A private equity accountability gap

Much advocacy on corporate accountability and responsible finance focuses on the public markets. But we are missing a big piece of the picture – the rapid expansion and influence of private markets, which often operate behind closed doors and with little oversight.

The following note provides food for thought and is a conversation-starter. It touches on the scale of private equity (as one segment of the private markets), its importance for advocacy on climate change, human and workers’ rights, and potential next steps for advocacy.

The scale

Private equity (PE) plays a rapidly growing role in the global financial system. As an expert on the financial industry put it in 2020, private equity is “a beast we are going to encounter with increasing regularity”.

Globally, private markets increased 8-fold between 2000 and 2018, from $700 billion in assets to 5.8 trillion. While some PE investors have been affected by COVID-19 downturns just like other investment streams, it is at moments of crisis like this that private equity will also seek to expand its reach. In fact as the Economist has highlighted, private equity is “due a growth spurt“:

“A year ago [in April 2020] Blackstone, a PE giant, reported a first-quarter loss of more than $1bn. A reckoning seemed overdue. Widespread defaults on over-borrowed PE-owned businesses were expected. A year on, Blackstone has reported record profits of $1.75bn. So much for comeuppance.” Economist, May 2021

Private equity is influential in all regions. For example Asia Pacific’s share of global PE is now 26%. In Africa, PE has traditionally been a key partner of development finance institutions – about 10% of the money raised by private equity funds for investment in Africa comes from the UK’s development finance institution. In the US, PE controls twice as many companies as are publicly traded.

Leverage points

From labor rights to the climate crisis, private equity can and should be an important target for advocacy.

There is an opportunity for follow-the-money and joint campaign strategies targeted towards governments as regulators, private equity entities themselves (some of which are becoming more reputation-conscious), as well as towards the banks that negotiate private equity debt, and the pension funds and other institutional investors that invest into private equity as Limited Partners (LPs).

There is a tension here – a pension fund will look to maximize the returns from its investments and is legally bound to do so – but institutional investors are increasingly sensitive to the longer term implications of their investments for climate change and inequality. As Institutional Investor has put it: “Given the size of the largest LPs, one could imagine a like-minded group of fewer than ten asset owners having the ability to influence the entire PE asset class”.

Examples: human rights, labor rights, and the climate crisis

PE plays different roles in different contexts; oftentimes positive, for example by spurring innovation and giving a boost to failing companies. However the industry’s overall focus on maximizing short-term financial returns exacerbates the risk of harm to workers, local communities, and the environment. A few illustrative examples:

Climate: Early stage investments through venture capital and private equity will play a growing role in technological innovation as governments advance zero carbon policies; while a) these investors may pay limited if any attention to the human rights dimensions of those investments and b) they will often continue investing in fossil fuels at the same time, and buy up fossil fuel assets divested by public companies. A recent survey of LPs found that they themselves believe PE firms are not doing enough on climate.

Workers: A frequently-cited example from the United States is Toys R US, which went bankrupt after being taken over by three private equity firms, leading to around 30,000 workers losing their jobs. Campaigners won the creation of a severance fund into which KKR and Bain Capital each paid $10 million – demonstrating that campaigns directly targeting PE can have an impact, albeit retroactive in this case (the third owner, Vornado, did not contribute). Toys R Us creditors have also sued the PE firms, saying that their executives took out millions of dollars to benefit themselves prior to bankruptcy.

Housing: Private equity firms such as Blackstone have become major landlords in North America, Europe, Asia, and Latin America (indeed real estate is the sector with the highest proportion of PE investments, followed by energy and utilities as the above infographic shows). UN mandate-holders and others have highlighted how the industry’s approach has undermined the right to adequate housing.

The need for action

Testimony by Americans for Financial Reform has summarized the problematic nature of PE, as it currently operates:

“The business model followed by the dominant private equity firms today is fundamentally predatory and extractive. Current law permits and even encourages private equity firms to be structured in such a way that the general partners [are] rewarded for maximizing immediate returns to themselves, and shielded from liability, accountability, and transparency for the decisions they make.”

In addition PE – from leadership downwards – still has a major lack of gender and racial diversity.

The industry will make the case for the various ways that it supports the businesses it invests in and generates economic growth. Yet it is telling that an industry-facing piece itself highlighted the negative experience some PE-portfolio companies have experienced during the pandemic:

“Their top concern cited was financial controls—such as those placed on investments and expenses as well as a lack of capital infusion. It was followed by tighter talent policies, such as headcount reduction and reduced compensation, while excessive operational scrutiny ranked third.”

Meanwhile the PE industry itself is gradually paying attention to “ESG” (environmental, social, and governance considerations), with varying degrees according to region. The UN Principles on Responsible Investment has a growing focus area on private equity and human rights. And private equity approaches are often favored by impact investors. There is a risk that the industry will self-define what its responsibilities are, and how well it is doing against them, without enough countervailing scrutiny and pressure from civil society. There is a need to fill gaps in terms of transparency and accountability – including regulatory reform (such as strengthening legal liabilities for general partners) – and to identify opportunities for joint-campaigns across issue areas focused on specific PE firms and their LPs.

For more on these issues – see Predistribution Initiative’s 2021 report “ESG 2.0: Managing and Measuring Investor Risks Beyond the Enterprise Model” (with good industry insights into business-model challenges with private equity and what can be done), and [June 2021 UPDATE] Empower’s freely available book for advocates, “Runaway Train: The Perilous and Pernicious Path of Private Capital Worldwide.