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Private equity 'well ahead' of regulatory thinking - State Street

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GLOBAL - Investors remain committed to private equity and are already benefiting from a "fundamental shift" in power away from general partners (GPs), according to State Street.

This suggests that the industry is "well ahead" of regulation when it comes to protecting investors' interests, according to Jack Klinck, the bank's global head of alternative investment solutions, presenting the findings of its latest Vision report, Private Equity at the Crossroads, in London.

A straw poll at State Street's Boston conference in October 2008, at the height of the financial crisis, found 49% of investors intended to increase their allocation to private equity during 2009 and only 13% were looking to decrease exposure.

Officials say there is a feeling that the current vintage could be a once-in-a-lifetime investment opportunity, but also that limited partners (LPs) could enjoy greater clout than ever before. Pension funds are said to be especially well-positioned, as their size would generally allow them to avoid the pressure of renegotiating capital commitments and calendars that afflict smaller investors such as endowments.

State Street said it has already seen evidence that general partners are willing to waive management fees with a view to recouping them when investments are realized.

It also anticipates there will be a sea-change in the way private equity businesses operate, from devoting more resources to shoring up investments as opposed to pursuing more and more deals; through the adoption of more transparent operations and technology; to the wholesale adoption of third-party administrators for systems, control procedures, custody and lending services. The bank estimated a mere 15% of the industries' assets are outsourced at present, and has predicted a rise to more than 50% over the coming years.

"We think there is a fundamental shift occurring, whereby LPs will have much more leverage over their GPs," said Klinck. "We are seeing more negotiation around fee structures, fund sizes and other terms than ever before. These are things that it is important for regulators to understand - this is a powerful market force at work, which is perhaps more effective than any regulatory force. The industry is well ahead of the regulator on this because of investor pressure."

Nonetheless, State Street warned that the balance of power could shift back to GPs if the fundraising environment becomes more liquid. Klinck acknowledged, however, that the industry recognises self-regulation is not going to be acceptable: "It simply hopes that regulatory demands line-up with investor demand," he said.

There is already evidence that private equity GPs are not about to roll over in the face of regulatory or investor demands if it is likely to increase their costs. Much of what State Street expects to happen with regard to outsourcing is included as demands in the European Commission's draft directive on alternative fund managers, and some in the industry have complained that there simply is not the capacity in the private equity administration industry to service a greater proportion of those assets.

"That might have been valid five years ago, but it's an increasingly difficult argument to make today," said Klinck, as a provider of those services.

He also insisted that deep concerns about the possibility of being subject to a single set of rules covering both private equity and hedge funds were justified.

"The draft directive shows a lack of understanding of the differences between hedge funds and private equity, and could be devastating for the industry," said Klinck.

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