Global regulator concerned as to private equity’s potential risks to financial markets(3)

The International Organisation of Securities Commissions has highlighted possible conflicts of interest and leverage as its focus for further investigation of the industry.

A special task force of the International Organisation of Securities Commissions (IOSCO) has found after nine months of study that private equity may have adverse effects on financial markets, and will continue its investigation, specifically analysing conflicts of interest and issues relating to leverage in buyouts.

Led by Hector Sants, the chief executive of the UK regulator Financial Services Authority (FSA), the task force said heightened leverage may increase risk of defaults and subsequently “be felt in both public and private markets”.

The regulator also raised concerns about possible conflicts of interest in private equity transactions, for example, management involved in a buyout, “may not always have an incentive to act in the best interests of existing shareholders by recommending a sale at the highest possible sale price, despite a fiduciary duty to do so”, its report said.

The report concluded that private equity’s effect on overall market efficiency was not part of its remit and the relevant laws existed to regulate issues concerning transparency and the public markets, market abuse, the diverse ownership of economic exposure and market access.

The task force will analyse further conflicts of interest relating to public to private transactions and the listing (or subsequent re-listing) of private equity portfolio companies.

It has also appointed cross sector body the Joint Forum, comprised of IOSCO and fellow supervisors the Basle Committee on Banking Supervision and the International Association of Insurance Supervisors (IAIS) to assess “the impact a default of large private equity portfolio companies could have on the efficient operation of related public debt securities markets and any systemic issues which may arise as a result”.

The FSA published its findings on private equity in April flagging market abuse and conflicts of interest as its key issues of concern.

Michel Prada, chairman of the IOSCO Technical Committee, said in a statement: “The growth of private equity in recent years poses a number of challenges for regulators charged with the oversight of international capital markets.”

A spokesman said IOSCO would probably publish its findings before the group’s annual conference at the end of May 2008.