Regulation seen as pushing up costs for PE: survey

Private equity firms are likely to be spending more on regulation this year, if a recent Duff & Phelps survey is any guide.

In its report, the Global Regulatory Outlook 2018, the advisory firm says that financial firms face challenges in the ever-changing regulatory landscape, which includes compliance with the EU’s incoming General Data Protection Regulation regime.

Joshua Cherry-Seto, chief financial officer at Blue Wolf Capital, a mid-market private equity firm, says that keeping up with ill-fitting regulations creates myriad inefficiencies and increases in expenses, particularly legal fees. As an example, he noted that their funds’ use of electronic tools, some of which are online, to enhance dealflow may run afoul of marketing rules that were last updated in the 1950s with retail investors in mind.

CFOs, particularly those in mid-market PE firms, aren’t likely to have the time and resources to focus on every challenging issue facing them, so they’re in need of outside help to address such concerns, he says.

“Where we’re spending a lot of time and money is on advisory services because the laws are a poor fit. And we just don’t know what we need to do, what we can or can’t say, and frankly, our advisors aren’t sure either,” Cherry-Seto said.

In Duff & Phelps’ survey of 124 senior financial services executives, 95 percent said they expect regulations to increase their costs this year.

In five years’ time, one in 10 firms expect to be spending more than 10 percent of annual revenue on compliance, compared to the 4 percent of firms who have spent that amount in the past year.

Among the pressing regulatory issues in Europe is GDPR, which will come into effect on May 25. While half of the executives said they were on track to comply, 40 percent were unsure and 9.5 percent weren’t ready.

In the US, the Securities and Exchange Commission is seen as more intent in protecting retail investors from fraud. When asked what impact regulation in the financial services industry will have on investor/consumer confidence this year, the majority, at 55.9 percent, said there will be little impact, but 35.1 percent said it will enhance or rebuild.

Cybersecurity is a major topic as firms strive to prevent security breaches to their computer systems: 78 percent of respondents say they plan to expend more resources and time on cybersecurity this year.

One thing respondents expect from regulation is greater harmonization between countries, with 19 percent saying  harmonization is the single most important factor in maintaining an effective regulatory system. But while 52 percent believe that regulators are working toward improvement in coordinating across borders, only 29 percent say that they have been effective in setting consistent regulatory standards worldwide, according to the report.

About a third of respondents in the Duff & Phelps survey were from hedge funds, while almost 15 percent came from private equity. By geographical location, 35 percent were from the UK, 28 percent from the US and 7.3 percent from Hong Kong.