Adopt ILPA clarity initiative, says panel

Private equity managers are being encouraged to adopt the International Limited Partners Association’s (ILPA) Fee Transparency Initiative, a standardised fee disclosure report, according to experts speaking at SuperReturn International in Berlin.

Private equity fees and expenses have been a very contentious issue for institutional investors and regulators alike over the last 18 months. ILPA’s standardised reports were launched in September 2015 and provide a template for private equity managers to disclose information on their fees, expenses and incentive allocations to clients. ILPA has been very active in formalising private equity best practices and has published reporting guidelines over the last few years advising managers on what to disclose in their quarterly reports and capital call and distribution notices.

Institutional investors attending SuperReturn broadly support the fee disclosure enhancements. Maurice Gordon, managing director and head of private equity at Guardian Life Assurance Company, welcomed the initiative. He said that a standardised document would simplify the reporting process for managers and their Limited Partners (LPs). Oftentimes, investors have diverse reporting requirements, which means managers have to supply a multitude of reports to clients.

One investor who allocates across alternative assets compared ILPA’s initiative to Open Protocol Enabling Risk Aggregation (OPERA or Open Protocol), a risk reporting template that was pushed heavily by Albourne Partners onto the hedge fund industry. Whereas Albourne Partners adopted a tough stance and told managers they would not recommend firms who failed to fill in OPERA, this does not appear to be the case with ILPA.

A number of investors said they expected managers to start filing these standardised fee disclosure reports within the next six months to two years. A handful of service providers including fund administrators and technology vendors are exploring how they can help private equity with this.

Nonetheless, the standardised nature of the report can be frustrating given that a one-size-fits-all template rarely fits well within an industry as diverse as private equity. Klaus Ruhne, partner at ATP Private Equity Partners, an institutional investor, said the ILPA report was forensic and could be quite time-consuming for smaller managers. Ruhne advocated the framers of the document should scale it down and simplify it.

A further challenge for private equity is that managers submit a significant amount of regulatory reports under the Dodd-Frank Act (Form PF, Forms ADV) and the Alternative Investment Fund Managers Directive [AIFMD] (Annex IV). Tax initiatives such as the US and UK variants of the Foreign Account Tax Compliance Act (FATCA) and the Organisation of Economic Co-operation and Development’s (OECD) Common Reporting Standard (CRS) and Base Erosion and Profit Shifting (BEPS) will also impact private equity. As such, there are question marks as to whether it is viable to add another report into the mix at a time when private equity is quite burdened with all of these regulations.

Fees have been a sensitive topic for investors. CALPERS, the Californian pension fund, has been particularly vocal in demanding how much carried interest its managers get paid. This has spurred local US state governments to force private equity to disclose this information. As such, some attendees believe ILPA’s intervention is a mechanism by which to stem off regulation.

The University of Oxford’s Said Business School produced research that found private equity extracted around $20 billion in hidden fees from clients. The Securities and Exchange Commission (SEC) is taking a tough stance too. In 2014, a senior examiner at the SEC said there were material weaknesses or law breaches in fee and expense allocations at approximately 50% of private equity managers reviewed by the regulator.

Inevitably, administrative sanctions have followed suit. Blackstone paid the SEC $39 million to settle claims it failed to notify clients about accelerated monitoring fees and discounts on legal fees its advisers had accrued. KKR settled for $17 million the SEC following accusations expenses from broken deals such as operational due diligence costs had been passed onto its clients’ funds but not to co-investment vehicles running KKR executives’ capital. Other managers including Lincolnshire Management and Clean Energy Capital have settled lower fines with the SEC over similar fee and expenses issues.

The issue over fees has prompted some large investors to co-invest with private equity or directly invest thereby bringing them into competition with their managers. Preqin found that nearly half of all private equity firms do not charge an annual management fee and almost the same number forego a performance fee on co-investments. As such, investors are increasingly exploring the concept of co-investing in this fee-conscious environment. Investing directly or co-investing can often have amplified returns.

However, the risks are higher. Private equity will have multiple investments whereas direct investing or co-investing can lead to concentration risk for the client. Furthermore, a number of private equity managers at the conference questioned the expertise of investors in this area. Nonetheless, direct investing and co-investing is the preserve of the largest institutional allocators such as sovereign wealth funds and major pension schemes.