I felt for Didier Millerot when he took to the podium at the Private Equity International CFOs and COOs Forum in October in London. There was a sense that those gathered in the audience, not known for being an aggressive, hostile bunch, might just vent their anger on the man from the European Commission as he stood up to explain why and how they are now facing a costly and onerous raft of new regulation.
Millerot, deputy head of the asset management unit at the EC's directorate general for the internal market and service (breathe), thankfully did not in the end face a volley of rotten vegetables or verbal abuse. He was there to give delegates an update on the controversial proposed Directive on Alternative Investment Fund Managers (AIFM), draft regulation that would require European managers of alternative asset funds – private equity included – to comply with an array of new rules.
Some of the messages in Millerot's candid, and at times humble, speech go some way to explain just why private equity in Europe has come face-to-face with a regulatory monster.
“As you all know,” he said, “we did not have much time to prepare our proposal – we did not have much time to consult over it.”
Millerot struck an almost apologetic note when recounting the difficult task which had been thrust upon his organisation from the “highest political level”, namely EC President José Manuel Barroso, who mandated the Commission to “very quickly present a proposal” to regulate alternative fund managers in Europe.
Despite the Commission's “good intentions” – a phrase twice used in the speech – it is evident that the proposal was drafted in haste.
When asked how such a proposal could be assembled and released before seeing the results of any impact assessment, the answer made it clear that such assessments had been sacrificed to pander to a more powerful political will. Millerot spoke of the need to have all the relevant data to measure the impact on one hand, and the political imperative on the other. “The two should go hand-in-hand and one should not be more important than the other,” he said. “Here I recognise that it was more a political decision than anything else.”
As well as the unseemly speed with which the proposal had to be drafted, the presentation also highlighted how much it deviated from the original guiding principles assumed by the Commission, namely that alternatives managers explicitly did not cause the financial crisis, that the regulation should get “the balance right”, that it should avoid EU protectionism, take inspiration from existing codes like Walker and that it should not risk depriving the EU economy from much-needed funding.
With these tenets in mind, it is hard to see how the proposal came to exist in its current form. As it stands, the legislation would make it impossible for European institutions to invest in funds managed by firms outside of the EU, unless they hail from a jurisdiction with “equivalent” regimes. This will most likely narrow the choices available to European investors – the bulk of which are pension funds – ultimately hurting their ability to generate returns.
It is also tough to see how the word “balance” applies to a proposal that – in order to scoop up those managers who would seek to circumvent the rules – adopts the “all-encompassing” approach. It was always questionable to lump private equity funds together with hedge funds for the purpose of regulation. The “allencompassing” approach includes real estate, infrastructure and indeed anything else that is not classed as a retail “UCITS” fund.
In its current state, the proposed directive raises a number of concerns. These were outlined at the conference by Richard Wilson, a partner at Apax Partners and the chairman-elect of the European Private Equity and Venture Capital Association. Not least of these is the cost of compliance, which many believe will be handed on to limited partners. The latest analysis of the costs involved – conducted by Charles River Associates on behalf of the UK's Financial Services Authority – concludes these could be around €756 million for the private equity industry in the first year and subsequently €248 million per year.
The industry might find some solace in the fact that the proposal is still just that: a proposal. The debate is ongoing and all parties – GPs, advisers and, perhaps most importantly, LPs – need to continue making their voices heard.