Asian advocacy: PE associations reach out to regulators

The battle lines have been drawn by China's regulators as they fight for the right to govern domestic private equity. It is a heavyweight matchup between the National Development and Reform Commission (NDRC), the country's top policymaking body and the industry's incumbent regulator, and the China Securities Regulatory Commission (CSRC), which is keen to follow the developed market model where the securities watchdog is responsible for private equity.

Caught in the middle are numerous industry associations, pulled this way and that by a complicated patchwork of allegiances.

This territorial dispute broke into the open towards the end of last year as policymakers ended their deliberations over proposed alterations to the Securities Investment Funds Law. The big question was whether private equity would be included, and therefore brought under the CSRC's purview.

"On the one hand, less onerous regulation is good for the industry, and participants prefer not to be subject to a second set of rules in addition to those laid down by the NDRC," says James Wang, a partner at Han Kun Law Offices in Beijing. "On the other hand, they don't want to cut ties to the CSRC. PE firms have traditionally relied on IPOs as their main exit channel."

Any impressions that the matter had been settled when PE was excluded from the regulation were undermined by the small print. The language leaves sufficient room for interpretation that the CSRC could still wield significant influence over "non-publicly offered funds." Meanwhile, several leading private equity firms appear to be voting with their feet. Hony Capital is among those to have joined the new Asset Management Association of China (AMAC) as "asset management members." To some, this is tantamount to quasi record-filing with the CSRC.

"When we deal with the NDRC and CSRC it's clear they are at war with each other," one international LP tells AVCJ. "Both are using industry associations as battlefields to recruit more members and gain influence. As long as the situation remains unclear they will continue the battle. If you are a local GP, which side are you talking to? Or are you talking to both sides?"

Industry participants are not opposed to regulation - the current NDRC guidelines are seen by many as insufficient, allowing smaller funds to evade oversight - but they want a single set of rules from a single authority. As Maurice Hoo, global leader of Orrick's M&A and PE practice and legal counsel to the China Venture Capital & Private Equity Association (CVCA), points out, the concern was that another layer of regulation would bring additional costs because there wouldn't be any reconciliation between the two.

A need for clarity

China isn't the only Asian jurisdiction where there is a need for regulatory clarity, although in other markets regulators are fighting to keep private equity off their desks.

"If you ask the Financial Supervisory Commission (FSC), they say it's nothing to do with them because it's not public markets while the Ministry of Economic Affairs applies the final stamp but is just a coordinator," says C.Y. Huang, chairman and CEO of local GP FCC Partners and chairman of the Taiwan M&A and Private Equity Council (MAPECT). "PE firms run between these agencies, asking who can help."

The contrast is not rooted in ideology so much as onshore versus offshore, and it runs to the heart of the challenges facing Asia's collection of private equity markets. For the likes of China and India, the question is how to regulate the asset class on a domestic level in order to protect investors who may not fully understand it. For the rest, PE is more entrenched yet faces unprecedented global regulatory pressure.

These two extremes share a common origin. Whether an individual manages renminbi raised from high net worth individuals in China or US dollars from pension funds in North America, they are part of an industry that has grown massively in the last decade, particularly in Asia. By the end of 2012, more than 3,000 private equity firms were active in the region, with $454 billion in funds under management. Ten years ago less than half the number of firms controlled about one fifth of the assets.

"Private equity has gone from almost nothing to very sizeable," says David Pierce, a partner of FLAG Squadron Asia and non-executive chairman of the Hong Kong Private Equity & Venture Capital Association (HKVCA). "With greater prominence, if you carry on trying to stay below the radar, doing things as before, you risk being regarded with suspicion. Most US PE people were generally shocked at how the industry has been characterized by the media. They see themselves as good guys doing good things."

With the lines still to be drawn by China's regulators, industry associations are preoccupied with ensuring these lines don't extend too far. International players, meanwhile, are responding to regulatory blueprints that are already largely in place in the US and Europe.

The Foreign Account Tax Compliance Act (FATCA) has placed more onerous disclosure requirements on managers who raise capital from US-based investors above certain thresholds. However, the EU's Alternative Investment Fund Managers Directive (AIFMD) causes more concern. The worst case scenario for Asia-focused managers is that they will have to set up onshore structures in Europe in order to market to investors in the region. This might fall beyond the means of many smaller operators.

An acceptable middle ground is Asia managers receiving a passport to operate in the EU based on the credibility of their local regulators - but what about those whose offshore status means they aren't tied to any particular authority? This question prompted the HKVCA to action. "When AIFMD came out in draft form a couple of years ago we engaged the Hong Kong government to participate in the process of seeking comment," says Pierce. "I believe it was the association's first attempt to influence and help the government understand our industry. Before that we weren't really on their radar."

Who regulates whom?

The association subsequently set up a dedicated technical committee and reached out to local regulators, to mixed effect. Although a number of Hong Kong-based PE firms, wary of AIFMD requirements, have chosen to register with the Securities & Futures Commission (SFC), the regulator's response has been passive. Public markets remain top priority and there is little interest in PE funds are domiciled in the Cayman Islands with nothing more than an advisory presence in Hong Kong.

Private equity firms managing these funds only fall within Hong Kong's regulatory remit if they are selling to local investors or if they offer other financial products, such as hedge funds, that already subject to oversight. On this basis, half the HKVCA's membership base is unregulated.

"The reality is that many of the component actions in private equity are regulated activities, but may be exempt from the need to be regulated here if you are advising a wholly-owned parent that is established elsewhere," says John Levack, managing director of Electra Partners and head of the association's technical committee. "The SFC is comfortable with that."

As a result, funds that do register with the SFC are subject to a form of regulation that provides little insight into their operations. Requirements include filing returns every six months to confirm there is enough cash in the coffers to cover employee salaries - a check more relevant to brokerages than PE firms - and senior professionals sitting exams on capital markets.

The concerns are twofold. First, European authorities might examine Hong Kong's regulatory regime and decide that it is insufficient for local managers to qualify for the AIFMD passport system. Second, mainland Chinese PE firms that want to raise US dollar-denominated capital might look to use Hong Kong as a fundraising hub and apply for local licenses, but ultimately opt for Singapore because the regulatory environment is more suitable.

Tax is an important consideration in this respect. If a Hong Kong fund is regulated onshore does that mean it could trigger permanent establishment and no longer be ignored by the tax authorities as an offshore entity? Given that the authorities don't tax capital gains, this shouldn't be a problem - but Hong Kong has no legal definition of capital gains. Singapore, meanwhile, has offered clarity.

"We are lobbying the Hong Kong government to make some changes to tax and regulation - and need to demonstrate to them that private equity is a strategically important industry," says Levack. "We have asked Hong Kong University of Science & Technology to look at the indirect jobs that are created. These include many white-collar jobs for graduates which are vital to Hong Kong."

This kind of proactive advocacy is already a hallmark of other industry associations' approaches. The British Private Equity & Venture Capital Association (BVCA) - which is older and better resourced than its Asian brethren, and deals with a broader range of issues throughout Europe - seeks to influence UK economic and industrial policy before it is made. This includes identifying sectors in which member firms might want to participate and making suggestions to the government on how to facilitate investment.

"Our members own thousands of companies in the UK and many of these companies are overseas as well. We have to show that we are part of national industries and that we have a lot of dry powder which needs to be put to work in British companies," says Mark Florman, the association's CEO. He describes the BVCA as having a "think-tank element," with permanent staff coming from policy and regulatory backgrounds and offering a clear understanding of how policymaking works.

Action by necessity

It is worth noting that this approach was in part the product of necessity. While the BVCA still has its critics, six years ago the association was in a far worse position when a previous CEO was pilloried by a House of Commons Treasury committee inquiry and then savaged by his own members for failing to defend the industry. The association was essentially forced into a corner and had to reconsider its engagement strategy.

Comparisons can be drawn with certain Asian jurisdictions in this respect. Several industry associations that claim to have made progress with domestic regulators can trace their efforts back to times when the industry was under pressure.

The Australian Private Equity & Venture Capital Association's (AVCAL) advocacy efforts began in 2002 and the creation of venture capital limited partnerships, but a greater challenge came five years later when the Senate Standing Committee on Economics investigated the asset class.

"It was after the Qantas bid [a PE consortium tried to buy the carrier in 2006] so there was a generally negative perception in the media and in politics about the role of private equity," recalls Katherine Woodthorpe, CEO of AVCAL. "We had to spend time with members of the senate committee, but also every influencer - advisors and representatives of both political parties."

More firefighting was required when the Australian Tax Office retrospectively revised its approach to taxing private equity profits and industry participants required clarity. There has also been the public fallout from a number of leveraged buyouts struck prior to the global financial crisis to contend with

AVCAL's proactive strategy has seen the introduction of private equity primer seminars for journalists and politicians. Last year 27 senior civil servants attended one of these sessions in Canberra; a similar event was held for government advisors several months ago. "We start these sessions by placing a bunch of different products on the table - brand names for everything from skin creams to sportswear - and people had no idea they are owned by private equity," Woodthorpe says.

Australia differs from most Asian markets in that large leveraged buyouts of brand-name businesses are available and they create more waves in the public and political spheres. It is a state of affairs with which Taiwan's PE community can sympathize after a KKR-backed management buyout of electronic components manufacturer Yageo was rejected by regulators in 2011 for reasons that few in the industry could fathom.

The situation prompted MAPECT to intensify its lobbying efforts. "We are trying to make the government realize that this is a serious situation. They say it is just one case but it isn't: this one case has damaged confidence of all PE investors in Taiwan," says Huang. "There is no certainty regarding government approval and as a result there have been no major PE transactions in Taiwan in the last 2-3 years."

The council's concerns are threefold: that the authorities are fundamentally opposed to privatizations; that they are overprotective of minority shareholders' interests; and that they don't offer clear enough guidance on the interpretation of regulations. It took the initiative with the Securities and Futures Bureau last year and now has quarterly meetings with the agency. Huang says this newfound engagement has delivered progress, but the concerns have yet to be fully addressed.

The other jurisdiction in which relations between regulators and industry associations have recently been formalized is India. Officials at the Reserve Bank of India, the Securities and Exchange Board of India (SEBI) and the Ministry of Finance have each been tasked with handling PE-related issues. Action came after the Indian Private Equity & Venture Capital Association (IVCA) stepped up its engagement in response to particular regulatory issues.

In the past couple of years, the country's PE industry has faced uncertainty over the tax treatment of offshore investment vehicles under the now-postponed General Anti-Avoidance Rules (GAAR); a wholesale reworking of the classification requirements for onshore funds; and withstood an attack by the Department of Industrial Policy & Promotion (DIPP) on put and call options used to secure private equity exits.

"The DIPP's about-turn was entirely because of the IVCA," claims Mahendra Swarup, the association's president and a partner at Avigo Partners. "With AIF, the outcome wasn't 100% satisfactory to everyone in the industry but what emerged from the drafting process was much better because of interaction with SEBI. We have done a fairly good job in educating the government on what the asset class does, that we aren't hot money and shouldn't be categorized with other types of funds."

Horses for courses

Australia, Taiwan and India may stand out as jurisdictions in which industry associations have tried to draw or redraw their relationships with regulators, but they are united by little else. The success of their engagement, the number and nature of stakeholders involved, the structure of their industries and the economies in which they operate, even the political systems of which the regulators are part - all are different.

Consequently, while there are common concerns regarding fundraising activity in Europe and the US, there is no common solution at local level. China, for example, has larger, more independent-minded industry associations representing GPs in the form of the CVCA and the China Association of Private Equity, and then a collection of groups led by regulators (the NDRC created its own version of the CVCA to counterbalance the CSRC-linked AMAC).

It is difficult to see consensus being reached apart from in extreme circumstances, but does that miss the point? Under the present governance structures it is difficult to see the advocacy process in China replicating that of Western-oriented markets.

"Lobbying associations are useful - they mean your voice gets heard," says Vincent Huang, a partner at Pantheon who is involved with the Limited Partners Association of China. "As to whether we can make a difference, this is more of a long-term issue. I don't think we are so powerful that can change the government's position."

In the fullness of time, a more mature private equity industry with a larger stake in the economy as a whole may be in a position to deliver sophisticated advocacy. There is also likely to be greater appreciation of the need to pre-empt the risk of a knee-jerk regulatory response to a crisis. As other Asian jurisdictions are discovering, this is easier to achieve when government agencies, and indeed the public, understand what the asset class does and how it can contribute to industrial development.

"In the past in Hong Kong we were a small industry, employing a relatively small number of people and were not active in engaging with the authorities," says Johnny Chan, executive director of Crosby Capital and president of the HKVCA. "This approach doesn't work anymore."

 

SIDEBAR: AVCPEC - Asia's association of associations

The first attempt at creating a pan-Asia private equity association came more than a decade ago; it didn't last. Fast forward to the present, the industry is larger and more globally integrated - and, in the form of the Asia Venture Capital and Private Equity Council (AVCPEC), there is a renewed effort to pool ideas and experience from across the region.

"We revived the idea two years ago," says Johnny Chan, executive director of Crosby Asia and president of the Hong Kong Private Equity and Venture Capital Association (HKVCA), who is heavily involved in the initiative. "It really sprung from the idea that more of our members are facing similar problems. There is a higher regulatory element that is being imposed or will be imposed on the industry."

AVCPEC's membership comprises nine private equity associations - one each from Japan, South Korea, Australia, India, Singapore and Hong Kong, and two from China. There has also been interest from overseas, with Britain's industry association (BVCA), participating in some of the early exchanges.

According to Mark Florman, CEO of the BVCA, the association has agreements with 45 counterparts globally and looks to support developing nations in particular. "I'm not saying we have the right solutions but our experience of arguing different cases and different models might help," Florman adds.

In its initial stages, AVCPEC is keeping the administrative duties to a minimum and trying to serve as an association of associations - a B2B forum for sharing industry best practice. Not everyone is drinking the kool-aid, though. Some industry participants note that it is difficult to accommodate the needs of groups that represent industries at different stages of development.

Mahendra Swarup, a partner at Avigo Partners and president of the Indian Private Equity & Venture Capital Association (IVCA), speaks up in defense of the council, observing that coordinated support from regional counterparts makes it easier for the IVCA to approach the government. "If the government hears from local associations and foreign associations it has more impact," he says.

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• Topics
• Regulation
• South Asia
• Australasia
• Greater China
• regulation
• Squadron Capital Advisors
• AVCAL
• Avigo Capital Partners