Sunday, February 23, 2014

Part 12: Korea Investment Corporation--Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Funds as Regulator and Participant in Global Markets

(Pix (C) Larry Catá Backer 2014)

This Blog Essay site devotes every February to a series of integrated but short essays on a single theme. For 2014 this site introduces a new theme:  Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Fund as Regulator and Participant in Global Markets.

There have been a number of studies that have sought to provide an overarching structure for understanding SWFs. The easiest way to to this is to find the largest and most influential funds and then extrapolate universal behaviors or characteristics from them.  This is a useful enterprise, it may erase substantial nuance that itself might provide the basis for a deeper understanding of SWFs within globalization and in the context of a state system in which not all states are created equal.  In this sense, while the large SWFs are better known, they do not define the entire field of emerging SWF activity. This study provides a brief critical inventory of the emerging communities of sovereign wealth funds. Each post will consider a different and less well known SWF.  Taken together, these brief studies might suggest the character and nature of the emerging universe of SWFs, and their possible rationalization.

This Post considers the Korea Investment Corporation.

At about $64 billion (2013), the sovereign wealth funds managed through the Korea Investment Corporation  is among the smaller funds.  As a member of the International Forum of Sovereign Wealth Funds, the KIC shares certain characteristics with the larger SWFs, grounded on the GAAP of the Santiago Principles.  The KIC is also a relatively new fund.  It was established in 2005 under the Korean Investment Corporation (KIC) Act No. 7393 (2005) as a non-commodity fund; or better put, as a government owned investment management company that specializes in overseas investment (Sovereign Wealth Fund Institute, South Korea).  "Although KIC is internationally known as Korea’s SWF, it is essentially an asset management company,7) but unlike major SWFs, it is not a fund in itself. In this sense, the appropriate conceptual equivalent of foreign SWFs for Korea should be the foreign exchange reserves owned by the Bank of Korea and the Foreign Exchange Stabilization Fund managed by the government." (Minsuk Kim, "Policy Issues and Challenges for the Korean Investment Corporation," Korea Capital Market Institute 3(1):71-79 (2011)).

It is organized in corporate form and its initial investment consisted of a transfer of sovereign reserves from the Bank of Korea (Ibid). The articles of incorporation may be accessed HERE.   Its vision is "be the premier sovereign fund for future generations;" Its mission is to "Increase national wealth by maximizing risk-adjusted returns - Invest for the benefit of future generations - Contribute to the development of Korea's financial industry." (Korea Investment Corporation Overview ; KIC In Search of Sustainable Alpha, 2012 Annual Report, p. 2).  But its core objective appears to be to project Korean economic power as a financial center: "KIC will also nurture finance professionals with global experience who can play an important role in advancing the domestic financial sector. By spearheading advances in asset management, KIC will contribute to shaping Korea into a Northeast Asian financial hub." (KIC FAQ. No. 19).

KIC is directed by a Steering Committee, which oversees the operation of the enterprise.  The Board of Directors, in turn, overseas the work of the Chief Executive Officer and the CEo's operations, which is divided among a CIO (who oversees the investment management division), a CRO (who oversees a  risk management division), and a COO (who oversees a corporate management division). (KIC, Organization).  The steering Committee was organized to serve as a means of preserving the autonomy of KIC from the state and the Bank of Korea.  It functions like a supervisory board:
The Steering Committee is the highest decision-making body of KIC. It is currently composed of nine members, including the committee chairman. Committee members include six professionals from the private sector, the CEO of KIC and the representatives of institutions that have entrusted assets exceeding one trillion won, namely the Minister of Strategy and Finance and the Governor of the Bank of Korea. Those six private sector members, who are nominated by the Civil Member Candidate Nomination Committee and appointed by the President of the Republic of Korea, serve two-year terms. The chairman of the Steering Committee is elected from among the civil members. (KIC Steering Committee)
The accountability of the Steering Committee is undertaken through an auditor.  "The full-time Statutory Auditor is appointed by the Minister of Strategy and Finance through deliberation by the Steering Committee. Auditor’s role and responsibilities are to audit business and accounting activities at KIC" (Ibid).  Hank Ahn has been the Chairman of the Board of Directors and CEO of Korea Investment Corporation (KIC) since December 2013.  Taeg-Ki Hong was appointed KIC’s Chief Risk Officer and Compliance Officer in April 2012. Dr. Keehong Rhee, a key figure in the establishment of KIC, joined KIC in 2006 as Head of Investment Management Team.  Dr. Keehong Rhee joined KIC in 2006 as Head of Investment Management Team and has contributed to the establishment of KIC investment organization and process in the early days of KIC. (KIC Executive Management).

The steering Committee operates through functionally divided sub-committees (Ibid).  The board of directors functions somewhat like subordinate consultation and facilitation group.  It is appointed by the CEO and the Steering Committee (Ibid).  The Board undertakes those matters delegated to it by the4 Steering Committee.  These may include: "use of emergency funds and carrying forward of budget; matters pertaining to the adoption, amendment to and repeal of internal regulations of KIC; and any other matters the Board deems necessary." (Ibid). The KIC management has adopted a Code of Ethics, the most interesting provision fo which declares:
Officers/Employees shall comply with international conventions and regulations related to investment and trade, such as Anti-Bribe Convention on International Commercial Transactions, respect the laws and cultures of, and contribute to the economic development of the local countries. (KIC Code of Ethics)
The investment policy of KIC reflects the economic welfare maximization strategies of the Santiago Principles:
The KIC investment objective is to generate consistent and sustainable returns in excess of the benchmark within an appropriate level of risk. Under the principle of prudent and responsible investment, KIC strives to increase returns while (1) minimizing the risks from individual markets and assets through portfolio diversification; and (2) exercising flexibility to seize investment opportunities.
 . . . .
Initially, our investments started with traditional asset classes such as stocks and bonds. However, the scope of investment at KIC has been broadened to include inflation-linked bonds and commodities as well as private equity, real estate, hedge funds and special investments. In addition, as part of portfolio diversification, we have increased our exposure to emerging markets since 2010.

Decisions related to strategic asset allocation are subject to deliberation by the Steering Committee, the highest-decision making body of KIC. The investment management agreements signed between KIC and sponsors specify eligible asset classes and benchmark targets, and they serve as the basis for risk management and performance evaluation. (KIC Investment Policies)
It has been reported that "KIC, which had around $64.5 billion in net assets as of end-September, has been diversifying its portfolio through strategic overseas investments in sectors like commodities and energy."Kanga Kong, South Korea, Russia to Create $500 Million Joint Investment Fund, Wall Street Journal MoneyBeat, 13 Nov. 2013. But its investment strategy has been criticized for not effectively taking into account the liabilities attached to its assets. One commentator has argued: "the foreign exchange reserves entrusted to the KIC have explicit liabilities - monetary stabilization bonds, foreign exchange equalization bonds - as a result of foreign exchange market interventions by the government and central bank. Therefore, KIC’s asset allocation strategy needs to account for the liability structure and policy objectives of these foreign exchange funds, which may turn out to be different from those of major foreign SWFs." (Minsuk Kim, "Policy Issues and Challenges for the Korean Investment Corporation," Korea Capital Market Institute 3(1):71-79 (2011))

KIC exercises its voting rights as a shareholder more discretely than either the Australian or Norwegian Funds. "KIC adheres to the basic principles of acting in good faith and enhancing shareholder value in the long term when exercising voting rights. Under these basic principles, KIC has drawn up related procedures to ensure voting rights are exercised appropriately." (KIC In Search of Sustainable Alpha, 2012 Annual Report, p. 27).  But the KIC Investment Policy Statement (2011) provides only that "The Corporation shall act as a prudent manager when exercising the voting rights.
In the case of indirect investment, the voting right may be delegated to EFMs as long as it is not in breach of the fiduciary duty of the Corporation. The Corporation shall report to the BOD and the Steering Committee on the results of exercises of the voting rights on a regular basis." (Ibid., p. 7). EFMs (external fund managers) are permitted under the KIC Act art. 31(2), selected by the KIC board of directors.  (KIC Investment Policy Statement (2011) p. 9). "The fund currently allocates 1.7 percent of its alternatives portfolio to fund managers outside Korea. He said, “In the upcoming year, we have a plan to increase investment outside [Korea] gradually. We expect the ratio of overseas [alternative] investment to be 6.8 percent next year and 7.8 percent in 2015.”" (Clare Burrows, CEO of Korea's SWF resigns, Private Equity International, 6 Nov. 2013)
KIC also engages in CSR activities within Korea. 
 KIC has been carrying out community service activities to fulfill its social responsibilities as a public corporation. Also, participation in various clubs and volunteering helps to create a vibrant and constructive organization culture. Fees received for lectures given at outside agencies and seminars are donated to social welfare organizations, and employees make visits and present donations on a monthly basis to an orphanage under the lead of the KIC Volunteer Group.

Additionally, KIC senior executives and employees participate in a program to deliver coal briquettes to low-income households every year. In 2012 KIC forged an agreement with the Korean Open Doctors Society to support volunteering activities aimed at people with limited medical access in Korea and abroad. (KIC In Search of Sustainable Alpha, 2012 Annual Report, p. 30).
Initially the KIC was deemed to be too restrictively constrained in its investment activities.  (Minsuk Kim, "Policy Issues and Challenges for the Korean Investment Corporation," Korea Capital Market Institute 3(1):71-79 (2011)).  This was modified in 2011 with changes to the KIC Act that permitted investment in domestic firms and expanded the size of the fund (Ibid). Like other SWFs, the KIC has begun to create strategic partnerships with other funds.
The Russian Direct Investment Fund (RDIF) and the Korea Investment Corporation (KIC) have signed a memorandum to form the Russian-Korean Investment Platform. The signing ceremony took place in the presence of Russian President, Vladimir Putin, and Korean President, Park Geun-hye, in Seoul.
The investment platform will focus on cross-border investments which fulfill Russian-Korean strategic interests. The parties intend to invest in companies and projects that facilitate trade and encourage investment cooperation between the two countries. (RDIF and KIC launch Russian-Korean Investment Platform, Russian Direct Investment Fund, 13 Nov. 2013).
See also Kanga Kong, South Korea, Russia to Create $500 Million Joint Investment Fund, Wall Street Journal MoneyBeat, 13 Nov. 2013 ("South Korea and Russia agreed Wednesday to create a $500 million joint fund with their sovereign wealth funds, aimed at increasing cross-border investments in various companies and projects. . . . Under the agreement, both Korea and Russia–through Korea Investment Corp. and Russian Direct Investment Fund–will invest the same amount of money into companies or projects in both nations, while also inviting private sector participation.").

The KIC, then, serves as an investment vehicle for the purpose of wealth enhancement and strategic development of key sectors. It is in a sense a future fund, but one operated for the purpose of enhancing the aggregate economic potential of Korea. Among the sectors to be developed through the KIC is the financial sector itself.
In December 2003, the “Northeast Asian Financial Hub Strategy” was adopted as a national policy initiative during a meeting chaired by the President of the Republic of Korea. The strategy called for the transformation of Korea into a regional financial hub led by the asset management industry. As a part of this strategy, the Korea Investment Corporation (KIC) Act was passed in March 2005 and KIC was officially launched on July 1, 2005. . . .  With an abundance of financial assets and the related legal and regulatory framework, Korea offers a favorable environment for the asset management sector. At the same time, demand for asset management services is growing due to low interest rates and an aging society. The founding of KIC sets the stage for the growth of asset management in Korea. (KIC FAQ. No. 19)
Yet most of KIC's investments are outside Korea, principally Russia, the United States, Brazil, Canada, China and India (KIC 2012 Annual Report). It is thus operated to use markets rather than to manage them and to serve as a fund through which the state can manage the direction of economic development within Korea.  More interesting, though, is the new strategy of combining KIC with SWF partners for joint investment.  The KOREA-Russia deal, in this context is one ot watch.

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