In the grand scheme of things – and despite industry complaints that mid-market portfolio companies could be saddled with an additional regulatory burden when they need it least – the proposed Directive on Alternative Investment Fund Managers looks to have let the industry off the hook.
The European Commission's proposed regulatory regime for private equity and hedge funds operating in the European Union has been stoutly criticised by some GPs as potentially costly and pointless.
The European Venture Capital and Private Equity Association's (EVCA) response centred on the regulatory burden that increased disclosure requirements would place on mid-market portfolio companies.
“We estimate that around 5,000 portfolio companies will have to comply with costly and unwarranted disclosure rules that go beyond even those required by publicly-listed companies,” said Jonathan Russell, chairman of a taskforce created by the European private equity industry to assess the directive. “The Commission's proposals hit the wrong people, at the wrong time, in the wrong way.”
An uncompromising response from the British Private Equity and Venture Capital Association described the proposal as “undesirable and immensely damaging” as well as “irrational”, because it seeks to bring the very different asset classes of hedge funds and private equity into “the same domain”.
But despite these concerns, it is significant that private equity funds, by merit of the fact that they do not use leverage at fund level and their investors are typically locked in for more than five years, are being treated differently from hedge funds.
Private equity funds need to have €500 million under management before they fall under the directive's remit, while other alternatives managers – for which read hedge funds – only require €100 million.
The taskforce mandated by the industry to argue private equity's corner in the regulatory debate had placed a lot of importance on the difference between the asset classes, and the Commission listened.
The directive requires private equity fund managers to register with the regulator in order to market funds in Europe, demonstrate they are operating responsibly in terms of risk management, outline what their funds will do, and report in detail on the assets and markets to which their funds are exposed. There is no talk of limiting a fund's activity – rather, the emphasis is on jumping through a set of hoops to keep the regulator informed.
Given that self-regulation was never going to be a viable option in the current political environment, this can be considered the next best thing. There may be costs involved in compliance, but is this level of portfolio company reporting not already in place for the benefit of limited partners? It may not be cripplingly expensive to adapt it.
One mid-market player with operations across Europe told PEI that, as it already focused on best practice and transparency within its various constituencies, it would not be opposed to a tighter regulatory regime in principle.
The view that things could have been made worse does not, however, diminish the argument that no intervention at all would have been a whole lot better. “Systemic risk” was a phrase that, once the financial crisis escalated last September, provided ammunition for anyone who wanted to see private equity more heavily shackled. In a post-credit crunch world, regulation was supposedly needed to curb the activities of those managers who would put a business's health at risk by heaping excessive amounts of leverage onto it. This is risk that our fragile financial system could do without, so the argument ran.
However, the lack of systemic risk posed by private equity was a core element of the industry's submission to the EC. It argued that any risk related to the use of excessive leverage would most effectively be regulated on the supply side: i.e., the banks. And the activity of the private equity fund manager, far from infecting the financial system with risk, will prove a valuable tool in stimulating economic recovery across the Eurozone. The Commission seems to have agreed that private equity poses little in the way of systemic risk: but decided to intervene anyway.
This directive will deliver little benefit to speak of. Its creation is misguided and blame-driven. However, the political journey embarked upon almost two years ago had built up such momentum that anything other than a more heavily regulated industry was an impossible outcome. We should be thankful for small mercies.