Australian private equity – is more regulation on the way?

Relatively light-touch regulation of Australian private equity funds has given the sector a boost in recent years, but more compliance could be on the way.

Australia’s private equity industry continues to grow, despite headwinds such as a slowing global economy, geopolitical tensions and inflationary pressure both domestically and internationally. Firms in the country now hold around US$18bn of dry powder according to data from McKinsey, and continue to search for deployment opportunities, with public market transactions having been a particular area of focus during 2023.

One supportive factor in this growth story has been Australia’s relatively minimal regulation of the private equity sector. In addition to a stable political environment, high-quality corporate governance standards and a reputation for innovation, Australian policymakers have recognised that light-touch regulation of private equity can drive competitive advantage in financial services.

Indeed, while there have occasionally been calls for reform, the current approach remains hands-off. Compared to developed markets such as the European Union and the US, Australian private equity firms are less burdened by compliance.

Regulated by manager rather than fund

In part, this reflects the fact that in Australia, it’s the private equity fund manager that is regulated, rather than the fund itself. The managing entity of the fund – typically the firm running it – is required to hold an Australian financial services license from the Australian Securities and Investments Commission (ASIC) to deal in financial products and provide financial product advice.

Individual managers at private equity firms will not typically need their own licenses or regulatory authorisations. However, ASIC may take their experience and standing into account when considering applications from their firms for a license to do business.

At a fund level, no regulation currently applies. This is based on the principle that private equity funds are only open to “wholesale” investors, who need less regulatory protection than their counterparts. The definition of wholesale investor in Australia is broad, but includes criteria around net worth, financial sophistication and investment experience.

Overall, private equity firms in Australia have less compliance to worry about than their peers in other markets – and other types of investment entity in Australia itself. However, there are some signs that regulatory requirements are about to increase.

More compliance to come?

For example, depending on the investments they make, private equity funds may also have to consider regulation at the portfolio level in Australia. Not least, there is a growing body of regulation requiring Australian companies to increase monitoring and reporting in relation to environmental, social and governance (ESG) issues. On greenwashing, for example, the Australian Competition and Consumer Commission is currently seeking feedback on proposed guidance that clarifies obligations under Australian consumer law for businesses making environmental claims.

Complying locally

Australian private equity firms and funds that want to operate in international jurisdictions – when raising money or when making investments, for example – will also need to comply with local regulation in each case.

In the European Union, for example, the Alternative Investment Fund Manager Directive is likely to be relevant. In the US, new rules introduced earlier this year to increase transparency and augment investor protection have significantly increased the regulatory burden on private equity funds. More specifically, the SEC’s quarterly reporting rules will require private fund advisors to supply investors quarterly statements detailing all performance, fees, and expenses. They will also need to disclose how waivers, payments, rebates, offsets and expenses are calculated and explain the structure and method used to determine performance-based compensation such as the distribution waterfall.

The Canva effect

It is also the case that scrutiny of regulated investors’ holdings in private companies is increasing. The tumbling value of Australian technology unicorn Canva has prompted the Australian Prudential Regulation Authority to launch a review of the investments made in the company, with a particular focus on superannuation funds, amid concern that some were too slow to mark down the value of their holdings in Canva. Such controversy could prompt debate over whether private equity funds should also be reporting on portfolio businesses in more detail.

Indeed, the superannuation fund sector’s increasing appetite for private equity investment could focus more attention on the sector at a broader level. Australia’s largest superannuation fund, AustralianSuper, recently announced its allocation to private equity would roughly double to AU$50 billion within the next three to four years. And as pension fund savers’ exposure to private equity increases, albeit indirectly, there will be those who make the case for greater regulation.

For now at least, Australia’s private equity industry is able to operate with relative freedom. That puts the sector in a strong position to capitalise on new opportunities when – and if – economic headwinds ease.