South Korea's financial regulator is expected to order Lone Star Funds to sell the bulk of its stake in Korea Exchange Bank after the U.S. buyout firm said it cannot meet the requirements as the major shareholder of the fifth-largest lender, watchers said Tuesday.

Lone Star reported to the Financial Services Commission on Monday, the last day of a one-week deadline, that it cannot find a way to recover its status as KEB's major shareholder, according to sources.

Lone Star is currently the biggest shareholder of the No. 5 lender, holding a 51.02 percent stake.

Last week, the FSC sent an early notification to the private equity fund ahead of requiring Lone Star to meet legal requirements as KEB's major shareholder, taking the first administrative step toward ordering the funds to sell the bulk of its stake in KEB.

Although the one-week period was given to Lone Star to submit its opinion, the move was deemed a de facto order, following the Seoul High Court's Oct. 6 verdict that found the U.S. firm guilty of stock manipulation charges.

Under local banking law, an executive or corporate entity that has been convicted of violating the law over the last five years is banned from owning more than a 10 percent stake in a lender.

Following an extraordinary meeting on Tuesday, the FSC said in an e-mailed statement it has decided to notify Lone Star to meet the legal requirements for a major shareholder, raising speculation that a stake sale order may be issued in early November.

Lone Star is requested to meet the requirements by Oct. 28, the regulator said, adding the short three-day period was decided as it is virtually impossible for the U.S. fund to comply with the order.

The request means Lone Star cannot exercise its voting rights over stakes that exceed the 10 percent limit unless it meets the requirements.

If the FSC officially concludes that Lone Star is ineligible as a major shareholder of KEB, the regulator is set to order the U.S. buyout fund to sell its KEB stake that exceeds the 10 percent limit, a move that will help Lone Star make an exit from South Korea after two botched attempts.

Its previous deals with Kookmin Bank in 2006 and HSBC in 2008 failed due to regulatory issues and the global financial crisis, respectively.

The order is also expected to pave the way for Hana Financial Group Inc.'s acquisition of the KEB stake.

Lone Star's 4.41 trillion won ($3.90 billion) deal to sell its stake to the No. 4 banking group has been in legal limbo since the FSC indefinitely delayed approval, citing the lawsuit over Lone Star's stock manipulation charges in its 2003 purchase of a KEB credit card unit.

Shares of Hana Financial jumped 3.8 percent to 39,650 won on the main Seoul bourse thanks to takeover optimism, while KEB closed flat at 7,710 won. (Yonhap News)