Private markets’ meteoric growth since the Global Financial Crisis has attracted the attention of regulators around the world, some of whom have reacted with urgency. Interestingly, the US courts recently vacated sweeping and controversial rules for private fund advisers that were adopted by the Securities and Exchange Commission (SEC).
But the matter is far from closed. Indeed, as the private investment sector enters a new era of not-so-cheap money, the absence of stringent regulations makes industry best practices and self-governance even more important.
The CFA Institute Research and Policy Center’s report, “Private Markets: Governance Issues Rise to the Fore,” illuminates how private markets function and makes recommendations for both investors and policymakers. The report is based on a global survey of CFA Institute members.
Its objective is neither to endorse nor to censure private markets, Stephen Deane, CFA, senior director for capital markets policies at CFA Institute and the report’s author, told Enterprising Investor.
Increased inflation and interest rates have jolted private markets into a new era, elevating the importance of governance issues, Deane asserts. Those issues involve the relationship between fund managers (general partners) and fund investors (limited partners), as well as other relationships and potential conflicts of interest. Despite increased scrutiny, there remains a dearth of public information on how private markets function, which may help explain the wide divergence of views on private markets’ regulation, according to Deane.
This report focuses on private funds, including private equity, credit, venture capital, real estate, and infrastructure funds — funds in which redemptions are limited if allowed at all.
Deane says he was motivated by a confluence of factors to write the report, which has value for investment professionals, policymakers, and academics. It consists of two main parts: the survey results and a primer on governance-related issues. “The idea is to explain the findings, to contextualize those findings to allow a deeper appreciation of the issues based on what others have written, and to provide talking points for experts and academics. We also talked to chief investment officers of pension funds and trade association leaders. We’ve turned to a variety of sources to inform ourselves on what’s going on.”
Ballooning Private Markets
“Private markets have become increasingly important because of how much bigger they’ve become. That makes them more important to the economy — it involves a lot of jobs at companies that, for example, are owned partially or totally by private equity or funded by private credit. So, it’s a much bigger part of the economy,” Deane explains. “And with the end of the era of cheap money, there is a question: are there potential risks to financial stability as a result? That was yet another reason for CFA Institute to be interested.”
Because private markets are not public markets it cannot be surprising that there is limited information available on them compared to public markets, Deane says. “So, it is understandable — but perhaps ironic — that we have polarized views. We’ve got increasing regulatory interest in the US, in the UK, in the EU, in China, there’s a closer inspection of what is going on, and yet we don’t have much information on the market.”
Deane recommends that regulators proceed with caution, if at all, in allowing greater retail access to private markets. It can seem unfair to keep retail investors out, he notes. On the other hand, the solid framework for investor protection in the public markets is missing in the private markets, he points out.
US Courts Rein in Regulator
The SEC Private Fund Adviser Rules were struck down by the US Court of Appeals for the Fifth Circuit on 5 June. The court’s ruling can be found here. Also, Appendix 3 in the report: “Dueling Court Briefs: The SEC’s Private Fund Adviser Rules,” has a summary of the opposing positions placed before the court.
“The court struck down the entire package of rules, but it did so on the narrow basis that the SEC lacked the authority to adopt the rules. So, there is still a question of whether the rules were a good thing regardless of whether the SEC had the authority from Congress to adopt them,” Deane maintains.
Now that the SEC rules have been struck down, it’s incumbent on the industry to demonstrate how private ordering can work. “Can it craft private ordering arrangements — including proper disclosures and resolution of potential conflicts of interest — that are for the benefit not just of the fund sponsors and the fund managers, but also of the fund investors who in turn in many cases have their own beneficiaries, who are ordinary people — firemen, teachers, police?”
Is there some way CFA Institute can help? Deane says he has no illusions that the organization is suddenly going to fill all the information gaps. “We can’t do that, but can we at least contribute to begin to fill in some information. That was a personally motivating thing — I thought that it would be interesting to do.”
CFA Institute Global Membership Survey
CFA Institute conducted its global survey in October 2023 to gather information about investment professionals’ views and practices regarding private markets. The survey represented all members, including those with experience as LPs and GPs. It focused on fundamental governance issues rather than market outlook.
According to Deane, “We asked several questions with a spectrum of options to choose from — basically, things are great, things are terrible, or in between. Most survey respondents picked that middle, moderate response both on their view of how private markets are functioning and their view of what the regulatory and policy intervention should be.”
He says most survey respondents, including LPs and GPs, on balance do support more regulation, but there’s a caveat: regulation should be limited. “They want more disclosure, and they are willing to support regulations to mandate that disclosure. But they don’t go so far as to say you should forbid a specific practice.”
Most respondents expressed a moderate point of view in assessing private market problems and the need for further regulation. A small majority (51%) said that private market practices can be improved, but the problems are not significant. A similar majority (52%) supported new regulations — but only limited measures. Respondents generally favored required disclosures (or disclosure and consent) rather than outright prohibitions. Turning to specific regulations, substantial majorities favored requirements for GPs to provide annual audits (79%), quarterly statements (70%), and a fairness or valuation opinion of any adviser-led secondary transaction (61%).
