Beware the battles yet to come

Keeping the pending AIFM directive from hindering LP-GP relationships and global capital flows was chief among concerns discussed by PE insiders gathered in Geneva this week, writes Philip Borel.

Short-term investment performance? Down. New deal activity? Down. Fundraising? Way down; members of the European Private Equity and Venture Capital Association collectively raised €13 billion last year, a far cry from the €82 billion raised in 2008.

These were some of the headline numbers presented to delegates at EVCA’s (very well-attended) Investor Forum in Geneva yesterday. They were entirely as expected. Nobody in the audience seemed startled. They had other things on their minds – the real story, if you will. 

The real story is the one that is yet to unfold. It’s the story of how the private equity industry will emerge from the ashes that the global credit firestorm put it in. The data available for 2009 does not tell it.


Last year’s short-term IRRs may not have been pretty, but so what? It’s what they look like in five years’ time that’s important. Deals have been scarce? Well, given the circumstances that was probably a good thing; LPs hate paying fees on uninvested capital, but they hate paying fees on badly invested capital even more. What they really want to know is whether the industry can go back to making good investments this year, next year and the year after. 

And as for fundraising: again, so far the drought hasn’t really mattered – if anything it’s the overhang of dry powder that is causing concern. Again, for the real test, you have to look beyond the evidence available so far. What structural changes lie in store for the industry, and how will they affect its ability to raise capital going forward? How many existing firms will be able to raise new funds? And how will institutional investors rate the attractiveness of private equity going forward, especially in Europe where it’s not just the market environment that must improve, but also the regulatory threat that needs to abate. 

Regulation, and the pending AIFM directive in particular, were big talking points in Geneva. “Finally the LPs have woken up to the problem as well – now AIFM really is all-pervasive,” said one delegate. Among the most urgently discussed concerns was the potential creation of protectionist measures (the so-called third country or “passporting” rules) as proposed by the European Council, which could make it impossible for EU-based institutions to invest in funds domiciled outside Europe, and also hinder the flow of non-EU capital into the region.

Now that some crucial decision-making on third country in Brussels is imminent, EVCA’s lobbying apparatus is running at full throttle to help prevent the worst. Even if the EU lawmakers won’t ultimately go nuclear on capital mobility, the way the regulatory ground is shifting at the moment is still fraught with danger. Caps on leverage or new disclosure requirements might not stop the industry in its tracks, but they can certainly push up private equity’s cost of capital, and hence erode its appeal as an asset class to investors. 

It’s that prospect that scares the industry, and fighting it has become a clear priority to many practitioners, especially through the frantic work being done by the associations. Last year’s deal tally on the other hand is neither here nor there. 2009 was always going to be awful. The key question is, what is going to happen next.