Private equity deals

In the aftermath of the insolvency of 2007 and 2008, supervisors harshened regulations in terms of capital requirements. If previous version of the Basel Framework proposed specific rules with reference to “investment in private equity and venture capital” in art. 80 of Part 2, this article totally changed in Basel III when that section was completely revised. In the new version, this article mentions “Equity investments in funds” and allegedly it should include investment in VBCs as the investment in venture capital or private equity occurs typically via a fund . However, the new format initiated an ongoing debate between Invest Europe, the European Association of Private Equity and Venture Capital, and the Basel Committee.According to the new version of the article, equity investments in funds must be treated in a manner consistent with one or more of the following three approaches, which vary in their risk sensitivity and conservatism: the “look-through approach” (LTA), the “mandate-based approach” (MBA), and the “fall-back approach” (FBA) . The LTA, like the name itself suggests, requires a bank to risk-weight the underlying exposures of a fund as if the exposures were held directly by the bank. This is the most granular and risk-sensitive approach. It must be used when: • there is sufficient and frequent information provided to the bank regarding the underlying exposures of the fund and • such information is verified by an independent third party. To satisfy the first condition above, the frequency of financial reporting of the fund must be the same as, or more frequent than, that of the bank’s and the granularity of the financial information must be sufficient to calculate the corresponding risk weights. To satisfy the second condition above, there must be verification of the underlying exposures by an independent third party, such as the depository or the custodian bank or, where applicable, the management company. Under the LTA banks must risk weight all underlying exposures of the fund as if those exposures were directly held. So the same applies, theoretically, for private equity investments, that are typically participated via funds. According to the LTA, the percentage that could be set aside, could correspond to 150%. The second approach, the MBA, provides a method for calculating regulatory capital that can be used when the conditions for applying the LTA are not met and information is not available. In this case, banks may use the information contained in a fund's mandate or in the national regulations governing such investment funds. Where neither the LTA nor the MBA is feasible, banks are required to apply the FBA. The FBA applies a 1250% risk weight to the bank’s equity investment in the fund. Despite it may be inferred that private equity investments are grouped in the equity investments via funds, in an issue of December 2017, the Basel Committee describes that banks must assign a risk weight of 400% to “speculative unlisted equity exposures” and a risk weight of 250% to all other equity holdings. This issue describes “speculative unlisted equity exposures” as the investments with short-term perspective or with resale purposes or that are considered venture capital or similar, and that are acquired in anticipation of significant future capital gains . On the one hand, bodies like Invest Europe dread that such high-risk weights may discourage banks in supporting the private equity deals as direct investors.