On the road to transparency

The publishing of Sir David Walker's initial recommendations regarding transparency and disclosure in the industry prompted predictable screams of 'whitewash' from the unions, elements of the press and the political class. Within the industry, the reaction was measured, with most firms proclaiming to be broadly supportive of the proposals. However, the report includes proposals that will make some buyout houses uncomfortable.

It recommends that companies that are valued in excess of £500m; were acquired for an equity consideration of more than £300m; employ more than 1,000 staff; or were formerly a FTSE 250-listed company should fall into a greater disclosure bracket. Companies falling within this bracket will have to file an annual report within four months of the year-end, as opposed to the nine months currently required. Walker also proposes that GPs publish an annual review in which they are to give a broad indication of the performance record of their funds, with an attribution analysis identifying how value was created within each portfolio company. In an effort to stem the tide of criticism, some GPs are preparing to go beyond the recommended disclosure thresholds. "Although only two of our current portfolio companies are caught by the enhanced reporting recommendations, we will run it through all 12," says Buchan Scott of Duke Street Capital. "Keeping track of value creation is a valuable metric. GPs do it, we certainly do and will be discussing with management the most effective way to utilise our data," Scott adds.

To the argument that greater transparency will corrode the competitive advantage private equity holds over the public market, Scott gives short shrift: "Privacy hasn't contributed to our success. In the public markets, quarterly reporting is not the issue. The problem is how people react to these reports." This is a persuasive argument. The illiquid nature of private equity does not afford investors the luxury of adjusting asset allocations in the event of a downbeat performance report. GPs have more reason to worry if opening the books reveals a direct correlation between debt levels and success. Scott believes that: "if firms have generated returns through an over-reliance on leverage, they would not want to disclose it".

Much was made of Walker's recommendation that outside directors, as opposed to non-executive directors, be appointed to the boards of portfolio companies where appropriate. The report flip-flops somewhat on the issue, insisting that 'box-ticking' compliance would be unhelpful, while at the same time outlining the benefits of recruiting an external figure to the board. The weight afforded to the importance of outside directors is, as one buyout manager notes, slightly behind the curve: "I was under the impression we all did this anyway".

Whereas many of the proposals may prompt mere discomfort and frustration, the one area of the report with the potential to have a physical impact the activities of a GP is the reduced end-of-year reporting recommendation. "If a business is going through a rescue refinancing, the auditors may find it difficult to sign off the accounts within four months. If the business cannot be signed off as a going concern, everyone may suffer," observes Martin Winter of Taylor Wessing. Faced with such a scenario, "it is possible that short-term decisions may be forced upon a company", says Winter. The strength of private equity lies in its ability to take decisions without recourse to short-term thinking. Arbitrarily modifying reporting procedures may, in some cases, interfere with this ability and damage a highly successful model.

Alongside greater transparency at the portfolio company level, many within the industry understand the imperative of a broader education offensive. The BVCA has an important part to play in this process, but must first ensure it is fit for purpose. Walker himself recognised this, remarking that the industry body "needs to up its game". Others are of a similar opinion. "The BVCA faces significant issues. It will need to restructure and start charging proper fees if it wants to represent the whole gamut of interests," says Scott. The BVCA appreciates this, confirming recently that an internal review is taking place. "The structure we have now is not precious. We will change it if it makes our organisation more effective and efficient," insists a BVCA spokesman. An easy target it may be, but it is wrong to point the finger in only one direction. As Winter points out, the industry body is, after all, "a creature of its members. It is an issue of collective responsibility." It has been suggested that greater resource is needed to commission reports and disseminate data in order to tell the private equity story. Some have advocated charging the biggest private equity houses higher fees. However, like any organisation, there is a hierarchy with those at the top dictating the course. "The BVCA doesn't lead the industry, but is a reflection of what the large buyout groups want. Partly it acts to retain its biggest members. If it wants to initiate any big changes, it first has to get agreement from the largest players," says one mid-market player. In effect, any change to the fee structure would need to be instigated by the largest buyout firms.

Walker's task was not an easy one. The poisonous environment in which the debate concerning private equity has thus far been conducted has raised expectations to a level that this report could never have satisfied. On remuneration and the tax treatment of carried interest, a satisfactory outcome seems impossible. Although Walker reiterated on a number of occasions that these issues were outside the scope of the report, an argument could certainly have been made for bringing them within its remit. It seems legitimate to question whether the rewards claimed by partners in the largest funds are commensurate with the risks being taken. Although most observers would recognise that the market operates in a way that precludes the possibility of this question being answered in a way that satisfies everyone, it seems reasonable to ask whether this is reason enough to avoid the issue.

Something of a waiting game now ensues before we see how these recommendations are adopted. With no monitoring mechanism in place, the report names unions, politicians and journalists the watch-guards of this new frontier. However, with private equity firms the ultimate arbiters of communication, difficulties may lie in store. The report states that, 'private equity firms will be expected to be more accessible to specific enquiries from the media'. This is open to wide interpretation. The media are always quick to assume their right to information trumps all. With these guidelines now in writing, there will be an even greater presumption of openness and many will expect to command a greater level of access. Should this fail to materialise and with no authority to turn to, the Walker report would be in danger of becoming a lame duck.

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