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The UK financial watchdog plans to probe whether there are conflicts of interest at managers of private equity and credit funds, shining a spotlight on to one of the fastest-growing and opaque activities in the City of London.
The Financial Conduct Authority said in a “Dear CEO” letter to asset management companies that it was concerned investors could be suffering from “poorly managed conflicts of interest” at managers of private assets.
“This year, we will start a multi-firm review focusing on conflicts of interest at firms managing private assets,” the regulator said. “Conflicts may increase where firms operate multiple intersecting business lines, continuation funds, co-investment opportunities or partner with other financial institutions,” it added.
Rapid growth in private equity and credit funds in recent years has attracted many of the largest asset managers and banks to expand into the area through acquisitions, partnerships and strategic shifts, as they seek to earn higher fees than they do on equity or bond funds.
As the private asset sector has grown, it has spawned greater complexity including co-investment by strategic investors, partnerships with banks or asset managers and continuation funds to pass assets from one set of investors to another.
There have also been concerns that because private assets do not trade daily on public markets there is greater potential for fund managers to value them in a way that benefits them at the expense of some investors.
Dear CEO letters are relatively rare and flag areas of particular concern to the regulator. Sector-wide reviews can lead to additional supervision, and even enforcement, against firms deemed to not have sufficient controls.
The FCA said it was close to releasing the results of an earlier probe into private market valuation practices, adding: “Firms should consider the report’s findings to ensure their valuation processes are robust, with a strong governance framework and audit trail.”
Listing private markets as its top priority in supervision of the asset management and alternative funds sector, the regulator said: “With rapid growth in private markets, we expect to see evolving and updated procedures to identify, manage and mitigate conflicts of interest.”
“We will assess how firms oversee application of their conflict-of-interest framework through governance bodies and reviews by the three lines of defence, to ensure investor outcomes are not compromised,” it added.
Continuation funds, one of the financial tools the regulator mentioned in its letter, allow private capital firms to transfer assets they own via one fund they manage to another.
The mechanism poses potential conflicts, leaving investors in either the old or new fund to lose out — although the processes usually involve a new investor to anchor the price.
Last year there were $62bn worth of transactions involving continuation funds globally, up from $43bn in 2023, according to a recent report by advisory firm Campbell Lutyens.
The watchdog’s move to shine the spotlight on the private asset market comes despite growing pressure from Sir Keir Starmer’s government for regulators to reduce the burden of bureaucracy on business and do more to support the UK’s stuttering economy.
The FCA’s letter also said it planned to “streamline” reporting requirements for many private asset managers as part of a review of the alternative investment fund managers regulations.
However, FCA executive director Sarah Pritchard said this week that the review was likely to include “some targeted changes” to the data it collected from private asset fund managers to find out more about their use of leverage.
