In the dog house

by Krystal Scanlon 3 May 2022

Private equity practitioners often bemoan the overly burdensome requirements put on them by regulators. But few would deny that financial markets must be well governed and kept safe. However, recent grumblings suggest key European financial authorities fail to truly understand alternative assets.

When it comes to which regulators have really gotten to grips with the industry, private equity’s relationship with the wider economy plays a major role. The UK highlights this well. “The FCA didn’t understand PE and PE didn’t understand what the FCA wanted. There's been ignorance on both sides,” says a London-based financial services compliance professional.

However, when it comes to jurisdictions where private equity is a dominant asset class and a key part of the overall economy, levels of understanding are much higher. According to a general counsel of a large-cap European GP, Luxembourg’s CSSF and Jersey’s JFSC have demonstrated a clear understanding. “Those regulators are much more focused and specialised around PE and much easier to deal with because it’s part of their overall business model. It becomes more tricky with regulators in jurisdictions where PE isn’t the main focus.”

Regardless of a regulator’s understanding of any industry, a financial authority’s core purpose is to implement and enforce regulation that has been handed down from governments or governing bodies. Following the 2008 downturn, huge swathes of protections were swiftly put in place. For some, the post-crash rules were not only rushed, many weren’t written with private equity in mind. “Many target UCITS and hedge funds,” says the European GC. “PE gets lumped in with them, but no one knows how we should apply it.”

According to Adrian Whelan, head of market intelligence group at Brown Brothers Harriman, given private equity’s size in relation to other asset classes, it would be almost impossible to have specific industry rules. “While I appreciate the burden this creates on smaller managers, do these GPs want a discreet regulation just for them, or would they prefer  commonality covering all asset classes? You either have to live with principle-based, broad  regulation, which suits many managers working across multi-asset classes, or you have  incredibly specific, tactical regulation. The latter results in huge regulatory fragmentation  across borders and products.”

Teaching old dogs

Another major factor in a financial regulator’s ability to enforce rules is its talent base.  According to one GP, the CSSF is considered an attractive employer. “It attracts good people to roles, pays market salaries and is believed to be a good place to work.”

In the UK, the FCA recently announced it hired 95 new staff to its authorisations team  “While this is good news, why did the UK regulator lose almost 100 people in the last 18 months?,” questions the London-based compliance professional. “The FCA is chronically understaffed, under-resourced and lacks retainment.”

Part of the FCA’s problem appears to be the narrow focus of its employees. “The FCA doesn’t seem to have invested time and energy into developing their employees or giving them  opportunities to broaden their experience. For example, one person who might work in X authorisations team - they only know about one type of firm and they’re focused on a single element of the authorisation process,” explains Abi Reilly, practice lead, funds at financial services regulatory consultancy Bovill.

This also explains wide variations in the quality of FCA case officers. “Some are great, really understand PE and know what they’re doing,” Reilly adds. “Others haven’t had training and it’s painful to try and explain how a firm operates in general, let alone in PE.”

While criticisms are easy to make, it’s important to note the recent pace of change taking place across the private equity industry, including ESG, digitisation, cyber, and the advent of crypto. Such rapid changes require new skill sets. “Our entire industry is currently working through some innovation challenges. Regulators aren’t immune to these changes, they’re muddling through the same challenges too,” says Whelan.

Dog eat dog world

Another key difference between regulators is their approach. According to Stephen Branagan, head of Ireland & global head of operations at Pantheon, we’re seeing the emergence of risk-based regulation across private assets. “The SEC, for example, is currently reviewing its regulatory requirements in an open consultation with the industry. These focus on transparency of fees, costs and so on.”

Our entire industry is currently working through some innovation challenges. Regulators aren't immune to these changes, they're muddling through the same challenges too.

In Jersey, the focus is on the service provider, rather than the manager. “It primarily relies on us fund administrators to have done our due diligence, but it also relies on LPs to be professional enough to withstand any losses, should they lose capital. It’s that attitude of ‘big boys can take care of themselves’,” says Aidan O’Flanagan, head of funds at Highvern who previously worked at JFSC. “It’s only if red flags appear that JFSC will intervene and ask questions.”

Luxembourg’s CSSF’s regulatory method is regarded as the most burdensome. According to Branagan, every complex element to do with any fund passes through the regulator. “The manager, the funds themselves, the GP, the board and ultimate beneficial owners. It’s a very rigorous process.”

“It can be painful,” notes the European GC, who believes increasing pressure from the EU might be driving CSSF’s stricter approach. “It’s a case of CSSF learning to balance servicing a business and a supervisor monitoring a business,” he adds.

Similarly, Ireland, which approved its new ILP fund structure in 2020, is also seen as a strict regulator. I know of a few people who considered Ireland but were turned off by the Central Bank because it isn’t easy to deal with,” comments O’Flanagan. “It’s all up in the air until we see how this new ILP plays out, to gauge the lay of the land there.”


One commonality across financial watchdogs is high levels of manual processes. Given a  large majority of PE funds are domiciled in Luxembourg, the European GC believes it would be in everyone’s best interest to make processes smoother. “Currently the CSSF’s processes are very burdensome,” he notes In contrast, Whelan points out that many PE houses still use paper-based processes. As such, he doesn’t think it’s fair to criticise regulators for relying on manual processes. “How can anyone criticise any regulator for being in the same situation?,” he questions. “Of course ESMA and other regulators are looking to digitise. They’re looking to use more data-led supervision rather than qualitative, particularly for AIFMD and UCITS reporting.”

Another recurring complaint is the ever-increasing timeframes for authorisation processes, particularly with the FCA. According to Reilly, it can take up to 12 weeks in some instances simply to secure a case officer. Similarly, the London-based compliance professional says clients often receive ‘Application incomplete’ notifications, despite filling in all applicable information. “The problem is, the clock doesn’t start until it’s complete. I wish they'd admit they don’t have anyone senior to review applications yet but will be in touch when they do.”

This notion feeds into underlying concerns around available resources in the FCA's   authorisations team. One fund administrator that applied for its UK licence in 2021  expressed the FCA had continually delayed their application. It wasn’t until the end of the process that the team discovered there was a lack of personnel in the FCA’s authorisations department.

On the contrary, JFSC is renowned for its speed and efficiency. O'Flanagan says funds usually receive authorisation within 48 hours, sometimes within the same day. “JFSC can push things through quickly because most work is done at the service providers. It’s the complete opposite of the likes of CSSF, where everything must pass through the regulator.”

While the general consensus is that CSSF tends to be slower than most, Branagan believes this is due to the regulator struggling to keep ahead of Luxembourg’s rapid growth. “There is a perception the regulatory approval process is less transparent than other jurisdictions, or at least less predictable,” he says. “By comparison, it’s relatively simpler and quicker to set up US vehicles because all regulation is focused on the manager.”

All bark no bite

While no one wants a heavy handed regulator, the London-based compliance professional  believes the FCA needs to step up its game in handling market abuse. Only two years ago,  the FCA was under investigation over its supervision and regulation of investment firm, London Capital & Finance (LCF), before the business collapsed. A report conducted by former judge of the court of appeal, Dame Elizabeth Gloster, found the FCA had failed to effectively supervise and regulate LCF.

“The FCA has a horrendous track record for actually fining individuals and getting to the bottom of issues. It doesn’t have the same aggressive enforcement approach the SEC takes to stop bad practice. It doesn’t seem to have teeth to go after firms.”

That said, the FCA’s Market Watch 68 states: “Where we have not published Enforcement action on particular failings, firms should not assume we will not take appropriate  Enforcement action.

The London-based compliance professional believes this indicates the FCA is going after  firms, but somewhere along the way both parties come to an agreement to keep the  investigation out of the public eye. “Market abuse should be made public,” she adds. "It  would shake up the industry and give everyone more faith in the FCA.”

Dog and bone

How financial watchdogs communicate has declined over the past decade. The London-based compliance professional highlights a particular instance in 2018-19. Numerous PE clients called her in a panic because the FCA had contacted them and needed support in how to respond. “When we got to the bottom of it, the FCA had formed a new team who were trying to understand PE. These were knowledge gathering calls. But interaction is so rare, everyone panicked.”

Reilly agrees the UK watchdog has become increasingly reluctant to have any in-principle discussions with the market, and seemingly prefers firms to simply submit applications, regardless of how inefficient this feels. “They just won’t do it anymore,” she adds.

However, ongoing dialogues aren’t part of the FCA’s remit. “FCA reps rarely turn up to BVCA conferences and AIMA doesn’t have as much contact as it should have. Trade bodies should have more access to senior FCA strategists, but it just doesn’t happen,” explains the London-based compliance professional.

Comparing this to CSSF’s communication levels, the European GC notes the arduous process of CSSF approvals. The GP had some meetings as preferred by the regulator, and CSSF was surprisingly open. “But after those meetings it reverted to us doing most of the work ourselves, as you see with most regulators.”

Another London-based compliance professional agrees CSSF is rather restrictive, with a general lack of willingness or discomfort to speak with managers. “I’m not sure if it’s a language barrier, or because they don’t know the answer, but we’re always pushed back to the website because ‘everything you need to know is online’, and that’s it.”

But an arm’s length approach could be intentional. A lack of initial guidance when it comes to new rules forces regulated firms to adopt a belt and braces approach. “We want to comply but without guidance we’re forced to take an overly cautious interpretation so we don’t get into trouble,” says the European GC. “It appears they don’t want to be seen out there handholding and telling us what to do, or giving any opinion.”

A lack of understanding, staffing issues, manual and time consuming processes as well as poor communication are clearly common gripes the industry has with the way in which  regulators operate. But these are simply operational complaints, rather than the actual  effectiveness of a regulator’s ability to keep the market and investors safe.

By and large, regulators have kept private equity in check. That said, there have been  anomalies, which raises questions about their effectiveness, such as the London Capital  failings saga and the Wirecard scandal where Germany’s BaFIN was taken to court despite   the case being subsequently dismissed.

Clearly, there are improvements to be made and new ways of working that could bring about more harmony between regulators and the market participants they seek to govern. But as noted, private equity is a dynamic and fast moving industry, with more capital and investors piling in by the day. It is no easy task to keep a growing market safe, however, better interactions between regulators and managers could go a long way in improving life for both parties.

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The Drawdown reached out to the FCA, Central Bank of Ireland, CSSF and JFSC. Of those, the CSSF had this to say:

“CSSF is always accessible. The industry appreciates that it can exchange with us in many working languages. We regularly receive positive feedback on these two dimensions.

We regularly and proactively publish our views and expectations towards the market. Our mission is to give industry guidance and ensure supervised entities respect legislation. In the event of non-compliance, we are not in a position to go into the details of a procedure, as the confidentiality of the investigation is required.

We are aware of the challenge of digitisation and increased demands for time to market and transparency. We have been developing a strategy of interactive portals to facilitate exchanges with the industry for a number of years.”

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