Reform drives custodian involvement in Korea

As the quest for transparency and efficiency opens Korea’s fund administration market, major custodians are busy striking up alliances with local fund service providers to get a head start.

Following the collapse of some of its major financial institutions, Korea last year promised to reform its financial structure and open up the collective investment market in exchange for financial support from the IMF.

Among the reform measures, mutual funds and unit trusts are required to outsource their performance evaluation and fund administrative functions to increase transparency and efficiency, opening up the largest investment fund market in Asia ex-Japan.

State Street has been operating in Korea for more than 10 years, holding a 90% share of the country’s foreign custody market. While that sounds impressive, put into context it represents not even 1% of the country’s W200 trillion ($176.68 billion) fund administration market. And the nation’s savers have tucked away enough pension money to match that sum.

State Street is expected to announce a partnership deal in the coming months with the fund administration arm of Korea Exchange Bank (KEB). Sources close to the talks have told FinanceAsia the bank is prepared to invest up to W2.5 billion in paid up capital to gain half ownership.

As the global custodian bank’s Asian managing director, KK Tse, puts it: “The custody industry has become a commodity in which, if a custodian wants to differentiate itself from competitors, it needs to do more than just settlement and safekeeping.”

Deutsche slides in

Probably with those words in mind, Deutsche Bank slipped into the fund administration picture three months ago, forming an alliance with a rapidly rising administrator, A Brain. The deal does not require Deutsche Bank to invest money in the company; instead it was given the option to purchase up to 30% of the company in the first year.

The Korean collective investment market can be divided into three sectors: AMCs (asset management companies) are responsible for mutual funds; and ITCs (investment trust companies) and ITMCs (investment trust management companies) manage unit trusts. Because the AMC sector is the smallest and youngest among the three, it is the first required to outsource its fund administration to independent third parties.

A Brain, just over one year old in Korea, controls close to W3 trillion of the W7 trillion available from AMCs. KEB has around W2 trillion under administration. The other major administrators are Riesen Korea, one year old and owned by Hanvit Bank, and AM Tec, in which Daehan Investment Trust Company has a 20% stake.

Let the battle commence

It is expected that once ITCs and ITMCs join the outsourcing rank, the real battle for market share will ensue.

“It’s important to understand our bank’s positioning in the so-called custody market,” says State Street’s Tse. “We do not want to be just doing the settlement and safe keeping tasks that sub-custodians are doing ... companies like A Brain earlier [are] providing investment administrative services to the mutual fund industry. That’s what we are interested in, not just being a custodian for domestic mutual funds or unit trusts.”

The three largest ITCs - Hyundai, Korea, and Daehan - manage an estimated W160 trillion in unit trusts while a dozen of ITMCs share W56 trillion. In Korea, unit trusts are closed-end investment products, while mutual funds are now semi-opened and will become fully-opened next year.

Unlike the mutual fund industry, unit trust operators are not yet required to separate fund administration from fund investment. Jay Kim, A Brain’s managing director, expects it may take years before they are made to do so. But new unit trust operators, he notes, will be required to outsource their fund administration functions.

“The business growth opportunity in Korea for foreign custodians holding foreign assets is minimal as the vast majority of the country’s investible assets are domestically focused,” says Tse. “What State Street is targeting is the collective investment vehicles for domestic investors in domestic assets.”

While foreign custodians can be both the administrator and the custodian for mutual funds, Tse says fund managers prefer to appoint local institutions as custodians and independent third parties as administrators.

“A large consideration by managers when appointing a custodian bank is how much that bank could underwrite their funds, or how many funds they could commit to sell via their network,” says Tse. “Foreign banks are not interested in that kind of business because they don’t have the distribution network.”

Pensions to boost market

In a bid to boost its flagging stock market performance, the Korean government recently launched a series of initiatives in the pension industry, including the lifting of stock investment limits by pension funds and the establishment of a W1.5 trillion fund with public and private pension money.

But, according to MY Ban, State Street’s vice president in Korea, the moves are not likely to boost custodians’ business directly. “Pension investments are directly managed by the pension funds themselves. They don’t need to appoint a custodian,” he says. But Ban notes the National Pension Corporation, one of the largest pension funds, has started outsourcing its fund administration to a third party. He is hopeful that the move will start an outsourcing trend in the industry.