By Dudley Russom and Ove Svejstrup, EY
In an era of Trump, Brexit and a phenomenal increase in cyber-threats, it is no wonder there is increasing speculation as to when the next big shock to the wealth and asset management industry will occur.
What has been done to ensure investors and General Partners are working in unison?
The Institutional Limited Partners Association (ILPA) released the Private Equity Principles in September 2009 (revised in January 2011) to foster a healthier relationship between Limited Partners (LPs) and General Partners (GPs).
Their main endorsers were institutional investors, experienced in the game of wealth creation. ILPA set out three main principles:
- Alignment of interest
Six years later, with further expectations from the PE industry - should more be done?
In 2016, the ILPA issued Phase I of their "Reporting Template" in an attempt to improve transparency of quantitative reporting and GP communication between LPs and GPs. The template addressed fees, expenses and carried interest with the goal of increasing uniformity in these disclosures.
This fell under the umbrella of the broader transparency principle, but for the first time, it became template-based rather than principles-driven.
Nevertheless, in EY’s 2017 Global Private Equity Survey, which surveyed 103 Private Equity CFOs, only 11% of respondents said they planned to fully adopt the ILPA template, 51% would perform a partial adoption and thus 38% did not plan to adopt it.
Improved investor reporting is a key factor for sustainability of businesses, with 62% of CFOs stating that they focused on it to be competitive; and 49% responding that information requests were the third highest factor in contributing to their firms’ complexity.
In March 2017, ILPA launched Phase II of the Reporting Template initiative to leverage existing template users’ experiences to identify best practice for implementation. There is an initial cost of adopting a standardised template for presenting information and we must wait and see what uptake and impact Phase II has.
What other potential solutions are there to improve transparency?
With so many variations of Limited Partnership Agreements (LPAs) and industries, investment objectives and investment strategies, the potential permutations of any underlying investor base are vast.
Reporting on an investor-by-investor basis can be costly for GPs as there is little consistency. It creates duplication for LPs as the lack of uniformity in the information provided by GPs means the approach for each must be adapted. Potentially the time taken could be better spent in aligning improved corporate governance at the GP-level and investing in data analytics.
Harnessing data is rapidly developing as a "must have" capability. The wide use of spreadsheets is a top data management concern for the majority of CFOs. 81% stated that spreadsheets could be replaced by investing in data. A better use of that time still, would be analysis of the data. If investors could also participate in this process their decision-making would inevitability improve. However, parameters would need to be carefully considered to avoid data analytics becoming a black hole for costs.
Investors enjoy using the word ‘transparency’. But what is their actual definition? As EY’s survey results on the uptake of the Reporting Template suggest that greater transparency through standardised reporting is not yet being stipulated as a requirement by investors. Furthermore, costs associated with improved governance goes against their very objective of cost control.
Fair value financial reporting – a mid-point solution
LPAs often use a non-fair value basis of preparation for the financial statements. Whilst LPAs need not apply IFRS or other accounting principles, they should at least require fair value. Currently, investors may receive bespoke information on fair value on a quarterly basis and receive the annual financial statements on a cost basis.
Ultimately, a transition to fair value would drive consistency as investors would receive one set of data. There are also clear synergistic benefits between fair value reporting to investors and the fact that most GPs’ carried interest calculations include some fair value considerations. This would eliminate investor-by-investor reporting and as a result reduce associated costs. Being audited to fair value would also provide investors with comfort that the numbers were reasonable and take into consideration market conditions, providing robust insight and serving the interests of investors. In turn this would allow GPs to increase their focus on qualitative matters in other forms of reporting via data analytics.
In conclusion, should standardised quarterly reporting be adopted and requested by investors, greater consistency and economies of scale would be achieved across their suite of GPs and managers. A powerful decision-making tool for investors could be created if this is combined with the audit process of the annual financial statements. Whilst the initial implementation cost could discourage some, the freeing of resources to focus on the ultimate prize of wealth creation should convince them.
Assurance Assistant Manager
Assurance Executive Director
You can read the other articles from Ipes' Private Equity update (edition 24) at the following links:
Jersey Private Funds Regime
Ipes wins at the Private Equity Awards 2017
The Private Fund Limited Partnership: A New Fund Vehicle for the UK