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Manager-led secondaries reaches its pivotal moment

Blackstone’s record-setting €21bn Mileway recapitalization comes at a time when regulators are weighing significant changes to such transactions.

Private real estate’s biggest transaction to date was agreed upon this week, and Blackstone was on both sides of it.

The New York-based mega manager plans to transfer the ownership of Mileway, its European logistics platform, from multiple opportunistic funds to the core-plus side of its business. The recapitalization carries a €21 billion price tag.

This type of manager-led secondary transaction, in which investors can choose to roll into a new vehicle or cash out, has been on the rise among real estate funds and throughout private markets. Such transactions made up 85 percent of the direct secondaries activity tracked by Canadian secondaries manager Setter Capital last year, up from 33 percent in 2018.

That uptick has caught the eye of US regulators, which question if investors’ interests are being neglected in transactions in which their managers are both buyers and sellers. Whether GP-led secondaries activity continues to grow will depend on how the industry adapts to a new set of rules being applied to it.

Last week, the Securities and Exchange Commission proposed new rules requiring managers to obtain third-party fairness opinions and distribute them to investors before closing a secondary transaction. The intent, according to the SEC, is to root out conflicts of interest in such transactions and ensure investor returns are prioritized over the economic benefits to managers, such as enhanced fees or carried interest. Managers would also have to disclose any material relationships they have with their fairness opinion providers.

There is some debate in the secondaries community whether the Mileway recapitalization qualifies as a manager-led secondaries transaction since it involves little or no secondaries capital. But given the current lack of clarity around the SEC’s definition of an adviser-led secondary transaction, what matters is such a deal could potentially fall under regulatory oversight in the future.

Either way, the SEC’s proposal would have little impact on Blackstone. In the case of the Mileway deal, which involves US investors, the firm obtained a fairness opinion from Morgan Stanley’s financial services subsidiary and a value fairness opinion from the investment bank Eastdil Secured. A Blackstone spokesperson said the firm runs robust processes ahead of the secondary transactions it initiates. These include exploring alternative exit strategies, securing approval from limited partner advisory committees and executing a “fulsome go-shop process” to ensure better deals cannot be struck with outside buyers.

“Our sole objective is to deliver the absolute greatest value to our investors, and we take this duty extremely seriously,” the spokesperson said.

Yet, regulations rarely hinder the biggest firms. While Blackstone can take on enhanced vetting processes by choice, smaller firms can less afford such a regulatory burden. This could limit the number of managers that can initiate secondary transactions.

On the other hand, additional transparency could make investors more willing to sign off on secondary transactions. Outside fairness opinions are especially useful for smaller institutions – and, increasingly, wealthy individuals – that are not equipped to assess deals independently. This speaks to the SEC’s broader effort to level the playing field for investors. This includes banning preferential treatment to large institutions. Ultimately, these efforts could draw more capital into private funds.

The biggest question for manager-led secondaries is: what comes next? In January, the SEC said managers must describe their secondaries activity to the agency within one business day. This additional oversight demonstrates the regulator’s interest in the practice and could portend more restrictions in the future. The SEC has already suggested manager-led secondaries could be a sign of decline in the private funds market and thus merits the attention of the Financial Stability Oversight Committee, which is tasked with finding weaknesses in the US financial system.

For now, manager-led secondaries are on the rise. The fact that the biggest real estate transaction on record falls under the category is a testament to that. Whether groups such as Blackstone can continue this growth or skeptical regulators take further action to curb it, the practice is at a pivotal movement.