According to Blackrock, the private equity industry tripled in the past decade and continues to grow at a lightning pace. This explosive growth has been fuelled partly by an increase in institutional investment. As these dominant investors have rushed in, they have brought significant influence to them. Frustrated by the traditional opacity of the market, these investors have pushed for more private equity transparency in fees.
By funnelling their voices through the influential Institutional Limited Partners Association (ILPA), there’s no question they have already created change. Then, recent U.S. regulatory action by the Securities and Exchange Commission has added significant fuel to the fire industrywide. So, where does the industry stand regarding changing fee disclosure practices?
A Changing Private Equity Fee Landscape
Many limited partners have historically felt in the dark when it comes to private equity fees. Frustrating them further, many funds have been shifting administrative expenses to investors that were formerly paid out of management fees.
It’s no surprise that the growing ILPA has proposed standards to ensure investors know what they are paying. While that’s understandable, this can create significant work for general partners.
Fortunately, one factor is on the industry’s side: recent advancements in fund accounting and back-office technology. Today’s sophisticated platforms can ease the burden of disclosure and increase transparency between general and limited partners.
As a technology-enabled fund administrator serving many private equity firms, Linnovate Partners has witnessed these industry changes firsthand. We talked to Linnovate Partners’ Founder and CEO, Henry Lin, to get his take on what’s happening and where things are headed.
1. Will you agree that transparency has increased in the private capital in the last 5 years?
Transparency is Increasing, and We Believe It is Here to Stay
At Linnovate Partners, we’ve watched this evolution firsthand. Based on what we see in our client base and the overall market, we believe transparency has increased over the past five years in the private capital markets. We started in 2016, so we’ve been around to see more investors pushing for ILPA standards.
We believe that with the momentum achieved by the ILPA, there is no turning back. Investors are raising their expectations and watching SEC actions closely. American firms have no choice but to comply or face increased regulatory scrutiny. Here in Asia, we think the pressure will continue to be felt as well.
While there may be exceptions, those general partners who don’t increase transparency may find themselves at a distinct disadvantage, both with investor perception and vulnerability to future regulation. While you could wait and see, that approach would seem to have its own risks.
2. What systems/ processes do LPs/ GPs have these days that they did not have 5 years back & that would make transparency easier?
Fortunately, Technology Helps Ease this Transition
Five years ago, less industry technology was available, so providing additional reporting to limited partners would have been labor-intensive. Today, with advances in databases, platforms and artificial intelligence, automation is doing much of the heavy lifting.
Outsourced solutions have expanded, with Linnovate Partners as an example. Instead of struggling to tackle this in-house, you can outsource all of it to independent specialists. At Linnovate, our team is exclusively focused on providing services that automate your back and middle offices.
As specialists, our firm and tech-enabled asset servicing peers have helped free up the industry from much of the work associated with increasing your transparency. So this additional accounting and reporting can be less of a burden and more of an opportunity for general partners to build stronger relationships with their investors.
We don’t see this outsourcing trend slowing down just because of the benefits clients realize from this move. In a June survey by Private Equity Wire, over half of respondents had already outsourced part of their firm’s operations. And about 75% of respondents said outsourcing “added value” to their businesses.
Outsourcing helps the general partners focus on their business while the technology and outsourced team deliver better transparency to their limited partners. It’s a win/win formula.
3. We saw drastic pressure from LPs on fees after the GFC – have the waves settled? Will we see further adjustments?
Management Fees Under Scrutiny Since the GFC
Yes, management fees were under fire after the Global Financial Crisis (GFC). From our data, we see that investors have been generally successful in beginning to get those reduced. According to our fund service team, the standard management fee is now between 1.5 to 2.0%.
We believe the pressure on management fees and other expenses is not going away. A recent Bloomberg article entitled Private Equity’s Opaque Costs Mystify the Pensions That Pay Them highlights why. The author notes that these expenses can reach tens of millions of dollars a year for large public pension systems.
These pension and sovereign wealth funds are some of the largest investors in the industry. One critical point: they are spending public money. So their leaders have a duty to push for an accounting of these fees. That’s not going to disappear.
With this regulatory attention and the ILPA actively pursuing its goals, fee disclosure will likely remain a focal point in the U.S. For Asia, this may not be as immediate. Still, we should ultimately prepare for this level of scrutiny to reach our shores as well.
Fortunately, with technical capabilities out there today through Linnovate and our peers, there is an answer. GPs can comply with less disruption to their business.
4. In your opinion, do you think the regulators are being reasonable?
In the U.S., it can be argued that the regulators are doing a good job for the public retirees and other smaller investors who may be passive stakeholders in the fund. Their actions are certainly prompting changes in U.S.-based funds subject to their rules.
Here in Asia, as we know, the regulators have been much more relaxed. We believe they are letting market forces take the reigns here, for now, to see how it goes. But with the Singapore Exchange announcing a new requirement to disclose CEO pay, it is safest to assume that the overall environment is ripe for even more regulation and disclosure.
It appears the industry is bracing for impact. A survey by the Intertrust Group found that over 59% of GPs surveyed expect LPs to call for improved disclosure on fee structures and expense allocations.
Bottom line, pressure for greater private equity fee transparency will not likely let up anytime soon. Even if Asia’s regulators don’t follow the SEC’s lead, the market will probably come to demand a higher level of disclosure and detail.