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The European Commission (EC) wants to impose new legislation on the private equity industry, writes Paul Osborne, head of corporate at City law firm Fox Williams.

Its proposals would, if enacted, put an additional burden on both funds and the companies in which they invest. They have been greeted with dismay in the City, but what would they mean for the industry?

The central notion is that fund managers should be subject to ‘harmonised’ governance standards across the EU, with robust systems put in place to manage risk, liquidity and conflicts of interest. The rules would apply to private equity funds with more than €100 million (£90 million) invested, though this threshold would be increased to €500 million for funds which do not use leverage and lock in their investors for a minimum of five years.

There would also be an increased regulatory burden on investee companies. The details are not yet clear, but it is probable that greater transparency would be required from companies, perhaps something more akin to public company-style reporting. The cost of compliance is likely to be significant.

The fear is that the directive, which is aimed at all ‘alternative investment fund managers’ including hedge funds, is an over-reaction to recent turmoil in the financial markets. Rather than stabilising the industry, critics say, it could lead to an exodus of private equity from the EU, both in terms of head office domicile and geographic investment strategies.

'The theory behind the proposals is fundamentally wrong'

Stuart Nicol is a director at Octopus Investments, which has more than €250 million of unquoted funds under management. He says, ‘The theory on which the proposals are based is fundamentally wrong. Private equity is a champion of good corporate governance. Companies in which private equity funds invest will nearly always be required to meet the most stringent corporate governance standards for that size of company.

‘Due to the disclosure requirements this regulation will put many private equity portfolio companies at a disadvantage to both their public and private competitors.’

Another powerful argument against additional regulation is that the EC itself has acknowledged that private equity funds do not pose a systemic risk. That begs the question of whether this is a politically motivated step. With 57 per cent of EU-based private equity and hedge funds domiciled in the UK, there is a concern that other European countries may be more prone to play politics rather than listen to considered business argument.

Lord Mandelson, the business secretary, has said Britain will fight to prevent over-regulation of its financial industry. Though it may be impossible to avoid additional legislation altogether, its scope and the timetable for its implementation may depend on careful government diplomacy and the efforts of industry champions putting their case to Brussels.