Memorandum from the Association of Investment
Companies
EXECUTIVE SUMMARY
1. The Association of Investment Companies
(AIC) welcomes the opportunity to submit further views to the
Committee's inquiry into private equity.
2. The AIC believes that listed investment
companies already represent excellent standards of public reporting
at fund level within the private equity sector and welcomes measures
to further enhance transparency within the industry. The Walker
Guidelines represent a suitable means to achieve this outcome
and should be given time to have an impact on reporting practice
before an full assessment of their effectiveness can be made.
3. However, the AIC remains concerned that
some owners (ie sovereign wealth funds and private corporate entities)
of large private businesses with a substantial public impact are
not covered by the Guidelines and recommend the Committee
give consideration to securing greater transparency by these organisations
and the businesses they own.
4. The AIC has also explored the reasons
why private equity funds may require different information from
owners of publicly quoted shares. There are various factors involved
but one of the most critical is the way in which different investors
engage with the companies concerned. The AIC has concluded that
this issue raise no matters of public policy concern.
TRANSPARENCY
5. The AIC welcomes the Walker Guidelines
(the Guidelines) on disclosure and transparency in private equity.
They provide a proportionate and flexible basis for the private
equity sector to report to the public. They identify areas where
there may be a legitimate public demand for information (ie where
a large portfolio company is involved) and balance the need to
disclose against the legitimate commercial interests of the fund
and its investors.
6. The private equity industry has engaged
closely with the development of the Guidelines and we anticipate
it will take a responsible attitude to future disclosure. With
this in mind, we have been disappointed with the critical reception
the proposals have received from some quarters. All parties should
be prepared to give the industry time (we recommend at
least two reporting cycles) to develop its approach before making
further judgements. This will allow best practice to emerge and
provide evidence on whether or not the approach embodied in the
Guidelines needs to be revised.
7. As explained in our previous submission,
listed investment companies (which are represented by the AIC)
are already highly transparent. Regulations already require information
to be published on their shareholders and directors, investment
strategy, governance and major transactions (amongst other issues).
They already offer excellent standards of public disclosure.
8. The AIC believes the scope of the proposed
disclosure for private equity vehicles set out in the Guidelines
is appropriate. Private equity funds which fully engage with the
Guidelines in good faith will make significant strides towards
the levels of transparency already achieved by our members. In
addition, the Guideline's "portfolio company" disclosures
are properly targeted on larger companies likely to have a significant
public impact and cover appropriate issues. However, the AIC remains
concerned that, even with the Guidelines in place, there are potential
gaps in disclosure.
9. These gaps involve owners of large UK
private businesses which are not conventional private equity funds
but are so-called "sovereign wealth funds" or private
corporate entities. Organisations of this type are not covered
by the Guidelines nor are the portfolio businesses which they
own. The AIC highlighted these gaps its response to the Walker
review as it believes the locus for the debate on transparency
should not be ownership by a private equity fund per se (which
is, of itself, an entirely legitimate form of ownership). Instead,
the transparency debate should be driven by the need for private
businesses with a significant impact on the on the public sphere—however
they are owned—to be suitably transparent. If they have
a major impact on public life they should make suitable disclosures
and, where appropriate, so should their owners.
10. The AIC therefore recommends that
the Committee consider these remaining "gaps" and how
they can be addressed to secure the disclosure standards set out
by the Guidelines.
INVESTOR INFORMATION
REQUIREMENTS
11. The information made available to investors
in public companies does differ from that which private equity
funds receive (and pass on to their own investors). This is not
inherently surprising and reflects the different nature of the
investment proposition and the approach taken by the funds. After
all, even shareholders in the same public companies may have different
information requirements.
12. For example, passive investors, such
as tracker funds, have little need for specific company data as
they are simply seeking exposure to a particular index. Other
shareholders with a more active approach might be concentrating
on selecting asset classes, so again may not be so concerned with
huge amount of detail on the operation of individual companies
they are exposed to. Still other approaches will involve investors
looking more carefully at the specific circumstances of investment
targets. This would include, for example, "value" strategies
where prospective purchasers are seeking to identify stocks where
the full value of the company has not been expressed in the share
price. Perhaps the investors likely to be most keen on securing
detailed information and analysis on individual listed companies
will be those with an "activist" remit. That is, they
seek to make strategic, governance or other adjustments to enhance
the performance of the company by making representations to the
board and other shareholders.
13. Given that there are diverse information
needs for investors in publicly quoted companies it is not surprising
that private equity funds also have different information needs.
The general view is that private investors demand, and secure,
more information from portfolio companies than is available to
public investors. There are a number of reasons why this is likely
to be the case.
14. The investment approach of the
private equity owner is likely to differ from public investor
as private equity funds will usually seek to implement specific
strategic changes. They might be thought of as "super-activist"
investors, who require information to determine and direct their
strategic interventions as well as to judge their effectiveness.
As a consequence, private equity owners will also customarily
be represented on the board of the investee company and may even
recruit a new management team to implement the desired strategy.
Of course, the fact that the company is owned by a private equity
fund also means that the fund is also in a position to demand
that the required information is provided.
15. Greater amounts of information may also
be required by private equity investors because the nature of
the risks they face are different. For example, private equity
investors face far greater liquidity risk. Shares in public
companies are easily tradable. By comparison, it might take significant
effort to sell a private business, or a stake in one, within a
reasonable timeframe and at an acceptable price. This is an additional
risk and it also helps explain why private equity investors may
demand greater information so that they can assess the risks of
a lack of liquidity against the attractions of the business as
an investment proposition.
16. Private equity funds may also be exposed
to greater diversification risk than funds exposed to publicly
quoted stocks. It would not be uncommon for a fund investing in
public companies to hold many small stakes in a large number—even
hundreds—of companies. In contrast, private equity funds
are likely to either own outright, or have very large stakes in,
a smaller number of companies. This (combined with the greater
liquidity risk) is likely to mean that private equity funds and
their investors need more information to make an ongoing assessment
of their exposure to particular companies.
17. While private equity owners may be in
a position to secure more in-depth information from portfolio
companies—and may have a greater need for that information
because of the risks they face—it should also be recognised
that there are good reasons why public companies limit the information
they provide in the public domain.
18. Portfolio companies providing information
to their private equity fund owners, who may in turn pass it on
to their own shareholders, are able to do so on a confidential
basis. They do not have to post information publicly to maintain
an orderly and fair market in their shares. This means that they
can restrict circulation and are able to provide material that
might be more speculative or commercially confidential. The nature
of private equity ownership reduces the risks of creating misunderstandings
about the prospects of the company or compromising its ability
to pursue its business objectives.
19. It is reasonable that private businesses
issue different information in comparison with publicly owned
ones. A critical reason for this is that they can circulate that
information on a confidential basis, which creates fewer risks.
Similarly, it is not surprising that investors with different
strategies have different information needs. The AIC does not
believe that this situation provides any issues of general public
policy concern.
20. The critical lesson from this discussion
is that, if a potential shareholder does not believe that a company
(private or otherwise) provides sufficient information to enable
it to assess it as an investment proposition, then they should
simply not purchase those securities.
January 2007
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