Memorandum from the Institute of Chartered
Accountants in England and Wales
EVIDENCE ON THE TOPIC OF TRANSPARENCY AND
SIR DAVID WALKER'S PROPOSALS FOR IMPROVING THE TRANSPARENCY OF
THE PRIVATE EQUITY INDUSTRY
MAJOR POINTS
The ICAEW views Sir David Walker's Guidelines
for Disclosure and Transparency in Private Equity ("the code")
as a positive development in the disclosure regime for the private
equity industry and considers the code to be a proportionate response
to calls for greater transparency and accountability. The code
separately addresses private equity-owned businesses and private
equity firms and their conformity will be on a "comply or
explain" basis. The onus is on the industry as a whole to
respond appropriately and demonstrate that the code can work so
as to enhance market confidence and public trust in the industry
and ensure its sustainability. The recently established BVCA panel
for monitoring and encouraging conformity with the code will play
a major role in this.
The BVCA panel will need to be vigilant as to
how the market receives the data analysis and the industry's conformity
with the code. If necessary, the panel may need to adapt its approach
to meet the objective of enhancing wider public trust in the industry.
The panel will also need to be mindful of how the principles underlying
the code could influence overseas private equity business.
COMMENTS ON
SPECIFIC AREAS
SET OUT
IN PRESS
NOTICE NO
05
The structure and effectiveness of the recently
established BVCA panel for monitoring, and encouraging compliance
with, the code of conduct
The key principles of a voluntary code of conduct
for transparency are:
— confidence in its structure and the
practice it promotes;
— flexibility, ie the ability of being
modified; and
— a monitoring mechanism which is seen
to be independent and effective.
In assessing the structure and effectiveness
of the BVCA panel for monitoring and encouraging compliance with
the code it is useful to draw analogies with the Corporate Governance
Committee of the Financial Reporting Council and the Code Committee
of the Takeover Panel.
The structures of these committees are characterised
by their independence and their inclusion of the main market participants.
It is significant that both committees have
members with experience of or a direct role in reporting. This
is particularly important for the monitoring role of the BVCA
panel, ie when evaluating conformity, as it will help build the
perception of good practice. It would also be an instrumental
factor in ensuring that future changes to the regime are considered
workable and are accepted.
Thus we support the intended inclusion of representatives
of General Partners on the BVCA panel and would support inclusion
of advisers to funds who can bring experience of the reporting
process. We would also support the inclusion of Limited Partners.
This would demonstrate that the interests of the investor community
are aligned with the objects of the code and would help conformity
with the code to become a generally accepted yardstick.
In addition to structural matters, the BVCA
panel will need to consider issues relating to process, such as
fair and appropriate sanctions in the case of non-conformity and
a mechanism for dealing with objections to decisions. It will
also need to evaluate the implications of making public the results
from monitoring.
The structure of the BVCA panel and its terms
of reference are likely to evolve over time. Developments may
come about depending on how the wider public perceives the panel
is performing in its objective of encouraging greater transparency
in the private equity industry. The panel should be given a reasonable
period to implement its terms of reference and to demonstrate
its independence and authority. The ultimate test of its effectiveness
will be whether the wider public concerns are addressed.
The appropriateness of the proposed level and
type of disclosure for the various stakeholders in private equity-owned
businesses
During the consultation period the ICAEW highlighted
certain concerns that the enhanced reporting requirements for
a subset of private companies (in this case, private equity-owned
companies) were unfair and could cause market distortion by deterring
private equity deals. Notwithstanding this we consider that the
disclosures for private equity-owned businesses are proportionate
and will address specific needs for communication and acknowledge
the importance of maintaining good stakeholder relations.
The requirement to identify the private equity
fund or funds that own the business will help prevent mistrust
and uncertainty caused by the perception that the owners are anonymous.
In terms of identifying the senior executives of advisers of the
private equity firm with oversight of the business on behalf of
the fund(s), we agree that this will improve accountability but
we consider it would be more in line with being transparent not
to restrict disclosure to UK-based individuals as is currently
the case in the code.
We agree that, in developing the code, it was
appropriate to refrain from setting guidelines in respect of board
composition and corporate governance of portfolio companies. The
board is responsible as a whole for ensuring a balance of skills
and experience appropriate for the company and a rigorous appointment
process will normally address this. We consider it helpful to
stakeholders to expect companies to identify executives of the
company, representatives of the private equity firm and outside
directors on the board.
The requirement for private equity-owned businesses
to include, as part of their annual report and accounts, a business
review that conforms to s417 Companies Act 2006 (including subsection
5) is sensible and provides practical guidance for such reporting.
As market practice in conforming to the Act's provisions evolves,
it will provide a useful benchmark in communicating to the various
stakeholders and help reporting focus on the economic substance
rather than the legal form of the business.
Much of the negative coverage of private equity
activity can be attributed to poor communication and analysis
of the context in which private equity transactions take place
(including the risks). The requirement that a private equity-owned
business's financial review should cover risk management objectives
and policies in the light of the principal financial risks and
uncertainties facing the company, will bring clarity and increase
understanding of the risks involved.
The benefits of additional disclosures by private
equity-owned businesses are accompanied by associated cost and
time implications. Certain companies will not have previous experience
of quoted company reporting requirements and deadlines. Stakeholders
and the monitoring panel will need to recognise this when evaluating
a business's conformity with the code.
Proposals for a respected capability for providing
comprehensive, industry-wide data on the private equity industry
Sir David Walker's proposals for "a respected
capability" seek to establish the BVCA as "the recognised
authoritative source of intelligence and analysis both of larger-scale
and of venture and development capital private equity business
based in the UK and a centre of excellence for the whole industry".
The data agenda in the proposals will, in our
view, be a major contributor to the reputation and sustainability
of the private equity industry providing the following apply:
— There needs to be confidence in the
quality of data collected and in the robustness and objectivity
of the data aggregation and analysis. This implies that "bad
news" or unfavourable performance indicators must also be
disclosed. We believe that this can be supported through engaging,
as proposed, the services of professional firms. It will also
be important for private equity-owned businesses and private equity
firms to feel responsibility to provide appropriate data and it
is up to the BVCA to create and foster momentum in the process.
— Data analysis must be representative
of the industry as a whole and efforts may be needed to persuade
private equity firms at the larger buyout end (where they are
not members of the BVCA) to contribute data.
— There needs to be commitment to appropriately
resource the data capability including the costs of engaging the
services of professional firms, the costs to private equity-owned
businesses and private equity firms of providing the data and
the costs to the BVCA of gathering and reporting data.
— The wider public response to data
analysis and the industry's conformity with the code needs to
be monitored. If necessary, the panel may need to adapt its approach
to meet the objective of enhancing wider public trust in the industry.
We support the publication of attribution analysis
as an effective way of encouraging accountability. Doing this,
as proposed, on an industry-wide basis will require consistent
judgements to be made in preparing the analysis so as to facilitate
verification and comparison over time. There have been criticisms
of the failure of the code to require individual firms to produce
attribution analyses. However, there are suggestions that the
industry-wide approach should be treated as work-in-progress towards
developing a "template" with which individual firms
can conform. We would support this approach as it will help eliminate
some of the inherent limitations in producing attribution analyses,
such as subjectivity and comparability.
The UK has the largest concentration of private
equity business in Europe and private equity is a cross border
business. Given also that there is no such code of conduct overseas,
the BVCA will be well placed to give early consideration as to
how data input requirements on private equity firms and the businesses
they own, as well as the resulting analysis, might be developed
or expanded to include data on non-UK private equity portfolios
and, potentially, data from overseas private equity industries.
The private equity-owned companies to be covered
by the code
Companies' legislation requires directors to
promote the success of the company for the benefit of members
while having regard to a number of other stakeholders. Well-governed
companies will provide relevant and proportionate information
even in the absence of reporting guidelines.
The private equity-owned companies to be covered
by the code have to satisfy a "test of UK significance"
as measured by the percentage of revenue generated in the UK.
While this provides welcome clarity as to which companies should
adhere to the enhanced disclosure requirements, it is important
for judgement to be exercised in the case of companies with UK-generated
turnover (and indeed other measures such as employee numbers)
immediately below the thresholds.
The monitoring mechanism for the code will enable
review of the thresholds for private equity-owned companies. It
may be appropriate for changes to be made in light of experience,
including where reporting is a matter of judgement rather than
strict adherence to a requirement.
December 2007
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