As US managers continue to field LP calls over questionable fund expenses and portfolio company fees, the consensus seems to be that the SEC’s recent high-profile intervention on the matter has had less impact (relatively speaking) on the other side of the Atlantic. In particular, there has been no indication that this issue has suddenly risen up the agenda for European regulators.
Market sources suggest there a couple of key reasons for this. The first is that because the fundraising environment in Europe has been tougher, most EU-based GPs are already offsetting 100 percent of any fees received against the management fee – thus mitigating the potential for conflicts. And second, the regulators in Europe are too busy trying to implement the myriad elements of the Alternative Investment Fund Managers Directive (AIFMD) to really focus on any one particular industry issue.
At least as far as private equity funds are concerned, the European Private Equity and Venture Capital Association's position appears to lend credence to this view: a spokesperson for the group said the trade body was “keeping a close eye” on the issue but didn’t anticipate taking any specific actions (presumably related to its professional standards handbook) anytime soon.
Nonetheless, while they may not be in the regulatory crosshairs yet, it would clearly be a mistake for EU managers to ignore what’s been taking place in the US. And not just because US LPs – whose expectations are likely to change as a result – remain such an important source of capital or the fact that the US private funds market often acts as a pacesetter in best practices and industry trends.
The AIFMD takes effect in just a few short weeks, and with it comes a new level of oversight for an industry that for most of its history has operated one step (or even two steps) removed from the public spotlight. Under the directive, GPs will begin providing more specific disclosures around what types of fees and expenses they charge to investors – a provision that for the most part has received little media attention, despite having major implications for the LP-GP relationship.
Then there is the oversight function of a depositary to consider. Under the directive, depositaries will act as third-party referees for questionable fund charges. And it’s anyone’s guess how they will apply these heightened oversight powers (which come with new liability risks) in the new AIFMD era.
In fact, CFOs in Europe tell us they’re already planning for some additional scrutiny on fee charges. A percentage of them in fact have already begun receiving information requests on fees as a result of the US probe. Depositaries speaking to pfm say they plan to reconcile any cash movements coming in and out of the fund’s bank account with a document provided by the GP that explains and justifies the transaction in more detail. This means depositaries will be doing more than just checking the invoice of a debit or credit to the account; they'll be determining that the charges are justified, based on a close reading of the partnership agreement.
So while regulators in Europe aren’t banging the drum on fees and expenses just yet, the conditions are ripe for it to happen. Studying what’s taking place in the US, and adopting the new best practices around fee disclosure and allocation, can therefore be a way for GPs to prevent a similar controversy from erupting in Europe, too. One thing's for sure: once AIFMD kicks in, they'll have plenty of other things to worry about.