Conflict resolution

As industry groups on both sides of the Atlantic prepare for some form of increased regulation, the International Organization of Securities Commission (IOSCO) Technical Committee has published a number of principles that private equity firms can use to mitigate the risks that conflicts of interest pose for their investors.

The commission’s report was produced by a working group that included regulators from the UK, France, Switzerland and Japan, as well as industry players like The Carlyle Group, Permira, Pantheon and the European Private Equity and Venture Capital Association (EVCA). IOSCO’s technical committee also includes regulatory authorities in China, India, Germany and Hong Kong. The European Commission has used its guidelines in the past as a reference point in coming up with various standards.

The report on conflict of interest risks, which will receive industry feedback during a consultation process ending next February, comes more than a month after IOSCO published its proposed best practices for the regulation of hedge fund of funds, including calling for managers to place more importance on liquidity and due diligence. It also comes on the same day that chair of the report’s working group, Dan Walters of the UK Financial Services Authority, spoke before the UK House of Lords on the potential impacts of the European Commission’s “Directive on Alternative Investment Fund Managers”.

While the IOSCO principles do not have the force of law, they could influence regulators in determining whether managers have adequate protections in place for investors. 

“I think the IOSCO reports ultimately feed their way into the regulatory agenda at the European Commission level and the local member state level, and the big ticket item on the agenda at the European level is the AIFM directive,” said Gus Black, a partner at law firm Dechert. “That is potentially going to take on board some of the concepts in the IOSCO paper when it eventually comes to pass.”

The guidelines could also influence regulators in the US, especially as the chairman of IOSCO’s Technical Committee, Kathleen Casey, is the commissioner of the US Securities and Exchange Commission. Many more managers are expecting to have to register with the SEC should current legislation in Congress get signed by President Barack Obama.

Among the principles outlines by IOSCO this week are:

– A private equity firm should establish and implement written policies and procedures to identify, monitor and appropriately mitigate conflicts of interest throughout the scope of business that the firm conducts. Such polices and procedures should be consistent with any legislation and regulation in the jurisdiction in which the firm operates.

– A private equity firm should establish and implement written policies and procedures to identify, monitor and appropriately mitigate conflicts of interest throughout the scope of business that the firm conducts. The purpose of these policies and procedures should be clearly highlighted to investors, who should be afforded a mechanism with which to offer feedback.

– A private equity firm should review the policies and procedures, and their application, on a regular basis, or as a result of business developments, to ensure their continued appropriateness. The periodic review of the policies and procedures should also include analysis as to the appropriateness of their application, which may take the form of, for example, a Compliance Monitoring Plan or internal audit.

– A private equity firm should favour mitigation techniques which provide the most effective mitigation and greatest level of clarity to investors. Mitigants can include addressing the conflict via: legally binding documentation; disclosure to investors; delegation of certain tasks to independent third parties (such as auditors); open competition for certain services; and reallocation of responsibilities with a firm. A firm should favour the mitigation that provides the greatest level of clarity to investors and potential for recourse in the case of investor detriment.

– A private equity firm should establish and implement a clearly documented and defined process which facilitates investor consultation regarding matters relating to conflicts of interest. A firm should also disclose the substance of opinion given through the investor consultation process and any related actions taken to all affected fund investors in a timely manner.

Though conflicts of interest were earlier identified as an emerging risk for the industry in an IOSCO report published in June 2008, David Cliffe, communications manager for the commission, said the subsequent financial crisis may convince more firms to adopt these guidelines.

“As a result of the last 18 months it has become apparent that there have been various types of conflicts of interests in the different market segments,” he said. “The atmosphere we are in at the present, people are looking for, and are more open to, guidance from regulators as to best practices in manaing these funds.”