(PrivateEquityCentral.net) The European Private Equity & Venture Capital Association (EVCA) is arguing that the proposed banking rules for the European Union could cause European private equity companies seeking capital to lose E5bn to E10bn in equity financing.
The new banking rules, proposed by a committee of central bankers and regulators known as Basel II, have sought to adjust the risk weightings banks would have to make on their investment in private equity or venture capital funds. In essence, banks would have to keep more money on hand than they currently do for every euro invested in private equity. That would lead to banks withdrawing from the industry, according to the EVCA.
Currently, the European regulators require that banks keep 8 per cent of cash on hand for investments in private equity: in essence, banks must have E8m in reserve for every E100m invested in private equity or venture capital. The new rules would require that banks have approximately E24m on hand for every E100m invested, according to Didier Guennoc, the public affairs director of the EVCA.
The EVCA is arguing that this would be catastrophic for private equity fund raising – and investing – in Europe because banks provide almost one quarter of the region’s capital for private equity and venture capital funds. In Italy, the figure is 52 per cent. In the UK, 16 per cent of the capital raised in private equity and venture capital funds comes from banks, according to the EVCA.
The new rules are based on a flawed calculation of the inherent risk of venture capital and private equity, the EVCA argues. Investors in a defaulted private equity investment lose less than stockholders in a defaulted company lose, the organisation added.
Guennoc said that because European pensions are just now beginning to invest more in private equity, the loss of bank funding would be more pronounced than it might be in the US.
Guennoc said that while he thinks the Basel II regulations will go through, it is unknown now what form they will take.
“The private equity industry is a tiny part of the industry [that will be affected by the new regulations],” Guennoc said. “Basel II will go through but it is still being thought about.”
The Federal Reserve in the US once made a similar decision. After Congress passed the Gramm-Leach-Bliley Act in 1999, which allowed bank holding companies’ merchant banking arms to act virtually in the same way as the merchant banking arm of financial institutions such as Goldman Sachs, the Fed decided that bank holding companies would have to hold 50 cents to every dollar involved in merchant banking activities.
This was universally lambasted by the banking world, and the Fed uncharacteristically backed away. They essentially halved the requirement, requiring a 25 per cent deduction for every dollar of merchant banking investment if that investment represents 25 per cent or more of the bank holding company’s Tier 1 capital.
Neither the Federal Reserve nor Basel II focused on the distinction between economic capital and regulatory capital. In essence, banks are required to hold money in their coffers to offset losses in any activity, including triple-A loans, private equity investment and other activities based on what the bank itself deems necessary. Some of the capital held for merchant banking activities may be part of what is held for other, less risky activities. If the regulatory capital requirements exceed this economic capital, that is when problems arise, Guennoc said.
The Basel II rules are now undergoing a year-long process of consultation, both in Europe and the US. The rules should be finalised by the end of the year and implemented in 2007.
Other groups that have weighed in on the proposed regulations include the European Banking Federation, the British Bankers’ Association and the Securities Industry Association in the US.