The $3.5 trillion private equity industry is facing one of its biggest challenges, as the fee structure of firms is coming under scrutiny. The call for more transparency has become increasingly heated, with new research showing firms have so far been slow to change. As pressure continues to build, many wonder whether the big private equity firms have done enough.
Start of the Scrutiny
Much of the increased scrutiny started after the financial crisis in 2008. Local governments across the Western world took a closer look at the financial institutions and private equity firms had a share of the attention.
More importantly, the US regulator published its report into the industry last year. The report highlighted a number of examples of situations where firms were charging inappropriate fees and the pressure started to build up.
This year has been especially busy, as many pension funds around the world have voiced their concerns over the fee structures. This has led tougher calls from the US authorities as well.
What Are Firms Doing?
DealMarket reported last week on the new Preqin study, which showed private equity firms still rely on traditional fee structures. Despite the mounting pressure, firms have been slow to respond.
On Sunday, the Financial Times reported how the ‘big six’ firms denied to answer the newspaper’s questions over fee structures. In the article, private equity specialist, professor Ludovic Phalippou from the University of Oxford Saïd Business School said, “Private equity managers’ fees and expenses are like an iceberg as so much remains hidden. And the iceberg is very deep.”
Yet, there is evidence to show firms are starting to understand the importance of more transparency over fees. Many firms have started slowly turning their attention to fixing the system and to consider new ways of dealing with fees as well as returns.
Furthermore, ILPA is working with six private equity firms to develop new reporting systems. Further 15 firms are expected to become involved with the scheme at the start of next year.
Will Small Firms Suffer More?
Unsurprisingly, the scrutiny and focus has been on many of the bigger private equity firms. But while the Financial Times article noted on the silence of the ‘big six’, many small and medium-sized firms were more than willing to discuss the issue with the newspaper.
This is mainly down to fears the current initiatives might have an unfairly harsh impact on small and medium-sized firms. The stricter reporting requirements would put pressure on these firms in terms of simple manpower.
As Gary LaBranche, chief executive of the Association for Corporate Growth, which represents many small and medium-sized private equity firms, told the newspaper, “Smaller private equity managers do not have the same kind of (reporting) infrastructure as the bigger players”.
Meeting Investor Expectations
While fees continue to remain in the headlines, the industry is still attracting plenty of investor attention. The question for many firms remains how well they can continue to provide lucrative returns for investors while also offering transparency over charges.
Mark Calnan, global head of private equity at Towers Watson, told the Financial Times, “A key challenge is to be able to distinguish between the marketing claims every manager makes and those they can genuinely deliver”.