The issue of transparency is a common thread that runs through nearly every governance topic on some level. The challenge generally is how to satisfy everyone’s need for the right information and how to get it to them at the right time for it to be of use. Financial experts, long-time investors, regulators and others have a multitude of thoughts and ideas on how to improve transparency.
Trial and error is one way to find solutions on how to improve transparency for investors. How well companies excel regarding transparency sometimes only comes to light after there’s been a crisis of some sort. That’s when companies feel the pressure to take the steps they should have taken all along. Major leaders in an industry are often proactive and take the lead in making improvements before issues reach a crisis point. Allianz SE, one of the largest investors in the world, is taking such a stand on the issue of improving transparency for investors, along with a coalition of others, and the force is growing.
Reporting Lacks Uniformity and Clarity
Investors complain that private equity firms have different ways of reporting fees, returns, values and assets. All companies use different terms and different metrics. To complicate things further, not all companies break out their fees.
It’s becoming more common for private equity firms to use bridge loans, which are also known as subscription lines, to pay for assets and boost returns. The extra fees add more debt to these already leveraged transactions. The difference in the returns isn’t always reflected on the disclosures.
There has been disagreement on reporting for many years, and it’s gotten to be a point of contention. Some companies blame investors for demanding specific data based on their own formulas. Private equity firms have some flexibility in how they value assets that they can hold for years.
The Abraaj Group provides us with an example in which differences in reporting valuations resulted in allegations of fraud by the U.S. Department of Justice. Six of the firm’s executives were charged with fraud and one of them pleaded guilty. Related to one of the investments, which was valued at 1.4 times the cost, TPG, a global private investment firm, valued the same company at 50% of that, according to sources who were close to the situation.
Allianz SE Leads the Charge to Standardize Private Equity Reporting
With an aim of reducing the risk of fraud and improving transparency, the German insurance company Allianz Capital Partners, which is part of Allianz SE, is a driving force behind the push to standardize how private equity firms report their performance and fees.
This is not the first attempt at a standardized reporting policy. The Institutional Limited Partners Association, with clients with over $2 trillion in private equity, devised a model for reporting fees and expenses in 2016, but it’s not widely used. The AltExchange Alliance was a coalition aimed at agreeing on reporting standards, but it folded even after gaining support from private equity giants in the field. Some firms believed that the AltExchange was gathering information for one of its founders, a software company called eFront. A spokesperson for eFront stated that AltExchange wasn’t a source of revenue for them and the firm wasn’t able to access data for its own purposes. Last year, BlackRock Inc. purchased eFront for $1.3 billion to expand into private markets.
Allianz Capital Partners manages over $35.8 billion in private equity investments. The unit is joining a coalition that’s pushing to create common reporting standards for all companies. Daniel Gregor, a board director at Allianz Capital Partners, supports the Adopting Data Standards Initiative, which was initiated by strategic advisor Lorelei Graye, who continues to round up more investors to support her initiative.
The goal of the program is to get private equity firms to accept the Adopting Data Standards Initiative as a standard way of showing fund performance. The coalition agrees that reporting disclosures must have more than “a degree of opaqueness” to stand up to criticism of the reports.
The Private Equity Industry Is a Fast-Growing One
The private equity industry is worth $4.1 trillion, and it remains one of the fastest-growing industries. In recent years, the private equity industry has exploded in size and complexity. Since the year 2000, private markets have increased by nine times, which is three times as fast as global public equities, bringing the total to $6.73 trillion. According to Preqin data, private markets also include infrastructure, private investments in property, debt and natural resources.
Typically, private equity firms charge an annual fee of 2% for 10-year funds and keep 20% of the profits. They can charge additional fees on top of that.
While private equity firms support improved transparency, they currently have the advantage of holding back some information, which gives them an edge on negotiations.
Digital governance software solutions may be the key to standardizing disclosures. Once the format has been either mandated or agreed on, boards could input the figures into a software program that would analyze and display the results in various graphs, charts and narratives. The benefit of digitization is that the reports would be highly secure and easily accessible.
Congress Supports Improvements in Transparency in Reporting
At the congressional level, Democratic senator and presidential candidate Elizabeth Warren proposed a comprehensive overhaul of private equity industry regulations. She favors standardizing disclosures.
In Pennsylvania, state politicians are working on legislation to require better disclosure from private equity to the Pennsylvania Public School Employees’ Retirement System and the Pennsylvania State Employees’ Retirement System, which has joint assets of around $90 billion.
Pennsylvania’s State Treasurer, Joe Torsella, says standardization would help prevent overstated figures that can be easily manipulated by metrics. Torsella acknowledges that reporting improved slightly after the 2008 financial crisis, but there is still substantial room for improvement. In the past, the Securities and Exchange Commission (SEC) has fined companies for failing to file disclosures.
As private equity continues to grow at a rapid pace, the support for creating a standardized report will certainly increase as well. Continued changes in the marketplace and the upcoming presidential election may also be factors in whether a standardized reporting format materializes.