With European banks having largely sold off the bulk of their private equity stakes as a result of financial regulations, they are now increasingly using the secondaries market as a portfolio management tool, but they are also left with smaller, trickier private equity assets to sell.
“Banks have now effectively gotten rid of the low-hanging fruit,” said Nigel van Zyl, a partner who advises on private equity and alternative asset funds at law firm Proskauer in London. “What’s left are the trickier assets that may not have a natural home or a natural buyer.”
According to Proskauer, banks globally accounted for 8 percent of capital invested in private equity in 2013, a drop from 11 percent in 2008. European banks still hold as much as $49 billion in private equity assets, some of which they plan to keep on balance sheet, according to industry experts.
In recent years, banks including Standard Chartered and Italy’s Intesa Sanpaolo have reduced their exposure to private equity as regulatory changes such as the Volcker Rule in the US and Basel III either prohibit financial institutions from holding the asset class or make it prohibitively expensive.
Earlier this year, Turin-based Intesa Sanpaolo finalised the spin-off of its private equity division with US asset manager Neuberger Berman agreeing to take over about €100 million of the bank’s private equity portfolio. The sale included stakes in Carlyle Group, Apax Partners, Cinven and Clessidra funds, according to Il Sole 24 Ore.
Other banks were quicker to shed their private equity assets. In 2011, Barclays sold a $740 million portfolio of fund interests to Ardian (known as AXA Private Equity at the time), and that same year, Germany’s HSH Nordbank offloaded its interest in 47 European buyout funds, worth around €620 million, to Ardian and LGT Capital Partners.
The main reason European banks like Barclays and Intesa Sanpaolo have sold private equity assets is the regulatory pressure they were under after the global financial crisis to clean up their balance sheets and increase the amount of capital they hold under the reformed capital adequacy requirements.
In the EU, Capital Requirements Directive IV (CRD IV) came into effect in January 2014 as part of the Basel III global banking reforms in response to the financial crisis. The reforms aim to help raise the resilience of individual banking institutions during periods of stress. CRD IV takes aim at capital ratios, making it more expensive for banks and investment firms to hold private equity in terms of risk weighting, with banks in theory having to hold as much as 190 percent of the value of their assets in risk-weighted capital. In practice, banks would have to hold much less than that, although the amount would still be considerable, according to a spokesperson at the Bank of England’s Prudential Regulation Authority.
In the US, the Volcker Rule came into effect in 2014 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, with the aim of preventing banks from making the types of risky investments that contributed to the financial crisis. The Volcker Rule affects financial institutions on both sides of the Atlantic because many large European banks have US operations and are therefore subject to the same rules. The rule, which has certain exceptions, largely prohibits banks from making private equity investments with their own funds. Implementation of the Volcker Rule was delayed by two years in January, leaving breathing room for some banks.
Michael Gerstenzang, a lawyer for Cleary Gottlieb Steen & Hamilton in New York who has advised large private equity firms on secondaries deals, said EU regulations will affect European firms in a different way than the Volcker Rule has in the US, where the regulation has meant financial institutions are prohibited from holding the asset class.
“The cost of holding private equity is going to go up for the European institutions so banks may each have their own view as to whether it’s worth incurring that cost when you compare these assets to the returns on other assets,” he said.
Some banks like BNP Paribas chose to act early and were actively selling private equity assets several years before the regulations came into effect.
“It was a busy time during the financial crisis,” said Philipp Patschkowski, a principal at Coller Capital in London who was working on secondaries deals at the time. “The secondaries market really took off in 2010. Banks focused on cleaning up their balance sheets, not just their private equity portfolios but all types of assets.”
But in addition to Volcker and Basel, there are now stronger factors related to portfolio management that are driving secondaries sales from European banks.
“Tighter regulation of financial institutions is one driver of deal flow, but the main driver now is strategy,” Patschkowski said. “We are seeing some banks that want to run asset-light balance sheets. If you want to do asset-light, private equity is clearly not the right thing to have on your balance sheet.”
One analyst who covers financial institutions in the UK and Europe concurred that banks are increasingly heading toward this asset-light model.
“Banks are becoming simpler and trying to get rid of all these complicated assets they’ve built up or acquired externally,” said Shailesh Raikundlia, an analyst at investment bank BESI in London. “They are becoming much leaner and simpler, and things can only continue that way.”