The Financial Services Authority has highlighted the dangers that private equity companies pose to the market.
Around two years ago private equity companies spent around £100b buying up assets around the world. But today, it is estimated that over two thousand private equity companies have raised around £300b to fund their continuing spending spree. What's more, since private equity firms like to supplement every pound of investor money with another £4 of debt, they may have over a trillion pounds waiting to unleash on global markets.
The size of private equity companies' wallets has now grown to such an extent that it is causing brows to furrow at the Financial Services Authority (FSA). In particular the securities regulator said the default of a large private equity company or cluster of smaller private equity firms seems inevitable. Consequently, it is worried about the negative implication that this could have on orderly markets. What's more, the FSA said in extreme circumstances this might impact the financial stability of the UK's markets.
So in response to the flurry of private equity activity, the FSA has published plans to increase scrutiny of the industry. One key risk that the regulator has identified is the excessive amount of credit that lenders are willing to extend on private equity transactions. Another area of concern is how owners will react in a crisis. In this regard the FSA is concerned about the use of opaque and complicated risk transfer practices.
The FSA also highlighted concerns about the substantial inflow of capital into private equity funds at the expense of other parts of the market. Additionally, it is worried about the increasing number of companies with growth potential that are being taken private -- it said that when these companies do eventually reach the public market, their growth potential may already have been fully exploited. Other areas of concern include conflicts of interest and situations when a significant flow of price-sensitive information in relation to private equity transactions may create considerable potential for market abuse.
In my view it is right that the FSA has highlighted certain areas of concern. However, the regulator needs to tread carefully to avoid over-regulating an industry that has served the market well. Private equity firms play an important role in enhancing market efficiency by targeting undervalued companies. Just ask any shareholder in restaurants group, Gondola Holdings, or investors in some of the UK ports who have been banging on about the undervaluation of their investments. That is, they were undervalued until private equity firms decided that the assets were undervalued, too!
> Beware The Buyout Bubble | Private Equity For Private Investors
