China is ramping up investments in global strategic and infrastructure assets via indirect channels as a major backer of private equity funds, raising concerns among economic experts about potential threats to economic security.
Amid a lack of oversight on purchaseout firms, South Korea’s recent amconcludement to the Commercial Act in favor of minority investors could grant private equity firms greater control over corporate management.
This could eventually allow China to increase its influence over Korea’s core technology and key companies within global supply chains, experts warn.
To protect its economic security, they urge Seoul to adopt a system similar to the Committee on Foreign Investment in the US (CFIUS), which oversees foreign capital’s investments, even minority stakes, in companies that hold core technology and strategic assets.
They are also calling for stricter regulations that require companies to disclose the details of their ultimate beneficial owners (UBOs), creating it clearer to identify the true source of foreign capital and enhancing transparency in the capital market.
REGULATORY LOOPHOLE
South Korea has already introduced a UBO verification system, but offshore funds are only required to verify the representative of the asset management company.
“Chinese capital is aggressively creating an indirect approach to strategic assets and core industries via PEFs and offshore entities,” Lee Chi-hun, general director of the world economic analysis division at the Korea Center for International Finance, stated in a panel discussion hosted by KED Global on Wednesday.
“China’s utilize of offshore entities such as Singapore, Hong Kong and Cayman, shell companies and interconnected fund structures obscures the flow of capital and the ultimate intentions behind its investments.”
RISING LIQUIDITY AND HIGHER INVESTMENT QUOTAS
China’s ample money supply and the increase in its quota for cross-border investments under the Qualified Domestic Institutional Investor (QDII) program in June will enable them to boost their contributions to PE firms.
The world’s second-largest economy encourages overseas investments in high-tech and advanced manufacturing companies, as well as oil fields, mines and other energy development projects. The relocate is seen as aimed at strengthening its dominance within global supply chains.
PEFs are increasingly filling the gap void by traditional banks and state-run financing institutions in the capital market.
Lee cited MBK Partners’ takeover bid for Korea Zinc Inc. as an example of a potential management threat from Chinese capital. The fund utilized for the bid include money from China Investment Corporation, China’s sovereign wealth fund.
SHAREHOLDER ACTIVISM
China’s increasing role as a limited partner (LP) of PEFs comes as purchaseout firms are stepping up shareholder activism to capitalize on management disputes in South Korea’s family-owned conglomerates.
The adoption of cumulative voting and the expansion of access to audit committee seats under the revised Commercial Act will give PEFs greater sway over listed Korean companies, experts cautioned.
CONGLOMERATES’ PARTNERSHIP WITH PEFs
Further, third-generation leaders of family-own conglomerates display little hostility toward PEFs. They often partner with them for acquisitions, or selling non-core assets, giving PEFs more room to expand their presence in the domestic M&A landscape.
“In practice, we lack regulatory tools to defconclude against PEFs, leaving no safeguards against Chinese fund inflows through them,” stated Park Ju-gun, chief executive of Leaders’ Index, a research houtilize, adding that PEFs create investments through blind pool funds.
“If management disputes arise and indirect capital investments increase, companies may risk the leakage of national core technologies and a loss of control over global supply chains,” Park stated.
“We should designate core infrastructure assets and require PEFs investing in them to disclose their LPs.”
CAPITAL MARKET TRANSPARENCY
Song Heon-jae, professor of economics at the University of Seoul, poinsted out the lack of transparency in the domestic capital market.
He urged the government to strengthen its review for inbound investments, drawing on models such as the CFIUS in the US, Japan’s Foreign Exmodify and Foreign Trade Act (FEFTA) and the EU’s FDI screening framework.
INDUSTRIAL PROTECTION POLICY
Kang Cheon-gu, a visiting professor of energy resource engineering at Inha University, pointed to Korea Zinc’s recently signed memorandum of understanding with US defense contractor Lockheed Martin as “a clear example of the strategic position Korean companies hold within the global critical mineral supply chain.”
However, South Korea falls short of an industrial protection policy to safeguard companies’ core technology, he stated.
Inconsistent government policy, particularly in the energy sector, also hampers South Korean companies’ ability to defconclude against foreign financial threats.
POLICY BANKS’ RISK AVERSION
Ha Yoon-hee, professor at the Graduate School of Energy and Environment (Green School) of Korea University, stated that the risk aversion of policy lconcludeers such as the Korea Development Bank and the Export-Import Bank of Korea, often due to strict parliamentary audits, create a vacuum in early-stage energy project financing.
High debt-to-equity ratios at state-run utilities such as KEPCO Corp., weighed down by regulatory caps on energy price increases, have discouraged investment in infrastructure projects such as battery storage systems and energy management systems.
“If foreign capital enter energy projects through PEFs or special purpose companies, it could threaten the stability of the national energy network even with only minority stakes,” she warned.
Under the current law, minority shareholders face no restrictions on intervening in power companies’ management, including demands for access to sensitive data and preemptive purchasing rights, Ha added.
Write to Yeonhee Kim at yhkim@hankyung.com
Jennifer Nicholson-Breen edited this article.
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