Regulation rollercoaster

For private equity, Obama administration policy proposals have been big news – some of it good, some of it worrying.

Will the Obama administration help usher in a period of pleasure or pain for private equity? For most GPs, the jury is still out on this. But if this week is any indication, Obama’s impact on the industry will likely be a bit of both.

On Monday, GPs were giving one another high-fives when US Treasury secretary Timothy Geithner revealed plans to combine federal funds with private capital – complete with generous leverage ratios and an equity matching scheme – to purchase up to $1 trillion in certain “toxic” securities and real estate loans. While not a perfect fit with the investment strategies employed by most pure private equity firms, the potential for some specialised alternative asset managers to clinch lucrative, starring roles in the programme was unmistakeable. As was the government’s intent to rely heavily on private capital for future initiatives potentially affecting other asset classes.


Geithner-related “euphoria” sent stocks soaring for US-listed alternative asset firms. On Monday, The Blackstone Group’s units jumped 24 percent, while Fortress Investment Group’s shares rose more than 36 percent – significant moves for stocks that had respectively fallen roughly 78 percent and 93 percent since listing.

Now for the bad news. Geithner stressed in a Wall Street Journal editorial the same day that Congress must craft oversight for the public-private programme that ensures regulations do not deter private investors. However by Thursday, he’d proposed a sweeping overhaul of the US financial regulatory system that replaced those high-fives with sweaty palms.

As part of the administration’s efforts to win greater regulatory control over large financial institutions, Geithner proposed rules that would significantly heighten oversight of hedge and private equity funds. Leveraged private investment funds with assets under management over a certain threshold would be obligated to register with the Securities and Exchange Commission. They would also be required to disclose any information deemed necessary for determining whether their activities might pose systemic financial risk.

It’s still unclear what that threshold would be, but the funds required to report to the SEC would be forced to hand over information including the names of LPs and leverage ratios on transactions. This data would be shared with a new “systemic risk regulator” which would determine whether a firm’s failure would pose a risk to the economy and would have the power to impose stricter capital requirements on firms deemed “at risk”. Though Geithner emphasised he is not suggesting private funds be regulated like banks, nor impose capital requirements on them, the proposals represent the first time significant US regulations could be forced on private equity funds.

The Private Equity Council, a US lobbying group that represents a dozen or so mega-funds, quickly issued a statement praising Geithner’s efforts, but categorically denying private equity poses any systemic financial risk. “Private equity firms invest in companies, not exotic securities and their investors are long-term investors, eliminating the ‘run on the bank’ type of risk that helped create the current financial crisis,” it said.

The Treasury’s regulatory reform plans are far from being a done deal. Many pundits are predicting their derailment or indefinite delays by foreseeable political firestorms. Still, most GPs are – and should be – bracing for some form of regulation in the not-too-distant future.

“The financial community recognises that additional regulation is inevitable,” Carlyle chief David Rubenstein told Reuters on the sidelines of PEI’s Emerging Markets Forum in New York yesterday. “No one is in love with regulation but we recognise it is coming.”

While the legislative process runs its course, US private equity practitioners could seek comfort from their peers in the UK. British private equity firms have long been regulated by the country’s Financial Services Authority. None of them are fond of the cost that entails. But neither are they finding it unbearable. Regulation per se must not be a disaster for the industry. The question is how heavily Geithner’s hand will come to rest on private equity when his work is done.