To the dismay of many fund managers across the private markets, a near-final version of the Securities and Exchange Commission’s impending fee disclosure rules is reportedly circulating around the agency, with a rule package expected as early as this month.
The new regulation for hedge funds, private equity shops, and VC firms would be the first meaningful regulatory change since the aftermath of the financial crisis—requiring funds to furnish things like quarterly fee and expense information to all of their limited partners and stop giving preferential treatment to certain investors via side letters. The regulation would also enhance fiduciary requirements funds have to their limited partners, among other things.
Since the new rules were proposed last year, private funds have filed plenty of disapproving comment letters, with Andreessen Horowitz arguing that this rulemaking would be a “radical departure” from the SEC’s current approach and a “sea change” that could stifle emerging managers. Fund representatives have been lobbying against the regulation in meetings with regulators. And Bloomberg reported earlier this week that the Managed Funds Association, a trade organization representing private funds and asset managers, told members that they are prepared to sue should the rule package not be watered down from the original 2022 proposal.
Meanwhile, limited partners—the ones behind the checks ultimately powering the $25 trillion private markets—say they are about to get back some of the negotiating power they’ve lost.
Let’s backtrack for a second. Over the past decade endowments, pensions, sovereign wealth funds, and nonprofits have furnished trillions of dollars into private funds. With that overabundance of capital, getting an allocation to an outperforming fund has gotten more competitive—and LPs have subsequently lost bargaining power in their negotiations for terms in LP agreements and side letters. Limited partners that push too hard on terms with side letters or limited partner agreements risk losing that hard-won allocation.
Here’s what the data shows: Only 8% of limited partners say they can successfully make favorable changes to their contracted terms due to negotiating leverage, according to research published earlier this year by the Institutional Limited Partners Association, a trade organization representing private equity LPs. And approximately 97% of limited partners report that the starting point for terms in limited partner agreements has shifted in favor of fund managers in recent years.
But with distributions so rare these days, we’ve interestingly been starting to see those power dynamics shift on their own. There are fewer exits freeing up capital, so fund managers are struggling to close the mega-funds they were able to close in 2020 and 2021. That gives LPs more bargaining power. Once the SEC furnishes its new rules, limited partners likely won’t have to negotiate for things like fee, expense, and performance disclosures at all—as many of them do now—and will be able to more easily compare fees across funds during the due diligence process. Though critics contest this will impose “staggering aggregate costs” on fund managers.
Mark DiSalvo, whose firm Sema4 specializes in taking over troubled funds at the behest of their limited partners when things go sour, says that, while fund managers don’t like change, he thinks they will ultimately grow to appreciate the new rules, as it will likely reduce potential contention between GPs and LPs. Most funds already make these disclosures available to their LPs anyway, he says: “[This] shouldn’t be troublesome to good actors.”
In his line of work, the major problems tend to stem from funds that aren’t disclosing this kind of information to their investors. He says that the vast majority of funds he has stepped into have had “no reporting or, at times, deliberate misreporting or misrepresentation of fees, among other expenses, that limited partners have been asked to bear,” DiSalvo says.
But as of now, don’t expect fund managers to get excited about a change.
Bringing chips back…Can the U.S. bring chip manufacturing back onshore? A new team at the Commerce Department—entirely comprised of private equity or venture capital investors, investment bankers, or other private market professionals—is trying to find out, according to a new feature from the Wall Street Journal on the small team of financiers responsible for allocating $39 billion in subsidies and incentives to hundreds of companies.
See you tomorrow,
Jessica Mathews
Twitter: @jessicakmathews
Email: jessica.mathews@fortune.com
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