Outlook 2016: Focus on fees

Pressure on the GP community for greater transparency on fees shows no sign of abating in 2016, says Gibson, Dunn & Crutcher partner Mark Sperotto.

Fees and expenses in the private equity industry have come under heavy scrutiny in 2015, especially during the second half of the year. A number of prominent LPs across the globe joined in the call for greater fee transparency, with the California Public Employees Retirement System (CalPERS) announcing that it would start requiring fund managers to disclose fees collected from portfolio companies and Dutch heavyweight PGGM vowing to stop investing in managers that do not fully disclose their fees by 2020.

Meanwhile, pressure continued to mount from regulators, with the US Securities and Exchange Commission signalling its intent to come down hard on conflicts of interest related to fee and expense arrangements. In October the Institutional Limited Partners Association released a fee reporting template seeking to standardise the way GPs share fee information with their investors.

“The pressure on transparency on fees, that’s a very important point that’s been driven out of the US. That has already happened in 2015 [and] will continue into 2016,” Sperotto said. “There is plenty of pressure from the LPs for greater transparency, and there’s scrutiny from regulators on the same point, so it’s a double whammy for the funds.”

Private equity has also come under fire from presidential hopefuls in the US, who have voiced intentions to reform the way carried interest is taxed. Sperotto predicts these intentions will “crystallise” in the coming years.

These are not the only regulatory issues the industry will need to be aware of going into 2016. As well as heightened awareness of anti-trust and competition law risk, increasingly stringent sanctions and accompanying enforcement actions implemented by regulatory bodies worldwide will also continue to pose challenges to private equity firms.

“The broadening use of sanctions also impacts portfolio companies which have to be wary of the customers and suppliers with which they transact,” Sperotto said. “It is something which will lead to more reflection and due diligence for private equity sponsors having to watch out for this added regulatory burden.”

Regarding deal activity in 2015, firms looking to complete large transactions have felt “a significant positive impact” from the bond market being open. However, the recent shuttering of a number of hedge funds and bond funds in the US could mean this changes.

“This will definitely be something to watch going into 2016 — the question is whether [it] is an indication of a wider, systematic problem or whether these were just isolated incidents of specific funds which were basically overstretched on risk,” Sperotto said.

“The other aspect is the impact on the bond market in general and whether it means the bond market closes. 2015 has been very open – we’ll have to wait and see what impact an environment of rising interest rates will have on the market through 2016.”

Another benefit for private equity firms at the larger end of the spectrum this year has been the prevalence and availability of the IPO as an exit route, something Sperotto expects to tail off slightly in 2016.

“I think through 2016 we are going to see increased competitive tension between the various forms of exit available to sponsors,” he said.

Something to watch going into the new year will be the effect that geopolitical and macro issues have on stock markets.

“A lot will depend on the impact of rate rises in the US and other geopolitical issues [such as the ongoing political instability in] the Middle East [and] what impact that’s going to have on the stock market,” Sperotto said. “If the stock markets are soft then you may see an uptick in public-to-privates, which have been few and far between during 2015.”