The increased size and scope of PE relative to other financial institutions has opened the door to increased scrutiny.
While LP requirements increase, so do those of regulators. Since the crisis, governments and legislators have sought to put in place regulations to monitor and reduce systemic risk throughout the global financial system. The increased size and scope of PE relative to other financial institutions has opened the door to possible increased scrutiny.
Moving forward, as systemic risk continues to be debated, there could be ramifications for the largest industry players. In the US, the passage of the Dodd-Frank legislation in 2010 will have a significant impact on the PE fund community.
Funds should expect and prepare for SEC examinations in the near future. Another provision in Dodd-Frank, termed the "Volcker Rule," contains restrictions around the ability of financial institutions to engage in PE investing. This rule promises to alter the behavior of banks from a PE perspective. In fact, we have already observed some shifts in banks' investing profiles as a result.
The Alternative Investment Fund Managers Directive
In Europe, the Alternative Investment Fund Managers Directive will have a large impact on funds located in the European Union (EU) and on those wishing to market to EU-based investors. The aim of the Directive is to increase transparency and disclosure and, as such, requires firms to provide information on funds' financial positions and risk profiles.
Nonresident entities, which pose little domestic political risk, are particular targets. China, India, Australia and Ireland are among the countries that are challenging their current tax regimes.
An increased focus on responsible investing
In addition to these considerations, the increased focus on responsible investing among the LP community and the wider world, will impact PE. There are now over 800 signatories to the United Nations Principles for Responsible Investment, which provide a set of guidelines for ensuring that investors pay due consideration to environmental, social and governance issues that can affect the performance of investment portfolios.
Among these are some of the largest LPs, as well as PE houses themselves, demonstrating the importance that many investors in PE funds attach to responsible investing. To that end, the Environmental Defense Fund (EDF) in the US teamed up with The Carlyle Group and KKR in recent years to focus on developing and driving environmental sustainability initiatives.
Its program with PE — Green Returns — has generated significant financial and environmental benefits for PE. Looking across their entire portfolios, PEs can assess the environmental opportunities — that can also translate into improved operational and financial performance for the portfolio companies.
Building on the growing focus on environment, social and governance issues in the PE industry, EDF has undertaken a new initiative with EY that aims to drive sustainability and incorporate the measurement and management of environmental performance as a core element of PE investment practices during the ownership period investment.
Anti-corruption becomes more of a focal point
Another area where PE firms are intensifying their focus is anti-corruption. Especially as PE firms look for new opportunities in expanded geographies, often unfamiliar markets — many where business and politics are often far more inter-connected — they are paying greater attention to their obligations under anti-corruption statutes including the Foreign Corrupt Practices Act in the US and the Bribery Act in the UK.
Regulators are currently stepping up their enforcement activities, and penalties for non-compliant firms and individuals have the potential to be severe. As a result, PE houses are working diligently to institute new policies and procedures to ensure their actions in foreign markets — and with foreign governments as well as sovereign wealth funds — are conducted in full compliance with applicable regulations and with the highest ethical standards.
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