This year the private equity industry has been delivering a clear message to the European Commission and, indeed, governments around the world: far from being a cause of the current crisis, it is an important part of the solution. It is therefore ironic that there are real threats to private equity emerging in Brussels. Political considerations are riding roughshod over rational argument, and there is a serious danger that private equity firms will be left with inappropriate and unnecessary regulation which could damage their ability to deploy capital in the future.
In the UK, at least, the private equity industry's message has not fallen on deaf ears. Lord Mandelson, Secretary of State for Business, Enterprise and Regulatory Reform, has made it clear that the government recognises the importance of private equity. As it looks for ways to stimulate the economy, support viable businesses through short-term liquidity problems and prepare them for the eventual recovery, the government knows that private equity has a critical role to play. A prime example is the Capital for Enterprise Fund which closed this month. It is aimed at assisting small and medium-sized businesses which are struggling to obtain bank debt, and professional private equity fund managers have been recruited to invest it.
It would be extremely unfortunate if kneejerk reactions by regulators were to stifle that model with ‘one-size-fits-all’ rules with little foundation in logic
But curbs imposed by Brussels in response to the crisis may yet attack the private equity industry in a way that impedes its ability to support recovery. Despite a 300-page dossier delivered by the private equity industry to the European Commission at the end of February, and a “hearing” organised by the Commission which rehearsed the merits of private equity – affirming the absence of any systemic risk from its business model – it is now clear that a new draft directive will be published in Brussels this month. It is widely thought that the directive will set low threshold levels which will capture a large number of private equity (including venture capital), real estate, infrastructure and other funds. Once caught, funds could be required to comply with strenuous systems of registration, disproportionately burdensome disclosure and notification requirements, capital requirements which have little foundation in logic, and curbs on leverage. While the industry has been working hard to shape those rules, there are powerful political interests at work, and some – including the influential Poul Nyrup Rasmussen, former Danish prime minister and leader of the Party of European Socialists – have continued to make it clear that they will not be happy with anything but the most potent curbs on private equity.
The draft proposal falls under the remit of Charlie McCreevy, the Internal Markets Commissioner. In recent months, McCreevy has acknowledged that private equity has found itself the scapegoat of the current financial crisis and that, in terms of regulation, the concerns with private equity are very different to other alternative investment markets. The worries, he has argued, focus on debt levels in portfolio companies and the management of wider relationships. According to a speech which McCreevy gave in February, the starting point for new rules should be existing regulation and oversight, and an understanding that investors in private equity are sophisticated, mainly institutional players who could undertake their own due diligence and negotiate their own terms. But political considerations exacerbated by looming elections are driving the agenda now, and McCreevy's rational intentions may be frustrated by expediency.
SPEED-UP AFTER SUMMER
It is anticipated that the legislative process will gather speed after the European Parliament elections and the new Commission appointments have taken place this summer. The process for adopting the proposed legislation will be split between the EU member states meeting in Council, and the European Parliament. This co-decision making process can, on average, be expected to last between 18 to 24 months, and will begin in earnest in late September/October, once the new Economic and Monetary Affairs Committee and the Legal Affairs Committee have taken office. The timing of the publication of this draft legislation, to coincide with the election process, is itself a telling indication of the political forces at work in Europe.
Private equity is already heavily regulated in the UK by the Financial Services Authority and recent moves by the industry towards self regulation reflect recognition that greater transparency and disclosure is both desirable and inevitable. It is obvious to many that businesses will need equity capital to replace the debt they can no longer get, and to shield them from further risk. It is also clear that private equity firms have the capital and skills to identify good businesses and to steer and sustain them through difficult times. Even though the industry is now facing the same commercial challenges as every other business, the private equity model of alignment of interest, innovation and active ownership offers real attractions in the current environment. It would be extremely unfortunate if kneejerk reactions by regulators were to stifle that model with “one-size-fits-all” rules with little foundation in logic.
THE LAW MAKING PROCESS
Phase 1: The Commission's draft proposal
The European Commission is the executive body that prepares and drafts proposals for EU legislation, including directives.
Charlie McCreevy is the Commissioner in charge of DG Internal Market and Services, which is the department responsible for drafting the proposals in relation to the regulation of private equity.
Having consulted on a proposal internally, the Commission formally adopts the proposal and, under the co-decision procedure, submits it simultaneously to the Council of the European Union and to the European Parliament.
Phase 2: The legislative process
Under the co-decision procedure the Parliament and Council share legislative power equally. The procedure is based on the principle of parity between the directly elected Parliament, representing residents of the EU, and the Council, representing the governments that comprise the EU. The two institutions must agree upon a final text in order for a proposal to become law.
Having received a formal proposal from the Commission, the Council and Parliament will pass this on to their relevant committees, working in tandem.
The Parliament committee will appoint a rapporteur whose main task is to follow the proposal throughout the stages of the procedure. Meanwhile, the Council undertakes its preparatory work within a working party. The working party reports to the Committee of Permanent Representatives (COREPER), which is responsible for preparing the Council's decisions.
The co-decision procedure provides for up to three readings of proposed legislation, depending on how quickly the Parliament and Council can reach agreement on the draft legislation.
In order to facilitate agreement between the institutions, a number of “trialogues” may take place throughout the process between delegates of the Parliament, Council and Commission (often considered the true negotiating forum).
Phase 3: Transposition of the directive into domestic law
Once the Council and Parliament have adopted a directive, it is binding law. However, in order to take effect, it must be implemented by each EU member state within a given period of time. This involves enacting domestic legislation to bring the member state in line with the objectives of the directive.
Simon Witney is a partner at law firm SJ Berwin, which advised on the UK government's Capital for Enterprise Fund. The firm publishes a weekly commentary on tax and regulatory matters that affect the European private equity industry. To subscribe please email firstname.lastname@example.org.