and political intervention in the private financial sector. For a long time, this has been a major factor undermining the competitiveness of the Korean financial market and its firms.

Investment involves not only profit but also the responsibility to bear risks and losses. It is clear that the fund manager and sellers were at fault for failing to provide consumers with full and accurate information. Nevertheless, investors who accepted high risks in pursuit of higher returns should also bear their fair share of responsibility.

To absolve investors of all responsibility is purely political and populist. Political influence affects the market negatively. Such decisions only create moral hazard among investors and ultimately lead to market contraction. This is a loss for both companies and investors. It also prevents the market from creating and developing competitive financial products, which could in turn disadvantage future investors.

As Hong Kong loses its appeal as a financial hub in Asia, many foreign financial firms are relocating to other countries. It is disheartening to find that none has chosen Korea. Strict financial regulation limits the freedom of enterprise. Added to that is political influence, which lowers the efficiency of the financial market. Under such adverse circumstances, it is difficult to expect any policy that would enhance financial competitiveness to emerge.

The FSS must provide clear and straightforward guidelines that accord with the spirit of the free market and that financial firms can follow. Consumers’ rights and freedom of choice in the financial market can be properly protected and promoted in a market where high-quality financial products compete with one another. Eliminating all possible liability through regulation can never be the answer.

Profitability and stability are proportional to the competitiveness of financial companies. Revitalizing the financial market and ensuring market stability can be achieved through clear rules and standards of conduct that do not infringe on the freedom of the market itself. Now is the time for the FSS to take responsibility, not run away from it.

Eun-kyung Kwak (rollypop55@gmail.com) is manager of the Economic Policy Department at the Center for Free Enterprise (CFE).

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Original title: Poor financial supervision and investors' devastation

Author: Eun-kyung Kwak

Date: 2020-10-22

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=23187