Private equity financing in the UK regulatory spotlight

With speeches two days in a row on the subject of the risks associated with lending to private equity, those regulated by the PRA can be in no doubt that this issue is gaining more prominence on the Bank of England's hot topic list.  That greater scrutiny may in turn impact the availability of lending from PRA regulated firms to private equity, although comments made by the FCA's CEO to the FT last week, caution against a rush to regulate.

So what are the immediate takeaways from these speeches?

While Nathanaël Benjamin's^[1] speech addressed the 'macro-financial vulnerabilities' of private equity funding and Rebecca Jackson^[2] was focused on firms' risk management, the underlying issue raised by both was interconnectivity of the private equity market and a perceived lack of transparency of that interconnectivity.  Mr Benjamin talked about an 'increasingly complex and interconnected' environment where 'banks find themselves exposed to various parts of the private equity ecosystem' while, in her speech, Ms Jackson describes 'a Cambrian explosion in the variety and complexity of financing products that banks now provide to the private equity industry'.

Ms Jackson was reporting on the findings of a thematic review undertaken by the PRA as a result of 'the scale, breadth, complexity, and interconnectedness of banks’ private equity related exposures'. The headline finding from that review is that only a very small number of banks can consistently aggregate data in a manner that, in the PRA's view, is appropriate to their exposures to the private equity sector.

As a result, the PRA have sent a 'Dear CRO letter' to the banks which had been part of the thematic work (which Ms Jackson described as a 'large cross section of major UK and international banks that have material aggregate exposures to the [private equity] sector').  As is generally the case in relation to Dear CRO (and CEO) letters, Ms Jackson was clear in her comments that firms with exposures in the sector who had not received the letter directly, should nonetheless take note of it.

In his speech, Mr Benjamin acknowledged that the majority of private equity demand globally is outside the UK. In Q&As following her speech, Ms Jackson talked about sharing information the PRA is collecting with home state regulators.  So, although the UK seems to be taking the lead on this, international banks should perhaps expect some scrutiny from regulators in other jurisdictions, including home state regulators: no national regulator is going to want to risk being accused of sleeping at the wheel if the identified risks were to crystalise.

Meantime, in an unusual public apparent divergence of views between the regulators, the FCA's CEO, Nikhil Rathi, was reported in the FT last week to be less concerned about this exposure risk.  However, reading between the lines, his point is perhaps more that regulators should avoid any kneejerk reactions on regulation and/or leverage limits before the relevant data is available and has been analysed.

The FCA is of course separately but relatedly looking at private asset valuation practices. As well as transparency, senior management accountability and governance are themes at the centre of this thematic work.  In a letter to CEOs of Asset Management firms in March, the FCA said it was conducting 'a multi-firm review examining valuation practices for private assets, including examining the personal accountabilities for valuation practices in firms, governance of valuation committees, the information reported to boards about valuations and the oversight by relevant boards of those practices'.

Although addressed to CROs, the PRA's letter also emphasises the role of wider senior management: 'Boards must be fully involved in overseeing the firm-wide strategy and combined business initiatives relating to the PE sector and be properly informed of aggregate exposure trends in associated credit and counterparty risks. Boards should consider and satisfy themselves of the scale and composition of such exposures within the context of the overall risk profile of the bank. They should also take measures that ensure they are able to take a consolidated view of their exposures to other important business segments and any associated counterparty and credit risk concentrations. This expectation is in line with previous communications, for instance following our review of the failure of Archegos.'

Firms have until 30 August to respond to the PRA's Dear CRO letter.

^[1] Executive Director, Financial Stability Strategy and Risk, Bank of England

^[2] Executive Director, Authorisations, Regulatory Technology and International Supervision (ARTIS), Prudential Regulation Authority