South Korea to launch 'cornerstone investor' regime Nov. 13 to curb post-IPO sell-offs

South Korea will introduce a "cornerstone investor" regime that allows institutional investors to receive IPO shares in advance, the Financial Services Commission said Tuesday. The system aims to curb the sharp share-price drops that often follow listings when institutional investors dump large blocks of stock, and to make offering-price calculations more rational. Institutional investors who receive shares under the regime must hold them for six to 10 months.

The FSC said the Cabinet approved Tuesday an amendment to the Capital Markets Act enforcement decree to introduce both a pre-demand forecasting system and the cornerstone investor regime. The amendment is set to be promulgated this month and will take effect Nov. 13.

The changes introduce two mechanisms: a pre-demand forecasting system that gauges institutional appetite for IPO shares before a securities registration statement is filed, and the cornerstone investor regime, under which institutions receive shares in advance in exchange for committing to hold them for a set period.

To participate in pre-demand forecasting, general private collective investment managers and discretionary investment managers must hold entrusted assets of at least 30 billion won ($22.4 million). This matches the eligibility threshold for the existing book-building process, though the amendment drops a provision that would have lowered the threshold to 5 billion won for firms registered for more than two years.

Participants must also meet requirements set by the Korea Financial Investment Association, including demonstrated capability in corporate valuation and internal management of non-public information.

After completing a due-diligence report, the lead underwriter may share corporate information — the kind that will be disclosed in the securities registration statement — with institutional investors and then gauge their desired purchase prices and volumes. A confidentiality agreement must be signed covering all information provided at that stage.

Under the cornerstone investor regime, institutional investors that commit to holding IPO shares for a set period receive an advance allocation. On top of meeting the pre-demand forecasting eligibility requirements, a participating institution must have sufficient equity capital or assets under management to absorb share-price volatility risk during the lock-up period.

Specifically, an institution must hold equity capital or entrusted assets equal to at least 20 times the value of the IPO shares it is allocated in advance.

"Because this is a relative standard, not just large institutional investors but mid- and small-sized ones can also have the opportunity to participate," the FSC said.

Lock-up periods are staggered according to the share of the allocation, to prevent a concentration of sell-offs when multiple lock-ups expire on the same date. Of the shares allocated to a cornerstone investor, 50 percent are subject to a six-month lock-up, 30 percent to eight months and 20 percent to 10 months.

The cap on advance allocations to cornerstone investors differs by market. Of the shares set aside for institutional investors — excluding retail investors, employee stock ownership associations and policy funds — cornerstone investors may receive up to 20 percent of the total institutional allocation on the Kospi, with a 10 percent cap per individual investor, and up to 30 percent on the Kosdaq, with a 20 percent cap per individual investor.

The FSC also built in safeguards against conflicts of interest that could arise under the cornerstone investor regime.

To prevent lead underwriters from pre-allocating large blocks to affiliates in oversubscribed IPOs, or from using affiliates to inflate subscription rates in deals at risk of falling short, contracts with institutional investors that have a conflict of interest — including major shareholders and related parties — are prohibited outright.

Exchanging direct or indirect benefits as a condition of a cornerstone investor contract is also banned.

Financial authorities expect the new regime to ensure that market demand is more fully reflected in the IPO pricing process, and that securing medium- to long-term institutional investors will help reduce share-price volatility immediately after listing.