JPMorgan averts Korean allocation crisis

How a legal opinion about KEB''s status nearly proved a $140 million allocation crisis for JPMorgan in Korea.

While Korea is Asia's most exciting market at the moment, its legal system can still throw-up some pretty amazing pitfalls, as JPMorgan discovered last Thursday.

Indeed, thanks to an oversight, the bank nearly ended up with a $140 million shortfall of stock that it could not allocate to foreign fund managers.

The Korean government is selling its remaining 28.6% stake in KT Corp. While Korea Telecom is already 49% owned by foreign fund managers, this latest divestment will see 5.7% sold to employees, 15% to other Korean companies, 3.7% to domestic retail investors and 4% to institutional investors.

The last tranche was to be split equally between existing shares and an exchangeable bond (due 2005), with the total size being around $560 million.

JPMorgan is adviser to the government on the sale, which has four domestic underwriters.

It was never envisioned that foreign participation would be wide, however. Under Korean law, the institutional tranche can only be bought by Korean entities. However, the stock is hot, and one way round the Korean law is for foreign fund managers to buy the local stock through a domestic trust.

Critically, this trust has to have a domestic bank as its custodian.

JPMorgan had set up just such a trust, through Korea Exchange Bank (KEB) and (along with Salomon and Goldman) had taken orders for $140 million of stock by foreign fund managers - which represented about a quarter of the institutional tranche.

So far, so stratightforward, you may think. However, a rival bank says that a last minute crisis ensued when KEB was almost declared a 'foreign' entity thanks to its 33% ownership by Germany's Commerzbank. If deemed 'foreign', this meant that it could not act as a custodian for the trust. That would mean switching the trust's custody to another bank - Cho Hung was the favoured choice, for example. However, that change would take a month to process under Korean regulations.

Put simply, that would mean JPMorgan would have taken orders from foreign investors that it would not have been able to fulfil. An embarassing situation might have ensued in which foreign orders had to be scaled back to zero due to the KEB problem. 


Shin & Kim had been JPMorgan's legal adviser on this situation, but the 'problem' with KEB's status seemed to come down to the legal opinion given by the lead law firm to the syndicate, Kim & Chang. In a very hairy period last Thursday, it had to deal with a very ambivalent situation in which it had to judge whether KEB was indeed a Korean institution.

There are two definitions that apply to whether a bank is considered domestic or foreign in Korea. One is whether it is more than 15% foreign-owned; which KEB clearly is. The second is whether half the board members are from the foreign entity. In KEB's case, Commerz does not control the board and Kexim and the Central Bank hold 43% of the stock.

In the end, common sense seems to have prevailed. At 2am on Friday morning, Kim & Chang finally gave an opinion that deemed KEB was a domestic bank.

A major embarassment was averted - since the trust structure was now intact and the $140 million of orders could be fulfilled - but for all concerned, this threw up a worthwhile lesson on the sometimes ambiguous nature of Korean regulations and laws.

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