By Jeremy Katzeff CFA®, Head of Buy Side Solutions at GoldenSource
Globally, there is a growing sense that a regulatory crackdown on private markets is looming. Although macroeconomic headwinds dampened returns for both private and public market investors in 2023, the fact that the former’s assets under management (AUM) soared over the last decade has certainly got watchdogs’ tails wagging.
In the UK, for instance, the regulatory spotlight is centered on private markets valuation practices, with FCA Chair Ashley Alder acknowledging at the Bloomberg Buy-side Forum in May that watchdogs need to consider the tools and data they require to oversee the activities of non-bank financial intermediation (NBFI), alongside the private markets in which they participate.
Meanwhile, despite being shut down by an Appeals Court in June, the US SEC’s planned rules to significantly enhance oversight of private funds suggest the regulator has the sector well and truly in its crosshairs.
The general consensus is, when it comes to increased regulatory demand on private markets, it’s not if, but when. The question must now be how can market participants avoid getting hit hard by any swift regulatory action that comes their way?
Clues of what’s to come
The rate of growth of private markets over the last decade is a glowing sign that greater regulation is on the cards. Private markets AUM totalled $13.1tn as of June 30 2023, having grown nearly 20% per annum since 2018. With many anticipating that growth will continue at this pace, private markets pose a greater systemic risk to the broader financial markets. In an era where the impact of elevated volatility remains and stability is a central focus, it’s understandable that regulators are looking to increase their oversight.
This is particularly the case amid the ongoing convergence of public and private markets, with the lines between the two spaces becoming blurred as investors seek further portfolio diversification. Asset management giant BlackRock’s recent agreement to acquire private markets data provider Preqin is a good indication that prominent financial institutions have their eyes firmly set on private markets opportunities.
Predictions aren’t just being made within back-office compliance teams though. Firms are openly expressing their perspectives on this trend. In a recent survey by Carne Group, for example, both UK- and US-based investment managers cited they are already raising capital for private funds in Europe – 94% and 88%, respectively – but regulation was decidedly the main hurdle to overcome. US managers claimed EU regulation around private assets was more complex than the US, and it will become even stricter over time. As firms look to continue diversifying their investment portfolios in terms of both asset class and region, regulatory divergences are going to prove trickier to comply with.
Adapting early ensures early advantage
With these different facets of the market landscape in mind, it’s important that firms operating in private markets ensure they are well equipped for an expansion of their regulatory reporting requirements. Compliance processes and regulatory reporting are only as good as the data quality that underpins it – and regulators are now beginning to enforce these data management principles in their oversight of financial institutions’ risk practices. Without putting scalable, robust and efficient data strategies in place, the regulatory burden will be more onerous in terms of both financial costs, time and personnel resources.
In short, private markets firms must be proactive in implementing change, otherwise they may be forced into being reactive by regulators – and face greater costs as a result.
This has been seen many times before in public markets, where a significant event – whether that be a collapse of an institution or a scandal – has triggered the change, albeit too late in the view of many.
Pre-2008, it was deemed acceptable if a hedge fund didn’t have a third-party administrator and relied solely on their own valuations for their assets. Of course, this changed with the crisis unearthed by the Madoff investment scandal. Now, all hedge funds have third-party administrators, shadow NAV tools and use at least one third-party price evaluation service.
The firms who, though may not have predicted that Madoff’s Bayou Group was to be exposed as an elaborate Ponzi scheme, understood the importance of implementing robust risk and data management processes for the long-term benefits, fared better than many others in the rush of reforms that followed.
This type of adaptation could very well be seen in private markets, if driven by investor requirements and another catalyst like a valuation crisis. For example, though the commercial office property market continues to shrink, many private equity firms haven’t adjusted their valuations downward to reflect the true market clearing prices.
Now, the question being asked is if regulators are going to step up to the plate to put measures in place before a lack of oversight leads to things going pear-shaped in private markets. Indications of late suggest yes – that they are, at the least, attempting to. But it will be the firms themselves that have the real power in updating and scaling their risk management processes and underlying data strategies, to allow them to increase resilience and more effectively ride the wave of regulatory intervention.
