Tracking the regulatory developments impacting private equity in the UK and EU could be a full time job. In fact, it is for many lawyers, lobbyists and other practitioners. For the rest of you, below is a round up that will keep you up to date on the most important topics. In short, various changes in law now in the pipeline will (1) reduce EU insurers’ appetite for allocations to private equity, (2) increase public disclosure by UK private equity firms absent a restructuring of commonly used vehicles and (3) implement an enhanced regulatory framework applicable to EU fund managers.
Solvency II’s impact
Solvency II, a new regulatory framework for EU insurers (and reinsurers) that is scheduled to come into force in January, 2014, is likely to make it less attractive (at least in regulatory capital terms) for EU insurers to invest in private equity than in, say, corporate bonds or sovereign debt. Solvency II requires insurers to calculate and meet a solvency capital ratio (“SCR”) using either the “Standard Model” or an “Internal Model” that an insurer develops and agrees upon with its regulator. It is expected that larger insurers will develop internal models whereas smaller insurers will use the standard model. In the standard model, it is proposed that a flat charge (effectively a discount) of 49% should be applied to the value of investment in private equity. This compares with a flat charge under the standard model of 39% for investments in listed equity, 25% for investments in real estate and 2.5% for investments in 3-year AAA bonds. The flat charge for private equity can be modified by up to plus or minus 10%, depending on movements in the public equity markets (i.e., it can vary between 39% and 59%).
Solvency II may also increase the amount of information that EU insurers require from private equity fund GPs in order to enable them to operate any Internal Model they may have agreed upon with their regulator.
Solvency II could also affect pension funds in EU Member States. This is because many occupational pension schemes are set up as insurance contracts. There is no clarity yet on whether the capital requirements of Solvency II will be extended to apply to occupational pension schemes generally. If they are, EU pension fund trustees, like EU insurers, may well find it less attractive to invest in private equity than in some other categories of investments.
In a recent speech at an open hearing on changes to the Pension Funds Directive, Michel Barnier, EU Commissioner for Internal Market and Services, sought to allay industry concern about Solvency II capital requirements being extended to EU pension funds, stating that although the Commission will draw on the approach of Solvency II, it will not be a “copying and pasting” exercise. Nevertheless, industry representatives remain seriously concerned about the proposed rule changes, believing that efforts to harmonize the regulatory regime are based on flawed logic and could have unintended consequences for pension funds and their members.
New Accounting Disclosure Rules for UK Limited Partnerships
Some anticipated rules in the UK are expected to require private equity funds to make more information publicly available (unless they are restructured). In the UK, the most commonly used vehicles for private equity investment funds are limited partnerships registered under the Limited Partnerships Act 1907, which have traditionally been subject only to limited filing and disclosure requirements. A UK limited partnership is only required to prepare and file annual accounts (which would be available for inspection by the public) if the partnership is a “qualifying partnership.” UK private equity limited partnerships have been carefully structured so that they are not “qualifying partnerships,” which has been accomplished by having at least one partner (typically a limited partner) that is an individual. As a result, it is extremely uncommon for UK private equity limited partnerships to be required to file partnership accounts and have them available for public inspection.
In April, 2010, changes were proposed to these rules because the UK Government decided that the original intention was that a limited partnership’s status as a “qualifying partnership” depends not on the status of its limited partners, but only its general partners. That would mean that most private equity limited partnerships would be required to file annual accounts available for inspection by the public unless one of their general partners is neither a limited company, an unlimited company, or a Scottish partnership each of whose members is a limited company. The proposed changes were intended to come into force in late 2010, but for various reasons their implementation was postponed, and they are now expected to be introduced in April or October, 2012.
The new rules will apply to the first accounting period of a UK limited partnership commencing after the introduction of the changes. Unless steps are taken to restructure, many private equity investment funds constituted as UK limited partnerships may soon have to start preparing and filing annual accounts in the same way as UK companies. Therefore, once the form of the new rules is finalized, existing UK limited partnership structures should be reviewed to check whether they now are “qualifying partnerships” required to prepare and file accounts.
Alternative Investment Fund Managers Directive—Update
As almost everyone in the industry knows, the Alternative Investment Fund Managers Directive (“AIFMD”) is required to be implemented by EU Member States by July 22, 2013. That means the next fifteen months will be a busy one for legislators and regulators.
We reviewed the AIFMD in detail in our Fall 2010 issue, but here’s a “refresher.” After July, 2013, all EU-based alternative investment fund managers (“AIFM”), including managers of private equity funds, will need to become authorized (and therefore regulated) under the AIFMD in order to manage alternative investment funds (“AIFs”) and market AIFs to professional investors. At that time, a fund “passport” (allowing AIFs to be marketed to professional investors throughout the EU) will be introduced for EU-based AIFM and EU-based AIFs. In 2015, the European Commission will consider whether to extend the passport to AIFM that are not based in the EU and to non-EU AIFs. Non-EU AIFM are likely to be required to be authorized if they wish to manage EU AIFs from 2015, and if they wish to market AIFs (wherever established) to professional investors in the EU from 2018, if the Commission decides to end national private placement regimes in 2018.
The AIFMD is a “framework” directive, which means that it requires detailed implementing measures. These are drawn up by the Commission and adopted under the EU’s legislative process. This is the process that is currently under way, and the Commission is expected to publish its draft implementing measures this month (March, 2012), which will then be reviewed for up to three months by the EU Council and the European Parliament. Unless rejected by the Council and the Parliament, the implementing measures are likely to be formally adopted by the EU in July, 2012. Therefore, each Member State will have just twelve months from that time (July 2012) to introduce the AIFMD into its national legislation. The Financial Services Authority has already started this process by publishing a discussion paper on the implementation of the AIFMD in the UK, and has acknowledged that there is a great deal to be done within a tight timeline. Note that not all EU Member States will implement the AIFMD into their legislation at the same time.
Over the next year or so, we can expect a great deal of material to be published as we move from a framework directive to detailed legislation implementing it in each Member State.
1. See “EU Directive on Alternative Investment Fund Manager: Good News at Last,” Debevoise & Plimpton Private Equity Report, Fall 2010.