Friday Letter: Rocking the boat

Speaking at PEI’s CFO/COO Forum, former Congressman Barney Frank talked about shared risk and the dangers of modifying the Dodd-Frank Act

“It’s about shared responsibility and shared risk,” said former Congressman Barney Frank at our CFO/COO Forum in New York this week, speaking of the eponymous Dodd-Frank Act and systemic risk. “We want to avoid everyone running to the same side of the boat and tipping the economy.” His comments came as part of a set of remarks to a packed room about systemically important financial institutions (SIFIs) and how financial institutions are reacting when they receive that designation. No surprise, his audience took note, as GPs have had to deal with shifting concerns around financing and liquidity as well as registration in the wake of the Act.

In addition to having to change how they finance loans and other parts of dealmaking, private equity firms are also faced with SEC registration once they reach a certain asset size threshold. Frank recommended regulators take a fresh look at that threshold, now that the realities of private equity investing are clearer to the powers that be.

While the Congressman’s views carry weight with GPs and regulators, few can fail to have noted that provisions in Dodd-Frank are already under scrutiny from a less supportive group: the newly elected Republican congress. Since convening earlier this month, the House has already taken a number of steps to weaken provisions in Dodd-Frank, including those that impact private equity registration with the SEC. The action was so swift and multi-faceted it even impacted a broader discussion around the omnibus budget bill. They also prompted President Obama to issue his first veto threat of the new year.

In the interim, the SEC is moving ahead with its examination and enforcement efforts with private equity. According to a recent Wall Street Journal report, KKR is now in the process of refunding some $10 million in fees to investors after the SEC found these to be egregious. This isn’t the first case of SEC enforcement in the wake of presence exams, and suggests that more scrutiny could be prompted if it results in benefits for investors. Speaking on the second day of the conference, the SEC’s Igor Rozenblit, co-head of the private funds unit there, reiterated the regulator's view that disclosures must be clear and restated every time a GP changes its terms.

Supporters of the Republican backed changes to Dodd-Frank have called them ‘modest clarifications’ but, in his state of the union speech, the President again made his resistance to them clear. Based on Rozenblit’s comments yesterday he has the full support of the SEC in making the examination process comprehensive. Investors like CalPERS also joined the debate this week, noting that they would be scaling back their private equity relationships and pushing for lower fees. “Dodd-Frank is a popular bill,” Congressman Frank told Private Equity International in an interview after his public remarks. “I think it’s going to be a mistake for the Republicans to try and run on this in 2016, I think it’s going to backfire.”

It’s hard to say for sure what will happen until a bill makes it to the President’s desk, but the new congress has been consistent in its push to make material changes to the regulation. 2015 could be shaping up to be a critical year that will have significant long term impact on how private funds raise, deploy and manage capital on behalf of investors. With heavyweight institutions from all corners of the financial markets already starting to put down markers as to their views and preferences, and with the 2016 general election looming on the horizon there's one sure prediction to make. This boatload of politicians, investors, financial institutions and regulators aren't going to agree anything about how the financial markets are going to be monitored and controlled easily or quietly.