Unshackling private equity

European private equity is at risk of being unnecessarily “swept up in a wide-ranging and indiscriminate regulatory rethink”, EU commissioner for internal markets Charlie McCreevy said during a recent speech before the British Venture Capital Association.

“We must not shackle the private equity industry with regulatory constraints that are neither necessary nor productive,” he said. “Otherwise, we will deprive capital-starved industries of much needed equity capital.”

McCreevy has in the past distanced the asset class from the causes of current financial markets crisis, calling private equity an important force for stabilising the European economy and playing an important part in the region's future recovery. But while he said private equity should not be lumped together with other asset classes for regulatory purposes, he warns that the industry must urgently look into improving transparency and stakeholder relationships.

“The private equity industry needs to be attentive to the impact of buyout activity on the social economy and better management of its relationships with key stakeholders,” he said. “Perceived failure to manage these relationships in the context of buyouts has fuelled pressure to regulate private equity activities.”

The focus on self regulation comes as McCreevy has come under more pressure this year from EU legislators to deliver tough measures to reign in private sector financial institutions. As politicians look for a scapegoat for the current economic crisis, many in the industry have expressed concern that the regulatory backlash against institutions such as banks and hedge funds will spill over into private equity as well.

For instance, the European Parliament is considering measures that would force capital requirements, binding disclosure and transparency, controls on asset stripping and capital depletion, caps on leverage and limits on director remuneration on the industry. While McCreevy's pro-private equity stance has helped keep such proposals from becoming law, the threat to the private equity model in Europe remains.

In his speech McCreevy also laid out the terms of a review he intends to undertake by March 2009 of the “scope, content and performance” of existing European codes of practice, with the results to be presented to the European Parliament. The review would look at three key areas: the coverage of industry codes, the monitoring and mechanisms for promoting compliance and consistency across member states.

“This review will not be a whitewash,” he said. “We will undertake a thorough and critical review. The yard stick will be the impact and effectiveness of codes. Policymakers and regulators will want to see evidence that these codes are influencing behaviour and avoiding undesirable outcomes.”

Responding to his speech, Javier Echarri, secretary general of the European Venture Capital & Private Equity Association (EVCA), said the EVCA would respond to McCreevy's review in two steps, the first of which will ascertain in coordination with national bodies whether there was any gap in the coverage of the codes. The second step would be to assess whether strong commonality exists between national codes and then look into how they can be expressed more similarly.

Echarri said he believed the existing codes of practice already regulated the industry very well, at both the national and European level. “My gut feeling is we are already covering every single thing,” he said. “It's obvious the ball is [in] the private equity industry's [court] to demonstrate how good the existing rules are.”

The British Private Equity and Venture Capital Association has also supported McCreevy's call for more self regulation and said that greater transparency will help block government interference in the industry. BVCA chief executive Simon Walker has said that as banks have stopped lending, businesses in Europe that would otherwise fail depend on private equity firms for muchneeded investment.

As part of an effort to show that the industry can regulate itself without government involvement, BVCA members including Terra Firma, Cinven and Apax have already signed on to voluntary guidelines formed by Sir David Walker which call for firms to disclose more detailed information about portfolio companies. While 16 private equity firms originally agreed to take part, more firms will likely have to follow McCreevy's call for greater transparency in order to keep the regulatory wolves at bay.