Regulation of private equity

Heed, Andreas
December 2010
Journal of Banking Regulation;Dec2010, Vol. 12 Issue 1, p24
Academic Journal
Private equity refers to highly leveraged merger and acquisition activity aimed at alternative assets with the involvement of specialised management assistance. The beneficial elements of private equity include the creation of job opportunities and contribution to economic growth. The fact that investments are made in alternative assets makes the market somewhat opaque to outsiders, and the lack of standardised methodologies for disclosure and performance reporting limits the availability of a lender to monitor the credit quality of a borrower. The major area of (regulatory) concern in private equity relates to the use of leveraged finance. Increase in the availability of debt capital and the emergence of new funding techniques led to a private equity boom in the beginning of the 2000s, with a resulting magnification in transaction frequency and value. In addition, multiples rose, transaction structures were extended and covenants weakened. These new properties of the private equity market raised concerns about the risks associated with the provision of leveraged finance by various financial institutions. Providers of leveraged finance are now subjected to distinctive risks that in the case of realisation may have implications on financial stability. The fact that the private equity market demonstrates similarities to the US sub-prime the mortgage market has raised further concerns about systemic risk present in the sector. This article asks the question if the inherent features of private equity provide for risks that can result in systemic instability and thus create a rationale for regulation.


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