Take the practice by buyout shops of securing bridge financing from banks on new deals as a temporary measure until permanent financing can be put in place.
“When market conditions suddenly turn, these [banks] can be left holding this potentially risky bridge financing (or committed to provide the final bank financing, but no longer able to syndicate or securitize it and thus forced to hold it) at precisely the time when credit market conditions…have worsened,” the SEC writes in a proposal published late last month to require registered buyout shops and hedge funds to regularly fill out so-called Form PFs. The forms would be used by the newly-created Financial Stability Oversight Council to monitor risks to the U.S. financial markets.
Additional systemic risks buyout shops could potentially pose to the financial system, according to the SEC:
• The leverage that buyout shops use to acquire targets “subjects those portfolio companies to greater risk in the event of economic stress,” the SEC stated, citing “industry observers.”
• A buyout shop could potentially acquire a bank, insurance company or other firm that also represents a systemic risk to the economy.
The SEC, which appears sympathetic to arguments that private equity firms pose less systemic risk to the economy than hedge funds–that they may even pose no threat at all–can expect to get an earful from buyout shops in their comments on the proposed Form PF.
In comments on a related SEC proposal last month (designed in part to clarify the definition of venture capital for the purposes of exempting them from registering with the SEC), several buyout shops argued that they presented little or no systemic risks to the economy. Peter C. Brockway, managing partner of Brockway Moran & Partners, went so far as to include a table in his letter describing six common risks and showing how they either don’t apply or only barely to private equity. As for counter-party risk, for example, Brockway wrote that “private equity funds have virtually no contingent obligations to others (such as unfunded revolvers, backstopping derivatives, or credit insurance.”
Under the Form PF proposal, buyout shops with $1 billion or more under management—the SEC estimates that about 250 U.S. firms fit the bill—would have to fill out the Form PF on a quarterly basis, providing information about leverage, use of bridge financing and investments in financial services firms. Registered firms smaller than that would have to provide less detailed information on their funds once a year. The information would be kept confidential.
The SEC has proposed introducing Form PF as part of its obligations to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act. It would apply to registered advisers to hedge funds, so-called liquidity funds and private equity funds; under Dodd-Frank, all private equity firms with more than $150 million in assets under management will be required to register as investment advisers with the SEC.