Today’s prevailing narrative is quite simple: heightened demands for a transparent view of investment risks are putting considerable pressure on private equity and real estate fund managers, and their service providers.
In short, risk transparency is becoming a key requirement which managers need to address. This is not that easy when one considers the complex structure of private equity and real estate funds and the illiquid non-tradeable nature of the underlying assets. The complexity of data needed to meet various global reporting regimes is a challenge. Indeed, the much talked about Solvency II regime in Europe is merely one cog of the risk transparency wheel now turning.
“One must also consider Annex IV reporting under the AIFMD in Europe. Another market we know well is Australia,” comments Hugh Stevens (pictured), head of Private Equity and Real Estate Services at BNP Paribas Securities Services. “There, the ‘Stronger Super’ regime aims for systemic transparency by making full disclosure of the underlying assets. Australian superannuation funds are big investors in private market assets – real estate, private equity and infrastructure – throughout the world, so this will directly impact the Luxembourg fund market.”
The reason for the Australian government’s plans to roll out the Stronger Super reforms is to make its superannuation system more robust and efficient and to help superannuants maximise their retirement income. The plan includes paying particular focus to self-managed superannuation funds and to beef up the disclosure and reporting requirements.
“An Australian superannuation fund might invest in international infrastructure through a Luxembourg vehicle and what the Australian regulators are saying is that superannuation funds have to satisfy themselves that they’ve got to the bottom of the economic targets in the funds. Regardless of the domicile of the fund, APRA (Australian Prudential Regulation Authority) just wants to know what’s in the fund. ASIC (Australian Securities and Investments Commission), the other regulator of these funds, has announced even deeper look-through reporting requirements for these investors and, in addition, the data would be made available to the public,” explains Stevens.
If ASIC’s proposals go through, the Stronger Super regime will therefore have an extra-territorial impact on private equity and real estate fund managers.
Greg Tanzer, Commissioner of ASIC, gave a speech on 3rd September 2014 where he talked about portfolio disclosure, governance and risk management expectations. Tanzer referred to the Superannuation System Review – which is driving the Stronger Super reforms – by noting that “systemic transparency is currently lacking in the Australian superannuation system”.
Tanzer went on to say that the obligation to publish portfolio holdings disclosure information would help create an information platform that would promote better analysis of superannuation funds. The level of illiquid assets in portfolios would be more observable and this would bring Australia into line with global practice.
“There is a crossover between regimes. In Australia, a market utility is emerging which is becoming the primary data collector. This would be responsible for collecting and then collating information from all private equity and real estate funds, alongside all other asset classes.
“This is an interesting development and our view is that a similar model will be needed in Europe for Luxembourg funds,” comments Stevens.
In the UK, the Walker report laid out guidelines on how to bring better transparency to the private equity market back in 2007. The guidelines, prepared by Sir David Walker, were formulated at the request of the British Private Equity and Venture Capital Association (‘BVCA’). In their view, concerns about a lack of transparency in the industry were deflecting attention from the positive role of private equity in generating growth and contributing to the real economy.
“We have therefore seen a voluntary transparency push with the formulation of guidelines in the UK and a regulatory initiative in Australia.
“Meanwhile, in Europe, under Solvency II, there are added commercial and economic reasons for transparency and look-through. If managers can prove what’s in their funds’ portfolios by providing look-through reporting, then investors – in particular insurance companies – can optimise their use of capital.
“So we see voluntary regimes, regulatory-driven regimes and commercial-driven imperatives, all of which are driving this need for risk transparency and reporting,” comments Stevens.
Stevens confirms that BNP Paribas Securities Services is already working with clients on numerous transparency reports and notes that insurers are getting ready ahead of Solvency II in a bid to “align to the new regulatory environment”.
Referring back to Australia for comparison, pension funds and their trustees now have both civil and criminal liability hanging over their heads if they get things wrong.
“If they are negligent in their look-through reporting they could actually face criminal charges. If trustees are awarding a mandate to invest in a target fund, transparency and risk considerations are now top of mind. We see investment committees refusing to make investments not on the basis of economics but purely on the basis that the fund is not able to produce the data required for APRA reporting.
“I would estimate that it will be the same under Solvency II. Underlying GPs who are not able to produce the required depth and complexity of reporting will find themselves at risk with large institutional investors,” opines Stevens.
Connor Sloman, Head of Asset Management Solutions, EMEA for Morningstar was quoted in April 2014 as saying that Morningstar was seeing “first-hand how asset managers are taking an active interest in providing additional insight into how their funds’ asset allocations may drive Solvency II capital charges.”
As Stevens points out, whilst there are different regimes for managers to deal with, once you scratch below the surface they share a lot of similarities.
In Australia currently APRA is requiring superannuation funds to look through to the first non-controlled entity. As a next step, ASIC is proposing that from next year superannuation funds will be required to report on a look-through basis right down to the underlying investments.
This move to deepen look-through reporting is encouraged under Solvency II and has also been reflected by the obligations on depositaries under AIFMD. “So there is a degree of consistency between different regimes but some important differences as well.”
Not all service providers are going to be well equipped to provide an industrial-strength risk transparency reporting solution. Given that under AIFMD managers will also be required to appoint an independent depositary, many will look to leverage off a single counterparty to reduce costs.
BNP Paribas Securities Services is all too aware of this. Last July it completed the acquisition of Commerzbank’s “Depobank” business. The firm now has USD125bn of PERE assets under custody giving it significant weight in the European market.
“There are now synergies available for managers to engage with the same counterparty to use our data expertise and record keeping to perform the depositary function and some of the regulatory reporting tasks. The benefit to this is that the data is already collected. It becomes a marginal cost to the manager to deal with different risk regimes and reporting obligations like Annex IV. I think there is going to be a degree of consolidation in the industry once Europe decides on the best model. Some of the more bespoke solutions that currently exist may fall by the wayside.”
With risk transparency on everyone’s agenda, getting the right solution in place is going to be paramount for global PERE managers.