‘Regulatory arbitrage’ threatens private markets if SEC does not keep pace

Differing ESG disclosure requirements governing public and private companies creates the risk of “regulatory arbitrage” for asset managers seeking havens from US regulators.

“If there’s more requirements imposed on public companies related to climate and human capital disclosures, [companies] may feel incentivised to be taken private to try to evade that additional level of scrutiny,” Andrew Park, senior policy analyst at the advocacy group Americans for Financial Reform, said during a private markets webinar this week.

The Predistribution Initiative, a US-based non-profit organisation seeking to create a more equitable global financial industry, hosted the virtual discussion, which covered recent and upcoming rules proposals from the US Securities and Exchange Commission.

During the webinar, Park warned that “asymmetric information” requirements for public and private companies creates a disclosure loophole that asset managers may use to their advantage. “As we see more requirements being placed on public companies,” Park said, “we want to see a level playing field so there isn’t a regulatory arbitrage between public and private companies.”

In January, the SEC unveiled proposals to “enhance” reporting requirements for private markets funds. The regulatory agency is expected to release new proposals next Monday, aimed at increasing climate-related disclosures for public companies.

According to Delilah Rothenberg, The Predistribution Initiative’s executive director, regulatory loopholes do not stop at environmental reporting.

“Inequality is growing at a systemic level,” Rothenberg said. “If portfolio companies are burdened with too much debt, will they be in a position to offer quality jobs and affordable goods and services?”

She added: “Is extracting value from companies taking away from the company’s ability to operate and serve its corporate purpose… is fund manager compensation growing at an exponentially faster rate than for workers of portfolio companies and beneficiaries of the LPs?”

Marieke Beeuwkes Spence, executive director of Impact Capital Managers, an industry network representing impact investors, said her organisation is in “absolute alignment” with the need to increase transparency in private markets. But a “cautionary approach” is needed to ensure new regulatory rules do not hurt GPs already trying to establish industry best practices.

“We feel that some of the proposed rules feel heavy-handed and may actually have an adverse [effect] on impact fund managers,” Spence said. “We would love to be thinking more expansively about how we can disincentivise bad actors and behaviours but incentivise and encourage the formation of authentic impact fund management.”

The downstream effects of any new regulatory rules must be factored into the “burden equation” LPs must consider when committing to asset managers,” said Jennifer Choi, managing director for industry affairs at the Institutional Limited Partners Association.

“We have to be cognisant of the fact that there will be some sort of cost created by these proposals, should they become rules,” Choi said. “Even though the rules proposals stipulate those costs would not be passed on to LPs, we know that this is an incredibly creative industry.”