Private equity dodges US regulatory bullets?

The Dodd-Frank Wall Street Reform and Consumer Protection Act, just approved by the House of Representatives and with the Senate scheduled to vote next week, contains what AVCJ sources describe as a much-watered-down version of the Volcker Rule, which sought to restrict banks as investors in the asset class. Furthermore, the discretion left to regulators to set capital limits for banking participation in alternatives still further, with up to 3% of Tier 1 capital available for private equity and hedge funds, and a 3% ownership stake limit in funds that in practice will be easy to work around. Banks such as RBS and HSBC that have already started spinning off their private equity divisions are likely to continue, but as much for issues of team alignment and strategic focus as any residual pressure from Volckeresque principles.

Almost simultaneously, the Securities and Exchange Commission has voted unanimously to allow private equity firms to continue using placement agents in dealing with pension funds and other major public LPs, although restricting this overall to registered agents. The attendant restrictions on “pay-to-play” practices and political connections within the placement business deal with most of the real issues that triggered the regulatory moves in the first place, while avoiding the scattergun effect of a total ban, which could have left smaller private equity firms with fewer capabilities, such as many Asian funds, terminally disadvantaged in direct dealings with US LPs.

So far so good. But private equity still faces other regulatory challenges, with the controversial European Union legislation on the industry still in train, and new initiatives, such as the recently-announced plan by New York State governor David A. Paterson to consider a tax on out-of-state private equity and hedge funds. Meanwhile, the Senate is still wrangling over the American Jobs and Closing Tax Loopholes Act, a raft of legislation ostensibly addressing unemployment benefits that in fact targets the taxation of carried interest income for private equity partners. Lobbying by private equity and VC firms has already cut back the initial provisions, and the bill’s repeated rejection means it may never make the statute book anyway.

It’s unclear why taxation of carried interest became so central to this act’s aims. But it is clear that broad regulatory pressure on the industry, or at least the incomes of its highest-profile proponents, is unlikely to ebb very soon.

Instead of concerning itself with regulatory issues, however, private equity might have more important and immediate business challenges to deal with. As Glenn Hubbard, Dean of the Columbia Business School and former Chairman of the Council of Economic Advisors to George W. Bush, recently remarked to AVCJ, “LPs’ attitudes towards private equity are driven less by Volcker Rule issues, and more by: do I want to invest in an asset class that requires enormous amounts of leverage to generate returns?”  As global private equity fundraising hit a new low of just over $41 billion in 2Q10, the lowest total since 2003, that is a question that private equity needs to find an answer to before breathing a sigh of relief over regulatory issues.

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• Topics
• Regulation
• North America
• LPs
• Fundraising
• Advisory
• Financials