Can private equity avoid the banking backlash?

Legislators across Europe are about to declare war on the banking industry, and private equity is in danger of getting caught in the crossfire

So the collapse of Europe's banking system appears to have been avoided – just. But now a new storm is brewing in Brussels, and there is no obvious place for private equity firms to seek shelter.

To be sure, the threat of bad weather coming in from Europe's political capital is not new. For two years now, a group of EU parliamentarians led by former Danish Prime Minister Poul Nyrup Rasmussen has been pushing for a clampdown on the industry. With an agenda that is expressly anti-private equity, the group wants to constrain the industry with risk capital provisions, transparency codes, caps on the use of leverage, even limits on executive pay.

Rasmussen's ideas have won significant support among members of the European Parliament, which from a private equity point of view is obviously dangerous. But thanks to the pro-private equity stance of EU Markets Commissioner Charlie McCreevy, and thanks also to successful lobbying work by the industry associations, the implementation of a Lex Rasmussen by the European Commission has not seemed likely. The Commission is due to reply to proposals from Parliament that are based on Rasmussen's ideas on 21 November, and until very recently, private equity professionals were quietly confident that its response would be broadly in its favour.

But that was then. Now an even greater threat is coming before the industry – that of it being hit not by an attack on private equity per se, but by a much broader campaign against financial institutions of many stripes and colours.

To say that the extraordinary $2.5 trillion global bail-out of the banking system in early October has boosted the political will to take regulatory action against the financial services industry is an understatement. Politicians in Brussels, and in other capitals across Europe too, are out in force looking for those responsible for the disaster. It's the banks – and to an extent the hedge funds – they're after, not private equity. But once governments open fire on these new targets (and it seems a certainty that they will), private equity will find it difficult to escape their broadsides.

GPs are aware of the danger, and they're taking it seriously. At a PEI conference held in London on 14 October, Cormac O'Haire of Terra Firma told delegates: “This is more than a threat. It's very real, it won't go away, the Commission is facing a tidal wave of political pressure to regulate. Three weeks ago we were winning the argument in Brussels about private equity, but now the danger is getting caught up in what's happening to the banks.”For private equity firms, the new predicament is not just dangerous, but also quite ironic. Even sworn enemies of their industry must acknowledge that this crisis is not of their making. Compared to other types of financial businesses, right now its corporate governance and risk management practices look sound. And unlike most banks and many hedge funds, the industry is still open for business, shifting its focus from leveraged acquisitions to turnaround investing. At a time when liquidity remains scarce and the real economy is expected to suffer badly from the financial mess, this should be welcomed and encouraged. Commissioner McCreevy has repeatedly done so, describing private equity as an important force for stabilising the European economy. But in the corridors of power in Brussels, his is a lone voice.

Again, the industry's main problem is no longer the prospect of hostile measures aimed directly at it. The main problem is the groundswell of negativity towards finance in general, and taxpayers' arguably legitimate desire to see tighter regulation of the sector. It's possible (though perhaps not likely) that enlightened legislators will come up with new rules on risk capital provisions and executive remuneration that do exactly what's needed for the banks. But the same rules applied to private equity could be stifling, and to expect lawmakers to be able, let alone willing, to exempt private equity in some way would be rashly optimistic.

Despite this, or rather because of it, industry lobbyists must try everything in their power to persuade lawmakers that private equity's ability to strengthen companies is a force that should be harnessed. They have a good story to tell, and now is the time to tell it. Merely hoping that this storm will blow over is not an option.