By Phil Davis – The current uncertainty in the world economy in general and in the private equity industry in particular has led to a dearth of dealmaking over the past couple of years, but a number of trends are emerging that suggest the logjam has been broken – something that could have a substantial and lasting impact on Guernsey as well as the industry as a whole.
To start with, dealflow and fundraising globally have seen a significant pick-up. According to data provider Preqin, globally there were 515 private equity buyout deals in the third quarter of this year with a total value of USD66.7bn, an increase of 29 per cent from the second quarter and of no less than 147 per cent from the first quarter, when deals totalling USD27bn were reported. Meanwhile, on the fundraising side 81 funds were closed in the third quarter raising USD57bn, a small but appreciable increase from USD49bn in the second quarter.
However, these global figures disguise the fact that activity in Europe is recovering at a slower pace than in the US while Asia, until recently considered a private equity backwater, is catching up fast. Among new launches, 37 US funds closed during the third quarter with investor commitments of USD41.1bn, compared with just USD8.3bn raised for 21 European funds. Asia and the rest of the world saw the creation of 23 funds with commitments of USD7.8bn.
In this light, Europe’s bounce-back may seem relatively frail, but there is anecdotal evidence of recent strong activity that may not be fully reflected in the figures. Justin Partington, group commercial director of specialist private equity administration firm Ipes, says: “After the summer, people have come back to a vibrant market in terms of exits.
“There is definitely a lot more confidence in the market and around pricing, and we are seeing clients successfully exiting positions. The sentiment is that we are not seeing a double dip, and if it does happen it will not be as major as the original recession.” More deals being done will free up funds for distribution to investors, making them more likely to commit to follow-on funds.
Mark Helyar (pictured), a partner at law firm Bedell in Guernsey, says pockets of Europe are recovering more rapidly than others. “We are seeing a lot of activity in Germany, which is recovering faster than many other places,” he says.
Nevertheless, across Europe as a whole, it is harder to raise funds, and those that do gain traction tend to be half the size of pre-crisis funds or smaller. “Limited partners are no longer prepared to commit to a 10-year blind pool, particularly in respect of start-up managers,” says David Bailey, managing director of Augentius Fund Administration.
“In some instances both the fund life and the investment period are getting shorter. Investors want to see what the managers do with a small amount of money over 12 to 24 months and then maybe invest more, rather than buy into a blind fund.”
If the economic outlook is the main reason that Europe’s growth rate and private equity markets are lagging the rest of the world, the regulatory environment is widely seen as hampering activity too. While the Dodd-Frank legislation is already signed into law in the US, the European Union’s Alternative Investment Fund Managers Directive is only now approaching final approval, and even then some of its measures will not fully take effect until 2015.
“The Dodd-Frank legislation in the US moved from thought to legislation in just 12 months,” Bailey says. “The rules are in place, they are pretty clear and will be applied from July next year. This has the effect of instilling confidence in the market.”
By contrast, Bailey says, the AIFM Directive has been under discussion for more than 18 months and its text betrays the tortuous compromises that have been necessary to settle fundamental differences between the EU’s 27 member states. “It is nowhere near as clear and straightforward as the US legislation,” he says. “Europe is a more complex place than elsewhere, but the debate has created uncertainty – not just in investors’ minds, but in managers’ minds in terms of how they structure funds and the like.”
Some industry members believe that the directive will make life harder for Europe’s alternative fund industry as a whole and make it less competitive in the global marketplace, with wider economic costs for the continent. “Europe might make life worse for all EU fund managers,” says Carey Olsen partner Ben Morgan. “The private equity industry has invested heavily in European industry. Mega-cap private equity fundraising in the last economic cycle has attracted investment from around the world and resulted in huge inward investment for Europe.”
The proposed directive could also deny private equity investors that have suffered losses over the past couple of years the opportunity to recoup them to some degree. “It is ironic that Europe wants to intervene at a regulatory level to the detriment of its investors who have made losses and wish to recover them,” Morgan adds. “Access to non-EU funds may be vital for those returns.”
Service providers privately acknowledge that Guernsey, a bellwether jurisdiction for the European private equity industry, is already experiencing fallout from the months of uncertainty about the terms of the directive and especially the contentious issue of access to EU markets for third-country managers and funds, and that some clients who planned to domicile funds in the island have decided to go elsewhere.
Many private equity professionals on the island agree that if the AIFM Directive were straightforward, clearly defined and implemented rapidly, there would be little problem. Augentius managing director Glyn Thomas says: “The community feels that the AIFMD is manageable. Guernsey is well placed to achieve equivalence with other regimes in terms of quality of regulation, so people are tending not to panic.”
The uncertainty does pose difficulties for firms wanting to raise successor funds and launch new types of products. “Some are concerned how they pitch the next fund to investors, who have questions about the AIFM regime and what it may bring,” Thomas says.
But other industry members believe the directive will ultimately create new business paths for Guernsey. “The AIFMD will present opportunities rather than threats for Guernsey in the final analysis,” Morgan says. “Whenever anyone has introduced business-unfriendly regulations, business finds a way round those rules.”
Even the changed market environment since 2008 could be beneficial to some industry players. Fund administrators, for instance, are likely to continue to benefit from the alternative investment industry’s shift – in the light of Madoff and other scandals – toward outsourcing back (and increasingly middle-office) functions to independent administrators.
This trend has been gaining ground in the hedge fund industry over the past few years but until recently it was less evident in private equity. Says Bailey: “We estimate that more than 80 per cent of European general partners do their own fund administration, but there is now increasing pressure from LPs for it to be performed independently.”
The private equity industry is slightly out of synch with the rest of the investment management industry in this respect, he believes. “Over the past 15 years or so, much of the industry has outsourced its securities administration work to third parties. Private equity is slowly addressing the issue, realising there are some high-quality products out there. It is true there were few options out there originally, but that has changed.”
The move to greater outsourcing could be speeded by the opening up of the Middle East and Asian markets. Many funds are likely to decide to outsource rather than go to the expense and complexity of building a back office network across the globe.
Guernsey’s service providers are wasting no time in exploring potential opportunities in new markets. Guernsey Finance chief executive Peter Niven notes that the promotional body opened an office in Shanghai three years ago to prospect opportunities in the Chinese market. “We have employed a local executive to open doors, provide translations and give advice to Guernsey firms that want to dip a toe in the water,” he says.
But these efforts take time to bear fruit. “It is not jam tomorrow,” Niven says. “We are putting down roots to show our commitment and forge relationships. We have been there for three years and we are starting to get traction, but our time horizon for these efforts to pay off is three to five years.”
Morgan believes the move is crucial to Guernsey’s future. “Guernsey will have to look at new markets as Europe remains mired in the doldrums economically,” he says. “It is dusting itself down and reviewing other opportunities around the world to ensure that its growth continues.”
That could come from unexpected areas. The island’s service providers are increasingly providing their expertise to up-and-coming financial centres that are positioning themselves to take advantage of emerging market growth.
For example, Bedell is helping to draft incorporated cell company legislation in Malta, which is trying to develop private equity infrastructure, and the law firm is also setting up an office in Mauritius to service Asian-sponsored funds investing in Africa. Says Helyar: “This is business that would otherwise miss out Europe altogether – but our knowledge and expertise is applicable across the globe.”
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