The Australian Private Equity and Venture Capital Association (AVCAL) recently launched its Code of Private Equity Governance (Governance Code). This represents an important initiative by Australia’s private equity industry body as AVCAL Chief Executive Katherine Woodthorpe said: “Formalising good governance practices by introducing the governance code means that we hold our industry up to high standards”.
We expect that for many PE fund managers, the Governance Code will mainly codify what is happening today in their business and governance practices. But its benefit could be greater visibility in what those governance practices are on a daily basis leading to an overall lifting in governance standards across the industry.
The Governance Code has been released with the twin objectives of making activities of Australia’s PE sector better understood and helping PE fund managers discharge their duties to their stakeholders, including investors, regulators and employees of the PE fund’s portfolio companies.
The Federal Government supported the launch of the Governance Code with Assistant Treasurer and Minister for Financial Services and Superannuation, Bill Shorten saying “I congratulate AVCAL on developing a code of private equity governance. Corporate governance is particularly important for private equity general partners given that active role in the management at the entities they invest in. As a growing and dynamic of Australia’s financial services industry, I am keen to see private equity continue to improve Australia’s overall productivity and strengthen Australia as a financial services centre.”
What does the Code say?
The Governance Code is a set of 7 principles that focus on governance of a PE fund manager’s activities. Those activities comprise two distinct areas:
- governance in managing the relationship with the PE fund’s investors and the arrangements around investment of their money; and
- governance arrangements for the portfolio companies that the PE fund invest in, having regard to the broad group of stakeholders that exist at the portfolio company level - akin to the stakeholder community that directors generally have regard to when they are a director of a company.
The 7 principles are:
- Principle 1 - promote and safeguard the interests of the fund’s investors, recognising the diverse nature of those interests;
- Principle 2 - embed ethical, responsible and rigorous decision-making by general partners and portfolio company boards and management;
- Principle 3 - promote effective portfolio company board composition and structures;
- Principle 4 - respect the interests of stakeholders at both fund and portfolio company levels;
- Principle 5 - ensure the integrity and utility of reporting by portfolio companies to general partners, limited partners and other stakeholders (private disclosure);
- Principle 6 - be transparent in dealings with other key stakeholders in portfolio companies (public disclosure); and
- Principle 7 - align financial reward with financial performance.
Against each of the principles, there is background commentary and guidance, albeit framed at a less detailed level when compared to the ASX Corporate Governance Principles and Recommendations. This is unsurprising given the diverse nature in size, scope and development of businesses in which the broad private equity industry invest - from extremely small, start up businesses where seed capital is invested up to multi-billion dollar companies at the larger buyout end of the market. Even more so when compared to listed companies, it is hard to have a governance code that applies to everyone in the PE sector yet describes in detail how each participant must behave in its own business and circumstances.
Who must comply?
AVCAL requires its members to adopt and implement the Governance Code in conjunction with the AVCAL Code of Conduct. AVCAL has set compliance to start from 1 July 2012.
The Code is intentionally a series of guidelines rather than prescriptive rules, following the recent governance initiatives around the world. As indicated above, it does draw significantly on the structure and framework adopted by the ASX Corporate Governance Principles and Recommendations, including the requirement to explain non-compliance on an “if not, why not” basis. This means it is not essential that every principle of the Governance Code is complied with but where it is not, it is incumbent on the PE fund manager to explain why that is not appropriate for its activities.
Relevantly, the Code suggests that PE Fund investors could insist PE fund managers adopt the Governance Code by incorporating compliance with it into the fund documentation and requiring them to publicise (for example on using their website) the approach they have adopted in implementing the Governance Code.
What impact will the Code have?
In some ways, that’s the question on every one’s lips. Initial reaction has been mixed as to its effect. Some commentators say they do not believe it will increase the amount private equity investment itself. In our view that is unlikely to be the real aim of the Governance Code. It should instead be seen as one of a number of initiatives being pursued by AVCAL to assist the PE industry in:
- educating and informing the public, media, government and investors as to how the PE equity industry operates; and
- implementing and adhering to high standards that build on and enhance the public reputation of and trust in the PE industry.
How PE fund managers respond to the Governance Code will be watched with scrutiny. The “private” in the industry’s name “private equity” is relevant here. When ASX listed companies disclose in their annual report how they have complied with the ASX Corporate Governance Principles and remuneration policies, they do so publicly to their shareholders and the market generally. A challenge for the PE equity industry when seeking to educate the wider community about what it does and its value, is that this principal “reporting” channel is on a private basis to its PE fund’s investors. There is no reason though why PE Fund managers wouldn’t seek to give detail on how they comply with the guidance code on their website so it is publicly available - we can see many positives around openness and transparency that would favour going down that route. Time will tell as to whether PE fund managers share that view.
Overall, we believe the Governance Code is a good step for the PE industry and AVCAL . The test is how the industry implements it and whether that will lead to a greater understanding and less cynicism about the “barbarians of the gate” portrayal of PE fund managers. Certainly a greater understanding that private equity industry its helpful for all of us - we are all investors in private equity through our super fund whether we like it or not (and whether we even knew it or not!)