Anna Coutts-Donald in London, and Joost Knabben and Jervis Smith in Luxembourg, weigh the findings of Vistra's recent private equity study against the broader European state of play
When examining the lie of the land in private equity (PE) in Europe over the last 12 months, there has been one dominant story – Brexit. This is hardly unexpected, as the UK's slow and tortuous (and as-yet-unfinalised) exit from the EU has actually loomed large over the bloc's political and economic landscape since 2016.
As such, it came as no surprise that in our recent research study, 'Private Equity: Where Challenges Meet Opportunities', the impact of Brexit was identified by 35% of respondents as one of the top trends shaping the PE industry.
Across Vistra's European offices, we have seen how every single PE manager has had to have a Brexit strategy in place, irrespective of the size of their fund. And the big 'winner' as a result has been Luxembourg.
Following the UK's Brexit referendum, Luxembourg was quick to market with both its Reserved Alternative Investment Fund (RAIF) and the Special Limited Partnership (SLP). The latter was effectively a 'copy and paste' of the UK limited partnership – so a lot of managers, when confronted with Brexit, opted for the Luxembourg SLP because of its familiarity and the solution it offered.
We estimate that around 90% of managers have placed business through Lux in recent years, either by fully setting up their own shop with appropriate levels of substance, or in a more hybrid formula – collaborating with service providers for both the administration of their funds and SPVs, as well as appointing an AIFM (ManCo) offered by third parties such as Vistra.
By the time of the UK's General Election in December 2019 and the subsequent agreement of the Conservative government's Brexit deal that saw the country leave the EU at the end of January 2020, the impact of Brexit in the PE space had largely played itself out. Indeed, since then, we've seen little difference across our offices, because managers and investors were prepared for it to happen. There were very few sitting on the fence.
The bigger picture
To a degree, it's been difficult to completely separate the 'Brexit Effect' from other factors that have been driving PE across Europe. The data does show, however, that PE has continued to be attractive as an alternative asset class. Figures from Private Equity International indicate that fundraising for Europe-dedicated funds in 2019 stood at $62.6bn against $59.8bn in 2016.
That said, while a number of mega-funds have managed to close – such as the €11bn Permira VII in October last year – smaller funds have found the markets more challenging. In the last 12-24 months, these funds have been harder to get off the ground. Yet this can't be attributed solely to Brexit.
The swathes of legislation that have been introduced in areas such as anti-money laundering and Know Your Customer (KYC), along with regulation such as the Alternative Investment Fund Managers Directive (AIFMD), have significantly increased the compliance burden. As a result of these changes, the cost of setting up a fund is considerably higher than before.
While the broader economic landscape in general and regulation in particular are having an impact on fund managers globally, adding Brexit into the mix heightens concerns, as we discovered in our research study. While an average 59% of respondents felt that current trends in PE are making investors more cautious, that figure rose to 70% for those in Europe.
It's arguably why the bigger managers have attracted investors whereas smaller managers and spin-offs have struggled – investors want certainty. This wariness may also be leading to record levels of dry powder in the global PE market, which Preqin estimated at $2.44trn at H2 2019.
As a result of this generally cautious environment, LPs are being far more rigorous and have higher expectations when it comes to due diligence and transparency. That not only extends to the fund itself but to the third parties any GP might be working with. Considering that 84% of LPs in our study said they want their GP to outsource, and 67% say they are keen to influence the decision of which provider to use, a heightened level of scrutiny is, perhaps, to be expected.
Indeed, it is becoming increasingly commonplace for LPs to want to see the credentials, policies and procedures, and financial stability of their partners, such as Vistra, in order to have a certain piece of mind. And as investors become more sophisticated and the appetite for outsourcing grows, this is only likely to continue.
It's in Europe that outsourcing appears to have the most mature market. While an average of 72% of GPs surveyed in our study currently outsource one or more functions to a third-party service provider, for Europe that figure was 82%. This happens across a range of services, such as tax compliance, SPV accounting, and registrar and transfer agency.
There are many reasons why GPs outsource – some simply prefer working with a service provider because they are able to share best practice when dealing with all the changes in the tax and regulatory framework. And on a more basic level, GPs just want to get on with fundraising, deal-making and keeping investors happy rather than preparing accounts and complying with regulatory reporting. If they have to run a hefty back office team then it eats into returns.
What's more, it's our experience that the highly regulated and competitive marketplace in Europe makes finding the right people to work for you more difficult, especially for smaller managers. We also regularly hear that there aren't enough compliance people – they are far more in demand nowadays and this causes a talent shortage in some jurisdictions.
However, given that the COO/CRO and associated Heads of Compliance now form part of the boards of these funds, compliance is very much seen as a valued role and equally as important as the deal teams.
The technological imperative
Alongside people, it's also in technology where outsourcing can deliver real results (as well as often-required cost reductions). Indeed, in our study, access to technology was rated the highest area where outsourcing has been positive or very positive, with 73% of respondents saying that is the case.
Demands for data – especially around portfolio performance – are becoming more complex, with investors and managers wanting that data at their fingertips in a preferred format, sliced in a way that they require. Yet, except for perhaps the largest managers, few GPs will be able to invest in their own technological platform. Conversely, others may well buy a product only to find it doesn't do quite what they want it to do.
A solution, however, is being found in a shift towards platforms and dashboards that enable easy access, in a secure manner, to the data required, but which are provided by a third-party that continuously adapts, modifies and improves the technology.
At Vistra, we developed the VFunds platform to address this very issue. By holding data at the most granular level, fund managers can log in, run a report, review the date in a dashboard and slice and dice it as needed for the different recipients, be that investors or regulators.
Likewise, Global Compliance, which is part of our cloud-based OverseasConnect platform, give clients complete control over and insight into their global operations. It allows users to keep track of regulatory deadlines and compliance obligations. This is particularly critical when operating on a global basis or across multiple European countries, involving different timezones, languages and currencies, and where those obligations are constantly changing.
While it would be easy to focus on the uncertainty around Brexit and a seemingly widening gap between the larger and smaller managers, Europe continues to be a key PE market and one in which we are proud to operate.
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