(2b) Financial regulation and private equity
Along the ‘finance-innovation-policy nexus’, policy measures directly targeted at institutional investors generate second-tier effects that influence the relationship between institutional investors and PE firms. The consequences of financial regulations implemented as a reaction to the financial crisis of 2008 at the second tier became apparent from the reaction of financial market participants interviewed. US investors argue that the undifferentiated approach in which risk is attributed to alternative asset classes within the regulatory framework does not adequately capture actual risk. According to VC/PE investors “a lot of government policy which has rightly been driving risk out of banking doesn’t work out favorably in terms of the supply of venture capital” (GER15 - Venture Capital Investor).
Countries that exhibit a less developed institutional investor base, are perceived by investors to be affected more severely by a loss of anchor investors, which traditionally facilitated further fundraising for PE firms. According investors, the loss of state-owned banks in Germany, as limited partners for PE created significant challenges due to the lack of local pension funds and endowments that typically fund a large part of the total PE investments. In addition, large parts of institutional investor funds are concentrated in a relatively small number of increasingly large PE firms. Institutional investors stress their need for efficient capital allocation with less partners and therefore lower transaction costs. This is furthermore accelerated by the demand to allocate funds at the PE firms that fall in the top return quartile. A less diversified institutional investor base also creates challenges for smaller PE funds in attracting attention from fund investors. Traditionally, fund-of-funds have addressed this segment of the market but as an additional financial intermediary between institutional investors and PE funds, they are equally affected by the same regulatory frameworks. “[Fund-of-funds] add an extra fee layer [... / and] because they spread the money widely your returns will be fairly average” (GER15 - Venture Capital Investor). Particularly in the German market, investors see some unfavorable regulations, namely at the fund level, that impact the size of growth in capital markets. They often mention, the inability to transfer a loss carry-forward in case of a change in ownership hinders investments in R&D in young companies and hinders the typical VC investment model in Germany.