Vol 10 (2013) - Issue 4

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The Regulation of Private Equity and the Alternative Investment Fund Managers Directive – Parts I and II

Introduction
This study critically examines the EU Alternative Investment Fund Managers Directive (AIFMD), which entered into force in July 2011 and awaits transposition into Member States’ law by July 2013. It assesses the important provisions of AIFMD with respect to the 'asset stripping' prohibition, the requirements for increased disclosure to portfolio companies and investors, a 'passport' system for authorised AIFM, remuneration guidelines, third party valuation and depositary requirements, and leverage constraints. In particular, it analyses the three main negative externalities potentially created by private equity, namely: (I) a lack of protection for employees of private equity portfolio companies, (II) an unequal balance of bargaining power between prospective investors and private equity funds and (III) the creation of systemic risk by the private equity fund structure and its use of leverage.
The discussion that follows is divided into three parts. Parts I and II will be the subject of the present article, and part III will follow in a separate article within this volume. In general, it will be submitted that, with the exception of issue II above, the provisions of the AIFMD do not in fact correspond proportionately to the risks posed by private equity. This suggests a significant degree of political impetus following the financial crisis, rather than genuine economic assessment. It will further be argued that the AIFMD is flawed in two major respects. Firstly, creating a vague class of 'alternative investment funds', rather than focusing on the functions and investment practices of these funds, severely undermines the task of properly addressing negative externalities. Secondly, the AIFMD does not offer a sufficiently global response to deal with risks posed by financial institutions in globally integrated markets. Insofar as the rest of the world does not follow the EU’s lead, the AIFMD may cost more than it is worth. Under this view, the EU faces an uphill struggle to implement Level 2 measures that fully address these concerns.

Private equity and AIFMD: the background
'Private equity' is equity raised by corporations privately, i.e. not on a public market. However, the term is usually used in reference to a more specific investment strategy pertaining to private equity funds, which shall be the focus of this paper.
Defining a 'private equity fund' presents difficulties due to the rapidly evolving nature of the financial services industry. Nevertheless, several essential characteristics may be identified for a working definition. A private equity fund is a closed-ended, illiquid investment fund that acquires, typically with a leveraged buyout, controlling stakes in unlisted companies (called portfolio companies). The fund manager, which is a management company called a private equity firm, aims to produce returns for its investors by making productivity and operating improvements in these portfolio companies. After a typical time frame of three to five years, the fund exits its position in the portfolio company via either: an initial public offering, a sale to another company or another private equity fund, or liquidation.