CAD III throws banks PE lifeline

The third Capital Adequacy Directive (CAD III), which will implement the Basle II Accord, has significantly reduced the level of capital that banks must hold against their private equity commitments, provided that private equity exposure is part of a sufficiently diversified portfolio.

Under Basle II this was assumed to be between 24% to 32% for private equity, whereas CAD III lowers this to 13% to a maximum of 17%, meaning that instead of holding between €24m to €32m for each €100m invested in private equity, banks may now hold between €13m and €17m in reserve. As it is a reduction of almost half that which was initially expected, the European Venture Capital Association (EVCA), which has lobbied hard on this issue, has given an enthusiastic welcome to CAD III.

Herman Daems, EVCA chairman, said: “The excessive capital requirements under Basle II would have had a negative impact on the ability of the industry to raise funds from banks and other investors?” According to EVCA figures, some 21.5% of capital raised for investment in private equity in Europe comes from bank sources. This equates to €5.5bn. And over the last five years banks have on average accounted for 25% of the capital raised in Europe for private equity investment.

In February this year EVCA reported the findings from an independent study that it commissioned into the level of risk actually posed by private equity investment. The study found that an investment through a fund-of-funds, where capital is collected from investors for investment in some 20 private equity and venture capital funds, has a 0% probability of total loss and about 1% probability of some loss.

The probability of a complete loss of capital invested via investment through a managed fund, where capital is raised from investors for investment in 10 to 20 portfolio companies in only about 1%, although the probability of some loss is around 30%. Direct investment, whereby an investor provides capital directly to a company, is the most risky with a 30% probability of total loss and a 42% probability of some loss.