Sir David Walker delivered his much-awaited consultative report on the UK private equity market, 'Disclosure and Transparency in Private Equity', yesterday. Sir David's complete Executive Summary is provided below, together with a link to a downloadable pdf of the complete report.

EXECUTIVE SUMMARY:

1. This executive summary describes the broad approach that is envisaged: detailed guidelines will follow after the consultation process is complete. The focus of the review is on the need for greater openness in respect of buyout activity.The guidelines that will emerge from it are not addressed to the venture and growth capital parts of private equity business, which are widely respected as important sources and support for new enterprise and have given rise to neither the visibility gap nor critical concern that have come to be associated with buyouts.

2. A private equity fund with a focus on medium to large-scale acquisition might typically have some 150 limited partners, in sharp contrast with the average of some 150,000 shareholders for a FTSE 100 company in the UK. Reporting by listed companies is aimed principally at the interests of shareholders, a large group holding stock that is traded in public markets. In contrast, the interests of the very much smaller group of ultimate owners in private equity, who hold an illiquid stake in a fund that cannot be traded on a public market, do not in themselves call for public disclosure. This review finds that reporting arrangements between private equity firms (general partners) and investors (limited partners) in private equity funds are generally satisfactory, and few changes are proposed.

3. But reporting by listed companies is also the channel for addressing the legitimate interests in their policies and performance of stakeholder groups such as employees, suppliers and customers, as well as the public interest more widely. These interests have been inadequately informed by the buyout end of private equity. In particular, its rapid recent growth in scale and economic significance has outstripped its recognition of implicit contractual obligations to these constituencies, over and above its explicit contractual relationships. As a result, the industry has come to be seen as needlessly secretive, feeding suspicion and, in some quarters, close to hostility. Much of the concern is exaggerated and risks obscuring the significantly positive economic contribution made by private equity.

4. There is thus a major transparency and accountability gap to be filled. The need is to identify the areas and reporting channels through which this can be done. But this does not call for the full array of obligations now imposed on listed companies, resistance to the burden of which appears to be a material influence in the growth of public to private buyout activity.

5. This need for greater openness and explanation cannot be met through any one channel, but calls for initiative and adaptation by three separate but related groups, namely:
- private equity portfolio companies
- the general partners who manage private equity funds
- the representative industry association.

6. The approach envisaged for conformity with the voluntary guidelines is on a comply or explain basis in the expectation that buyout firms and portfolio companies will generally conform, with the added discipline, especially in the present environment, of external scrutiny by unions, politicians and the media, all of which can be confidently expected to play a part in seeking and smoking out explanation for any divergence from the guidelines. No other monitoring process is therefore proposed.

7. It is proposed that portfolio companies that were: formerly listed as FTSE 250 companies or where the equity consideration on acquisition exceeded £300 million or where the company has more than 1000 employees and an enterprise value in excess of £500 million should report to an enhanced standard beyond that required in the 2006 companies legislation.

Views are invited as to whether these are the appropriate thresholds for enhanced reporting by portfolio companies.

The main ingredients of such enhanced reporting would be:
- filing of the annual report and financial statements on a company website within 4 months of the year-end as against the 9 months currently provided in companies legislation
- the report to provide detail on the composition of the board, indicating separately executives of the company, board members who are executives of the general partner or fund and directors brought in from outside to add relevant industry or other experience
- the narrative in the statements by the Chairman or CEO and in the board's operating review to refer to the company's values and approach to its reputation, with specific reference to employees, customers and suppliers and, as appropriate, the company's role in the wider community
- financial reporting to cover balance sheet management, including links to the financial statements to describe the level, structure and conditionality of debt
- there should be a short interim statement not more than 2 months after the midyear, but no requirement is envisaged for publication of quarterly earnings statements.

Views are invited as to whether these are the appropriate ingredients in enhanced reporting by portfolio companies.

8. Such enhanced reporting is intended to apply to operating companies owned by private equity: standards for reporting by other private companies are outside the scope of this review, but the approach developed here may increasingly be seen as at least a benchmark for other large private companies.

Does the prospective imbalance in reporting obligations as between private equity portfolio companies and other large private companies give rise to public policy or other concern? And, if so, how should this be addressed?

9. The guidelines will include a provision as to the approach that should be taken by the general partners or fund in a situation in which a portfolio company encounters severe business difficulty that threatens its survival. Generalisation is difficult because the circumstances of such (hopefully rare) situations will differ. But the proposal is for commitment by general partners that they would see it as their responsibility to assist in the transition to management by a creditor group as smoothly as possible along the lines provided in the Statement of Principles of INSOL (International Federation of Insolvency Professionals) on multi-creditor workouts.

10. General partners should publish an annual review, accessible on their website, which should become an important channel of communication on the values that inform their approach to business and the governance of their portfolio companies.
This general communication should include:
- an indication of the leadership team of the management company, identifying the most senior members of the general partner team or general partner advisory group
- a commitment to conform to the proposed guidelines on a comply or explain basis
- under the rubric of the values of the private equity firm and the general partners, the philosophy of their approach to employees and the working environment in their portfolio companies, to the handling of conflicts of interest that may arise, and to corporate social responsibility
- a broad indication of the performance record of their funds, with an attribution analysis to indicate how much of the value enhancement achieved on realization and in the unrealised portfolio flows from financial structuring, from growth in the earnings multiple in the market in the industry sector, and from their strategic and operational management of the business.
- a categorisation of the limited partners in their funds, indicating separately UK and overseas sources to include pension funds, insurance companies, corporate investors, funds of funds, banks, government agencies, endowments of academic and other institutions, private individuals and others.

11. Alongside communication through such annual reviews, private equity firms will be expected to be more accessible to specific enquiries from the media and more widely.
Confidentiality concerns will constrain responses that can be given in some situations, but the line between openness and secretiveness should be drawn with much greater flexibility than hitherto, especially in respect of large transactions which, in the listed sector, would attract very full public presentation.

Views are invited as to whether these should be the recommended elements for an annual
review and for greater openness on the part of general partners.

12. Industry-wide initiative and communication: alongside enhanced reporting by portfolio companies, there is a major role for data collection, aggregation and dissemination on an authoritative industry-wide basis broadly to cover:
- scale of funds raised
- categorisation of limited partners by type and geography
- scale of existing private equity portfolios and of recent buyout activity
- leverage levels and debt structures, indicating the relative significance of covenants (or their absence)
- estimates of levels and changes in employment and new capital investment by portfolio companies
- aggregate performance measures for portfolio companies, including revenue and profit growth
- estimates of aggregate performance measures for funds
- estimates of aggregate fee payments by private equity management companies and by portfolio companies to other financial institutions and for legal, accounting, audit and other advisory services.

All of this calls for substantial amounts of data but not all of it is clearly additive, and judgement will be required to make qualitative overall assessments in some areas, for
example in providing an assessment of the overall performance of funds on an aggregate basis and, in another area, given the wide array of definitions of leverage ratios and types of covenant used in the industry. Hence the importance of investing resource in developing an authoritative and respected capability that avoids misleading aggregation of apples and pears and commands confidence within the industry as well as externally.

Views are invited on the coverage of this data agenda and proposal for evidence-based analysis, keeping in mind the need to avoid undue reporting burdens on the industry.

13. The data should be drawn on in high quality evidence-based economic assessment, to be effectively and pro-actively deployed. The overall objective should be to create a centre of excellence for the private equity industry that should come to be seen and respected as such and, would thus make a major contribution to filling the void that currently exists in terms of credibility and authority. This will take time to build, but it is a high priority for the process to start now.

14. Beyond more effective communication, there will be need for the industry's representative body to institute arrangements to keep the proposed guidelines under review so that they can be adapted as priorities and changing circumstances require: a small group of trustees chaired by an independent outsider is envisaged for this purpose.

Views are sought on the appropriate model for review of the guidelines on a timely, effective and authoritative basis.

15. Given the cross-border nature of private equity, there is a need for pro-active engagement with industry bodies beyond the UK, in particular in Continental Europe and North America, to promote the guidelines put in place in the UK as at least a reference benchmark.


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