Private-equity funds in Asia will experience better growth than their counterparts in Europe, and possibly also better than in the United States, thanks to a very different approach to regulation.
So concludes a report by New York-based financial IT consultancy Celent, which documents how regulation in the US and Europe has compressed fees, changed funds’ capital structure and continues to drive industry restructuring.
Anshuman Jaswal, the report's author and a senior analyst at Celent, says he does not believe these changes will lead to regulatory arbitrage among PE firms. But the report makes clear that places such as China are rolling out the red carpet for PE while the European Union and, to a lesser degree, the US are passing regulation that will make it difficult for the industry to return to its former prominence.
The key message of the report is that European regulators should reassess the collective impact of the Alternative Investment Fund Managers Directive (AIFMD), Basel 3 and Solvency 2 on the sector. In the US, Dodd-Frank, the Volcker Rule and other regulation is also hampering the industry.
The report makes clear these regulations have been enacted to prevent PE firms from becoming systematic risks through the shadow-banking system, and to protect stakeholders such as employees of companies that get acquired by PE funds. Regulation has not been passed in the interest of protecting PE investors, such as pension funds or insurance companies. Moreover, the rules have lumped together PE with hedge funds in a ‘one size fits all’ approach, despite the very different time horizons and objectives of these products.
Asia has also seen some regulation of the industry. The Securities and Exchange Board of India now requires all PE firms to register with it before raising capital onshore. And the government’s proposed tax-avoidance rules will affect offshore investors into PE funds, along with all other types of investment vehicle.
Similarly, new rules promulgated last year by the Monetary Authority of Singapore require all investment managers to deposit customer assets with a third-party custodian and to outsource fund administration.
Such rules tend to apply to investment managers of all kinds, not specifically those in private equity. They are aimed at consumer protection and should make local markets more robust, over time.
Moreover, China is liberalising rules for private equity, encouraging its institutional investors to allocate to the asset class and opening the door to more foreign participation. Although China has a long way to go in this regard, its relatively open stance has seen it account for 10% of PE’s global fundraising in 2011, versus only 1% in 2009.
Declining activity in the US and Europe is not due solely to regulation. Since the 2008 crisis, debt is no longer easily available to PE deals. Pre-crisis, deals could involve up to 70% debt financing, a level that in the US has fallen to 60%. Sources of equity financing have also changed, from the company’s management to the PE fund itself.
Finally, a mix of market forces and regulation are pushing investment banks, commercial banks and, in Europe, insurance companies out of the PE business.
Recession and the eurozone crisis are the biggest dampeners on private equity worldwide. The US market is below peak levels by more than 50% in terms of capital invested, at $361 billion at the end of 2011 versus $796 billion in June 2007. The UK has seen similar declines, and continental Europe even more severe declines.
Activity in Asia, however, saw gains in the first and fourth quarters of 2011, and now the region has a slightly bigger market in terms of aggregate capital than Europe, at $210 billion versus $195 billion.
As the US continues its economic recovery, PE activity will pick up, in terms of assets raised and committed. Europe, due to the eurozone crisis and to AIFMD and related regulation, will see PE shrink.
Asia is likely to see the most growth in PE business, thanks to a far better economic performance and a regulatory environment that, though fragmented, is generally becoming more open to private equity.