A sprawling probe into South Korean hedge funds whose investments lost billions of dollars has evolved into a political scandal that risks undermining efforts to position the Asian country as a financial hub.
Prosecutors have since June been investigating alleged financial frauds at Lime Asset Management and Optimus Asset Management, two big hedge funds accused of misappropriation and embezzlement after they froze withdrawals due to liquidity problems.
The scandals risk shaking confidence in South Korea’s finance industry just as the government seeks to promote Seoul as an alternative financial hub to Hong Kong, whose own reputation has been hit by political turmoil.
The wide-ranging probe has raised broader concerns over governance in the country after it engulfed politicians and regulators, some of whom have been accused of taking bribes.
It has also strained South Korea’s $386bn private investment funds, an industry the government has attempted to nurture via rapid deregulation.
Private investment funds in the country are those with fewer than 50 investors, each of them investing at least Won100m ($89,300). They include private equity funds that have interests in running an invested company and hedge funds with leveraged investments mostly in derivatives and structured products, according to the Financial Supervisory Service.
Deregulation “has led to serious financial crimes and mismanagement by some players, while lowered barriers have lured retail investors unable to handle the massive risks”, said Hwang Sei-woon, a researcher at Korea Capital Market Institute.
Private investment funds in South Korea have boomed since 2015 when rules were loosened to allow them to be set up without regulatory approval, numerous reporting obligations were abolished and the minimum investment amount was slashed from Won500m ($445,000) to Won100m. Nearly 10,000 private investment funds have sprung up since the 1997-98 Asian financial crisis, with assets under management nearly doubling over the past five years.
But more casual supervision has led to a series of scams and cases of mis-selling. Thousands of retail investors are estimated to have suffered total losses of Won5.5tn since August last year due to funds freezing withdrawals, according to the FSS.
“As the investment risks for juicy returns were not highlighted, many investors saw private equity funds as the goose that lays the golden eggs,” said Mr Hwang.
Exotic funds that promise high yields and are linked to assets such as oil-based derivatives and German sovereign bonds have long been popular among South Korean investors, despite frequent meltdowns in these products.
Lime, which was once South Korea’s largest hedge fund manager with $4bn in assets, halted withdrawals worth Won1.6tn last year after investing in illiquid, high-yielding assets. Regulators have said Lime’s funds were seriously mismanaged, with some illegally investing in one another in a bid to cover redemptions.
Chung Woon-hee, a 55-year-old construction worker, said she has only been able to redeem 40 per cent of the Won300m she invested in one of Lime’s funds. “It was my entire savings. I can hardly sleep these days,” she said.
Lime is not the only example. Optimus, a $430m hedge fund manager, was ordered to suspend operations after prosecutors charged its top managers with fraud. The fund, which was supposed to invest the bulk of its assets in bonds issued by state-run companies, instead put money into non-performing loans.
The two asset managers did not immediately respond to requests for comment. They have previously declined to comment on the allegations and regulatory probes.
The matter has become a political hot potato, with South Korean president Moon Jae-in last month ordering a thorough investigation into the cases of Lime and Optimus.
A former senior presidential aide has been accused of taking bribes from Lime’s main financier, while other government and regulatory officials have been accused of illegally supporting the fund managers. The officials have denied any wrongdoing.
Industry officials have blamed regulators for incentivising the industry’s rapid growth, which they say was not adequately supervised. Faced with a public backlash, the FSS has ordered banks and brokerages to fully refund investor losses amounting to about Won160bn from Lime’s trade financing funds. They also plan to strengthen regulatory oversight and investor protection.
“The industry’s liberalisation has nurtured a bunch of crooks,” said Financial Justice, a civic group. “The absence of proper supervision has created these monsters like Lime and Optimus. Financial regulators should be held accountable.”
Regulators have said they plan to investigate all private investment funds over the next three years and to raise the minimum investment in these vehicles from Won100m to Won300m.
That could help clean up the industry, observers say, but will probably slow the breakneck growth it has experienced in recent years.
“Sellers will be reluctant to market those risky products while investors will also shun them,” said a brokerage executive. “They are paying a high price to learn the lesson. But this will probably be part of their growing pains in the long term.”