FSS Tightens Review of Overseas Real Estate Funds… "Total Loss of Principal" to Be Clearly Stated

Key Investment Risks and Large-Scale Losses Must Be Disclosed Starting September 30

The Financial Supervisory Service (FSS) is strengthening investor protection for high-risk funds such as overseas real estate funds. Beginning on September 30, key investment risks must be stated on the first page of the prospectus for high-risk funds, and any past large-scale losses must also be disclosed. In particular, for overseas real estate funds structured as subordinated equity investments, the possibility of partial or total loss of principal must be clearly stated.

On the morning of September 9, the FSS held a meeting at its headquarters in Yeouido with key executives from asset management firms and the Korea Financial Investment Association to discuss these enhanced investor protection measures and the readiness of the industry. The plan centers on strengthening self-inspection for overseas real estate funds by management firms, requiring clear disclosure of key risks for high-risk funds in the securities registration statement, and tightening the fund review process.

Seo Jaewan, Deputy Governor at the FSS, said, "Overseas real estate funds and REITs (Real Estate Investment Trusts) launched by management firms generally consist of a senior loan from a local institution and a subordinated equity investment by a domestic investor. These are high-risk products that are vulnerable to loss of right to maturity (EoD) and forced sale-induced investment losses if property appraisals decline, regardless of rental income." He called on asset management firms to make diligent efforts in risk management as product manufacturers. In the past, in some cases, entire investment amounts were lost due to impaired underlying assets and the subordinated equity investment structure.

From September 30, the FSS will implement revisions to the securities registration statement for ten types of high-risk funds: overseas real estate funds, overseas REITs, equity-linked funds (ELF), derivative-linked funds (DLF), leveraged and inverse funds, covered call funds, target maturity funds, gold spot funds, and overseas feeder funds, among others.

The first page of the simplified prospectus will list a total of four key investment risks: one principal loss risk and three special risks, enabling investors to intuitively identify major risks. For overseas real estate funds, in addition to the risk of principal loss, risks such as fund leverage, risk of dividend not being received, and foreign exchange fluctuation risk will be presented.

In addition, each asset management firm will be required to provide the names of similar funds with historical loss rates exceeding 20%, investment region and asset, date and size of the loss, and other details. This is intended to improve investor understanding of potential risks. For income-type real estate funds with subordinated equity investment structures, it will be explicitly noted that, regardless of rental income, funding losses may occur in the event of property price declines as a result of first-lien lenders exercising their collateral rights under local loan agreements, potentially resulting in partial or total loss of the fund principal.

At the same time, the FSS has strengthened self-inspection for management companies with overseas real estate funds. Since April of this year, the FSS has required management firms to directly perform their own evaluation of on-site inspections conducted by foreign contractors, with the internal control department providing its assessment comments. This information must be reviewed and signed by the CEO and the compliance officer. In addition, to help investors anticipate worst-case investment outcomes, firms must include profit and loss performance graphs and stress test scenario analysis results in the registration statement.

As a preventive measure, the FSS is also reinforcing the review process for high-risk funds. At the beginning of the year, a special review team was established within the Asset Management Supervision Division, and a focused review system was introduced with multiple designated reviewers. During the review of overseas real estate funds, the FSS closely examines the on-site self-inspection report and whether the standard key risk disclosure has been incorporated. An FSS official stated, "We will also closely review whether the product structure is high-risk, such as whether a senior lender can unilaterally dispose of the property counter to the wishes of fund investors."

Participants at the meeting agreed that thorough risk management is essential from the product design and manufacturing stages, and confirmed their commitment to using past large-scale loss events as important lessons to improve reliability and provide consumers with products in which they can invest with confidence.

Deputy Governor Seo emphasized, "With global geopolitical risks and interest rate uncertainties resulting in a deteriorating market environment and weakened investor sentiment, launching high-risk products such as those with mezzanine or subordinated investment structures that could potentially harm consumers requires exceptionally careful consideration of loss potential at the design and manufacturing stages. The FSS, for its part, will also conduct strict reviews of high-risk funds, including overseas real estate funds, from an investor protection perspective."

This content was produced with the assistance of AI translation services.