CFA analysts support better governance in private markets

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A recent survey conducted by the CFA Institute unveils diverse opinions among investment professionals regarding the need for additional regulation in private markets. While there is clear support for enhanced governance and disclosure practices, especially on fees, views on the severity of current issues and the need for further regulation vary significantly.

The survey, carried out by the CFA Institute Research and Policy Centre, delved into various aspects such as conflicts of interest, information asymmetry, relations between General Partners (GPs) and Limited Partners (LPs), transparency, valuation issues, fees and expenses, and the broader regulatory landscape.

Majority sees room for improvement, no problems

Approximately 51 percent of respondents believe that while there is room for improvement in private market practices, there are no significant problems or market failures. Conversely, 24 percent perceive substantial problems or market failures, and 17 percent think private markets are functioning well.

Key concerns identified by respondents include the frequency and accuracy of valuation reporting, the comparability and accuracy of performance measures, and the fairness and transparency of fees. Opinions on the negotiating power between GPs and LPs are divided, with 41 percent believing GPs dominate negotiations, while 38 percent disagree.

Strong support for moderate measures

The survey also reveals strong support for certain regulatory measures. Seventy percent of respondents favour quarterly statements detailing private fund fees, expenses, and performance. Additionally, 79 percent support annual financial statement audits by independent public accountants, and 61 percent endorse a fairness or valuation opinion for adviser-led secondary transactions.

Differences in perspectives on fee and expense disclosures were noted between GPs and LPs. While 51 percent of GPs find current disclosures adequate, 58 percent of LPs disagree.

Olivier Fines, head of advocacy and regulatory affairs for the EMEA region at the CFA Institute, noted that CFA members, financial analysts accustomed to working with financial data on publicly listed companies, have traditionally been cautious about private markets.

Regulators want to regulate

Central banks and other regulators are increasingly focusing on private markets. Currently, about a quarter of global assets under management are in the alternatives sector, with private equity and private debt comprising approximately half of this quarter.

The timing of the CFA report is particularly pertinent given the recent US decision to vacate proposed SEC rules on private funds. Notably, around 50 percent of CFA members favour more regulation, but they advocate for targeted measures specifically addressing fund fees, expenses, and valuation opinions.

Call for global standards

The survey results can be interpreted as a call for global standards for transparency in private markets. Regulators worldwide, including the SEC, the Financial Stability Board, the European Securities and Markets Authority (Esma), and national regulators like CSSF in Luxembourg, are recognising the need for improved regulation.

ESMA chair Verena Ross, in a recent interview with Investment Officer, highlighted the “need to look at the right mix” of industry initiatives and policy measures that balance the needs of both professional and retail investors. “Obviously, costs and fees are one aspect of that,” Ross said. “The industry needs to find the right mix of cost and performance that actually allows investors to get the returns they need to make it an attractive proposition.”

Low rates pushed private allocations

The increased scrutiny of private markets follows a decade of low interest rates, which pushed institutional investors towards private markets. “Ironically, nobody really cared, even a few years ago, about private equity or hedge fund performance, so long as they were only a niche market,” said Fines.

Whether an investor is retail or professional does not matter as much as whether they understand the investments’ liquidity constraints, fees, and complexity, Fines added. Many retail clients are already exposed to private markets through pension funds that sometimes invest as much as 35 percent in these strategies.

Trustee guidance and transparency

“So the question is, are the trustees properly advised?” asked Fines. “Do we have enough experience to make those decisions on behalf of their beneficiaries? And if the level of transparency becomes lacking, does the governance in place lend itself to the right level of bargaining power between the investors, the LPs, and the managers, the GPs? This is where regulators are starting to feel uneasy, wondering if, through side deals or side letters, some investors are getting better terms than others, or more favourable exit terms.”

According to Fines, the core of the legal debate in the US is whether sophisticated investors, like pension funds, should demand better terms or disclosures from their investment managers. The question then becomes whether it is right to make private markets resemble public markets, which was the crux of the SEC private fund rules.

Balancing regulation and market function

“By making the private sector more like public markets, could we inadvertently harm the investment and financing model that has become prevalent in several industrial sectors, especially technology?” Fines asked. “It’s not as simple as it’s often portrayed. Yes, we need more disclosures, but the more you intrude into the business model, the more you transform it. So you’ll find arguments on both sides.”

The CFA survey ran from October 10 to October 22, 2023, and was sent to a random sample of 60,000 CFA Institute members globally, achieving 848 valid responses from various markets, including Australia, Canada, China, Germany, Hong Kong, The Netherlands, Singapore, Switzerland, the United Kingdom, and the United States.