South Korea tightens rules to prevent CVCs from circumventing investment regulations

South Korea's Fair Trade Commission (KFTC) is set to revise the enforcement decree of the Monopoly Regulation and Fair Trade Act to close loopholes that allow large business conglomerates to make indirect investments into companies affiliated with their owners. The proposed changes aim to prevent corporate venture capital (CVC) firms, held by holding companies of major business groups, from circumventing regulations by investing through external funds.

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This revision aims to strengthen regulations against fraudulent practices related to holding companies and business groups, and to improve the system for independent management by relatives.

Under the current Fair Trade Act, general holding companies are permitted to own CVCs as an exception to the principle of separating finance and industry. However, direct investments or investments through CVC-established funds into companies controlled by the group's owner are restricted. The KFTC identified that CVCs could still indirectly invest in owner-affiliated companies by becoming limited partners (LPs) in external investment funds, which then invest in those companies. This practice is considered a circumvention of existing investment prohibitions, and the revised decree will classify such actions as illegal activities.

Furthermore, the KFTC's revision will explicitly prohibit debt guarantees between companies within conglomerates subject to mutual debt guarantee restrictions (those with assets over 12 trillion won). This addresses the issue of companies using special purpose companies (SPCs) to facilitate debt guarantees. Previously, while direct debt guarantees to financial institutions were forbidden for these conglomerates, they could indirectly achieve a similar outcome by having an SPC raise funds from a financial institution and then lend it to an affiliate, with another affiliate guaranteeing the SPC's debt to the financial institution. The revised rules will classify such indirect debt guarantees via SPCs as illegal.

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The KFTC determined that such methods were effectively circumventing the current investment prohibition regulations.

In addition to investment and debt guarantee regulations, the KFTC is introducing provisions to revoke the exclusion of relatives from owner-related party status if they serve as executives in affiliated companies. This measure targets the 'relative independent management system,' which previously excluded certain relatives and their companies from the owner's sphere of influence. The revision aims to close a regulatory gap where companies with over 20% ownership by the owner's family, but with shares held by excluded relatives, were not subject to regulations against unfair profit distribution. The KFTC stated that these revisions are intended to strengthen regulations against fraudulent practices related to holding companies and business groups, and to improve the system for independent management by relatives.

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This addresses the issue of companies using special purpose companies (SPCs) to facilitate debt guarantees.