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Private equity takes to standardization

Standardizing private equity against all odds

Private equity is generally considered a diverse sector given the wide range of investments, which feature unique characteristics, supported by distinct operational processes and fund structures across managers. Similarly, institutional investors have distinct priorities and individual requirements, which general partners (GPs) have to take into consideration. Nonetheless, these varying characteristics and approaches have not deterred the over USD 3 trillion1 industry from trying to standardize core operational activities, most notably fee reporting and limited partner (LP) agreements.

Finding a way to standardize private equity fees

Key insights

  • The surplus of standardization initiatives and assurances from private equity managers that they already provide clients with information about costs has impacted widespread adoption of the ILPA fee template
  • ILPA efforts to streamline LPAs are welcome, but may not be sufficient to accommodate the needs of the diverse private equity industry
  • Some private equity firms, despite the challenges facing ILPA, believe areas such as valuation and client onboarding could also be improved through standardization initiatives

One of the primary architects of standardization has been the Institutional Limited Partners Association (ILPA), an industry body that designed and developed a private equity fee reporting template in conjunction with more than 50 LPs and 25 GPs globally.2 The resulting template seeks to inject more transparency into how private equity firms disclose their costs to clients,3 an issue that has come under greater scrutiny.4 That a number of managers settled SEC charges linked to incongruous fee allocations has also heightened investor focus on the need for cost transparency.

“The ILPA template has been a great effort to provide LPs with more detailed information about private equity costs and charges, allowing them to assess and benchmark managers. GPs are targeting the same institutional clients, and they commonly seek to achieve the goal of greater transparency from the industry," said Priya Nair, Global Head of Product Management, Private Capital Services at RBC Investor & Treasury Services. Nonetheless, adoption of the template is not yet widespread,5 perhaps owing to a focus on aggregate returns over standardization opportunities.

Fee standardization stalemate

While many private equity firms are supportive of the ILPA's underlying principles and the need for standardization to an extent, they point out that managers already share detailed information about costs with clients. Managers also argue that many investors have specific reporting needs driven by demands from their own LPs or regulators, making standardization impractical in certain circumstances.

“The ILPA template has been a great effort to provide LPs with more detailed information about private equity costs and charges, allowing them to assess and benchmark managers”

The limited adoption of the ILPA's template may be the result of the abundance of standardization initiatives elsewhere. Invest Europe has been producing comprehensive reporting guidelines for private equity since 2000,6 which many GPs incorporate, so they are reticent about assimilating the ILPA's template into existing disclosures. Meanwhile, the UK's Financial Conduct Authority (FCA) is inviting asset managers, including private equity, to sign up to its voluntary cost disclosure regime proposed by the Institutional Disclosure Working Group.7 Some UK managers may consider sidestepping the ILPA's template if its contents are duplicated in the FCA's new reporting framework, which is expected to launch later in 2018.

The standardization does not stop with fees

Private equity managers regularly comment about the legal and administrative costs associated with Limited Partner Agreements (LPAs), documents which have steadily expanded as a result of new regulatory and tax obligations introduced by rules such as AIFMD and FATCA.8 In response, the ILPA is developing a model LPA along with a number of international law firms in what it hopes will help standardize fund documentation even further.9 The ILPA's LPA standardization endeavour has received a number of GP endorsements, but there is some skepticism about its chances of success, despite the sound intentions.

Efforts to expedite and standardize client onboarding through the rationalization of AML and KYC processes is another area of potential focus

Law firm MJ Hudson notes that, “A model LPA would have to be suitable for use by first-time domestic small-cap funds, multi-billion-dollar international mega funds, and everyone else in between. While it may make a serviceable starting point for a new fund manager, well-established GPs that have raised a number of funds may well be reluctant to junk their intensively negotiated, long-trusted suite of documents. There is also the added cost and effort of managing legacy funds and successor funds side-by- side when they are operating on quite different documentation."10 Juggling the competing interests of multiple institutional clients in a model LPA is also not without challenges.11

Future targets for standardization

Standardization initiatives in private equity to date have delivered mixed results, but some managers at the Super Return CFO/COO conference were vocal advocates of the need for more harmonization of industry practices. One private equity firm said that while guidelines for valuation processes had been created, such as the International Private Equity and Venture Capital Valuation Guidelines, managers valuing the same assets often reached wildly different or conflicting pricing conclusions, an issue that could be remedied through further standardization. Nonetheless, valuing investments is highly subjective, making it very difficult to systematize.

Efforts to expedite and standardize client onboarding through the rationalization of anti-money laundering (AML) and know your customer (KYC) processes is another area of potential focus. Compliance departments at private equity firms frequently engage with high volumes of documentation during AML and KYC checks, while institutional investors in some markets question the need for sharing of personal or sensitive information. Enhanced AML and KYC standardization would accelerate onboarding and potentially make these mandatory checks less invasive for clients and more cost effective for fund managers.

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  1. Preqin (July 24, 2018) Private Equity Industry Grows to More Than $3tn in Assets
  2. Institutional Limited Partners Association (January 2016) Fee Reporting Template: Suggested Guidance
  3. Ibid.
  4. Financial Times (August 6, 2018) Private equity fees and returns face scrutiny
  5. Ibid.
  6. Invest Europe (2018) Investor Reporting
  7. IPE (July 5, 2018) UK regulator backs voluntary cost disclosure templates
  8. MJ Hudson (April 2018) Will Private Equity Benefit from Standardised Documents? 
  9. Ibid.
  10. Ibid.
  11. Ibid.