Q. I heard that private equity might be regulated. Since when?
A. Elements within the European Parliament have wanted stricter regulation of private equity and hedge funds for some time - the credit crunch, financial crisis and recession, along with various scandals such as the Madoff affair, in which many European investors got burnt by a non-EU based fund, have brought these pro-regulatory voices to the fore.
Q. Who is behind this push for regulation?
A. Poul Nyrop Rasmussen, the leader of the Party of European Socialists, has been instrumental in getting the directive to this stage. Last year Rasmussen wrote a report which was highly critical of private equity and hedge funds. Despite lobbying by ourselves and others, the European Parliament voted to back the report, a move which required the European Commission, the executive branch of the European Union responsible for proposing and implementing laws, to formally draw up legislation backing calls in the report for regulation of private equity and hedge funds.
Q. Will it affect me?
A. As currently drafted, it will affect you if the total of all your funds under management comes to more than €500m. If you apply leverage at the fund level, the threshold for compliance with this regulation moves down to €100m. There are also separate additional requirements if you own more than 30% of a company which has 250 employees or more and turnover greater than €50m. All of these limits will be the subject of intensive ongoing lobbying over the coming months by those who want them reduced as well as by those, like ourselves, who want them increased.
Q. Why should I be bothered?
A. The transparency requirements will require you to publish a detailed annual report about your fund, disclosing financial statements and other sensitive information. You will also have to publish an annual report for each portfolio company, including financial information and the development strategy for the company. Other privately-owned competitors will not be required to make such information publicly available - a considerable competitive advantage. There is also the cost of implementation: A ball-park figure would be around £10,000-£15,000 per quarter. Remember also that if you currently fall outside the directive, your next fund may push you into the regulatory zone.
Q. Our fund is based outside of the EU so we don't have to worry, right?
A. Wrong. Under the proposal, non-EU domiciled funds can only market and fundraise in Europe if the country in which the fund is based has regulation equivalent to the proposed directive - which the Commission has given itself the power to decide. This creates massive uncertainty and at worst would prohibit a US private equity fund, for example, from raising money from European investors. This in turn could give rise to tit-for-tat retaliation prohibiting European funds raising money from US investors.
Q. Ok, you've got my attention. Anything else I should be aware of?
A. Capital requirements will oblige you to have at least €125,000 set aside and also additional capital equal to 0.02% where funds exceed €250m. Firms would be required to appoint an independent valuer, which could result in someone who understands your business and its value being replaced by someone who doesn't. Early indications are that valuation fees could be £40k per annum per portfolio company.
Q. What stage are we at? Is this the final bidding?
A. The thresholds and compliance requirements we are currently looking at may be the best case scenario. The consultation process has another 18 months to two years to run and some Commissioners will be pushing to significantly tighten the rules. (At one point, not at an early stage of drafting, the threshold for unleveraged funds was as low as €10m).
Q. Who is defending us in Europe?
A. The BVCA is mounting a defence alongside other national associations and EVCA. There are some sympathetic Commissioners who recognise private equity poses no systemic risk, including Charlie McCreevy, the Commissioner responsible for markets (although his term is up at the end of the year and the choice of his replacement may go some way to determining the final outcome). The Swedes, who assume the European Parliament presidency in July, broadly support our position. Some British officials, including City Minister Paul Myners, have also been making our case.
Q. What other political events might influence things?
The situation is extremely changeable. European Parliament elections in June, the Irish vote on the Lisbon Treaty due later this year, McCreevy's departure, his replacement, the instincts of the country which holds the rotating Presidency, the lack of influence a (probable) British Conservative government may have following their pull-out from the European People's Party (the largest group in the European Parliament), and the possible re-election of Jose Manuel Barroso as European Parliament President will all affect the direction of this process.
Q. What can I do?
A. Talk with MEPs, MPs and officials and emphasise the consequences of this regulation for the private equity industry and for the British economy, from its anti-competitive bent, to compliance costs and potential lost taxes and fees should this regulation drive funds out of London (and Europe). Stress the fact that private equity firms pose no systemic risk, they make real-world investments in companies, disclosure to investors is extremely comprehensive and with the amount of un-invested cash at its disposal the industry will help drag the UK out of recession if allowed to do so. Make it clear that the burden on the FSA would potentially be overwhelming, as it would have to police this system and approve, on a case-by-case basis, each application for a private equity fund to hire third-party assistance such as an administrator or marketer. Make fellow mid-market practitioners aware of the regulation and its potential effects. Support the trade bodies in requests for information and advice.
Q. What about if we agree to sign up with Walker?
A. Sir Mike Rake, the Chairman of the GMG which monitors compliance with the Walker Guidelines, is planning a consultation with the mid-market to determine whether the thresholds should be revised downwards. It is too early to say what difference it may make to the final outcome of the European issue if a broader mid-market group were to sign up to the guidelines, but the fact that we have a working system of independent regulation has helped sway opinions up to this point and given our defenders, such as McCreevy, far more ammunition than they might otherwise have had.
DISCLAIMER
In this introductory note, we have attempted to extract for you the essence of what is a huge European document. This note is inevitably incomplete and should not be relied on. The original European document can be found at: http://ec.europa.e/internal_market/investment/alternative_investments_en.htm
