Q&A: Augentius Execs Discuss AIFMD, Private Equity Regulation

Feb 17 2015 | 9:55am ET

David Bailey is one of the four founders of Augentius, the largest independent private equity and real estate administrator in the world. Bailey has been very involved with the implementation of the AIFMD, providing evidence to ESMA and working with the FSA and UK Treasury. Recently, FINalterntives spoke with Bailey and his colleague, Brendan Tyne, managing director in the U.S., about AIFMD and what it means for fund managers.

How is Europe's Alternative Investment Fund Managers Directive affecting U.S. private equity managers? Are they taking steps to comply with the regulations or are they relying on reverse solicitation?

David Bailey: U.S. Private Equity managers are taking the AIFMD in their stride and adapting as best they can. There are considerable risks in following the reverse solicitation route. In the first instance there is no clear definition as to exactly what constitutes reverse solicitation; different countries across Europe have different views. In addition, the managers are opening themselves to a ‘no fault divorce’ situation in the years to come in the event that their reverse solicitation activities were not sound. Bearing this in mind the majority of managers that we meet with are seeking to follow the Directive and primarily using the individual country private placement regimes for marketing purposes.

You say private equity will be increasingly under the microscope in the U.S., what sort of new regulation do you expect private equity managers will see?

Brendan Tyne: We think new regulation is somewhat unlikely. Any new regulation would be subject to the political climate and the level of scrutiny politicians wish to place on the private equity industry.  However, without additional regulation, the SEC has been far more active recently in their examinations of private equity funds.  The SEC is taking a very close look at how private equity fund managers are managing their funds with respect to transparency and conflicts of interest.  Since October 2012, the SEC has examined over 150 newly registered PE funds and has set a goal of examining 25% of all new registrants by the end of 2014.  Based on their findings, the SEC has raised concerns over transparency and conflicts of interest.  The two main areas that the SEC has focused on are: fees and allocation of expenses and marketing and valuation issues.

While the SEC has indicated uncovering issues with 50% of the funds it has examined, most of these have been minor mistakes and very rarely has there been criminal activity occurring within the funds. 

Institutional investors are putting pressure on GPs to reduce fees, is this going to be a trend in the space?

Bailey: Since the 2008 financial crisis investors and their funds have been in short supply and as a consequence have had the upper hand over GPs seeking to raise new funds. More recently, as private equity has been able to return substantial funds to its LPs, the investors have been keen to reinvest in the sector. As a consequence we are seeing our clients raise funds in reduced timeframes, and, in some instances, be over-subscribed. In these circumstances the ability of LPs to negotiate reduced fees is limited. There is no doubt that there have been wide ranging discussions across the industry regarding fees in recent years and the industry has responded to the issues raised, but whether this will remain the case going forward has yet to be seen.

Augentius believes 'tax inversion' deals and other deals aimed at lowering tax burdens will lead to more global regulation of private equity activity. What would that regulation look like? Is it a good or bad thing for the industry?

Tyne: The OECD already has a program in place to investigate this and is investigating 15 areas to address Base Erosion and Profit Shifting [BEPS]. The final action plan is not expected to be complete until late 2015, but the interim report was issued in September 2014, covering 7 of the areas under investigation.
BEPS is likely to affect private equity in two main areas: The way that funds are structured and portfolio companies are held within the structure and the way that portfolio companies carry out their activities.

For funds, this means three things:  a) There is greater evidence of substance e.g. location of board members, where the decisions are taken etc. with all board members present (i.e. not attending by phone). b) The business rationale for the Company to be established in a particular state/country – i.e. favorable tax may not be a rationale. And c) Moving away from the face to face advance taxation agreements, as have occurred in some locations in the past, to greater transparency.

For portfolio companies, all these things apply, and also a) The effect of any tax changes on B2C businesses, especially where the digital environment is utilised. For example the EU has changed VAT law so that B2C digital supplies will be subject to VAT where the consumer belongs rather than where the supplier is based. These changes, effective 1 January 2015, will see for example Amazon charging 20% rather than 3% VAT on e-books sold into the UK. And b) Consider any transfer pricing arrangements especially in the case of Global Multi-Nationals [MNEs] to include country-by -country reporting.

What is your outlook for private equity fundraising in 2015?

Bailey: Two thousand and fourteen was one of the strongest years for fund raising in the sector for a number of years and Preqin’s year-end report suggests that 2015 could be even stronger. We have certainly seen many of our clients have successful fund raises and this seems to be continuing into 2015. That said the world is an uncertain place. The Greek situation is creating some uncertainty within Europe, which itself has seen little growth. And while the US appears to be powering ahead, the situation in the Middle East could create problems for the world as a whole.

Our initial view for fund raising is that 2015 should be a good year but there are plenty of reasons to derail this view. But fund-raising is only one side of the equation. Managers have to be able to see ways to invest their funds at the right price and properly priced deals were not easy to come by during the second half of 2014. 

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