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EVCA chief: EU regulatory capital rules will sting
March 16, 2011

TheDeal Magazine

Private equity and venture capital firms on both sides of the Atlantic face a massive fundraising hurdle from new regulatory capital rules for insurers and pension fund managers, the head of the European Private Equity and Venture Capital Association warned Thursday, March 10.

These investors have traditionally provided 70% of all commitments to private equity and venture capital in Europe, either directly or through other managers, but that could halve in the face of European rules intended to ensure financial stability in the wake of the banking crisis.

Speaking on the sidelines of the EVCA Investors Forum in Geneva, the association's chairwoman, Uli Fricke, said insurers have already begun reassessing their commitments to the industry, after the European Union agreed a new Solvency Directive for insurers last year.

The "Solvency II" rules stipulate a 49% regulatory capital requirement for every euro invested in a venture capital or private equity fund, which will either force insurers to put aside additional cash to cover their investments, reduce their allocation to the asset class or withdraw from investing in private equity and venture capital altogether.

Because the directive applies to investors, rather than managers, even the biggest U.S. funds are concerned. A firm could be based in New York, registered offshore and keep all its investments in the U.S., but if its limited partners are based in Europe the regulatory capital requirement will apply.

"It's a huge issue," said the managing director of one U.S. private equity fund, who preferred not to be named. "We'll have to see what effect it has on fundraising."

A U.K. placement agent pointed out that even the likes of BC Partners Ltd., the British buyout shop that made a first close of a new fund this week at a better-than-expected €4 billion ($5.5 billion), might already have seen falling demand from insurers.

"We don't even know if there was a different balance between insurers, sovereign wealth funds or other investors," she said.

Pension funds fear similar curbs may be introduced for their investments in alternative assets, in part because the insurance industry wants to ensure a level playing field. In some European countries with big state-pension sectors it is the insurance companies that manage virtually all private assets, while in others, big private pension funds play a similar role.

A revised pensions funds directive is still only in the early stages of negotiation, but experts watching the negotiations with the European Union institutions in Brussels believe the insurance requirements may be repeated wholesale for the pensions industry. The European Commission will review the pensions fund directive in the third quarter.

Fricke said work by the association had helped persuade the EU that insurers who have their own dedicated risk assessment systems for private equity and venture capital investment may set aside reduced amounts of regulatory capital to match that risk, but only the biggest and most sophisticated insurers have that capacity at the moment.

"It's a big challenge," she said. "The vast majority of insurers are medium-sized, and we realize they will need support ... in getting the appropriate tools in place."

Fricke, who is also the managing director of German firm Triangle Venture Capital Group, gave the example of one German insurer she had spoken to who had dropped plans to raise his allocation to the asset class from 2% to 5%. She said setting aside 49% of his assets under private equity management under the new rules would have eaten up all his equity.

EVCA officials concede that while the EU is still working on the final implementing guidelines before the insurance directive comes into force in January 2013, the overall regulation will not change.

Fricke said her organization has been working hard over the past year to produce guidelines. The group is developing the guidelines together with insurers and academics as well as limited partners to ensure the system will work. Once they are approved in the summer and the European implementing rules are clear, EVCA will start what she called "a significant outreach program" to insurers to help them work with the new regime.

How will that approach affect insurers' intentions? That has yet to be seen.