Friday, December 12, 2008

EU Internal Market Commissioner McCreevy Says Self Regulation Still Open to Private Equity Firms under Codes of Conduct.

Fearing that private equity firms could get swept up in a wide-ranging and indiscriminate regulatory rethink, European Commissioner for the Internal Market Charlie McCreevy said that private equity may still be a candidate for self regulation under codes of conduct like the UK Walker Guidelines. Private equity does not give rise to the macro-prudential systemic concerns driving the regulatory agenda, he told a group of British venture capitalists.

The Walker Guidelines, issued by a working group headed by Sir David Walker, recommend that private equity firms disclose on their website a commitment to conform to the guidelines on a comply or explain basis and to promote conformity on the part of the portfolio companies owned by its fund or funds. The firms should also disclose the most senior members of their management or advisory team and confirm that arrangements are in place to deal with conflicts of interest. The guidelines also call for a description of UK portfolio companies in the private equity firm's portfolio.

The failure of some private equity funds will lead to painful losses for investors, the commissioner acknowledged, but there should be no knock-on consequences for the wider financial system. Banks and other financial institutions have lent money to finance private equity portfolio companies, he noted, but these exposures are relatively limited. Thus, he will neither lump private equity funds with other categories of leveraged financial institutions nor shackle them with unnecessary regulatory constraint.

This does not mean, however, that private equity is entirely off the hook. The private equity industry needs to be attentive to the impact of buy-out activity on the social economy and must better manage its relationships with key stakeholders. Perceived failure to manage these relationships in the context of buy-outs has fuelled pressure to regulate private equity activities.

There are also concerns relating particularly to corporate governance, transparency and reporting that warrant further attention. And, some private equity deals have been over-leveraged.

Thus, the Commission will review the Transparency Directive in order to examine issues such as notification thresholds, investment policy disclosure and identification of shareholders. In addition, the Commission will address the issue of remuneration in the financial sector; and in particular the need for reward structures to be more closely aligned to the real medium term benefits accruing.

In general though, the types of policy issue raised by private equity do not lend themselves to a regulatory solution. The concerns relate to the way in which private equity funds manage their relationships with investors and stakeholders in portfolio companies. Regulation cannot prescriptively define the type of conduct or behavior that private equity managers should follow when initiating, implementing and managing deals.

In his view that self-regulation represents the most promising avenue for promoting the desired behavior by private equity managers, the commissioner is comforted by the recent G20 declaration calling on regulators to first look to the industry codes of best practices before considering the need for any regulatory intervention. This is the approach that the European Commission will follow, he announced.

Thus, the commissioner promised a thorough and critical review of the codes of conduct for private equity firms, focusing primarily on the Walker guidelines. Already there is a concern since only 32 out of a possible 200 members are current signatories to the guidelines. The limited reach of the Walker guidelines is also apparent when you look at the number of portfolio companies covered by them.

Only 56, out of about 1,300 portfolio companies in the UK that are targeted by private equity investments, are reported to comply with the disclosure and transparency rules. These kinds of statistics are not going to impress ``trigger-happy regulators,’’ said the commissioner. Since the guidelines are voluntary, there will have to be monitoring, as well as mechanisms for promoting compliance.

There must also be cross-border consistency of codes of conduct. Currently, the European private equity market is characterized by a proliferation of significantly different industry codes. At a certain stage, said the commissioner, it may be possible to codify the common elements of inconsistent national codes into a set of widely understood and widely upheld guidelines.