Top financial regulator Gary Gensler is advancing options his agency can take to introduce greater transparency and a level playing field in private markets.
Gensler, installed as chair of the Securities and Exchange Commission in April, laid out a potential agenda for action at the 2021 ILPA Summit, held last week.
As a premise to this, Gensler spoke about why private funds matter, noting the recent supersizing of private equity and hedge fund assets – to almost $9 trillion net, by his count. They also matter “because of what, or who, stands on either side of them,” meaning investors and businesses.
Because of their sheer size and economic impact, Gensler told the ILPA Summit it is time for the SEC to ask, “whether we’re meeting our mission with respect to this important slice of the capital markets.”
To address this question, Gensler said he has tasked regulatory staff with assessing, and preparing recommendations on, key issues of interest to general partners and limited partners alike.
Fees and side letters
They include the transparency of fees and expenses. Private funds, Gensler said, have “multiple levels of fees,” including management and performance fees, as well as portfolio company fees, that together amount to “hundreds of billions of dollars” per year. These fees perhaps do not include a host of others, such as those collected from LPs.
“I wonder whether limited partners have the consistent, comparable information they need to make informed investment decisions,” Gensler said. It is possible, he added, that more competition and disclosure of fees and expenses would “bring greater efficiencies.”
Another topic for SEC study is arrangements that allow GPs to determine which LPs “they’re letting in and on what terms,” Gensler said. He pointed to the use of side letters, which are in some cases benign but in others can involve the negotiation of preferred liquidity terms or disclosures. This may lead to similar investors paying different fees.
Regulatory staff will look at how side-letter provisions might benefit from increased transparency or whether certain varieties should be prohibited.
Return metrics and waivers
Further, Gensler wants the agency to scrutinize performance metrics and suggest ways for improving transparency. In contrast to mutual funds, about which there is plentiful knowledge and information, “basic facts about private funds” are not as readily available to the public, let alone LPs, he said.
An additional topic on the SEC’s list is the use of waivers by GPs to modify or reduce their fiduciary obligations. Done at the state level, this practice is inconsistent with federal fiduciary duty, Gensler said.
The SEC will for this reason investigate the need for prohibitions on certain types of practices. It will also explore options for mitigating conflicts of interest and strengthening “trust” in private markets.
Regulators have “learned a lot” about private funds since the 2010 Dodd-Frank Act registered many advisers, Gensler said. Much of this has come from Form PF and examinations and enforcement regimes.
As the final item on his potential agenda, Gensler said, “I think we can freshen up Form PF.” To support public oversight, SEC staff will look into opportunities for enhancing reporting and disclosure through this “important barometer of financial system resiliency” or “other reforms.”
Gensler’s overarching goal, he said, is to “bring more sunshine and competition to the private funds space.” If the SEC gets it right, the result could be “meaningful benefits to investors on the one hand and capital formation on the other.”
Once regulatory staff have done their work, recommendations will be submitted to SEC commissioners and then made available for public comment. In reply to a question from ILPA senior policy counsel Chris Hayes, Gensler declined to specify a timeline. “Stay tuned,” he said.