Private equity continues to suffer from an image problem – and failure to address this could lead to further regulatory constraints, a study has warned.
A report by specialist bank Investec, which interviewed some well-known industry players including Sir Ronald Cohen, the founder of Apax Partners, and AlpInvest chairman Volkert Doeksen, said “sector-wide failure to effectively communicate the private equity model has undoubtedly led to the increased regulatory burden” and warned “any assumption that the current raft of regulation is ‘it’ for private equity is potentially dangerous”.
It said firms should look “for signs of danger”, notably “the so-called 'Skin in the Game' directive”. Officially known as Article 394 – formerly Article 122a of the Capital Requirements Directive – this is a banking regulation that came into force in January 2011 and requires the sponsor, originator or original lender of a transaction to hold a minimum of 5 percent of the net economic exposure of a deal. If such mandatory increases in personal commitments were extended to the buyout sector, it could price many private equity executives out of their own funds.
To avoid this, the industry needs to tackle the lack of understanding of private equity by policymakers and the general public, the study warned.
This should include making clearer distinctions between different strategies, Markus Golser, a senior partner at Graphite Capital, suggested in the report. “One of the issues with private equity generally is that the term ‘private equity’ does not really mean anything… We have got a massive PR issue around that distinction.”
Additionally, the industry “needs to adapt to changing circumstances”, Cohen added. “There is greater regulatory interest in its activity because it gets swept up with hedge funds and other financial instruments, which have little to do with it. It needs to behave as a mature industry now. It needs to provide thought leadership about economics and the way economies can create jobs.”
It is likely that in the future, private equity will attract more and more attention from critics and regulators, according to the study.
“It’s critically important that the industry addresses its image,” Simon Hamilton, global head of Investec Fund Finance, told PE Manager. “If they don’t, LPs will be facing headwinds to invest in private equity. It therefore will be harder for a pension fund or an insurance company to invest in an asset class which has got a negative connotation.”
GPs should be actively involved, he argued. “I don’t think you can give the responsibility to national industry associations; it’s a job for everybody. Private equity is a mature industry and [it] needs to start behaving as a mature industry. It needs to find a way of articulating its successes and the positive impact it has on the economy.”
There are some signs that GPs are becoming more aware of the need to promote the industry, he said. “Five years ago, very few private equity firms had full time investor relations coverage. Most firms now have invested heavily in teams to speak to existing and new investors. I think you see an evolution of that role, [so] they don’t just speak to LPs but also become more vocal to the wider market and the media.”
The study’s warning comes just weeks after private equity's tax arrangements in the UK came under fire, with an anti-corporate campaign group teaming up with the Independent newspaper to produce a report criticizing the industry's use of the Quoted Eurobond Exemption.
A few weeks previously, British trade union Unite called for reform of the tax laws that apply to private equity-backed business and demanded a specific investigation into Kohlberg Kravis Roberts-backed Alliance Boots, which it claims has avoided £1.12 billion ($1.93 billion; €1.43 billion) in tax – an accusation the company denied.