If it ain’t broke? What ASIC’s review means for private markets and deals

ASIC considers the risks associated with a lack of transparency in private markets on investor decision-making.

Valuation transparency

While the stability of valuations of private assets can be attractive to investors, the lack of transparency as to how these valuations are made may have the effect of reducing trust in valuations of private market assets. ASIC notes that valuations of private market assets may be made infrequently, based on inconsistent methodologies or expert opinion and can be subject to additional layers of complexity when it comes to assets which are not yet readily observable or those managed under multi-layered fund arrangements. Although potential investors will undertake due diligence, it may not be possible to verify information behind a valuation.

Performance information

ASIC also considers the risk of opacity in private markets where investors are reliant on fund managers for information about the performance of private capital funds, making performance more difficult to accurately assess and rely upon when compared to public market assets.

ASIC focuses on risks associated with the market integrity of private markets. Public confidence in market integrity is undermined any time conduct such as a leak or suspicious trading ahead of an announcement occurs. ASIC notes the risks to market integrity in private capital transactions without the regulatory scrutiny applied to public markets. ASIC is especially interested in how confidential information and conflicts of interest are handled in take-private transactions (including related-party transactions, misaligned incentives and treatment of confidential information) to identify suspicious trading.

ASIC considers the ‘substantially bigger appetite for leverage’ of private companies (including private capital funds embedding leverage into an investment structure and private credit funds engaging with highly leveraged borrowers) when compared to public companies and the inevitable vulnerability associated with a highly leveraged position, to be another key risk of private capital markets. There is an increased risk of these borrowers defaulting on debt, and in the event of a large-scale company collapse, ASIC has acknowledged the unprecedented potential effects considering the ‘interwoven tiers of private investment and leverage’. 

ASIC considers the illiquidity of private investments as compared to public investments to be another risk of the growth of private capital markets, as private market investments are long-term and investors are not able to quickly realise their investments, which ASIC considers to be a particular risk for investors in the event of governance failures.

Though retail investors have traditionally faced significant barriers to entry to private markets, ASIC notes that as private markets grow, so too does the accessibility and participation of retail investors in private markets, which they access through managed investment schemes or membership in an APRA-regulated superannuation fund that has exposure to private assets.

ASIC considers the question of whether retail investors are sufficiently protected by current financial services laws against the risks associated with private assets outlined above, with the possibility that ASIC may introduce further reforms considering the increasing amount of large super funds’ portfolios that are made up of private investments.

Although the purpose of the Discussion Paper is to commence the process of review and pose questions rather than outline proposed reforms, certain features ASIC considered in a positive light in the context of public markets can provide insight into potential reform for private capital markets, including additional disclosure and transparency in respect of fees, valuation processes and performance, conflicts of interest and leverage and liquidity risks. Such changes would be entirely consistent with the Australian financial services regulatory landscape. In that regard, the Discussion Paper may foreshadow an ASIC programme of testing the themes raised with the approaches taken with private capital players. Such an approach has been adopted in other sectors, including by compulsory means (such as requiring the production of documents and interviewing key personnel), albeit we would question the applicability of a broad approach here given the wide variety of private capital interests.

Ultimately, any private market regulatory reform should be introduced as a means to achieving specific end goals, rather than simply because certain existing practices or rules are different to those in public markets. In particular, any reforms to increase transparency in private markets should be justified on the basis of addressing specific current risks which are problematic, rather than transparency for transparency’s sake.

There are also features of our law which already apply to private investments and deals that ASIC could turn its focus up on. For example, insider dealing and misleading or deceptive conduct laws do not just apply to listed investments and with the growing Venture Capital and Private Equity markets as well as significant M&A processes, market participants would be well advised to tailor their processes with this in mind. Further, in the long term, the Discussion Paper signals potential interest from ASIC, which has the potential to raise ASIC's expectations of conduct, for example in relation to expectations on (private company) directors in the performance of their duties. However, we would question simply assimilating the standards expected of directors of public companies with those of private companies given the variety of interests which those companies can have.

ASIC acknowledges that private markets and public markets are subject to different regulatory standards for a reason, being that participants in private markets are more sophisticated and able to protect their own interests when compared to those with access to public markets. Importantly, retail investors only access private markets through advised or other regulated channels. It is vital that this context remain front and centre in ASIC’s ongoing assessment of private and public markets.  

We would suggest that private companies, their directors and all investors in private capital markets, particularly fund managers, evaluate the state of their compliance with existing regulations in light of ASIC’s increasing focus on private market transactions and investments.

We can also glean insight into potential changes in the Australian landscape based on the examples ASIC provided of measures underway in certain overseas jurisdictions highlighted in the Discussion Paper (United States, United Kingdom, European Union, Canada, New Zealand, Hong Kong and Singapore). Certain measures below may not be applicable to Australia, though it seems likely that ASIC will follow in the footsteps of its overseas counterparts to achieve the effect of reducing the divide between public and private markets in Australia.  

ASIC provides examples of overseas jurisdictions taking steps to increase transparency and oversight of, and access to, private markets.