Relief at Basel II compromise

The European Union’s Basel II banking proposals have been amended in a move that may ease the concerns of Europe’s private equity community.

The threat to private equity fundraising arising from proposals in the European Union’s Basel II Accord appears to have eased due to the granting of an important concession.

Currently, European regulators require banks to set aside eight to 12 euros of cash (the precise amount is at the discretion of national regulators) for every 100 euros invested in private equity. But under the Basel II rules, which were drawn up last year, it was suggested that banks should hold in reserve between 24 euros and 32 euros for every 100 euros invested in the asset class in order to more accurately reflect its risk profile.

The European Private Equity and Venture Capital Association (EVCA) objected to the proposal on the grounds that banks would be more likely to withdraw from the industry, making fundraising for private equity firms much tougher. Its lobbying efforts appear to have borne fruit. A statement from the European Commission said that under CAD III, the EU directive that will implement the Basel II Accord, the reserve capital amount required has been revised to between 13 and 17 euros per 100 euros invested.

“The improvement in the levels of capital under CAD III, compared to those in the Basel II Accord, is a significant achievement for the private equity and venture capital industry in Europe,” said Herman Daems, EVCA chairman. “The excessive capital requirements in Basel II would have had a negative impact on the ability of the industry to raise funds from banks and other investors, invest in companies and act as a key driver for European economic growth.”

Bank capital is a vital component of private equity’s capital base, accounting for  €7.5 billion ($9.3 billion) on average per year over the past five years in Europe, or 25 percent of all funds raised, according to EVCA. In some countries the percentage of bank capital is significantly higher, for example Spain (44.7 percent), Germany (40.7 percent) and France (36.5 percent).

It is not only fear of the Basle II proposals – which are not scheduled to come into force until 2006 – that has led banks to withdraw from private equity in recent years: disappointing performance has also been a factor. Last year, the contribution of banks to private equity fundraising dipped to 21.5 percent of the total (€5.5 billion).        

Said Simon Witney of City law firm SJ Berwin: “There are a number of reasons why some banks have reduced their exposure to private equity, and some of those reasons remain, but I think this eliminates the concern over regulatory capital. I doubt if the 13 percent requirement is material enough on its own to cause banks to withdraw from the asset class.”