Private Equity Fees and Regulations: An Overview

The history of the private equity industry reveals that the PE funds had minimal regulatory laws. The main reason one can attribute for this could be that the high-net-worth individuals were sustaining the losses in adverse conditions. However, when investment capital started to come to form other resources such as pension funds and endowments, and the aftermath of the 2008 financial crisis, the PE investments came under the scrutiny of the government.

Let us understand the management fees collected by the PE firms and the regulations imposed by the government here.

Private equity management fees

The private equity giants have increased their earnings from fees. Blackstone may exceed USD 3 billion in fee-related earnings in 2021, while KKR witnessed the biggest jump. It may see USD 1.5 billion, as per estimates of Q4, Pitchbook reports

If the duration of the assets is longer, then the management fees are more!

What are these management fees in private equity markets all about?

PE firms are looking forward to expanding their assets in domains where they can have a steady stream of management fees. Management fees are fees given to a money manager for choosing investments that prove to be profitable or non-profitable to the company. Also, the general partners collect performance fees known as carried interest. The management fee is 1.5 to 2 percent of the committed capital whereas the carried interest will be 20 percent. The management fees get utilized for salaries of the investment staff, due diligence expenses, and monitoring of the portfolio company.

For instance, when an investor invests in a mutual fund, the investor sends the investment amount. Then, the investor will send the charged expenses and an annual management fee. The management fee is expressed as the stated percentage of the market value.

A USD 1 billion funds charging a 2 percent management fee will result in earning of USD 20 million per annum regardless of profit or loss for investors.

Private equity regulations

As we all know, the primary sources of funding in the US include public pension funds, funds-of-funds, wealth funds, corporate pension funds, insurance companies, wealth managers, high net worth individuals, endowments, and family offices.

Prior to Dodd-Frank Act, it was reported that the PE firms passed in fees to clients without their knowledge. It is reported that the PE firms in the US maintained lesser transparency and the funds were excluded from being registered with the Securities and Exchange Commission and meet the reporting requirements.

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act addressed the problems that might have contributed to the great recession -the financial crisis of 2008. It brought transparency and highlighted that the private equity industry must improve its disclosure. According to the act, the private equity firms with more than USD 150 million will register as investment advisers with the Securities and Exchange Commission (SEC). The information of size, services, investors, employees, services offered, and conflicts of interest should get reported.

The private equity firms operating outside the US are subject to additional regulatory demands by the European Union and other regulatory bodies at the national level. There exist exemptions for venture capital fund sponsors and PE funds sponsor with less than USD 150 million in assets under management. However, they too have a reduced filing obligation with the SEC.

If a PE fund trades or holds a commodity interest contract, the sponsor will be deemed as the commodity pool operator and the advisor as to the commodity trading advisor. They must get registered with the US Commodity Futures Trading Commission (CFTC). Also, they should be the member of the National Futures Association.

To conclude, all these regulations have brought the PE industry operations under scrutiny.