Korea is about to enter the hedge fund market, according to an article in Korean Times, and it’s prompting an interesting discussion about financial regulation.In Korea, it’s against regulations to act as a hedge funds’ prime broker and manage its assets. It’s a conflict of interest.
From Korea Times:
Securities firms will also have to choose between becoming a prime broker or managing hedge funds as regulations won’t allow a company to assume both roles due to a conflict of interest. Qualified securities firms are likely to provide prime brokerage services while spinning off hedge fund management units.
The regulation is being discussed as securities firms in Korea, which are tiny compared to global investment banks like Morgan Stanley and Goldman that have satellite offices in the country, are having trouble competing.
And if Korea develops a hedge fund industry, which it looks like it will soon, it’ll only increase the divide further. Korean securities firms will have to compete in order to get enough capital to qualify as a prime broker. Right now, only a few meet the capital requirements: 2.5 trillion and 3 trillion won.
The competition might incite them to become more competitive, but the regulation that prevents securities firms from managing hedge fund assets AND being their prime broker could make it more difficult.
Korea Times explains:
Prime brokers generate most of their income from lending securities while clearing hedge funds’ trades and managing their assets. Goldman Sachs and Morgan Stanley nearly dominate the market although there are smaller players, including international financial giants such as Credit Suisse and Deutsche Bank.
So if Korean firms can’t do both, not only will they generate less income than their competition, but they might not be able to offer hedge funds the benefits that come with the “conflict of interest” of having their prime broker do both.
We brought this rule up at dinner last night while discussing the recent settlement JPMorgan will pay for allegedly helping Magnetar create a CDO that would fail, bet against it, and find clients to take the fall.
If JPMorgan wasn’t allowed to both manage a hedge fund’s assets and be its prime broker, would that have happened?
We’re not sure what the exact regulation in the U.S. is, but everyone agreed that it sounds like there could be a conflict of interest, and it should be examined.