Key trends impacting the private equity industry

Some local private equity professionals say Luxembourg’s anti-money-laundering rules are stricter than EU requirements. Illustrative image: Markus Spiske/Unsplash

Some local private equity professionals say Luxembourg’s anti-money-laundering rules are stricter than EU requirements. Illustrative image: Markus Spiske/Unsplash

Private equity outfits are facing a host of market and regulatory pressures that require changes to their strategies and operations. These range from the global clampdown on tax avoidance to investors’ evolving liquidity expectations. Here is a primer on four of the top challenges.

1. More liquidity

Increasingly, European investors can turn to the secondary market to manage the length of their private equity investments. Funds generally have a 10- to 15-year lifecycle, and traditionally investors found it difficult to exit even if they had identified a buyer and had approval for sale from other stakeholders. This is changing, with fund general partners increasingly willing to take the relatively straightforward steps to allow exits. Conversely, but in a similar vein, funds are seeking ways to smoothly extend their commitments to underlying investments beyond the traditional two to five years. This gives greater comfort to the companies and reduces fundraising, underwriting and administration costs.

2. AML level playing field

According to some PE players, Luxembourg’s anti-money-laundering and counter-terrorism-financing rules are particularly onerous and sometimes go well beyond global minimum requirements. Probably local law makers and regulators fear headlines linking the grand duchy with financial crime. Hence the hope that plans to beef up EU AML/CFT rules could level the playing field across Europe. Harmonised rules could put Luxembourg at less of a disadvantage as a jurisdiction and simplify doing business cross-border.

3. Tax changes

Global anti-tax avoidance rules are adding complications to how cross-border PE funds are structured. These standards have been translated into EU law via two anti-tax avoidance directives, ATAD 1 and ATAD 2, and despite PE funds not being in the business of shifting profits for tax purposes, many have been snagged. Hence increased structuring sophistication is often now required, with options to ensure that different investorswith different tax profiles can be dealt with in parallel, with costs only falling on those directly affected. Separate vehicles might need to be created or feeder fund relationships established. This might increase costs and reduce certain flexibilities but would ultimately ensure investments are tax neutral as well as being transparent to the authorities.

4. Three taxonomies

PE funds are still adapting to the needs of the sustainable finance disclosure regulation introduced in March, not least due to the long-term illiquid nature of these investments. Measuring the ESG profile of these private assets requires particular care and effort. The draft green investing taxonomy was published in July, and this is giving fund managers a steer towards the shape of the final document set for publication in November. Final rules are set to be implemented in mid-2022. This structure and standardisation are generally welcomed by the industry, giving them pointers on how to take sensitive decisions. Then the industry will have to manage the social taxonomy and a further “brown” taxonomy related to move towards net-zero carbon emissions.

Originally published in Delano’s Private Equity 2021 supplement. Be among the first to read print edition interviews and features by subscribing today.