The private equity industry has been apathetic and self-righteous in equal measure during the three years of political wrangling that have brought the AIFM directive to the brink of implementation. But as the impact of this punitive regulation moves from dinner-debate fodder to reality, the time for both insouciance and bitterness is rapidly receding and the time for action is approaching fast.
Ian Armitage, the soon to retire chairman of HgCapital and one of European private equity’s most revered figures, is only too aware of the risk that ill-conceived regulation poses for the asset class. Asked, as part of a farewell interview with Real Deals, what concerns him most about the direction in which the industry is heading, he replies that “regulation and political idiocy” are high up on his list.
“Why do regulators think they can make better decisions about risk than someone whose livelihood depends on it?” he reasonably asks. “I also think the attempt to control leverage at a portfolio level is bonkers. Let the market decide.”
But it seems that many private equity investors are still wallowing in asperity and denial. An extensive risk management survey, featuring in-depth interviews with over 50 general partners from across Europe – carried out by Real Deals, in association with global insurer Marsh – reveals that only 15 per cent view a burgeoning regulatory threat as their key concern.
Admittedly, GPs looking to identify ulcer-inducing anxieties are spoilt for choice in the current market, with the eurozone crisis quite rightly stealing the top spot with 43 per cent of the vote, and second place falling to fundraising. But there is a worrying sense, nonetheless, that the industry believes the absorption of a stringent new regulatory regime will look after itself.
A third of private equity firms still have no formal risk register in place, according to our survey, relying instead on PPM and LPA documentation, and only eight per cent of firms have hired a dedicated risk management professional.
But while a certain nonchalance prevails at a fund level – where GPs are happy to rely on their own integrity and judgement – there is no doubt investors are considerably more jumpy when it comes to portfolio risks.
As pending AIFM regulation is compounded by myriad other regulatory attacks against business, including revisions to the Companies Act and most recently the Bribery Act, two-thirds of firms have become more involved in risk management protocols in their portfolios over the past two years, while a similar number expect to become more involved in the immediate future.
Meanwhile, there is little doubt that the private equity industry has become increasingly litigious, with three-quarters of survey respondents believing an increase in personal action against directors to be likely in future.
“In the past you could isolate these things at a portfolio company level, but now they are moving up to the fund as the controlling shareholder,” explains Isis’s Wol Kolade. “Action against directors will increase as people become more aware that there are many avenues in which to create mischief.”
“There is an increasing focus on regulation and legislation, whether it is fulfilling carbon obligations, health and safety or keeping a copy of your loan notes,” adds another European GP. “In private equity we have had two years of talk and over the next three years we are going to see more implementation.”
Indeed, it is a cyclical inevitability that a poorly targeted regulatory backlash, and litigious surge, will accompany an increase in business failure. In this sense, it is understandable that many private equity professionals appear unwilling to devote too much time or energy to unravelling whatever bureaucracy and bother might be foisted their way – choosing instead to begrudgingly roll with the punches.
But far from an incremental irritation, the upheaval due to hit next year will fundamentally change the foundations of the industry. It is a regulatory time bomb that must not be ignored.
For an unprecedented analysis of risk management in private equity, see the 4 October edition of Real Deals.