Korea National Pension Becomes Eat-and-Run “Vulture” Investor
by Brendon Carr
Yesterday the National Pension Service (NPS)—manager of Korea’s Social Security-like retirement pension plan—announced its intention to invest $300 million in some private-equity funds operated by “TPG”, or Texas Pacific Group.
A reporter dropped me a line asking if I thought it was a “surprising move” for NPS to be putting such an amount of money into TPG, whose current fund-raising is aimed at coming up with $7 billion for distressed financial institutions. The reporter thought with the current sub-prime crisis and market turmoil in the United States that investments in financial institutions might be too risky for NPS.
Maybe. But consider this—Korea knows TPG. They have a history together.
Rescue of Korea First Bank
In consortium with Newbridge Capital (or maybe TPG invested in Newbridge, I don’t remember), Texas Pacific Group rescued the insolvent Korea First Bank (now known as Standard Chartered Bank’s subsidiary SC First Bank) in the dark days of the Asian Financial Crisis, and turned that bank around. Newbridge sold its 51% stake for a respectable profit (I think they made a 300% return on investment in six years)—and the Korean goverment, which retained a 49% stake, also made money thanks to the private-equity “vulture” investors.
The tax-free nature of Newbridge’s gain, thanks to transaction structuring done in accordance with then-current tax treaties and the most concrete government guidance (i.e. oblique whispers, and evasive responses, with the government refusing to write anything down so as to be able to reneg on advice five years later), provoked a disappointing orgy of Roh-orchestrated public outcry. Newbridge making a tax-free profit led to Korea basically tearing up its tax treaties because the notion of a foreign fund making money was so abhorrent. ("Eat-and-Run" was coined to describe their horrible practices of rescuing wrecked companies, fixing them up, and then—quelle horreur!—exiting the investment.) And it set the ball rolling toward making Lone Star Public Enemy #1, and a sharp decline in foreign investors’ confidence in doing business with Korea.
One may expect the TPG fund will make a good return in America. The management team made its bones in the savings-and-loan crisis of the early 1990s. They know how to make returns rescuing financial institutions.
The Wheel Turns
Now the wheel has turned, and Korea is the distressed-asset investor. The $300 million of individual Korean retirees’ funds were entrusted to TPG because Korea knows this management group’s track record. But given the moral posturing taken against the foreign “eat-and-run” investment funds and their wicked capitalists, I hope NPS pays all its taxes (and then some) on its investment in the US—and doesn’t tolerate those sharpies at TPG doing anything so “immoral” as structuring anything to lawfully minimize taxes due. Otherwise the irony will be too great.
And perhaps next time, when Korea’s next market crisis happens and the vulture funds come back, there will be a more mature attitude taken—Korea having had the experience of making money as a private-equity investor. (If a loss is incurred, though—look out! And stand by for more denunciation of foreign funds.)
The NPS has announced its intention to invest 15% of assets overseas, so watch for more deals like this in the future.
UPDATE 9:12 p.m.—I am reminded by my associate Ms. In-Kyu Hwang that Korea’s other pile of money, the Korea Investment Corporation, recently invested US$2 billion in Merrill Lynch with much the same objective as NPS’s TPG entrustment. And serendipitously, she has a short piece in our firm’s Korea Herald column today on the topic of Korea’s move into the sovereign wealth fund sphere:
KOREA’S SOVEREIGN WEALTH FUND
Korea Herald, March 6, 2008by In-Kyu Hwang
The subprime crisis in the United States has had the secondary effect of focusing a lot of attention on sovereign wealth funds, as several have invested in some of America’s largest banks in order to help them through this tough period. One of these funds, the Korea Investment Corporation, or KIC, entered the spotlight by investing $2 billion in preferred shares of Merrill Lynch on Jan. 15.
Accordingly, by purchasing 3.1% of Merrill Lynch, the KIC became the second-biggest shareholder after Temasek Holdings, an investment company owned by the government of Singapore.
The KIC, as the first and only sovereign wealth fund in Korea, was established under the Korea Investment Corporation Act on July 1, 2005 in order to control foreign exchange effectively and raise the global competitiveness of the local financial market by using some of the country’s foreign currency reserves of over $200 billion.
Under the KICA, the president and CEO of the KIC is responsible for supervising the overall affairs of KIC, while a steering committee—composed of the president/CEO, the Minister of Finance and Economy, the governor of the Bank of Korea and six nongovernmental delegates—has the authority to decide on the corporation’s affairs, and the auditor of the KIC conducts independent inspections. Also, the KIC is entrusted with assets by the government, the Bank of Korea and/or government fund managers as defined under the Framework Act on Fund Management. The target assets for investment are limited to the securities prescribed in the Securities and Exchange Act, foreign exchange and derivative transactions as listed in the Foreign Exchange Transaction Act and the deposit of money in internal and external banking facilities and the sale and purchase of real estate.
Currently, the KIC is entrusted with $17 billion of foreign currency reserves from the Bank of Korea and $3 billion of foreign exchange equalization funds from the Ministry of Finance and Economy. The KIC is expected to get a foothold in the diversification of investment returns and knowledge about global asset management through its investment in Merrill Lynch.
However, as the KIC has the character of a public institution with restrictive financial resources and target assets, it is distinguished from the sovereign wealth funds of other countries, including Temasek, of which investment activities are less restricted.
With the new administration of Lee Myung-bak and increased international scrutiny of sovereign wealth funds in light of recent high-profile investments, the KIC faces three challenges. One issue is whether or not the KIC or newly created sovereign wealth funds should be opened to private fund investment. The second issue is how to manage the KIC’s exposure to risk, especially considering large investments in companies with exposure to the sub-prime crisis. And the final issue is how to cope with the movement for increased restrictions and controls placed by advanced countries and international organizations on the KIC as a result of the explosion of investment in the assets of advanced countries by Asian sovereign wealth funds recently.
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