Through the looking glass

The Walker Group’s remit in the consultation document published in July was to review disclosure and transparency in the private equity industry, with a specific focus on the operations of large buyout firms. The document shows a great deal of thoughtfulness and intellectual clarity in defining the complex and multi-faceted issue of disclosure. Looking at the draft recommendations, though, EVCA has a number of concerns.

The political environment that prevailed in the UK immediately before and during the time of the writing of the consultation document was characterised by suspicion and mistrust of private equity. Contrary to many of the prevailing criticisms at that time, the private equity industry has contributed positively to the growth of London’s importance as a global financial centre and to the UK economy at large.

According to the consultation document, the guidelines are intended to focus on large buyout houses. EVCA has 1,200 members across 58 countries. The majority of large buyout houses that have significant investment activity in Europe are members of EVCA. It is important for us therefore to examine and assess some of the recommendations presented in the consultation document, lest they have the potential to harm not only the UK private equity industry but wider UK and European economic competitiveness.

Many of these issues of disclosure are well covered by the UK and European industry’s own guidelines on professional standards and reporting, which have been adopted widely and praised by the FSA and other regulatory bodies. The fact the relevant legislation varies from country to country has been taken into account when drafting these professional standards. Uncertainty could present new challenges on issues to which the industry has devoted substantial effort.

EVCA recognises the need for the industry to improve its communications with stakeholders as it expands; moreover, the industry should be seen to have high standards of governance and transparency. But private equity should not be constrained by the imposition of levels of disclosure that would go beyond those required of other private companies and that would remove the benefits for portfolio companies of being private rather than listed entities. Additional reporting requirements that apply only to private equity-backed companies would put them at a disadvantage against other private businesses, whether owned by families, other private or public companies, hedge funds or the integrated finance units of banks.

Another area of concern is the definition of a large company. The suggested indicators may well bring within their scope a number of mid-market companies. The definition of size can vary by economic cycle and corporate development stage, which could mean entering and exiting the definition boundaries over time and cause uncertainty over whether or not a company would have obligations under the guidelines.

Furthermore, the guidelines as published in July could even apply to some smaller, high-growth companies, whose path to success is not always a straight upward line. These companies often attract successive rounds of finance, and disclosure of certain information between each round could have significant effects not only on the companies but on their venture backers.

We also note that, while the original goal of the consultation document was public disclosure by large private equity firms, the current draft goes beyond these and into areas of communication to LPs, marketing of funds to LPs, corporate governance of portfolio companies and contractual agreements between GPs and LPs.

Our last concern centres on the suggested attribution analysis of how to value growth achieved on unrealised investments. The consultation document considers that this is particularly important as a communication and educational tool. However, the degree of complexity inherent in such attribution analysis means that the costs of its production may be quite significant. Surely, it would be more efficient to make attribution analysis solely on realised investments on an aggregate basis?

In anticipation of the final guidelines and their implementation, EVCA will wait and see how the recommendations in the July paper are developed – we and many of our UK member firms have submitted detailed, constructive critiques and suggestions. It is important that other European jurisdictions also wait and see, rather than rush into hasty conclusions.

The UK’s financial services industry has been a global success in large part because of the principles-based approach of its regulators. The UK is also Europe’s most mature private equity market and a major part of its financial services industry. It is our hope that the final report takes the industry’s comments into account and comes up with final proposals that are workable, affordable and productive rather than a barrier to a flourishing and entrepreneurial contributor to the British economy.