Supplementary memorandum submitted by
the Financial Services Authority
1. This Memorandum is submitted by the Financial
Services Authority as a follow-up to the oral evidence given by
Hector Sants and Sally Dewar on 3 July.
2. The Memorandum expands on our oral response
to a question asked by Mr Cousins and provides answers to the
four factual questions asked by the Chairman.
3. In Mr Cousins' question [Q510], he suggested
that the FSA could not give assurances on two points, which we
understand to be the following:
Whether debt issued in connection
with private equity transactions has ultimately resided within
regulated entities; and
Whether debt issued in connection
with private equity transactions has ultimately resided in the
Hector Sants responded orally. We provide further
4. As other parties have noted in their
evidence to the Committee, in recent years loan markets have undergone
a rapid transition in terms of secondary trading and risk transfer.
One consequence has been to allow some lending institutions, typically
investment banks, to move from an "originate and hold"
model to a "capital turnover" model, in which they originate,
and then distribute, their exposure to specific loans. Our leveraged
buyout survey, completed in 2006, found that of 15 investment
banks asked, six said they follow a capital turnover model. Our
future surveys of this market will enable us to analyse whether
banks continue to change their lending model and the potential
impact this may have. A potential positive consequence of this
change, from a financial stability perspective, is that the failure
of a specific transaction is less likely to have significant financial
consequences for any individual creditor.
5. A further consequence of this change
is that debt originated by UK-based companies can be distributed
widely across the global market and held by entities which are
not directly regulated by the FSA. Likewise, debt originated by
foreign companies is now held in the UK. As we noted in our oral
evidence, we believe that this does not affect our ability to
discharge our mandate with respect to financial stability. Under
our risk-based approach to regulation, we focus our supervisory
attention on the areas which present the highest risk to our statutory
objectives. In this case, our attention is appropriately weighted
towards the FSA-regulated lending banks, which act as the transmission
mechanism for exposure to private-equity owned companies to be
distributed across the market. For many years our supervision
of these entities has included reviews of the firms' management
of their credit, market and underwriting risks in the area of
private equity (as significant business lines). Our supervision
of firms in this sector takes two main forms: "close and
continuous" monitoring of individual firms, and "thematic
reviews" of a number of firms to examine a particular aspect
of their business or their controls. We will continue to emphasise
to firms' senior management that their scrutiny of the progress
of material exposures is an essential part of their risk management
process. These firms are also subject to prudential supervision
requiring them to hold capital in relation to the risks they are
Recognising the importance of monitoring the
impact that leverage could have on our objectives, we are carrying
out two projects to enhance our understanding of the market. One
is the twice yearly leveraged buyout survey which we outlined
in our previous written evidence to the Committee. This is being
supplemented by enhancing our understanding of the risks posed
by market developments to the restructuring of corporate firms
in financial distress. We see our role here as raising the profile
of potential market implications and encouraging participants
to plan for such eventualities. We are working with the market
in this regard through contact at the trade association and individual
6. This will allow us to highlight key areas
of risk to the market, so that participants can prepare for the
challenges that may lie ahead. We believe these steps will supplement
our existing supervisory approach and provide appropriate mitigation
against the current level of systemic risk we perceive to be associated
with failure in a private-equity backed firm.
7. The Chairman asked four questions, to
which we agreed to respond:
What is the average duration of an
investment by a private equity firm?
How large is the private equity market?
How many deals have been done by
What is the geographical location
internationally of the largest buy-out markets?
FSA Authorised firms, including private equity
firms, are required to submit periodic regulatory returns. These
are used in our ongoing supervision of the market and are subject
to rigorous scrutiny to ensure that we only request information
which is necessary, and can be justified on a cost-benefit basis.
We do not regularly collect deal specific data.
The Chairman has asked for certain market information,
not all of which is held in our records. We have therefore included
data obtained from two other sources; Private Equity Intelligence
(a 3rd Party data provider) and the Centre for Management Buy-out
Research (CMBOR). We have found both to be reliable sources of
objective market data.
8. What is the average duration of an investment
by a private equity firm?
The "Average Time to Exit" for all
UK private equity backed Buy-outs/Buy-ins (over the five year
period 2002-2006 inclusive) was five years and four months. Over
the 10 year period 1997-2006 the "Average Time to Exit"
was five years and 0 months. This data is calculated by year of
exit. For clarity, a firm purchased in 2000 and sold in 2005 would
be included in the 2005 figures as a five year investment.
For comparison, the "Average Time to Exit"
for all UK Buy-outs/Buy-ins (including non-private equity backed
transactions), over the same period, was five years and four months.
Over the 10 year period 1997-2006 the "Average Time to Exit"
was five years and two months. Source: CMBOR
9. How large is the private equity market?
We have used the metric of "funds raised",
a metric of potential impact that private equity could have, by
investing these funds. In the calendar year 2006, UK based fund
managers raised funds of £33.64 billion in the UK, compared
with a global total of £223.24 billion. Historical data for
a 4 year period is included under point 11 below. Source: Private
10. How many deals have been done by size?
VALUE RANGES OF PRIVATE-EQUITY BACKED UK
BUY-OUTS/BUY-INSNUMBER OF DEALS
|Less than £5m||99||95
|£5m - £10m||36
|£10m - £25m||70
|£25m - £50m||23
|£50m - £100m||27
|£100m - £250m||23
11. What is the geographical location internationally
of the largest buy-out markets?
Data is contained within the table below. This shows funds
raised by fund
manager, according to the location of their head office. This
data is not necessarily indicative of where funds have been, or
will be, invested.
FUNDS RAISED BY YEAR OF FINAL CLOSE (£ BILLION)
Source: Private Equity Intelligence.
Data is by year of final close-ie when funds were closed allowing
no further investors to commit capital. Back
By year of final close (see footnote above). Back