By Richard Watkins and Stephanie Biggs
According to Preqin, a record 2,084 private equity funds are in market as of January 2014, seeking to raise an aggregate US$750bn. This certainly accords with our perception that private equity firms are back in fundraising mode, with many firms looking to raise new funds in 2014 in what seems to be a relatively more positive environment.
These firms will need to contend with a number of new regulatory developments that took place during 2013.Some, like the AIFMD marketing rules and the US JOBS Act, directly regulate private equity firms’ marketing activities. Others, such as the Volcker rule and Solvency II, will affect certain limited partners’ ability or willingness to invest.As everyone must by now be aware, the Alternative Investment Fund Managers Directive took effect across the EU in July – at least in theory (even now, a significant number of EU member states still have not implemented AIFMD fully). Last-minute transitional relief in key jurisdictions effectively delayed the practical impact on fundraising for a few months, but firms coming to market in 2014 will have to grapple with the new rules. A number of onshore firms now hold the much vaunted ‘marketing passport’ – although a few have been surprised to find themselves being charged fees by local regulators for using it – and many others have applications in the pipeline. The position for offshore firms, including those based in the Channel Islands, is still evolving. Firms are weighing up the costs and benefits of active marketing in the EU under national private placement regimes, trying to assess whether there will be sufficient investor interest to justify not only the initial cost of submitting marketing approval applications, but also the ongoing back office costs associated with AIFMD-compliant reporting and the ongoing fund costs such as depositary fees for jurisdictions (such as Germanyand Denmark) where an external depositary is required. While the EU has become more restrictive, the US has – in some respects – become more liberal towards fundraising by private equity firms. SEC rules have for many years prohibited private equity firms from engaging in general solicitation of, or general advertising for, investors. That restriction was lifted in September, and firms are now permitted to engage in general solicitation and advertising provided that the firm takes reasonable steps to verify that each investor qualifies as an ‘accredited investor’, the investor is in fact an ‘accredited investor’ or the firm has reasonable grounds for believing they are, and the firm satisfies certain other private placement requirements, such as restrictions on the transferability of fund interests. It remains to be seen whether firms will take advantage of this new flexibility, as high net worth investors may view the additional verification requirements as intrusive, and may be less keen to invest with firms that are required to undertake these additional checks than with firms that continue to market in the traditional way. Firms will also need to consider whether general solicitation or advertising targeted primarily at US investors could potentially result the firm breaching ‘no public offer’ restrictions in other jurisdictions.
In December, US regulators issued final regulations under the Volcker Rule. The Volcker Rule generally prohibits private fund investing and proprietary trading by banking entities, including non-US banking entities with a US banking nexus, dramatically reducing the pool of capital from banking entities available to private equity fund managers. In our view, the final rules were marginally more favourable with respect to fund investing than originally proposed, in particular with regard to the exemption allowing a non-US banking entity with a US banking nexus to invest in non-US private fund, so long as the non-US fund offering is not is not deemed to ‘target’ US residents. The regulators indicated that complex private fund structures (such as a limited partnership with multiple feeder entities) should be ‘integrated’ when determining whether the fund as a whole has been offered to US residents, but there is no express prohibition on a non‑US fund that otherwise meets the exemption investing in parallel with a US fund formed by the same manager. As a result, it may be possible for firms to raise capital from certain non-US banking entities by using a parallel fund structure, provided precautions are taken to avoid the parallel vehicles being treated as integrated. Also on a positive note, implementation of the EU Solvency II Directive, which will increase the regulatory capital ‘cost’ of private equity investing for EU insurers, has been deferred until January 2016, and the solvency aspects of IORP (the equivalent initiative for EU pension funds) have been delayed indefinitely. You win some, you lose some…