Private assets under the spotlight

June 2024

In recent years, European governments have been seeking to “democratise” private and illiquid assets to facilitate better their distribution to retail, insurance and pension investors. They have also been encouraging greater investment in certain private asset classes such as infrastructure to aid economic growth. In parallel, authorities are seeking to bolster public markets in the face of potential decline.

Historically, large companies have been mainly funded by banks or by going to the public markets, and the regulatory system has been built around this. But increasingly, companies are turning to private sources of funding. And asset managers are widening their product ranges to offer alternative strategies whilst investors seek to improve their returns.

As the private assets industry has grown and become more interconnected with the real economy, regulators are interested in potential risks to financial stability and investors' outcomes. Policy measures and supervisory action are therefore likely to drive greater regulatory oversight of the sector.

Following this introductory article, KPMG in the UK will explore in a series of articles how private asset managers and banks look set to be impacted by the industry's changing dynamics, regulators' priorities and interventions, and how firms can prepare and respond.

Industry trends

While specialist private asset managers are seeking to grow their assets under management (AUM), increasingly so-called mainstream asset managers are diversifying their product offerings into the private assets space to cater to companies and projects seeking investment, to meet investor demand for greater returns and diversification, and to increase margins in the face of higher costs. This includes launching new fund regulatory vehicles that have recently been made available or revised by regulators, such as the UK Long-Term Asset Fund and European Long-Term Investment Fund respectively.

Various authorities and regulators have recently emphasised the growth, and increasingly important role, of the private asset management industry. For example:

The Bank of England (BoE) estimates that the global private equity industry has grown from USD 2 trillion in 2013 to USD 8 trillion in 2023 and that the private credit market amounts to USD 2 trillion. In comparison, the BoE estimates that the public equity market is worth approximately USD 100 trillion.
The ECB estimates that in 2023, 81% of European leveraged buy-outs were financed by private credit, compared with 56% in 2021.

Companies have turned to private sources of equity funding as they may perceive it to be more straightforward and less time consuming than going public. The BoE estimates that £250 billion is now actively invested in UK companies via private equity.

There are also trends driving a growth in private credit. Some companies may see private credit funds as a safer "through the cycle" lender as opposed to banks which may scale back lending in certain sectors in the event of stress. Banks will find it more capital intensive to lend to certain companies due to incoming Basel 3.1 Risk Weighted Asset (RWA) requirements. And some larger, global banks are looking to their asset management businesses to generate more stable fee-based revenue than their traditional trading and investment banking businesses.

Regulatory drivers

A range of authorities and regulators are paying close attention to the growth of the private asset management industry.

The renewed regulatory interest in this area comes from the unprecedented growth of private finance, its increasing role in funding the real economy, and its increasing interconnectivity with regulated public markets.

Jean-Paul Servais,

IOSCO Board Chair and Chair of the Belgian Financial Services and Markets Authority

May 2023, Keynote address at the ICMA annual conference

Government authorities are keen to draw on private capital to help fund their economies' recovery and promote economic growth, contribute to efforts to modernise infrastructure, and to support the transition to a more sustainable economy.

Initiatives such as the UK Productive Finance Working Group have been established to bring together government, regulators and industry to work on solutions to barriers to investing in long-term illiquid assets. Supporting insurers' ability to contribute to UK growth, particularly through investment into UK infrastructure and transition to net zero, is also one of the objectives of the UK review of Solvency II.

Central banks, organised at global level under the Financial Stability Board, are concerned about the private asset management industry from a financial stability perspective.

Private asset funds are subject to some of the more general concerns that central banks have with the non-bank sector — particularly around liquidity management, leverage and increasing interconnectedness with the real economy. The European Commission has recently launched a consultation on macroprudential policies for the non-bank sector.

There are also specific concerns relating to private asset managers' role in replacing bank finance and their activities in the ongoing higher interest rate environment — for example, due to potentially higher default rates in the private credit market. As a result, the IMF has called for a “more intrusive” supervisory and regulatory approach to private credit funds. The IMF has also raised concerns about how well private equity funds' time horizons align with the long-term nature of life insurance business — this has been rising up the policy agenda given the growing number of PE-backed insurers.

Prudential regulators, such as the PRA in the UK, are particularly focused on the adequacy of individual banks' risk management frameworks related to the increasing scale, complexity, leveraged and interconnected financing of private assets-linked businesses — as illustrated by the PRA's recent “Dear CEO” letter to the banking industry.

The PRA is also ringing alarm bells about the migration of credit risk to PE-backed insurers in offshore jurisdictions, which can then be re-directed towards private, illiquid assets. It is concerned that UK life insurers — who are increasingly taking on pension risk via Bulk Purchase Annuity (BPA) transactions — may not have appropriate risk management in place, particularly in relation to the management of underlying collateral.

Securities regulators such as IOSCO, the FCA and ESMA are focused on firms' conduct and market integrity. IOSCO is continuing work started in 2023 to assess potential risks relating to conflicts of interest and valuation practices. On the latter, there are specific concerns around their subjectivity and stale prices that lag public markets.

Some of these themes are being picked up by national regulators — for example the FCA will build on its 2023 liquidity management review by launching a review later this year on valuation practices, focusing on governance, accountability, management information and oversight. There are also efforts to increase transparency of funds' holdings through new or expanded regulatory reporting — such as under AIFMD II in the EU.

Listing authorities are looking to streamline processes to improve the attractiveness of public listing. However, they are also considering new types of trading venue that will allow private companies to trade their securities in a regulated environment on an intermittent basis and allow investors more transparent and efficient way to invest in private markets. More broadly, there are efforts to facilitate the tokenisation of assets and wider financial services products.

This series

In this series, we will explore these themes in more detail, including the challenges and opportunities around launching new fund products, banks' management of private asset counterparty risk, developments in the capital markets and listing regimes, and the greater scrutiny and upcoming regulations that will impact private asset managers.

Contacts

KPMG in the UK has the depth of knowledge and experience to help your organisation effectively plan your strategy and regulatory arrangements so you can make the most of private asset opportunities whilst managing potential risks.