Alternative Funds 2022 Comparisons

Alternative investments are attracting a significant pool of local wealth, including sovereign wealth and pensions, and investment by high net worth individuals and family offices.

The growth of Korean investors’ overseas allocations is outpacing that of their domestic allocations, driven by limited opportunities in their own jurisdiction and a thirst for higher returns. Fund managers are extending into new locations, with Korea being an attractive destination for finding new investors.

Under the Financial Investment Services and Capital Markets Act of Korea (FSCMA), collective investment schemes or funds are classified into public funds and private funds, depending on whether the fund is offered to investors by way of public offering (ie, investment solicitations vis-à-vis more than 49 prospective retail investors) or if it is offered to certain eligible investors by way of private placement. There is no separate classification for funds investing in alternative assets. However, since most of the funds investing in alternative assets are established as private funds, the terms “alternative investment funds" (AIFs) and “private funds” will be used interchangeably in this chapter.

Under the FSCMA amendment, which took effect on 21 October 2021, private funds are further classified into two types:

• privately offered collective investment schemes available for all investors (General Private Funds or GPFs); and
• privately offered collective investment schemes available only for institutional investors (Institutional Private Funds or IPFs).

GPFs can be established using various types of legal structures. In practice, the most common form of GPF is an investment trust, which has the following features:

• an investment trust is formed by a trust agreement between a collective investment management entity licensed to manage GPFs (a GPF manager) and a company licensed to engage in trust business (a trustee is typically a local bank or a securities company);
• investors invest in the fund by purchasing trust units of the investment trust at their base price (net asset value per trust unit);
• the GPF manager has the responsibility and discretion to manage and operate the fund in accordance with the fund's investment objectives; and
• the trustee is obligated, in its capacity as the trustee of the fund, to follow the GPF manager's instructions regarding the acquisition and disposal of the fund assets, and to keep the fund assets in custody under the name of the trustee but segregated from the proprietary assets of the trustee.

GPFs may also be established in various corporate forms, usually as an investment company or an investment limited liability company, the major features of which are detailed below.

Investment Company

Investment companies have the following major features:

• a GPF manager incorporates the fund in the form of a joint stock company in which investors are shareholders;
• investors invest in the fund by subscribing for the shares of the investment company at their base price (net asset value per share);
• the fund is governed by articles of incorporation (AOI);
• the GPF manager sits as a corporate director of the investment company, with the responsibility and discretion to manage and execute the investment objectives of the company;
• the investment company is required by law to appoint a trustee for custody of the fund's assets; and
• the investment company is required by law to engage an administrator for fund administration services.

Investment Limited Liability Company

Investment limited liability companies have the following major features:

• a GPF manager incorporates the fund in the form of a limited liability company in which investors are members;
• investors invest in the fund by subscribing for equity interests in the company at their base price (net asset value per equity interest);
• the company is governed by the AOI;
• the GPF manager sits as a corporate director of the limited liability company with the responsibility and discretion to manage and execute the investment objectives of the company; and
• the company is required by law to appoint a trustee for custody of the fund's assets.

IPFs must take the form of an investment limited partnership company. Members of an investment limited partnership company consist of at least one member with unlimited liability (unlimited liability member) and at least one limited member with limited liability (limited liability member) to third-party creditors of the investment limited partnership company. Investors participate in the company as limited liability members. The manager must be the unlimited liability member of the investment limited partnership company.

The FSCMA is the primary body of law regulating the investment funds industry in Korea.

The main regulator is the Financial Services Commission (FSC). Many of the supervisory responsibilities of the FSC are delegated to the Financial Supervisory Service (FSS), the enforcement arm of the FSC, which is responsible for day-to-day supervision and regulation of the financial industry, including fund registration and reporting of fund establishment, regular and ad hoc regulatory reporting, securities registration statement filings, processing of fund manager licence applications and so on.

Investment Restrictions – Target Investment Assets

In terms of target investment assets, private funds are allowed to invest in any assets that have monetary value. However, private funds making investments in real estate assets must not:

• dispose of real estate assets located in Korea within one year of acquisition, except where there is special urgent need for early disposal; nor
• dispose of land without any building or other structure before starting a real estate development project on such land.

Restrictions on Leverage

Private funds are subject to certain limits on their borrowing, guaranteeing and investment in financial derivatives. Specifically, the ratio of the sum of the following amounts over the GPF's net assets (leverage ratio) must be lower than 400%:

• the aggregate amount of assessed risks incurred by the GPF's exposure to derivatives;
• the aggregate amount of guarantees and the value of the assets provided as collateral for a third party;
• the aggregate amount of borrowed monies; and
• other transactions that have a leverage effect.

Restrictions on Management Participation Investment

A private fund making investments in a portfolio company with the aim of participating in its management, business restructuring or improvement on its governance (such investments are “management participation investments”) by way of acquisition of either 10% or more of the total number of outstanding voting shares in the portfolio company or less than 10% of the total number of outstanding voting shares in the portfolio company that enables the IPF to exercise de facto control over the major business of the portfolio company (eg, by way of appointment and dismissal of directors) must dispose of such voting shares in the portfolio company within 15 years of their acquisition.

In addition, a private fund must report any management participation investment to the FSS within two weeks of the investment.

Private funds can make investments by way of originating loans. A private fund that originates loans must comply with the following:

• loan-originating private funds must not make loans to individuals;
• the investors in a loan-originating private fund must be limited to institutional investors and financial institutions. However, if the loan-originating private fund extends loans to borrowers that are established for the purposes of acquiring, developing, managing or improving real estate or special assets (meaning assets other than securities and real estate assets), the foregoing limitation on investors will not apply; and
• the constituent documents of the loan-origination GPF must specify the percentage of the loan originations, and the limitation on the investors in the loan-origination private funds.

Korean law does not expressly prohibit private funds from investing in digital assets. However, it appears that there has not been any Korean fund established for the purposes of investing in digital assets since the regulators informally took the position that investment managers in Korea should not invest fund assets in digital currencies until the pending legislation creating the regulatory framework on the digital asset market is finalised.

There are no specific restrictions on private funds’ investments in consumer credit and other loan portfolios or cannabis/cannabis-related assets.

The establishment of a private fund does not require prior authorisation or registration from the regulators. However, an ex-post report must be filed with the FSS within two weeks of a private fund’s establishment.

Local funds must have Korean investment managers as their managers. Specifically, a GPF must have a GPF manager as its investment manager and an IPF must have a licensed IPF manager as its general partner. A GPF manager may outsource its investment management function, subject to certain reporting requirements and restrictions (see 3.6 Outsourcing of Investment Functions/Business Operations).

An investment trust is a contractual form of fund, so it is not a legal entity. Other GPFs established in a corporate form and IPFs are legal entities, but they are prohibited from having their own standing officers or employees other than their corporate directors or general partners, who must also be their GPF managers or IPF managers, as applicable. In addition, corporate GPFs and IPFs must maintain a main business office but are required not to have any other business offices.

A GPF is required to engage a trustee for custody of the fund's assets. In addition, a GPF in the form of an investment company is required to engage a local administrator, and GPFs established in other legal structures usually engage local administrators.

An IPF is required to engage a trustee for custody of its assets.

Non-local service providers are prohibited from being engaged by local funds.

Taxation of AIFs varies depending upon the type of AIF. In addition, treatment under the relevant tax law may vary depending on whether the AIF meets the following requirements to be classified as a “qualifying fund”:

• the AIF is a collective investment vehicle in accordance with the FSCMA;
• the accounts are settled and the funds are distributed once or more often on an annual basis; and
• capital investment/entrustment and redemption is in cash.

Taxation of a Trust

There is no taxation at the trust level and taxable income is only recognised once the income is distributed to the investors. Any income distributed by qualifying funds to individual investors is taxed as dividends, whereas income distribution by funds that do not meet the requirements of a qualifying fund is taxed according to the nature of that income (ie, interest, dividends, capital gains or business profits). When the income is distributed to corporate investors, the distribution constitutes taxable income for a given taxable year and is subject to corporate income tax at the corporate investor level. As such, the tax treatment of the distribution does not differ based on whether or not the fund is a qualifying fund.

Taxation of Company-Type Funds

At the fund level, company-type funds, such as investment companies and investment limited liability companies under the FSCMA are, in principle, subject to corporate income tax on investment profits from investment operations. However, if 90% or more of the distributable income is paid out as dividends, this amount is deducted from the taxable income, which enables the fund to avoid double taxation at the fund level. After taxes are paid at the corporate level, net profits are distributed to each investor in the form of dividend income and taxed again at the investor level.

Taxation of IPFs

IPFs may elect to be treated as pass-through entities for tax purposes so that income tax is not incurred at the IPF level and each partner’s income from the IPF will be subject to corporate income tax or individual income tax. If the IPF does not make such an election, the fund itself, as opposed to the investors, is liable for taxes at applicable corporate income tax rates.

At the investor level, income arising from the IPF is regarded as dividends, except in the case of the following foreign investors resident in a country that has a tax treaty with Korea:

• a foreign pension fund with characteristics similar to the National Pension Service;
• a not-for-profit entity that does not distribute income to its partners; or
• an investment company engaged in asset management for a foreign government, local government agency, central bank or other entity similar to the Korea Investment Corporation.

For those investors that qualify for such exception, their income from the IPF will be classified based on the underlying income recognised by the IPF. Accordingly, if the IPF received capital gains, then the distribution of such capital gains to the qualifying foreign investors will be treated as capital gains for the foreign investors and not as dividend income.

Trusts established in Korea do not generally qualify for benefits under the double-tax treaties Korea has entered into with other jurisdictions. However, the Korea-US double-tax treaty allows for the treatment of income received by a partnership or trust to be determined by the residence and taxation of the partner or the person subject to taxation on such income. Company-type funds established in Korea would generally be considered Korean-resident corporations and would therefore be eligible for benefits under double-tax treaties.

It is common for private funds to establish special purpose vehicles (SPVs) as their subsidiaries.

Local companies are usually the promoters and sponsors of local AIFs.

Most of the investors in local AIFs are local investors. Therefore, in general, Korean investors, such as banks, asset managers, corporate investors, insurance companies, government agencies, public pension funds and family offices invest in AIFs established in Korea.

Traditional public funds market has been experiencing a decline as a result of slow economic growth and stagnant capital markets, (open to all investors, including both retail and institutional investors), with total assets under management (AUM) slightly increasing from KRW210.3 trillion (approximately USD174 billion) in 2009 to KRW299.6 trillion (approximately USD250 billion) in March 2021.

In contrast, the demand for private funds (aimed primarily at institutional investors, corporations and high net worth individuals) has risen sharply. The AUM of private funds (excluding IPFs) has more than tripled, from KRW108.2 trillion (approximately USD90 billion) in 2009 to KRW519.9 trillion (approximately USD430 billion) in June 2021.

In terms of investment strategies, the growth of AIFs focusing on real estate, infrastructure and private credits has been outstanding over the past several years.

Recently, however, there has been a series of scandals where private funds managers and their distributors were reportedly involved in various irregularities, such as mis-selling, embezzlement of fund assets, and managing funds in violation of the constituent documents of the funds, resulting in huge losses to the investors in private funds, especially retail investors.

Investor Disclosure Requirements – GPFs Offered to Retail Investors

Distributors and any other persons engaged in investment solicitation or sales of GPFs vis-à-vis prospective retail investors must provide such retail investors with a key product information document for each GPF. The key product information document must include information on the following items.

• Basic information:
1.        name of the fund;
2.        name of the manager;
3.        names of the distributor, trustee and administrator;
4.        minimum investment amount and duration; and
5.        timeline for fund distribution, redemption and dividend payment.
• Details of the fund terms:
1.        investment strategy;
2.        major target assets;
3.        investment structure and underlying assets (in the case of investments in other funds);
4.        restriction on the use of leverage;
5.        management of idling cash;
6.        valuation and calculation of base price; and
7.        fees and expenses.
• Description on the risks:
1.        risk grade of the fund;
2.        risk factors; and
3.        liquidity risk and its management.

In addition, GPF managers must provide retail investors in the GPFs with a quarterly asset management report for each GPF including information on the base price of the collective investment securities as of the end of each quarter and a summary of the asset management activities during the quarter, among other matters.

The key product information documents and the quarterly asset management reports of GPFs are not publicly available.

Regulatory Reporting Requirements – GPFs

GPF managers must file a quarterly report with the FSS for each GPF they manage, including the following information:

• the current status of transactions of derivative products;
• the current status of guarantees and the provision of fund assets as collateral;
• the current status of borrowings;
• the current status of the fund assets;
• measures to mitigate risks associated with the management of the fund assets; and
• the current status of other transactions having the leverage effect.

In addition, if any of the following events occurs in relation to a GPF, its manager must report such event to the FSS within three business days:

• the GPF's leverage ratio surpasses 400%;
• the GPF holds a non-performing asset; or
• a decision on redemption (including deferral of redemption) is made with regard to an open-ended fund.

Finally, a GPF manager must file an amendment report within two weeks when there is a change in any item reported in the fund establishment report of a GPF it manages.

Regulatory Reporting Requirements – IPFs

An IPF manager must file a report with the FSS regarding each IPF it manages, including the following information on an annual basis where the AUM of the fund is less than KRW10 billion (approximately USD8.6 million), or on a semi-annual basis where the AUM of the fund is KRW10 billion or more:

• the current status of transactions of derivative products;
• the current status of guarantees and the provision of fund assets as collateral;
• the current status of borrowings;
• the current status of the fund assets; and
• the current status of other transactions having the leverage effect.

In addition, if any of the following events occurs in relation to an IPF, its manager must report such event to the FSS within three business days:

• the GPF's leverage ratio surpasses 400%;
• the GPF holds a non-performing asset; or
• a decision on redemption (including deferral of redemption) is made with regard to an open-ended fund.

Finally, an IPF manager must file an amendment report within two weeks when there is a change in any item reported in the fund establishment report of an IPF it manages.

Effective on 31 August 2022, offshore funds registered as private funds in Korea, and which hold Korean investors, may convert its registration to a public fund registration by meeting certain regulatory requirements. 

GPF managers are typically established as joint stock companies. IPF managers are established mostly as either joint stock companies or limited liability companies.

Both GPF managers and IPF managers are subject to the registration regime. The requirements for registration as a GPF manager and an IPF manager are set out below.

GPF Manager Registration

• Local presence – the applicant must be:
1. a local financial company;
2. a joint stock company; or
3. a local branch of a foreign financial investment company engaged in fund (collective investment scheme) management business.
• Minimum shareholders' equity: KRW1 billion (approximately USD860,000).
• Personnel: at least three full-time investment professionals.
• Facilities: the applicant must have office space and physical facilities, including security equipment and computer equipment sufficient for conducting a hedge fund management business.
• Officers: officers of the applicant (including directors and the statutory auditor) must meet the requirements under Article 5 of the Financial Companies Corporate Governance Act – essentially, they should not have been subject to any criminal or other sanctions in the past five years.
• Major shareholders: major shareholders, including the largest shareholder and significant shareholders with a 10% or more shareholding in the applicant, must meet certain standards of financial soundness and social credibility.
• Financial stability and social reputation: must be financially sound and socially reputable.
• Prevention of conflicts of interest: the applicant must have a system in place to prevent conflicts of interest.

IPF Manager Registration

Local presence: no specific requirements. However, as a matter of policy, the regulator requires the IPF manager to be a local corporate entity in Korea. Most commonly, local IPF managers are established as a joint stock company or a limited liability company.

• Minimum shareholders' equity: KRW100 million (approximately USD86,000).
• Personnel: at least two full-time investment professionals.
• Facilities: not required.
• Officers: same as for a GPF manager.
• Major shareholders: not required.
• Financial stability and social reputation: same as for a GPF manager.
• Prevention of conflicts of interest: same as for a GPF manager.

General Requirements

The applicant prepares the application and supporting documents and will normally need to have a pre-filing consultation with the FSS reviewing officer. With respect to the time required for a GPF manager registration, the FSC must process the application and complete the registration within two months of the applicant filing a full application package, excluding the time taken by the applicant to supplement the application when required by the regulator. In an IPF manager registration, the FSC must process the application and complete the registration within one month after accepting the completed application package, excluding the time taken by the applicant to supplement the application when required by the regulator

Fund managers are generally established as corporations in Korea. Management/advisory vehicles that are established or tax-resident in Korea are subject to corporate income tax on any form of profit-related returns, including carried interest and management fees.

The corporate income tax rates are as follows:

• 10% on the first KRW200 million of taxable income;
• 20% on taxable income over KRW200 million up to KRW20 billion;
• 22% on taxable income over KRW20 billion up to KRW300 billion; and
• 25% on taxable income over KRW300 billion.

In addition, the local surtax is taxed in addition to corporate income tax, at progressive tax rates ranging from 0.1% to 2.5% on the taxable income.

There are no exemptions or rules available in Korea to ensure that alternative funds with a manager in Korea do not have a taxable presence in the jurisdiction.

As discussed in 3.3 Tax Regime, there is no special tax treatment on carried interest; it is subject to corporate income tax at the regular tax rates applicable to Korean corporations.

GPF managers are allowed to outsource their investment function or business operations in relation to the management of GPFs, subject to certain restrictions and a prior reporting obligation to the FSS. Specifically, a GPF manager may outsource investment function in relation to a GPF investing in assets located in other jurisdictions to an offshore investment manager if such offshore investment manager is licensed in its home jurisdiction to engage in collective investment management businesses.

By contrast, IPF managers are not allowed to outsource their management functions to third parties.

See 3.2 Regulatory Regime.

Non-local managers are not allowed to establish local AIFs under Korean law. However, non-local managers may access Korean investors by way of offering AIFs established in other jurisdictions (offshore funds) to Korean investors, as long as such offshore funds are registered in advance with the FSS.

Eligible investors for a GPF are:

• professional investors including financial institutions, mutual aid business entities, listed companies and individuals who pass certain financial investment asset and income/asset thresholds; and
• non-professional investors, including individuals, corporations, public pension funds and collective investment vehicles making investment in the fund in accordance with the distinctions below:
1. KRW300 million or more when the leverage ratio of the fund is less than 200%; or
2. KRW500 million or more when the leverage ratio of the fund is 200% or greater.

Eligible investors for an IPF are:

• institutional investors, including financial institutions, mutual aid business entities and listed companies;
• officers or investment professionals of the IPF manager making an investment in the fund in the amount of KRW100 million or more; and
• other IPFs.

Since 1 January 2015, establishing a single investor fund has been prohibited in Korea, except for when the single investor is a certain type of prescribed investor, such as public funds established pursuant to laws (eg, the National Pension Fund), Korea Post, and mutual aid associations and mutual aid co-operatives (eg, the Korea Teachers Credit Union and the Military Mutual Aid Association).

Traditionally, most of the investors in AIFs consisted of large institutional investors and financial institutions. Recently, however, an increasing number of high net worth individuals have started to invest in AIFs.

Please see 4.1 Types of Investor in Alternative Funds.

The marketing of AIFs must be conducted by way of private placement to the eligible investors listed in 4.1 Types of Investor in Alternative Funds and must not be offered by way of public offering. In addition, the FSCMA provides a few more specific regulations on the marketing of GPFs, including the applicability of the suitability and appropriateness test, depending on the types of investors and the requirements for investment advertisements.

Finally, establishing a single investor AIF is prohibited except when the single investor is a certain type of prescribed investor, such as public funds established pursuant to specific laws (eg, the National Pension Fund), Korea Post, and mutual aid associations and mutual aid co-operatives (eg, the Korea Teachers Credit Union and the Military Mutual Aid Association).

Local investors can invest in AIFs as long as they are eligible investors as listed in 4.1 Types of Investor in Alternative Funds.

GPF managers and IPF managers can market their own funds without obtaining an additional licence. However, a GPF manager must employ a certified investment solicitation expert or engage an outside investment solicitation individual registered with the FSC in order to market GPFs it manages without engaging an outside fund distributor.

GPF managers or IPF managers can opt to engage locally licensed investment brokers or investment dealers as distributors of their funds (generally, banks, securities companies and insurance companies). In practice, most GPF managers engage outside fund distributors, while the marketing of IPFs is usually conducted by their own managers.

Please see 2.17 Disclosure/Reporting Requirements regarding the mandatory pre-investment disclosure and ongoing reporting requirements for GPFs offered to retail investors.

GPFs and IPFs offered solely to institutional investors are not subject to any mandatory disclosure requirements to investors. However, private funds managers customarily prepare and provide an investment proposal document for the prospective institutional investors, which normally includes information on the investment structure, strategies and risks, plus the track record of the manager.

Resident Investors

With respect to resident investors, the income from the qualifying fund is generally subject to withholding tax at a rate of 15.4% (including local surtax), subject to certain exceptions available for sovereign investors or financial institutions (such as banks and insurance companies). Any taxes withheld by the funds are creditable when the corporate income tax or individual income tax is calculated.

Resident Corporation

For a resident corporation, any income from the fund is subject to corporate income tax at progressive tax rates:

• 10% on the first KRW200 million of taxable income;
• 20% on taxable income over KRW200 million up to KRW20 billion;
• 22% on taxable income over KRW20 billion up to KRW300 billion; and
• 25% on taxable income over KRW300 billion.

Local surtax is charged in addition to corporate income tax, at progressive tax rates ranging from 0.1% to 2.5% on the taxable income.

Pension Funds

As not-for-profit corporations, pension funds are also subject to tax. However, the effective tax rates for such pension funds are generally significantly lower because of special reserves that they can set aside and deduct from taxable income. Furthermore, pension funds, such as the National Pension Fund or Korea Post, are part of the Korean government body and are therefore not subject to corporate income tax.

Resident Individual

For a resident individual, any income from the qualifying fund is classified as dividends and subject to individual income tax at progressive tax rates ranging from 14% to 45%. In addition, local surtax is charged in addition to individual income tax, at progressive tax rates ranging from 1.4% to 4.5% on the taxable income. Pursuant to the amendment to the Individual Income Tax Act which introduces new rules on financial investment income for individuals, the progressive tax rates of 22% (for the taxable income up to KRW 300 million) and 27.5% (for the taxable income in excess of KRW 300 million) will apply for certain income from the qualifying funds earned on or after 1 January 2023.

Non-resident Investors

For a non-resident investor, the income from the qualifying fund is generally subject to withholding tax at a rate of 22% (including local surtax) or the applicable withholding rate under the relevant tax treaty, subject to certain favourable exceptions available for foreign sovereign funds that invest through domestic IPFs, as discussed in 2.11 Tax Regime.

Korea signed the Model 1 Intergovernmental Agreement (IGA) with the USA on 10 June 2015. Korea has been treated as if it had an IGA in effect since 30 June 2014, following the issuance of implementation regulations by Korea’s FSC on 18 June 2014.

On 29 October 2014, the Korean government also entered into the Multilateral Competent Authority Agreement (MCAA) to exchange information with the jurisdictions committed to the Common Reporting Standard (CRS). On 16 February 2017, Korea amended its regulations to implement the automatic exchange of financial information with foreign countries under the CRS and FATCA.