Click here for printer friendly page

Under the regulatory microscope

Over recent years, the private equity industry has become a major driving force in many European economies, says SJ Berwin. Private equity is now widely acknowledged to be a valuable source of finance for many businesses, encouraging entrepreneurship and helping companies to grow and succeed. This conspicuous success has raised the profile of the industry with those in the financial services sector - not least with the UK’s financial services regulator, the Financial Services Authority (“FSA”).

The FSA has recently published its Financial Risk Outlook for 2006 and its annual Business Plan, in which it sets out its regulatory priorities for the coming year. One of the FSA’s statutory objectives is to maintain confidence in the UK financial system, and the growing importance of the private equity industry within the overall capital markets has not escaped its notice.

The FSA has established a dedicated, specialist team to supervise firms operating in the private equity sector. During 2006, the team will conduct a series of themed visits to private equity firms, aiming to increase the FSA’s understanding of the private equity market and to establish whether the FSA’s oversight of the private capital market is “effective and proportionate”.

Issues earmarked by the FSA for further investigation include: the effect that continued growth in the private equity market relative to the public market may have on the efficiency of the overall capital markets; whether the leverage and illiquidity inherent in private equity structures may increase the risks to financial stability; and whether market standards, including those related to transparency and disclosure, remain appropriate given the increasing, albeit indirect, interest of retail investors.

UK private equity firms should not be unduly alarmed by the FSA’s interest. Effective and proportionate regulation is, on the whole, good for the industry. As the chairman of the British Venture Capital Association said in a recent speech, the fact of being regulated is often seen as a badge of credibility. It gives investors, portfolio companies and others dealing with private equity houses confidence that they are working with well run businesses with good corporate governance procedures. The key concern is that regulation should be proportionate to the (comparatively low) financial risks posed by the industry, as over-regulation not only imposes an excessive compliance burden on firms, but can stifle the flexibility and innovation that are at the heart of the industry’s success.

With the industry under scrutiny, this may be an opportune moment for firms to address those issues raised by the FSA last summer, such as ensuring that compliance manuals are up to date and, in particular, that anti-money laundering procedures are robust (see last week’s Private Equity Comment). Firms should seize the opportunity offered by the proposed visits from the FSA to demonstrate to the regulator that private equity firms are responsibly managed organisations and that a light regulatory touch is all that is required.