Private Equity (2/2)

In the discussion paper, FSA seeks to address this question: "What's the appropriate level and form of regulatory engagement with the private equity sector"? Too much regulation could be detrimental to capital market efficiency but too little regulation could damage market confidence. The paper sets out an initial risk analysis based on historical industry views and recent regulatory assessments.

Key risks identified by FSA are summarized below:

• Excessive leverage - If lending on private equity transactions is not prudent, the default risk may substantially affect the financial stability.
• Unclear ownership of economic risk - The risk transfer practices (e.g. use of credit derivatives) may create operational problems in credit events.
• Reduction in overall capital market efficiency - The quality, size and depth of the public markets may be damaged by the expansion of the private equity market.
• Market abuse - The significant flow of price sensitive information in relation to private equity transactions may create a high potential of market abuse.
• Conflicts of interest - Material conflicts arise in private equity fund management between the fund manager and the investors.
• Market access constraints - Private equity funds lack liquidity as they are not available to retail investors by listing.
• Market opacity - Performance assessment of private equity is less transparent.

UK FSA is reviewing the regulatory framework governing private equity, but HK SFC remains silent. Under HK's regime, private equity transactions are not considered as "dealing in securities" as the shares are not transferable. While private equity funds are securities, it is unlikely SFC would authorize them for public marketing. So currently private equity funds are only sold to professional investors. Perhaps in forseeable future SFC may set up a new regulatory regime for private equity funds, just like what it did previously for hedge funds.