Private equity firms would have to register their funds, and provide additional disclosures. Carried interest would be taxed as ordinary income. U.S. banks would be required to divest private equity holdings, while European institutions would effectively be banned from serving as limited partners in North American or Asian funds.
It was almost as if regulators had discovered a speck of residual shine on private equity’s Golden Age, and were determined to dull it down.
But a funny thing happened on the way to the reckoning: Many of the proposed changes — including some that many PE pros have accepted as fait accompli — are being watered down, postponed or abandoned.
Take the situation in Europe, for example. We wrote last week about how EU regulators were reconciling a pair of directives that could severely limit the ability of European institutions to invest in private equity or hedge funds domiciled outside of the EU. The proposals also included possible leverage and compensation caps, plus loads of new disclosure mandates (including one that would require “taken-private” companies to continue providing public financial reports for two years).
European regulators had given themselves until the end of this month to reach agreement, but Reuters reports this morning that the talks have “collapsed.” Now, the next-earliest vote will come in September, although there is no indication of serious movement on the key issues of contention (including a so-called passport, which would allow a PE firm to gain access to all EU institutions by satisfying the regulatory requirements of a single EU member).
Back here at home, things are no more certain. The much-discussed change to carried interest tax treatment is tied up in a so-called Job Extenders bill that appears to be on “death’s door.” Even if it were to somehow be revived, Congress long ago gave up the ghost of treating carried interest as ordinary income — instead proposing a hybrid structure in which some carried interest would continue to be treated as capital gains (still waiting for an elected official to explain that concession as anything other than an attempt at political expediency).
And then there are the PE-specific provisions included in the larger financial reform package, which is in the midst of its “final, frantic hours.”
This is the bill that contains the so-called Volcker Rule, which originally would have prevented U.S. banks from either sponsoring in-house private equity funds or from investing their own capital in third-party funds. As of last check, it appears that Wall Street has secured some softening on that last point, winning an argument about how investing alongside their clients makes for a better alignment of interests. We’re also expecting some clarification on the first point, but it’s likely to be more of a how-to guide to divestiture, rather than a divestiture exemption.
Finally, there is the registration issue. Private equity funds with more than $150 million in committed capital will be required to register, although the costs will be relatively low if a fund is that large. Venture capital funds, on the other hand, have been completely excluded (even those with $1 billion+). Still no official word on how “private equity” or “venture capital” will be defined, except that the SEC will tell us later. In other words, this isn’t going into effect any time soon.
Look, it’s possible that the winds of change will boomerang in the upcoming days, weeks or months. Europe could get its misguided act together, a tough Volcker Rule could be passed and the Job Extenders bill could be saved (or perhaps carried interest taxation finds its way into other legislation). But, as of this moment, private equity is beaming with unexpected optimism.