“Regulation is coming” was the headline of affiliate title Buyouts’ cover story in February 2022. Just over a year on, that regulation is beginning to be applied to the industry.
On Wednesday, the US Securities and Exchange Commission voted to adopt the first part of a series of proposals that affect how the private funds market operates – a $25 trillion industry that plays an important role in each sector of the capital markets, as chair Gary Gensler said in remarks to an industry lobby group this week.
The results of Wednesday’s vote do not in themselves herald a sea change in the way private fund sponsors will conduct their day-to-day business. For private equity managers, the largest changes appear to regard reporting material events, such as the removal of a GP, some fund termination events and, crucially, any GP-led secondaries transactions.
It’s worth noting that the SEC’s original proposals regarding this recommended reporting sponsor-initiated processes within one business day; Wednesday’s adoption allows for 60 days from the end of the current quarter, so the US regulator has compromised – some might say watered down – its original proposals from last year. Managers will also likely have to file more often and more deeply, so they’ll have to build up the infrastructure to keep track of the data required.
Legal experts we have spoken to over the last 24 hours were still digesting the changes. One secondaries and fund formation lawyer said it was important to put the new requirements in context: the secondaries industry, for example, has gone from “nothing to not a very high bar” in terms of regulation. Requiring managers to confidentially report GP-led activity to the regulator within a 60-day period is not particularly onerous, he pointed out.
“It’s not as bad as it looked like it was going to be,” said another private funds lawyer. “This isn’t a slap on the wrist for the industry – this is just part of a wider SEC drive towards transparency, which I think is net positive and in line with industry expectation.”
What this week’s vote does suggest is that upcoming votes on proposals may indeed be pushed through. Still pending is yet another Form PF overhaul, in partnership with the Commodity Futures Trading Commission, and the much-awaited final text of the regulator’s plans to overhaul the private funds model, which may include fees, side letter agreements, co-investments and even NAV lending.
Disclosures around fees and fiduciary responsibilities are what LPs are most focused on. In March, the Institutional Limited Partners Association published the results of a survey and analysis that backed up the SEC on certain proposals in its finalised Private Fund Advisers Rule. ILPA also called for two items to be off the negotiating table with GPs: cost disclosures and minimum standards for fiduciary duty.
Speaking to us last week in London, representatives from ILPA said bargaining and negotiations between LPs and GPs was a key area they have been working with the SEC on.
“Even if you are a large investor, even if you are a well known LP, there’s a lot of challenges that you face inherent in the industry based off of a number of factors,” said Neal Prunier, senior director for industry affairs at the investor body. These include limited partnership agreements being with the GP; the balance of power having shifted in the sponsor’s favour in recent years; the consolidation of law firms, which has made negotiation processes more difficult; and the reliance on side letters for any bilateral agreements – something that is “very inefficient”, Prunier said.
Commissioners who voted against Wednesday’s proposals called the rules “a compliance exercise”, “a kitchen sink data collection effort”, “arbitrary and capricious” and “another example of cumulative impact of numerous and overlapping rules”. The successful enforcement of these rules in full will hinge on striking a balance between what’s important for LPs and requiring an appropriate level of disclosure for their fund managers.
– Madeleine Farman contributed to this report.