In its desperation to create more tech stars, South Korea’s government bears some of the blame for spreading moral hazard in the nascent local hedge-fund industry.

Lime Asset Management Co., the country’s biggest hedge fund, has frozen $710 million in withdrawals and come under regulatory investigation while struggling to meet redemptions in a dangerously too-good-to-fail form of convertible bonds aimed at boosting tech startups. The government encouraged Lime and other funds to load up with such instruments, but they have found it extremely difficult to exit when a surge of investors have tried to pull out their money.

Convertible bonds are popular in volatile sectors like tech for investors looking for the safety of fixed income and interest as well as the benefits of an equity upside. Witness the clamor early this year in China for convertibles. So hot was demand as the stock market surged that regulators took steps to cool the frenzy, including preventing their purchase through multiple accounts. The problem in South Korea is that high volumes of convertibles kept being issued while the Kosdaq index of mainly small-cap technology stocks has fallen. That’s because these bonds have a uniquely Korean flavor — an incentive in the form of refixing clauses that allows an investor to negotiate a lower equity strike price whenever shares fall.

AD
AD

This ability to keep lowering the equity conversion price as markets tank meant that hedge funds faced little risk in buying them. The phenomenon “posed a serious moral hazard problem — I think South Korea is the only country that allows this kind of refixing,” said Bruce W. Lee, chairman of an environmental, social and corporate governance research firm, Who’s Good.  

As if that wasn’t attractive enough, the government gave tax breaks for investments in Kosdaq stock and convertibles. No wonder funds piled in.

 The government was effectively incentivizing the hedge-fund industry to foster new blood in technology. Asia’s  fourth-largest economy has struggled to nurture entrepreneurship in the smothering shadow of such giants as Samsung Electronics Co. The top 10 family-run conglomerates control more than a quarter of all business assets. It isn’t surprising that South Korea has just nine unicorns, or privately held startups worth more than $1 billion, CBI Insights data show. The biggest and best-known, e-commerce company Coupang, has some backers like  SoftBank Group Corp.’s Vision Fund and was last valued at $9 billion.

AD
AD

To contact the author of this story: Nisha Gopalan at ngopalan3@bloomberg.net

To contact the editor responsible for this story: Patrick McDowell at pmcdowell10@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

©2019 Bloomberg L.P.

AD
AD