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Private Market Governance: A New Era

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The rapid growth of the private markets since the global financial crisis has attracted the attention of regulators around the world, with some taking urgent action. Interestingly, a US court recently struck down sweeping and controversial rules on private fund advisers adopted by the Securities and Exchange Commission (SEC).

But the issue is far from settled. Indeed, the lack of strict regulation makes industry best practices and self-regulation even more important as the private investment sector enters a new era of less-cheap capital.

The CFA Institute Research and Policy Center report “Private markets: Governance issues come to the fore” sheds light on the functioning of private markets and offers recommendations for both investors and policymakers. The report is based on a global survey of CFA Institute members.

The purpose is not to promote or condemn private markets, Stephen Dean, CFA“The 2019-2020 financial crisis is a major turning point for the U.S. and the U.S. economy,” said David G. Wilson, senior director of capital markets policy at CFA Institute and author of the report. Enterprising Investors.

Rising inflation and interest rates have ushered in a new era for private markets, Dean argues, making governance issues more important. These issues include the relationships between fund managers (general partners) and fund investors (limited partners), among other relationships, and potential conflicts of interest. Despite increased scrutiny, there is still a lack of public information about the functioning of private markets, which Dean says may help explain the wide divergence of opinion on regulating private markets.

The report focuses on private funds, such as private equity, credit, venture capital, real estate and infrastructure funds – funds where redemptions are limited or not permitted at all.

The booming private market

“The private markets have become more important because they’ve grown in size, and therefore more important to the economy. For example, companies that are partly or wholly owned by private equity or funded by private credit have a lot of jobs associated with them, so they’re a big part of the economy,” Dean explains. “And the end of the era of low interest rates raises the question: Does that create potential risks to financial stability? That’s another reason why CFA Institute is interested.”

Dean says it’s only natural that there is more limited information about private markets than public markets, because they are not public: “So it’s understandable that we are polarized, but it’s also perhaps ironic. There’s increased regulatory interest in the US, UK, EU and China, and they’re scrutinizing what’s going on, yet we don’t have much information about the market.”

Dean recommends that regulators proceed with caution when allowing retail investors greater access to private markets: It may seem unfair to shut them out, he says, but private markets lack the robust framework of investor protections that exists in public markets.

US courts rein in regulators

The SEC Private Fund Adviser Rule was invalidated by the U.S. Fifth Circuit Court of Appeals on June 5. See the court’s decision here. hereAdditionally, Appendix 3 to the report, “Conflicting Court Opinions: The SEC’s Private Fund Adviser Regulation,” provides an overview of the conflicting positions filed with the court.

“While the Court struck down the entire rule, it did so on the narrow basis that the SEC lacked the authority to adopt the rule. Thus, the question remains as to whether the rule was appropriate regardless of whether the SEC had the authority from Congress to adopt the rule,” Dean argues.

Now that the SEC rules have been repealed, it is up to the industry to show how private ordering will work: “Can private ordering arrangements be developed that include proper disclosure and resolution of potential conflicts of interest so that they serve the interests of not only fund sponsors and fund managers, but also fund investors, whose beneficiaries are often ordinary people such as firefighters, teachers and police officers?”

Is there anything CFA Institute can do to help? Dean says he has no illusions that the institute will suddenly fill all the information gaps. “It can’t, but we can at least help start to fill them in. That was my personal motivation. I thought it would be fun to try.”

CFA Institute Global Membership Survey

CFA Institute conducted a global survey in October 2023 to gather information about investment professionals’ views and practices regarding private markets. The survey was conducted on behalf of all members, including those with experience as LPs and GPs, and focused on fundamental governance issues rather than market outlooks.

According to Dean, “We asked several questions with multiple options – essentially the situation was good, the situation was terrible, or something in between. Most survey respondents chose the moderate middle ground, both in their views on the functioning of private markets and their views on what regulatory and policy interventions should be.”

Book Covers - Private Market Research Report RPC

He said the majority of survey respondents, including LPs and GPs, generally support increased regulation, but with the caveat that it should be limited: “They want more disclosure and are prepared to support regulation that requires that disclosure, but they’re not saying that certain conduct should be banned.”

The majority of respondents took a moderate stance in assessing private market problems and the need for further regulation. A minority of respondents (51%) said private market practices could be improved but the problems were not significant. A similar majority (52%) supported new regulation, but the measures were limited. Respondents generally supported mandatory disclosure (or disclosure and consent) over an outright ban. Turning to specific regulations, the majority supported a requirement for GPs to provide annual audits (79%), quarterly reports (70%), and fairness or valuation opinions on advisor-led secondaries transactions (61%).

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